Rite Aid: The Offer Stinks, But It'll Go Through Anyway

Summary

• Albertsons' offer for Rite Aid is not a shareholder-friendly deal.
• Cerberus is relying on RAD management's opportunism and investor fatigue.
• It may just work.

By most accounts, Albertsons' offer to acquire Rite Aid (RAD) is not a shareholder-friendly deal for those with a stake in the latter company. I made clear in my article on RAD last week (read here) that I think Rite Aid is toast without an acquisition and that a higher offer would be unlikely. In this article, I'll discuss why I think this deal erodes value for current RAD shareholders and why the deal is likely to go through regardless.

Quick recap, Albertsons is offering the following: For every 10 shares of RAD, shareholders can either elect to receive 1) $1.83 in cash and 1 share of Albertsons or 2) 1.079 shares of Albertsons. The implied valuation is as follows:

• 10 shares of RAD = 1 share of Albertsons + $1.83
• 10 shares of RAD = 1.079 shares of Albertsons
• 1 share of Albertsons + $1.83 = 1.079 shares of Albertsons
• $1.83 = 0.079 shares of Albertsons
• 1 share of Albertsons = ~$23
• 10 shares of RAD = 1 share of Albertsons + $1.83 = ~$23 + $1.83 = ~$25
• 1 share of RAD = $25/10 = $2.50

The problem is that the market doesn't seem to think a share of Albertsons is worth all that much as RAD is still trading significantly below the implied buyout price:

RAD data by YCharts

As I mentioned in my previous piece, the implied price leaves a 25%+ premium for investors right? Well, hold on. Rite Aid is currently struggling, yes, but a merger with Albertsons would completely eliminate whatever slim chance exists for a turnaround. If Rite Aid is a small boat in the middle of the ocean with little chance of making it back to shore, Albertsons is an anchor that would slowly drag the whole thing down. Albertsons is similar to Rite Aid in that it is debt-laden, has a good base of net sales that it can only convert into thin (and getting thinner) profit margins, and operates stores in desperate need of makeovers. It's basically a larger-scale version of Rite Aid.

No matter which option RAD shareholders choose (cash + Albertsons stock or just Albertsons stock), part of the assessment for voting "yes" or "no" must be to consider what the value of the combined company would be because shareholders in RAD will become shareholders in the new entity. If the market doesn't like what this new entity has to offer, the value of the entity's stock might make the implied buyout price, which is based on Albertsons' assumption of its value, lower than the $2.50 buyout price Albertsons' estimates suggest. So let's examine what a pairing would look like.

Both Rite Aid and Albertsons are suffering from the same underlying illness: Amazon (AMZN) and its ilk. Combining the companies together would just create a bigger company with the same problems and the same bleak outlook. I think it's apparent this deal is not beneficial for all involved parties, specifically, and especially, RAD shareholders. So what's going on here?

Let's start with Albertsons' side of things: why does Albertsons want to merge with Rite Aid? Here are some of the proposed benefits for Albertsons:

1. Acquiring Rite Aid provides $375 million in operating expense synergies within three years according to the companies.
2. Reduced supply chain complexity due to geographic overlap of stores.
3. The acquisition includes Rite Aid's PBM, EnvisionRx, which also happens to be the PBM for 280,000 of Albertsons' employees.
4. Adding more pharmacy locations provides better leverage for acquiring drugs.
5. Traffic to current Rite Aid stores can help sell Albertsons' grocery products.

While these may all be well-founded, there's another, and in my opinion, more important reason for this acquisition that has to do with Albertsons' current puppet master: Cerberus Capital Management. Under the current offer, Albertsons will be rolled into Rite Aid, providing Cerberus a way to sell its existing stake in Albertsons quickly and easily without having to find and negotiate with another private equity firm. Easy, right?

Just one problem: Cerberus has decided to make a bet on the opportunism of Rite Aid's current management team and the fatigue of RAD shareholders by providing an offer well below what the company is actually worth. I've been on the bear train since my first article on the stock last year, but even I can acknowledge that the current offer is not shareholder-friendly in the slightest. As SA contributor Chris Lau noted in his RAD article (read here), while Walgreens (WBA) paid $2.28 million per store, the current offer from Albertsons values the rest of Rite Aid's stores at just $970,000 per location. In other terms, Walgreens paid $4.375 billion for 1,932 Rite Aid stores and Albertsons wants to pay $2.6 billion for the remaining 2,670 stores.

