For investors in Rite Aid Corporation (NYSE:RAD), the situation keeps getting worse. Almost every week brings a new development that sends RAD stock to new 52-week lows.
The latest blow comes from the Federal Trade Commission, which keeps asking more questions about the company’s long-delayed merger with Walgreens Boots Alliance Inc (NASDAQ:WBA).
And Amazon.com, Inc. (NASDAQ:AMZN) didn’t aid matters. Rumors that Amazon will be entering the pharmacy business sent a shock through the sector. Throw in a celebrity investor selling RAD stock lately, and it has been a rough month. But with Rite Aid now around $3.50, is the price finally cheap enough to make it a buy?
RAD Stock Cons
Merger Doubts Intensify: Rite Aid and Walgreens have engaged in an elaborate more-than-year-long courtship now. Originally, WBA offered $9 per share for Rite Aid, back when business appeared to be healthy. After numerous hold-ups, Walgreens cut its offer to $6.50-$7 per share for RAD stock.
That, combined with an agreement for the merged entity to sell hundreds of stores to Fred’s, Inc. (NASDAQ:FRED), appeared likely to get the deal finally done. However, since the firms announced the revised merger agreement, RAD stock has started moving inexorably lower again. The latest concerns come as reports surfaced saying that the FTC is continuing to ask tough questions about the proposal.
Investors had assumed a Donald Trump presidency would make regulators go softer on mergers, but so far, this doesn’t appear to be playing out in reality. One would think that Amazon entering the sector would relieve anti-trust concerns, as well. But the Amazon argument wasn’t enough to sway the FTC to approve the proposed Office Depot Inc (NASDAQ:ODP) and Staples, Inc. (NASDAQ:SPLS) tie-up either.
Amazon Threat: Amazon has laid waste to entire segments of the retail industry. When they make a move, you had better pay attention. So while little is confirmed yet, reports that Amazon may enter the pharmacy business demand attention.
Articles surfaced last week suggesting that Amazon is quietly preparing to enter the space. According to CNBC, Amazon has discussed the move for years, and has now started hiring key staff that would be necessary to build out this business. More than 20% of the U.S. pharmacy business is already mail-order, suggesting it might not be as hard for Amazon to succeed as we might think. On the other hand, many pharmacies have already offered same-day home delivery for years. Regardless, while Walgreens or CVS Health Corp (NYSE:CVS) can probably fend off Amazon, given Rite Aid’s weak balance sheet, even a modest Amazon effect could be devastating.
Einhorn Selling Some: The presence of David Einhorn as a major owner of RAD stock served as a cheerful note in a stressful situation. However, that relief may be disappearing.
Regulatory filings show that David Einhorn sold a chunk of RAD stock recently. And he had this to say in his latest commentary to shareholders: “We had expected that Walgreens and RAD would satisfy regulatory concerns [… instead …] even at this date, the regulatory concerns are not resolved. We are watching the situation carefully and we have trimmed the position, as our original thinking was incorrect.” Even after RAD stock plunged, some investors think it is a worse bet now than previously.
RAD Stock Pros
Price Way Down: Throughout most of 2014 and 2015, RAD stock traded around $7 per share, give or take a buck. Initially, Rite Aid stock owners felt underwhelmed with Walgreens’ offer. Many folks didn’t want to sell unless Walgreens paid at least $10.
Sure, times have changed. Rite Aid’s business has declined since 2015. However, just how far have things gone? At this point, it seems the market has already concluded the deal is dead on arrival. Would RAD stock really fall much farther in the near-term once Walgreens finally walks away?
What If the Deal Closes? While it seems increasingly unlikely that the deal closes, it isn’t impossible yet. Perhaps the FTC is just doing its job to the fullest, rather than looking for reasons to shoot the deal down. Perhaps the arrival of competition will make the FTC rethink its position.
In any case, if by some chance, the deal actually closes, RAD stock would be a home run. Upside for investors buying here would be between 80% and 100%. Even though the odds of the deal closing have diminished, the level of potential upside still makes it an interesting proposition.
Still Valuable to Somebody: It’s easy to look at Rite Aid’s collapsing stock price and think the company is heading for bankruptcy. And yes, the company has real challenges with its business model. There is high leverage here, along with a perception that Rite Aid has fallen behind the competition.
However, Rite Aid is still generating about a billion dollars a year in EBITDA. Get its assets onto a stronger company’s balance sheet, and that value can be unlocked. Furthermore, Walgreens has estimated that the combined company could find $1 billion a year in cost savings by 2019. Investors have now taken Rite Aid’s enterprise value down to under $11 billion. $1 billion a year of EBITDA plus up to a billion in cost synergies is a lot of value on an $11 billion price tag.
Verdict
There is a high probability that the WBA stock deal doesn’t close. The FTC seems to dislike retail mergers as of late. And Walgreens is likely losing motivation about closing the deal. They might even pay the break fee instead of completing the acquisition.
But at this point, you can make a good argument that RAD stock already reflects all this bad news — and then some. The market is clearly pricing Rite Aid stock as though the company is heading for an early death. If by some chance Walgreens manages to buy Rite Aid, investors would reap huge rewards in the span of a few months.
And even if the deal breaks, the stock might rebound. It’s a high-risk situation, but the reward could be large.
At the time of this writing, Ian Bezek owned WBA stock. He had no positions in any of the other mentioned stocks. You can reach him on Twitter at @irbezek.
