Updated from 9:13 a.m. EDT

While analysts praised the price J.C. Penney ( JCP) got for its Eckerd drugstore chain Monday, the market anointed CVS ( CVS) the long-awaited transaction's winner.

J.C. Penney announced earlier it will sell Eckerd in a two-part transaction with CVS and Canada's Jean Coutu Group that will generate about $3.5 billion in cash. The divestiture completes a longstanding goal of CEO Allen Questrom, the former Federated Department Stores ( FD) executive brought in to turn around Penney after the stock collapsed in late 1999.

But while the shares have more than doubled since Questrom arrived in August 2000, they were recently trading down 43 cents, or 1.2%, to $34.40 Monday. CVS, on the other hand, was up $2.36, or 6.8%, to $37.14.

The transaction calls for Jean Coutu to acquire 1,540 Eckerd drugstores and support facilities in 13 Northeast and Mid-Atlantic states for $2.375 billion, while CVS will acquire 1,260 drugstores and support facilities primarily in Florida and Texas, plus Eckerd's pharmacy benefits management and mail-order business, for $2.150 billion.

J.C. Penney expects to collect about $3.5 billion in cash after closing adjustments, taxes, fees and other expenses. The company will use some of the money to buy back shares. The transaction is expected to close by the end of the second quarter.

"This sale will allow J.C. Penney to focus entirely on our core department store and catalog/Internet business," J.C. Penney said in a statement. "Our core business has made tremendous progress over the past three years, with significant improvement in both sales and operating profit, and we remain confident we will achieve our operating profit goal of 6% to 8% of sales in 2005."

The company received more money for the chain than both Citigroup analyst Deborah Weinswig and Merrill Lynch analyst Daniel Barry expected. Barry called J.C. Penney "the turnaround of the decade" and expects to see productivity gains and margin expansion at the core department store after the deal is completed.

Richard Hastings, retail sector analyst at Bernard Sands, also thinks J.C. Penney got a good price for the chain, which he said will help them reduce debt and focus on competing against other department store chains, especially Kohl's ( KSS).

J.C. Penny is "tearing off its clothes and getting very competitive," said Hastings. "They have had a huge infrastructure of private labels for more than a generation. They are leveraging those resources and have a great variety of styles at very good profit margins."

Compared with Kohl's, J.C. Penney's offerings are more contemporary. Meanwhile Kohl's "represents the old modesty," Hastings said. Kohl's offerings are more family-oriented, while J.C. Penney appeals to younger shoppers and is adept at modifying its merchandise quickly to appeal to changing tastes.

Judging by the early returns, investors also like the value received by CVS, which expects the deal will be accretive to earnings in 2005 and beyond. By 2005, the company expects $100 million in synergies. CVS will finance the transaction with a combination of short- and long-term debt.

On a subsequent conference call, CVS said it valued each Eckerd store as worth roughly $1 million, including about $400,000 in inventory, while the mail order unit was valued at around $800 million.

Hastings, however, emphasized the huge amount of work CVS is looking at to be successful at re-launching the Eckerd stores under the CVS brand. Beyond the money it will spend to spruce up stores, competition from national drug-store chain Walgreen ( WAG), already a big rival of CVS, are impediments to quick progress.

Hastings thinks CVS will be able to turnaround the Eckerd chains, but stressed that in the near term, CVS is inheriting weakness at Eckerd, not strength. In December 2003, for example, Walgreen's same-store sales exceeded Eckerd's by 20 percentage points.

In all, Walgreen is a formidable rival in nearly every aspect of competition, Hastings said. "Walgreen has walked into major Eckerd markets in the past and clobbered them. I believe the edge will ultimately continue to be at Walgreen. CVS competes against Walgreen, but I do not perceive Walgreen as competing against CVS."

Nevertheless, CVS expects the acquisition to be 12 cents to 15 cents dilutive to 2004 per-share earnings, after integration and other expenses associated with the transaction. In 2005, CVS expects the deal to be 15 cents to 20 cents accretive to per-share earnings, and to add about $150 million to cash flow in 2005. In 2006, the company sees earnings per share boosted by 25 cents to 30 cents.

Analysts polled by Thomson One Analytics currently expect CVS to earn $2.21 a share in 2004, $2.44 a share in 2005 and $2.78 a share in 2006.

The combined 2003 revenue of CVS and the operations it is acquiring was about $33 billion, CVS said. The company expects to fill 13% of the nation's prescriptions once the deal is completed.

CVS is also acquiring distribution centers near Dallas and Houston and Orlando, Fla. CVS will have 5,000 stores after the deal is completed. The company said on the conference call that most of the Eckerd properties it is acquiring are "compatible real estate with store sizes similar to our own."

Due to the deal, CVS said it now expects to have 250 to 275 new and relocated CVS stores in 2004, up from its prior guidance of 225 to 250 stores. CVS said it will continue to look for opportunities to expand in Phoenix, Ariz., Las Vegas, Southern California, Minneapolis and Chicago.

Jean Coutu operates 332 Brooks Pharmacy stores in six Northeastern states.

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