For the sake of being conservative, let's assume the value of Rite Aid's remaining 2,670 stores are worth 11% less than what Walgreens paid per store, which comes out to about $2 million per location, that would yield a market value of $5.34 billion for the rest of Rite Aid's stores. Subtract $3 billion in long-term debt and that gives us $2.34 billion in company value. That values RAD at about $2.20 per share.

However, we also have to consider Rite Aid's PBM, which was purchased in 2015 for $2 billion. For fun, let's assume that this business inexplicably lost 50% of its value over the past three years, which would give us a total market value for RAD of $3.34 billion or about $3.15 per share, a 50%+ premium to current price levels and 25% higher than the implied price of the offer currently on the table. Even with overly conservative estimates, the offer from Cerberus seems to be lowballing Rite Aid's true value.

Here we come to the crux of the issue: if this deal is lowballing Rite Aid's value, why does Rite Aid management team seem so eager to play ball anyways? Because Cerberus knows how the management team of a flailing company usually thinks: they would rather take a quick, easy payout than have to engineer a turnaround over the next few years or longer. That's why Rite Aid's current CEO, John Standley, will be the CEO of the combined Albertsons-Rite Aid entity (as well as a board member), and had this to say about the merger:

This powerful combination enables us to become a truly differentiated leader in delivering value, choice, and flexibility to meet customers’ evolving food, health, and wellness needs.

Standley might truly believe that, but he also must know that accepting the current offer would be detrimental to RAD shareholders. However, perhaps putting up a fight would hurt his chances of a top position at the new company.

Cerberus is also counting on something else: investor fatigue. Sure, some investors have bought RAD in the low single digits (think $1-3 per share) fairly recently and will be disappointed by this deal, but many others have been holding shares since much earlier than that and would just like to see an end to this unfortunate saga. Not to mention institutional owners like Vanguard, Oppenheimer, and BlackRock that might just be content to eat the loss and simply move on. By extending such a blatantly low offer, Cerberus is likely hoping shareholders will simply throw up their hands and take the deal if just to end the misery.

And you what? I think it'll work. I don't think opposed shareholders will be able to muster the resistance to get this offer rejected. Getting a deal like this done without the support of board members seems unlikely, indicating that the larger institutional stakeholders are already on board for this move. The only thing that could sink this merger now in my opinion is an activist investor or another bid from a third party that forces Cerberus to sweeten the deal, which both seem like unwise events on which to pin an investment.

With that said, institutional ownership is only about 50% of shares outstanding with another 1% owned by insiders (apparently not too much confidence in the stock!) so a "grassroots" campaign to get this offer rejected is perhaps not impossible, but the odds do not appear to be in favor of this becoming reality. In all likelihood, this deal will go through to the disappointment and frustration of many shareholders and be referred to over the next few years as an example of how management's self-interest and investor fatigue can lead to poor shareholder returns.

Investor Takeaway

To cap this off, let's evaluate some scenarios for RAD shareholders using the conclusions in the article:

1) If you're a RAD shareholder who thinks an Albertsons-Rite Aid combination could succeed, maybe you don't mind Albertsons getting Rite Aid for a bargain price in which case you should keep your RAD shares, exchange them for Albertsons shares when a deal is consummated, and hold on tight. Personally, this doesn't seem like a very appealing option considering the baggage and deteriorating performance both companies have.

2) If you're a RAD shareholder who wants nothing to do with Albertsons shares and instead want a higher buyout price, I think you're probably out of luck. The deal has the support of Rite Aid management, and there's no indication that the board opposes the deal. If you're in this boat, you should assess what a share in Albertsons is worth and determine if it makes more sense to sell your RAD shares right now or if you should wait until you can get cash and a share of Albertsons (I'd go for the former).

3) If you're a RAD shareholder who doesn't want a buyout at all and wants to go it alone, you're welcome to hold your shares and vote "no" to the current offer, but ultimately I think Rite Aid going it alone would be an even worse alternative to Albertsons' current offer due to Rite Aid's operating struggles.

4) If you're a RAD shareholder who wants a higher buyout price and will vote no on the current offer expecting it to be rejected, I think you might benefit from a more pragmatic approach. The deal has approval from Rite Aid's management and the BOD has expressed no reservations, therefore holding RAD in hopes of a rejection and higher buyout price seems futile.

