It was a sad day when Rite-Aid (NYSE:RAD) betrayed its investors and reduced its sale price to Walgreens Boots Alliance (NASDAQ:WBA) to $7 a share or less, from the previous $9 level. Some investors had felt that even $9 was too low a price, given Rite-Aid's remarkable comeback story. Yes, it might take a few years for Rite-Aid to deleverage, improve efficiency and become a cash cow, but the store refurbishment project is proceeding apace (and upon completion will no longer be a cash drain), the demographics of aging are a tailwind, and the existing debt carrying costs are manageable.
The putative reason for the reduction in price was a projected Federal Trade Commission (FTC) requirement for divestiture of additional stores in order to allay anti-trust concerns. However, the new price will be 20% lower even if there are no additional divestitures. Why is that?
Rite-Aid has 4600 stores nationwide, according to their website here, with the original agreement involving a proposed divestiture of about 1,000 of those stores, according to streetinsider here. The new plan would involve an additional 200 stores. How does the risk of divestiture of those additional stores reduce Rite-Aid's value to Walgreens by so much? If the divested stores are not highly profitable, the impact on earnings is negligible and Walgreens may be better off without them. If they are profitable with a positive margin trend, they should command a commensurate cash premium when sold. If they are leased, the leases and locations have intrinsic value, which will be monetized in the sale price. If they are owned, the revenues from selling them can be used to pay down Rite-Aid's debt and improve the balance sheet, or even better, to increase cash on hand, which sweetens the pot for Walgreen -- that money could then be used to open new stores.
There appears to be no circumstance where the risk of additional selective divestiture should bring a lower price for Rite-Aid, and certainly not a price this much lower. Divestiture was already baked into the initial purchase price, and the contingency of a modest increment should not reduce the sale price by 20%.
The TDAmeritrade (TDA) Think or Swim platform, under the analysis tab, has very positive comments about Rite-Aid. Yahoo Finance gives the company a 2.6 rating here, between hold and buy. These positive analyses don't reflect the "yard sale" low price just negotiated. One has only to look at the fundamentals of the company to conclude that much progress has been made, and is continuing, in the Rite-Aid turnaround.
Earnings trends are promising. Note that revenues are not an accurate indicator, because the margins on lower-cost generic drugs are higher. The potential increase in future earnings is likely the principal reason Walgreens began this takeover - euphemistically called a merger - in the first place, not to mention Rite-Aid's expansion of its mail order business and consolidation of its generic drug supply chain.
We'll have to wait until the facts and details come out, but few would be surprised to discover that Rite-Aid executives end up with more money by throwing investors under the bus financially.
Walgreens will walk away happy, indeed overjoyed. Any discussion about Rite-Aid potentially being "non-accretive" to Walgreens in 2017 may be a red herring to make the deal seem less desirable and to justify the reduction in purchase price. As a practical matter, Walgreens needs Rite-Aid in order to go head to head with CVS Health Corp. (NYSE:CVS). Given this corporate realpolitik, Rite-Aid executive should have held out for the original $9 price, at the least.
The bottom line is that Rite-Aid should never have agreed to a buyout at this price point. It would have been far better to abandon the merger and continue alone on a positive path to long-term success.
So what should investors do at this point? We have no choice. We will hold until the merger is approved, which under a Trump administration will likely be soon. Unfortunately, it didn't happen soon enough, so we'll have lost 20% on the end result.
While I doubt that anything illegal was done, the whole situation smells of old fish, as did the original deal to begin with. And speaking of fish, some investors might wish that when the Rite-Aid executives are sitting on their yachts, fishing and enjoying their bonuses, maybe Neptune will stir up the waters and make them a little seasick.
Disclosure: I am/we are long RAD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.