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It’s strike two for Rite Aid Corporation (NYSE: RAD).
An eagerly desired merger with Walgreens Boots Alliance (NASDAQ: WBA) fell apart in 2017. On Wednesday of last week, another planned merger collapsed, this time with grocery store chain Albertsons. A major Rite Aid shareholder, Highfields Capital Management, opposed the deal, and shareholder advisory firm Institutional Shareholder Services (ISS) recommended that shareholders vote against the merger.
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Rite Aid stock sank on the news of this second merger being called off. Many investors question whether the pharmacy chain can be successful as a stand-alone entity in the face of formidable competition.
However, it’s important to remember that every share sold in the wake of the Albertsons deal collapse also had a buyer who was counting on ultimately making a profit. Could they be right about Rite Aid? Is the stock actually a buy after the big sell-off?
The “let’s make a deal” perspective
Let’s first look at why Rite Aid stock fell after the Albertsons merger was called off. Clearly, many investors were more pessimistic about Rite Aid’s prospects without the merger on the table. There certainly was some merit to that increased pessimism.
The reality is that Rite Aid is in a distant fourth place in the retail pharmacy business behind CVS Health (NYSE: CVS), Walgreens and Walmart. Rite Aid’s sale of 1,932 stores to Walgreens as a backup plan to the failed merger between the two companies resulted in Rite Aid becoming a much smaller competitor.
Merging with Albertsons would have resulted in a significantly larger — and arguably more competitive — company. A combination of Rite Aid and Albertsons would have claimed a No. 1 or No. 2 position in roughly two-thirds of the metropolitan markets where the companies operate. There would have been synergies created by the merger and a lower leverage ratio.
Now, though, Rite Aid is back to going it alone as a smaller fish in a big pond where swimming has become increasingly dangerous. The company continues to lose money. It still has debt totaling $3 billion. While opportunities for growth exist, they’re difficult to capitalize on with current rivals looking at those same opportunities and a potential game-changing competitor, Amazon, targeting the retail pharmacy market. It’s no wonder that many investors sold their Rite Aid shares as soon as they heard the Albertsons merger was off.
An opposing view
Investors who were negative about the Albertsons merger were more positive about Rite Aid’s prospects than those who favored the deal. Their opposing view is straightforward: Rite Aid can do better.
That doesn’t mean that opponents to the Albertsons merger don’t want Rite Aid to make another deal, though. They just didn’t like this particular agreement, in large part because Rite Aid shareholders would only have owned 30% of the combined company if the merger with Albertsons had been completed.
But could Rite Aid find another buyer? Maybe. In a letter to shareholders arguing the merits of the Albertsons merger, Rite Aid’s board of directors and management team stated that there have been “discussions with an extensive list of third parties around a range of strategic options for Rite Aid.” Although no other offers have been put on the table since the Albertsons deal was announced, it’s possible that another candidate could step forward in the coming months.
Another potential scenario for Rite Aid is that it could be bought by a private equity firm. It’s not too hard to imagine a deal like this resulting in the company eventually being sold off in pieces and parts, with Rite Aid’s EnvisionRx pharmacy benefits management (PBM) business potentially fetching a nice price tag.
And Rite Aid could still make a go at operating as a stand-alone company. In its recommendation for shareholders to oppose the Albertsons deal, ISS stated that Rite Aid “faces significant risks as a stand-alone company.” However, the firm also said that Rite Aid “appears to have reasonable prospects as a stand-alone business now that management no longer has to focus on the Walgreens Boots Alliance transaction and can instead allocate resources and attention to driving operational improvements.”
Ironically, the wave of big mergers and acquisitions in healthcare could present an opportunity for Rite Aid. CVS Health is in the process of requiring Aetna. Cigna is acquiring large PBM Express Scripts. There’s still some speculation that Walmart could buy Humana, which is already partnering with Walgreens on in-store clinics. This flurry of dealmaking could leave many smaller health insurers looking for a pharmacy and PBM partner that isn’t aligned with one of the big insurance companies.
To buy or not to buy
As we’ve seen, there are reasonable arguments both for and against buying Rite Aid stock. In my view, though, the matter can be settled by asking one question: Is Rite Aid the best stock on the market to buy? I suspect that most investors, even those who think Rite Aid could turn things around, would answer this question with a quick “no.”
I’m personally not a fan of CVS Health or Walgreens at this point, and both companies are in much better shape than Rite Aid is. My view is that the dynamics in the pharmacy and PBM businesses are changing so rapidly that it’s virtually impossible to know how things are going to shake out. I think that Amazon will be more successful in retail pharmacy than naysayers think it will be. And I’m uncertain about what the impact of drug pricing changes will mean for PBMs.
Rite Aid competes in an industry that’s in flux. The company is a relatively weak player in that industry. There simply are too many better stocks that investors can buy right now to risk waiting on a strike three for Rite Aid.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Keith Speights has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.