5) If you're a RAD shareholder who is holding onto shares because you think a third-party will swoop in and offer a better deal than Albertsons' current offer, I think you are likely to be disappointed. Rite Aid has declining comps, is barely eking out a profit, and still has $3 billion in debt, which don't make for an attractive acquisition target. Albertsons buying the company seems more like an act of desperation as it would just combine together two entities that are both struggling mightily against the same market trends.

I don't really see any appealing path forward for RAD shareholders at this point. The offer currently on the table undoubtedly undervalues the company's shares even with conservative estimates, but I don't think that will matter in the grand scheme of things. The deal is likely to be approved due to support from Rite Aid's management and lack of opposition, so far, from the BOD. I don't think Albertsons' stock is particularly appealing and, if I were a RAD shareholder, I wouldn't really be happy with that as my buyout prize. I think the optimal strategy for investors is to simply sell the stock and move on.

Best of luck!

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Thanks for reading!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Steve Krol]

Request for Letter Writing Campaign

My theory, and it is only that, is The FTC may be part of the problem here. No great brain storm there; they held up the original Walgreens merger for 2 years, however, I smell an additional problem now, which requires further action, and for those of you who are not lazy that do more than talk here to write one more important letter:

It should not be lost on most of you, but perhaps need reminding, that as soon as Walgreens was given the blessing of The FTC to purchase 1900 Rite Aid stores, Walgreens IMMEDIATELY announced that they would close (not sell) 600 of them that were within 1 mile of an existing Walgreens store. How does this maintain competition; it obviously lessens it. Those 600 stores could have easily been sold to Freds that was eagerly waiting to grow and make something of themselves. Given the close proximity of the sale and closure of stores, The FTC gave their blessing to it. So, it is reasonable to conclude that something is wrong here, WITH THE FTC, and it is reasonable to conclude that something could be just as wrong if The FTC allows a merger with Albertsons that is obviously in deep financial trouble, unable to go public twice already, in one of the worst retail industries of supermarkets. It is also true that Cerberus senior management is filled with Wall Street executives AND others closely aligned with past Republican administrations-Dan Quayle, former Vice-President and John Snow. So, something smells wrong here.....

You are urged to write Senator Klobuchar, Ranking Democrat, serving on the sub-committee that oversees The FTC, suggesting that her committee needs to investigate this whole Rite Aid merger matter, as it certainly hints of some sort of malfeasance on the part of The FTC. It may be true that the Trump administration wants to lessen business restrictions generally, but when you look at the background of the Cerberus senior executives and the close ties they may have with this administration, The FTC may not be a friend of the Rite Aid shareholder given the irregularities in this transaction, especially if The FTC approves this fool hearty merger. My copy of the letter being sent to Senator Klobuchar will also be sent to my contact at The FTC, suggesting to him and his staff that The FTC mat be opening up a can of worms if they approve this merger.

Please send your emails to: Senator Klobuchar
Klobuchar.senate.gov (please note a period both before and
after the word senate)

[ziaakbari]

no vote for sure

[papayamon]

I'm sure RAD management is tickled shitless with the stock's price now.

[GameTheory]

Destination Insignificance...... prophetic
https://seekingalpha.c...

[Red702355B]

If Amazon bought RAD and placed $4.00 valuation per share. Amazon valuation was $1500 per. $100,000.00 in Rad value would get you about 66 shares of AMZN. ! What my point--just dreaming !!!!

[papayamon]

Why would they offer $4 when $3 would get the job done?

[rusty13]

The market is saying this deal is toxic to RAD.. Something got to give beside RAD's PPS..

[papayamon]

People know what a sham this deal is. Standley deserves an ass whipping for even proposing this. Of course, this will bring the stock price down. RAD management knows this. It's all part of their plan.

[bmclaurine]

If the price of RAD continues to deteriorate and Albertson's IPO is met with total disdain, how can this deal not fail ? Won't RAD be forced to go it alone ? I'm voting NO !

[ziaakbari]

no vote please every one

[rusty13]

It can get a little messy if the merger takes place before your call options expires.. When is the merger expected to take place again?

[User 27519093]

Buy the stock now.

Sell the $2 strike calls.

The past is pain.

[ziaakbari]

no vote

[Seegood]

THANK YOU snowbrdr 1220 for the website addresses. A very concrete and valuable piece od info to help us take action. See website list above.

[RWDS]

At my cost basis I will probably take the cash + shares and prepare to dump the stock on day 1 along with everyone else. I will probably come out ahead, slightly. But this is definitely not the end game I was hoping for with RAD.

