Kmart Corp. has signed a letter of intent to sell its Payless drugstore unit to Leonard Green & Partners, the Los Angeles-based investment firm that controls Thrifty Drug Stores, The Times has learned.
Such a deal could double the number of Thrifty stores in California--bolstering its strong position in the state--and expand its presence in the West. According to sources familiar with the negotiations, Leonard Green & Partners would pay about $1 billion for Payless.
Payless, based in Wilsonville, Ore., is the nation's eighth-largest drugstore retailer. It has 565 stores in 12 Western states--including 200 in California and about 60 in Southern California. Los Angeles-based Thrifty ranks 11th among the nation's drugstore chains. With 497 stores in California, it is already the state's largest drugstore retailer, followed by Longs Drug Stores, which has 261 stores, Payless and Sav-On Drugs, with 188 stores.
Thrifty currently operates only in California, and such a merger would give it a strong presence in much of the Western half of the nation.
Kmart and Leonard Green would not comment on their negotiations. A letter of intent is not a final agreement, but gives Leonard Green & Partners access to Payless' financial records. The two parties must also negotiate other details before a deal can be completed.
A number of industry analysts expect that if the deal goes through, the financial structures of the two chains would merge. A merger would provide a Thrifty-Payless entity with more buying power, giving it the negotiating strength to purchase goods more cheaply and possibly pass those savings on to consumers, according to industry analysts.
That would make it more competitive with discounters such as Wal-Mart--and, ironically, Kmart--that vigorously compete with drugstore chains in products such as small appliances and health and beauty aids, said Ed Weller, an industry analyst at Robertson, Stephens & Co. in San Francisco.
"This kind of deal would allow Thrifty to enhance its market penetration," Weller said. "It would also allow Kmart to eliminate a distraction and improve its financial condition."
"If it happens, this would be a good deal for Kmart and for the buyer of Payless," said Kurt Barnard, a New York-based retail economist. "The environment in California is extremely competitive. If Payless is merged with a California chain, that company would lower prices and consumers would benefit."
Kmart, the nation's second-largest retailer, has been negotiating with Leonard Green & Partners and a number of other bidders. The company announced in early August that it was soliciting offers for Payless, which it acquired in 1985.
A new report by retail analysts at Salomon Bros. said same-store sales at Payless--stores that have been open at least 12 months--registered a 4.6% decline during the company's first 35 weeks this year because they were "hurt by a continuing weak California economy."
The sale of Payless would allow Kmart to focus on its core retail business, industry analysts have said. It would also ensure that Kmart could pay shareholders its annual dividend, which has been threatened by the discount retailer's weak earnings.
Thrifty was losing money when the Green partnership acquired the chain in September, 1992, but the company said the chain recently began to operate profitably.
Thrifty is a private company and does not disclose its earnings. It had sales of more than $2 billion last year and employs about 11,000 people. Payless had sales of $2.3 billion and operating income of $113 million in 1992. It employs about 20,000 people.
Biggest Drug Chains
Here are the four largest drugstore chains in California, ranked by number of stores in the state:
Source: Company reports
Researched by GEORGE WHITE and ADAM S. BAUMAN / Los Angeles Times