Is The Walgreens' Rite-Aid Deal Dead?

| About: Walgreens Boots (WBA)

The much-anticipated acquisition of Rite Aid (NYSE:RAD) by Walgreens Boots Alliance (NASDAQ:WBA) is in serious doubt.

Even though the deal was announced in November 2015, it still has not happened. Both stocks are still trading on the exchanges, and the companies are putting out separate sets of books. That's a far cry from Kroger's (NYSE:KR) acquisition of Roundy's, which was announced at the same time; November 2015. Roundy's ticker disappeared shortly afterwards, and the Roundy's brand appears in the list on Kroger's website.

Yet, Rite Aid and Walgreens are still operating as separate companies: and now one of the biggest names on The Street is casting doubt on the deal. Jim Cramer told his viewers that Walgreens should not buy Rite Aid on May 23, 2016.

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The hold-up to the acquisition appears to be the Federal Trade Commission (FTC), which put the kibosh on Staples' (NASDAQ:SPLS) Office Depot (NYSE:ODP) acquisition earlier this month. The FTC's regulators felt that deal violated antitrust regulations; and they might feel the same away about a Walgreens-Rite Aid merger.

The FTC was apparently afraid that the Office Depot/Staples merger would create an office supply monopoly. Its bureaucrats might be afraid that a Walgreens-Rite Aid merger would create a drugstore monopoly or a company that is too big. Those concerns seem unfounded given the number of drugstores operated by competitors; Kroger alone operated 2,111 pharmacies in 2014.

The problem is that the FTC does not appear to be operating rationally or keeping up with the times. There was no evidence that a Staples/Office Depot merger would affect the office supply market; yet it killed that deal.

How Would Deal's End Affect Walgreens and Rite Aid Stock?

Naturally, many people will be wondering how the end of deal will affect Walgreens and Rite Aid stock.

Office Depot and Staples have seen their share prices plummet since the collapse of their acquisition plans. Office Depot was trading at $3.44 a share on June 10, 2016; and Staples was trading at $8.72 a share on the same day. Investors will wonder if the same thing could happen to Walgreens and Rite Aid.

The best answer is no, because Staples and Office Depot are very unhealthy companies with declining revenue and falling sales. Staples' TTM revenue fell by $160 million during first-quarter 2016, dropping from $21.06 billion in January to $20.9 billion in April. Staples' revenue has been falling for nine straight quarters since first-quarter 2013.

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Office Depot's revenues have been falling for five straight quarters since December 2014. Office Depot's revenues fell by $330 million during first quarter 2016, dropping from $14.48 to $14.13 billion.

In contrast, Walgreens has displayed impressive growth and its revenues increased by $31.95 billion between February 2015 and February 2016, rising from $84.58 billion to $116.53 billion. Cramer seems to be right; Walgreens is capable of impressive revenue growth without Rite Aid.

Can Rite Aid Survive Without Walgreens?

The revenue figures show us that Walgreens does not need Rite Aid, but Rite Aid needs Walgreens. Rite Aid's revenue growth has been impressive, but some of its other numbers have not.

Between February 2015 and February 2016, Rite Aid's revenues increased by $4.21 billion, rising from $26.53 billion to $30.74 billion. That figure sounds real good until you take a look at Rite Aid's net income. During the same period, Rite Aid's net income fell by $1.94353 billion, dropping from $2.109 billion to $165.47 million.

Walgreens reported a net income of $3.385 billion in February 2015; that fell to $3.368 billion in February 2016. The larger drugstore operator is making a lot of money while Rite Aid's figures look dangerously close to a death spiral.

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Rite Aid also reported a free cash flow of $169.82 million, $997.4 million in cash from operations and $124.47 million in cash and short-term investments for first-quarter 2016. The company appears to have no float, which is probably why management is trying to sell out to Walgreen, which has a lot of float.

Walgreens reported a free cash flow of $2.036 billion, $6.412 billion in cash from operations and cash and short-term investments of $3.586 billion for the first quarter of 2016. The larger drugstore company is making plenty of money and generating a lot of float.

The numbers tell us that Walgreens can thrive without Rite Aid while Rite Aid will have to find another buyer, or collapse. It will need to sell itself to a private equity company or perhaps another retailer like Kroger to avoid the death spiral.

Finding such a buyer should not be difficult, because Rite Aid was trading at $7.85 a share on June 10. It also had a market cap of $8.235 billion on the same day.

Will Walgreens Dismember Rite Aid?

Another possibility is that Walgreens will dismember Rite Aid in order to comply with the FTC's wishes. The larger drug store operator might sell off a large percentage of Rite Aid's stores, and keep just the ones it wants.

A possible buyer for some of those assets would be CVS Health (NYSE:CVS). Rite Aid operates stores in a number of markets such as Denver where CVS's presence is limited to pharmacies inside Target (NYSE:TGT) stores. Since Walgreens already has a large footprint in Denver; selling the Rite Aid stores there to CVS could satisfy the FTC.

Farmacias Ahumada Walgreens-Boots Alliance Farmacias Ahumada Walgreens-Boots Alliance's subsidiary in Chile.

Walgreens is still a good long-term investment because of its growth; Rite Aid is not. One advantage to Walgreens is that it has a large footprint in Europe and Chile, where government-funded single-payer health insurance systems pay for most prescriptions. That ensures a steady source of revenue backed by taxpayers that Rite Aid cannot tap.

Walgreens is a good investment with or without Rite Aid. Rite Aid is a company that will collapse or disappear without a deep pocketed buyer like Walgreens.