[muishin]

If everyone is dumping on day 1, I doubt you'll get better than $18 a share, maybe much less. So add $1.83, you get $19.83 or $1.98 before the merger, probably in a best case scenario. Why tie up your money and take the risk for 4 months for $0.04 better than you're getting selling today?

[electrons]

For this POS, there will be no day 1. Day 1 probably would be the day the deal was approved.
People are going to trade RAD for foreseeable future.

[rusty13]

Just sweeten the deal to secure a YES vote so I can get out.. I'm sure it won't get some with a higher DCA to a break even point but we have to take what we can get at this point..

[kintox]

That’s all I’m asking for — a sweetened deal, please.

[grocery_IT guy]

First of all, this article is written from the point of view that Amazon is a disruptor to grocery shopping as we have known it for the past 65 years. The assumption being, as I've tried to wrap my mind around it, that people will now order dry goods, meats and produce on-line, let a 16 year old grocery picker pick out their food and deliver it to their home. News alert, Amazon is not the first company to try this. There was an attempt by many grocers in the early days of the internet to try this and it was a dismal waste of resources.

Second, Albertsons is far from the flailing conglomerate of loser banners that some would want to believe. Buying stores all over the country at fire-sale prices (just like they are trying to do with RAD) has resulted in mounds of debt and that's the risk but if you believe that they can pull off this experiment there is only one way to currently own the company and that's by buying RAD.

I certainly understand not buying, or selling, RAD and just wanting out of the misery but there is reason for hope.

[papayamon]

The new model for distribution is ALDI. Vastly more efficient than Albertson's . In addition, even if you argue the industry will be all right, you have to consider the management. Stealing from RAD shareholders will translate into stealing from Newco shareholders.

The crooked management discount will be large. I would never invest in another company with Standley or Miller at the helm.

Notice the market's reaction here? It knows the entire situation is a steaming turd.

[GameTheory]

Standley Steamer

[Steve Krol]

grocery_ITguy

The hope is not hooking up your star to a money losing Albertsons chain that could be run by the very 2 executives, Miller and Standley, who ruined Rite Aid further in the early 2000's. Investing in a debt-laden company as interest rates are destined to rise further also appears to be foolish. Just as RAD was lowering its debt now, you want to trade that in for huge debt again?
No, unless this whole thing was preordained by The FTC to allow Walgreens to buy 1900 stores and immediately close 600 of them and allow Albertsons to take the rest, this is not the way to maintain competition. And if was pre-ordained by The FTC and not disclosed immediately to shareholders, WOW what a class-action lawsuit, so I doubt the scenario but it does bear a thought or two.

No, I still prefer door number 3, not allow the merger, remove Standley and the board, bring in good mgt. and slowly see the RAD stock recover

[ziaakbari]

no vote for sure

[Jeff Bain]

What does everyone think of the Jim Donald hire?

http://bit.ly/2FTjtgk

[Jeff Bain]

Burt P. Flickinger III, managing director of Strategic Resource Group, in an interview with WGB described Donald as "one of the great inspirational retail leaders," with success across multiple formats that should increase momentum at Albertsons.

"Albertsons was at death's door not long along, and so was Rite Aid, but today these companies are poised to be the worst nightmare for Walgreens and Kroger," Flickinger said.

http://bit.ly/2FhgOMu

[Steve Krol]

Jeff Bain

Jim Donald? Laughable

Article link suggests he is a turnaround artist for struggling companies?

Really? Starbucks turned HIM right around, and pushed him out the door in 2008 due to reported poor decisions involving "over-expansion", something that is Rite Aid's specialty, and now soon to be seen once again at Albertsons?

No problem, Mr. Miller to the rescue, who obviously helped him land a RAD director seat in 2008 at the time that the RAD stores were at there worst, and continuing mismanagement. Now, one director is not the whole board, but while he was there, clearly he made no positive impact since even by 2010 RAD was still reporting their worst losses.

Moral of this news report-Where is The SEC to stop "you go on my board, I go on yours. You work in my company, I will throw life preservers to you, if you need one".

This should only act to secure more "NO" votes, if life is fair, but I have not promised you that as fact at all.

[Jeff Bain]

Steve Krol,

Yeah, but it was also that Howard Schultz missed the old espresso machines and thought the automated ones detracted from the "charm" of the stores. If I understand right, Donald was dismissed the same day that McDonald's announced nationwide roll-out of McCafe.

