Just days before Rite Aid Corporation (NYSE:RAD) saw merger partner Walgreens Boots Alliance Inc (NASDAQ:WBA) terminate the deal, I wrote an article about the three possible scenarios facing Rite Aid and RAD stock should its savior run away.
In a nutshell, Amazon.com, Inc. (NASDAQ:AMZN) could acquire it, private equity firms could make a play, or management could do their own buyout. None of these scenarios envisioned what happened next.
Walgreens and Rite Aid called off their merger but made a secondary deal instead that where WBA will buy 2,186 RAD stores for$5.2 billion. Also, Walgreens will pay Fred’s, Inc. (NASDAQ:FRED) a $325 million termination fee for ending its agreement to sell the Tennessee discount retailer and pharmacy as many as 1,200 Rite Aid stores.
Walgreens Saved Rite Aid’s Bacon
My position on RAD stock before the merger was simple: If the sale doesn’t go through for whatever reason, Rite Aid was in trouble.
“I do not believe RAD stock is worth nearly as much on its own as it would be in the hands of a much better operator like Walgreens. And without Walgreens, there aren’t many other better operators who are willing to pick up the check,” I wrote June 27. “If this deal doesn’t go ahead by the July 7 deadline, I have little hope of shareholders seeing $7 at any time in the near future.”
Shortly after the merger was called off and the side deal announced, I got an email from a reader asking me if I still felt this way about RAD stock.
His argument is that with debt paid down, Rite Aid could live to fight another day and possibly find another suitor making its stock worth more than $2.
“It really gives them a lifeline whereas there probably wasn’t one if they had just gotten the deal scuttled and there was no transaction,” Bloomberg Intelligence analyst Jonathan Palmer said about the changing storyline. “I don’t think it’s an easy path forward for them but it’s certainly an easier path than stand-alone Rite Aid with the mountain of debt.”
Palmer’s correct. The only thing this side deal does is give Rite Aid time to come up with a better plan to deliver for shareholders. I don’t think anyone could have predicted things would turn out as they have.
However, if you bought RAD stock around $4 thinking the original merger was going to happen, you’ve suddenly received a lifeline from WBA that you wouldn’t have had if the two parties had gone their separate ways with no side agreement.
Don’t Look a Gift Horse in the Mouth
If you’re one of these people and bought RAD stock in a taxable account, I suggest you sell it now and take the capital loss. If you bought in a tax-deferred account, you might want to wait until the stock gets back to $4 and your break-even point.
Rite Aid’s best chance was to get with a better operator. That was Walgreens. Just because Rite Aid will have 80% less long-term debt ($2.0 billion) — assuming it uses the entire $5.2 billion to pay down debt — doesn’t mean everything is perfect.
With half as many stores, Rite Aid will have less revenue coming in. Admittedly, it will have some geographic strongholds like California (577 stores) and its home state Pennsylvania (535 stores) which will account for almost 50% of its locations. That will be easier to manage for sure.
On the downside, it now has 14 states with fewer than 10 stores compared to two states before selling half its stores. Those will have to be sold. The South is no longer a viable part of Rite Aid’s footprint.
Bottom Line on RAD Stock
The company believes the remaining stores have better sales and profitability. We won’t know the full extent of that until the deal is completed, the stores divested, and a quarterly report delivered without the 2,186 stores on the books.
That likely won’t be until this time next summer, although in the meantime management might report earnings on a pro forma basis to give RAD stock investors an indication whether or not it has a shot at making money.
Personally, I just don’t see Rite Aid pulling it off. It couldn’t make money with 4,500 stores; how’s it going to do it with 2,300?
I just don’t see this ending well for RAD shareholders despite the lifeline the company is gripping.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.