Its finally over. After nearly 2 years of twists and turns, Walgreens Boots Alliance Inc (NYSE:WBA) has finally gained FTC approval for its deal with Rite Aid Corporation (NYSE:RAD). This helps RAD stock significantly.
The deal, which was initially a full-on acquisition of RAD by WBA at a $9.4 billion price tag, took many turns after the FTC kept rejecting the deal. After the $9.4 billion (or $9 per share) acquisition was shot down, WBA proposed selling some Rite Aid stores to Fred’s, Inc (NASDAQ:FRED) and lowering the acquisition price to $6.50.
The FTC didn’t like that, either. So WBA came back with an offer to buy 2,186 Rite Aid stores for $5.175 billion in cash. But even that offer got revised at the last minute. The deal that finally got approved by the FTC is for Walgreens to buy 1,932 stores (254 fewer stores than originally proposed) for $4.375 billion ($800 million less than originally proposed).
For RAD shareholders, it’s good to see a deal finally go through. On the flip-side, the deal got cut last minute, implying less cash for RAD to pay down debt.
Consequently, RAD stock is down 10% on the news.
But I think this is an opportunity to buy what I view as a significantly undervalued name.
Rite Aid Offers Deep Value Here
There are a few reasons to buy RAD stock.
Firstly, the balance sheet is about to get a much-needed makeover. Its disappointing that the final deal is only worth $4.4 billion versus $5.2 billion, but that is still an influx of $4.4 billion in cash to pay down debt. There is also another $325 million coming through the pipeline as a result of a merger termination fee.
So RAD will have about $4.7 billion of cash inflow as a result of this deal. Assuming roughly $500 million of that goes to other uses (see this pro-forma deck), that gives RAD about $4.2 billion to pay down debt. That will take the debt load down from $7.2 billion to a much more manageable $3 billion.
Secondly, Rite Aid just unloaded its low performance stores. The average unit sales of RAD’s whole store base is $5.7 million. But the stores RAD still has after the asset sale have average unit sales of about $6.1 million. So these stores have higher sales volume.
Consequently, the remaining stores are also the big profit drivers. The remaining stores accounted for roughly 65% of the company’s $1.1 billion EBITDA in fiscal 2017. And that is based on the original proposal of 2,336 remaining stores, not the actual result of 2,590 remaining stores. That 254 store difference is more than 5% of RAD’s total store base, so its safe to assume RAD will retain at least 70% of EBITDA.
Thirdly, RAD stock is dirt cheap. The new RAD will have 60% less debt but maybe 30% less EBITDA. That means the valuation just got a whole lot more attractive.
Consider this. The debt load will get reduced from $7.2 billion to $3 billion. There is still roughly $200 million in cash on the balance sheet, so net debt will stand around $2.8 billion. Adding that back into RAD’s current $2.6 billion market cap, you get to an enterprise value of about $5.4 billion.
Trailing EBITDA is about $1 billion. Assuming RAD keeps 70% of that, then trailing pro-forma EBITDA is $700 million.
That gives RAD an EV/EBITDA multiple of about 7.7-times.
Bottom Line on RAD Stock
A 7.7-times trailing EBITDA multiple is pretty good for a business that isn’t going away any time soon.
So I think playing the contrarian here is the right move. This sell-off feels overdone, and I think RAD stock has significant upside in both a near and long term window.
As of this writing, Luke Lango was long RAD.