Rite Aid Corporation (NYSE: RAD) just handed off the first lot of 97 stores to Walgreens Boots Alliance Inc (NASDAQ: WBA) under its agreement to sell 1932 stores for about $ 4.4 billion.
The deal is a watered down version of the original transaction which envisaged Walgreens taking over Rite Aid for $9 per share. Those plans, then valued $17 billion, had to be junked after they ran into anti-trust complications.
Chagrined Rite Aid shareholders have watched their stock plunge relentlessly down through this year losing nearly 80% of its value. All this, in the midst of a raging bull market.
Yet, bailing from Rite Aid may not be a very smart investing decision at this point.
Rite Aid Corporation (NYSE: RAD) May Have Hidden Value
Rite Aid is expected to complete the transfer of the remaining stores in phases by spring 2018, and has indicated that it will use the sale proceeds to retire existing debt.
That will help the pharmacy chain to reduce its interest expenditure as well as substantially lower its financial leverage. The revised deal also allows Rite Aid to use Walgreens’ network for buying generic drugs for 10 years, and that could cut Rite Aid’s costs.
The transaction is also expected to generate a tax advantage because the gain it will record on the sale of the assets is expected to be largely offset by its net operating loss carry-forwards.
There is also a view that Rite Aid’s current market capitalisation of $ 2.07 billion is not representative of the sum of its parts, i.e., (a) its remaining unsold stores, and (b) Envision Rx, its pharmacy benefits manager (PBM) business unit, which it acquired in 2015 for about $ 2 billion.
According to one analysis, Rite Aid’s remaining stores are much more profitable compared to the ones divested to Walgreens, and a back-of-the-calculation would show that these stores on average generate 23% higher sales. On a conservative valuation these remnant stores may be worth as much as $ 4.9 billion. Further, assuming a 25% deterioration on its acquisition cost, the Envision Rx unit may be valued at $1.5 billion. Sum-of-parts, therefore is $6.4 billion. This implies a net equity of $4.2 billion when $2.2 billion of debt is adjusted, or a value of $3.94 per share.
By this analysis, at their current price of $1.89, Rite Aid shares are highly undervalued.
Rite Aid Corporation (NYSE: RAD) May Be an Attractive Acquisition for You-Know-Who
Rite Aid shares may also have been supported in recent days by persistent media speculation that the company is an excellent acquisition target for online ecommerce giant Amazon.com, Inc. (NASDAQ: AMZN) who is said to be looking to extend its reach into the pharmaceutical space.
What’s in Rite Aid for Amazon? Plenty, actually. Amazon would get, on a platter, 19 state pharmacy licences, over 2500 store locations, six distribution centres and thrown in for good measure, a pharmacy benefit management business. Rite Aid locations could also double up as physical interface locations for Amazon – locker locations or return drops.
So, could Amazon repeat the Whole Foods deal with Rite Aid?
They should, according to analyst John Blackledge at the Cowen Group in Wall Street. “Depending on the pace Amazon would seek to enter the market, an acquisition such as Rite Aid could accelerate the pace and be a relatively low-risk acquisition,” he said in a note. “Our Cowen proprietary survey data suggests 67 percent of Amazon Prime members would purchase prescription drugs through Amazon if they were available,” he added.
The deal could also give Amazon a quick leg-up as a pharmacy benefit manager. “It can serve as its own mail pharmacy, and capitalize on Prime 2-day delivery,” says Blackledge. “From there, Amazon could build out its own retail network, and find itself working with other retail pharmacy chains to participate in its retail network.”
Rite Aid Corporation (NYSE: RAD) Stock
Given the possibility of the market price of Rite Aid shares catching up with their valuation, and the likelihood of a buyout, investors should avoid selling out in exasperation at the current low price.
Instead, they may consider averaging down their purchase cost by adding some more shares at the current price.