He was handpicked by Sam Walton to run the Supercenters, I would have to research more to find out how that went, but Walmart seems to have done pretty well. Pathmark didn't turn out so well, but that's what led to Walmart job.

I'm just learning as I go, trying to see glass half full.

[papayamon]

Imagine how disheartening it must be to be a rank and file RAD employee. To see an idiot like Standley being rewarded at such a ridiculous level for such gross incompetence and dishonesty. I could find a better CEO in skid row among the drunks.

[rusty13]

You didn't have to wait for RAD's turnaround story just headlines of WBA's $$$ transfer into RAD that would have given me enough price appreciation for a decent profit.. Those with a higher DCA would need to take on more for a risk of an actually turnaround story or a real M&A..

[kintox]

q4 ER was suppose to be another catalyst too but standley and board derailed that opportunity.

[Jamjack]

Was looking for a specific vitamin supp product. Walmart was out. Rite Aide was $5 higher the place was dead devoid of customers. CVS, was almost as dead but pricing was way better which surprised me. Just saying Rite Aide may be on life support. it had been ages since I've been in one. Sad.

[Steve Krol]

Jamjack

You confirm what I already told the board, what I sent to the board to prove that one or more RAD corporate executives do not properly do their jobs.

As some of you know, in November of 2009 I requested and got a meeting up at Harrisburg(Camp Hill, Pa.) with Mary Sammons, Chairman/CEO and the real Chairman/CEO unofficially John Standley, who did most of the talking. The purpose of the meeting was to review several dozen operational issues discovered in my unannounced visits of stores throughout the country. It dealt with store, district and regional management issues, which, when not done properly reflects right back to the senior management.

One of the major items on the Agenda was the impression I had that Rite Aid store prices, in general, were higher than the competition. I could hardly get my statement out before Standley interrupted me and said that Rite Aid was absolutely competitive on price. I went on to other topics, none speaking kindly of management over the 80 minute meeting, and reported back to the shareholders at the following year's Annual Meeting, (which management unsuccessfully tried to silence), by indicating that I left that Harrisburg meeting disgusted. It meant I had yet another project to do.

So, back to Olympia, Washington I went (on Cooper Point Rd.), a new store location that had more problems than I knew what to do with, to do a pricing comparison between Rite Aid and Walgreens up the street. My first mistake was starting with Walgreens first, because after choosing only regularly priced items at random, over 45 of them, and then trying to match them up at Rite Aid, I was unable to find many of the items at Rite Aid. So, I reversed it and started at Rite Aid and matched them up at Walgreens. The majority of Rite Aid items were more expensive, some outrageously so. This report was submitted to the Rite Aid board, and, of course, as usual I heard nothing back from the company or the board. So much for the company motto, that they believe in being communicative with their investors, something that we also notice is not the case again over the last 2 years+.

So, Jamjack, nothing gives a customer a better reason, with all the competition around, to stop going to a Rite Aid if on too many occasions the customer believes they are "being ripped off" at a Rite Aid. This, certainly is not always the case, and I do believe Rite Aid , in general , has had better pricing for their prescription drugs for cash customers, than say CVS. However, as a Rite Aid stockholder I never want our customers to believe they have overpaid on any item they patronize us for.

[Jamjack]

Mr. Krol,
Your words were so precise and your actions so well expressed. I did a little more research beyond the pages of SA. I have not been a shareholder, but once was a fairly regular customer for over the counter supplies. My research indicates that you have been advocating for change for some time to increase the profitability and ultimately the survival of the company. As noted in these other articles you had difficulty in getting anyone to listen. I am truly sorry. You had a large stake and tried for the benefit of all shareholders of the company. As a small shareholder in any company I have ever been a shareholder in, those like you are true friends of the small investor. Having worked my way through college at the lowest levels of retail, you are correct bad management at store level on up to regional levels will reflect back on senior management. I wish you well and hope you are rewarded in your future endeavors. jamjuk

[Steve Krol]

Jamjackl

I appreciate your comments.

What does it also say when Jean Coutu, who sold their Rite Aid stores to Rite Aid in 2007, and as a result had a 30% minority but substantial position in the company, and they too, could not affect change at the company.

Life is full of moments in time when just one different decision could have made all the difference. One of the Coutu brothers could have been named new Chairman/CEO, prior to the decision to bring back Standley in 2008, when the board had "thrown in the towel" on Mary Sammons incompetent performance. That brother did not want it, and hence the mess we are in today. I had his ear, when they did not have the ear of the rest of the board. What a shame.