Over the last few months, pharmacy chain Rite Aid Corporation (NYSE:RAD) has been on a rollercoaster ride as investors questioned whether a merger with Walgreens Boots Alliance Inc (NYSE:WBA) would go through. Last week, the ordeal finally came to an end after two years of back-and-forth between the two companies and the Federal Trade Commission. The final outcome looked to be the worst possible scenario for RAD stock: Walgreens decided to abandon the deal.
Source: Mike Mozart via Flickr
The news sent RAD stock more than 30% lower in a matter of days as investors speculated on whether the beleaguered store would be able to continue operating much further into the future.
However, while the abandonment of a merge with Walgreens wasn’t good news for RAD stock, there are still some traders out there who are looking at the company’s $2.36 share price as an opportunity, and they aren’t wrong. They’re dealing in some pretty risky business, but I agree that it may not be as bad as it looks for Rite Aid.
Three Reasons RAD Stock Isn’t Done Yet
A New Deal
While Walgreens is no longer acquiring RAD as originally planned, Rite Aid isn’t going to walk away empty handed. Instead, Walgreens has agreed to buy 2,186 RAD stores for a purchase price of $5.175 billion. The deal will also allow Rite Aid to buy generic medication sourced by Walgreens for a 10-year period and requires Walgreens to pay a break-up fee of $325 million.
On one hand, the new deal will make Rite Aid’s business significantly smaller. That could make it more difficult for the already struggling chain to compete with its much larger competition — Walgreens and CVS Health Corp (NYSE:CVS).
Not only that, but pharmacy retailers are already facing headwinds from new drug legislation favoring less profitable generic brands and the rise of online shopping. A scaled-down Rite Aid may not be able to cope in such a challenging environment
The Silver Lining
However, it’s not all bad news. For one thing, RAD is getting more money per store than it would have in the initial deal. The new deal means that RAD will get $2.4 million per store, rather than the $2 million per store that the two agreed to back in 2015.
Another reason the new deal looks good for Rite Aid is the fact that it allows the firm to cut down its debt load significantly. Management has said they will use the influx of cash to pay down its debt obligations, and the firm’s operating losses means that RAD will likely pay very little, if any, federal tax on the gains it receives from the sale.
Rite Aid stock is certainly under a lot of strain. Even with two-thirds of its debt paid off following the Walgreens sale, RAD stock will be facing strong headwinds as a small fish in a large, and relatively choppy, pond. But with that said, it’s still not as bad as it looks.
CEO John Standley has said that the company will be in a better position to improve profitability moving forward with fewer stores and far less debt. The reduced store footprint means Rite Aid will be able to shift its focus to its pharmacy benefit manager segment EnvisionRx. Not only that, but the possibility of a takeover is still very real.
RAD could be an appealing takeover target for Amazon.com, Inc. (NASDAQ:AMZN) if the e-commerce giant really is serious about making its way into the pharmacy business. There’s also a possibility that a smaller chain like Fred’s, Inc. (NASDAQ:FRED) might merge with RAD to create a third pharmacy superpower.
Bottom Line on Rite Aid Stock
RAD stock is probably going to make its way higher in the months ahead. Not only do I believe that the company has the ability to use its streamlined size to its advantage, but I think the stock will see a lift once the deal is finalized regardless. Now that the merger is off the table and investors have accepted this fate, the firm is going to absorb the news and move on. In a few months when the FTC approves WBA’s offer to buy Rite Aid stores, investors may be a little bit more positive about the deal and Rite Aid stock will reflect that sentiment.
As of this writing, Laura Hoy was long RAD.
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