The combination of CVS Health Corp (NYSE:CVS) with Aetna Inc (NYSE:AET) seems like a strong move, and it raises questions as to who will scoop up Rite Aid Corporation (NYSE:RAD) and its stores and pharmacy management business.
First, let’s look at the CVS-AET merger. Here’s why this works. AET is an insurer. Every time one of its consumers needs drugs, AET has to pony up its share of the drug costs. That lowers its profits. But with CVS, every time a patient needs to get a drug, CVS makes money. Thus, Aetna’s consumers can now buy drugs in CVS stores, so AET costs are now going to be balanced out.
That, in turn, should help Aetna’s consumers with lower drug payments. CVS also is going to increase the number of clinics it has. This may save both firms money because people may be enticed to use CVS clinics instead of going to the doctor. In addition, when people go to the clinics, they’ll be right there in a CVS store. Perhaps they will purchase other items.
The combined entity should make about $7 billion in profit. Yes, it will mean that it will have $81 billion in debt on its balance sheet that will never be paid off. But hey, the banks are happy as long as the debt is being serviced.
Look for Return on AET Stock
With AET stock currently trading at $178 and the buyout price being $207, there is substantial upside here with the closing sometime in mid-2018. The only sticking point is regulatory approval. There doesn’t seem to be any obvious obstacles to this, but considering the AT&T Inc. (NYSE:T) deal with Time Warner Inc (NYSE:TWX) has been delayed due to the DOJ’s laughable lawsuit, one never knows.
So you can buy AET stock here at $178 and look for that 14% return over the next year. You could take a little less risk by selling the 20 July $200 naked puts for $22. That way you collect most of the upside now. If the merger fails, the stock gets put to you at an effective price of $178. Because AET was trading at around $160 before the announcement, that’s probably a floor if AET stock falls back to where it was before the merger. So downside is limited, and getting AET stock put to you is hardly the end of the world.
As for RAD stock, my thesis hasn’t changed. Cerberus Capital thought about purchasing some Rite Aid stores. Private equity firms akin to Cerberus like to take assets and bring in experienced people to improve cash flow.
RAD Ripe for Picking
Private equity shops adore cash flow. The more cash flow there is, the faster the private equity firm gets a return on its money. If the cash flow situation improves, the company is spun out into a new IPO and the firm cashes in its chips.
RAD stock seems ripe for this arrangement. While the operational situation has been getting worse at Rite Aid, it still has almost 2,000 stores and a pharmacy management business. The 2,500 stores it just sold will pay down debt substantially and that creates more cash flow instead of it going to debt service.
RAD stock was as high as $7 when there was merger talk, so I still think there is substantial upside from $1.70 per share now.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any of the aforementioned stocks. Meyers has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
