Fred’s said to be looking for a buyer

Fred’s Inc., the regional discount chain that’s exploring a sale, has approached potential buyers including drugstores and private-equity firms as it seeks initial bids in about a month, people with knowledge of the matter said.

The company contacted possible suitors including CVS Caremark Corp., Walgreen Co. and Dollar General Corp. late last week, said one of the people, asking not to be identified because the process is private. Buyout firms including Miami- based H.I.G. Capital also were contacted, two people said.

Shares of the retailer rose $1.84, or 1.8 percent, to close Friday at $19.93, giving Fred’s a market value of about $733 million.

Fred’s appeal lies in its pharmacy business, said one of the people. Pharmacy customers, especially in rural areas where Fred’s stores are located, are extremely loyal, and the profit margins of the division could persuade a buyer to take on the lower-performing merchandise and grocery businesses, said Dutch Fox, a retail analyst at Friedman Billings Ramsey & Co.

“The crown jewel of Fred’s is its pharmacy business,” Fox said in an interview. “It’s incredibly difficult to cold start such a business.”

Fred’s, which operates more than 700 general merchandise stores in the Southeastern U.S., said in January that it hired Bank of AmericaCorp. and Peter J. Solomon Co. to explore strategic options and enhance shareholder value after Christmas-season sales disappointed.

Spokesmen at CVS, Walgreen and Dollar General declined to comment, as did Jerry Shore, chief financial officer of Fred’s. Tony Tamer, a co-founder and managing partner at H.I.G., didn’t reply to an email seeking comment.

Memphis-based Fred’s could fetch $19 to $24 a share in a sale, according to estimates by MKM Partners LLC and FBR.

The high end of that range is 33 percent more than Fred’s closing price Thursday of $18.09 and would value the company at $883 million.

The premium would be driven by the value of Fred’s pharmacy division, which could fetch a multiple of as much as 0.6 times sales compared with closer to 0.3 times sales for the remaining businesses, Fox wrote in a Jan. 10 note.

Pharmacy revenue accounted for more than 40 percent of total sales of $461 million in the third quarter, and grew 8 percent from the previous year, compared with a 2.2 percent increase in total sales, the company said in November.

The discount-store business is “basically a breakeven business attached to a pharmacy business,” Fox said.

Low profit margins are a major concern for potential buyers, said the people familiar with the situation. Fred’s margins on earnings before interest, taxes, depreciation and amortization were about 4.3 percent in the year through November, data compiled by Bloomberg show. CVS’ margins were about 7.8 percent last year on that basis, while discount chain Dollar General reported margins of about 12 percent in the 12 months through November, the data show.

Walgreen Co. has made regional acquisitions recently, including buying USA Drug for $438 million in September 2012 and Kerr Drug’s 76 retail stores and specialty pharmacy business for an undisclosed amount last year.

In December 2012, CVS acquired most of Medicine Chest Pharmacy’s locations in Texas for an undisclosed amount.

H.I.G has more than $15 billion under management, and investments in companies ranging from food processor Albertville Quality Foods to Die Cuts With a View, which sells scrapbooking products.

Information for this article was contributed by Brooke Sutherland of Bloomberg News.

Business, Pages 31 on 03/01/2014

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