Walgreens–Rite Aid Deal In Its Final Act

Drug store chains Walgreens and Rite Aid announced on October 27, 2015 an agreement under which the former will acquire the latter for $17.2 billion in cash.

The deal valued each of Rite Aid shares at $9, a 48-percent premium over the closing price on the day ahead of the deal announcement.

The companies had said then, the deal would likely close in the second half of calendar year. The deal was expected to be accretive to Walgreens earnings in the first full year after the closing, with synergies estimated to be in excess of $1 billion.

Subsequently, on February 4, 2016, Rite Aid shareholders voted in favor of the merger.

The FTC Roadblock

Walgreens was then left with the unenviable task of negotiating with the Federal Trade Commission regarding the potential divestitures both the parties should make in order to secure regulatory approval.

Against this backdrop, reports emerged that Kroger Co KR could lap up hundreds of stores of both the companies that would help them win regulatory backing.

Deadline Extended

A year after the announcement of the deal, Walgreens and Rite Aid pushed back the closure deadline to early 2017 from the previous deadline of the second half of 2016.

Meanwhile, Walgreens and Rite Aid announced in December 2016 that they have agreed to sell 865 Rite Aid stores and certain related assets to Fred's, Inc. FRED for $950 million in cash. The deal, however, was contingent on the closure of the Walgreens–Rite Aid deal.

Deutsche Bank had commented then Fred's had taken a giant leap in its transformation from a dollar store to a bona fide pharmacy, with the proposed purchase. The company was seen to transform into a long-term viable competitor in the space, with a more national footprint.

Another Delay, Reduction In Offer Price

Come January of 2017, the prospects of consummation of the deal worsened after Walgreens, citing a further delay, lowered the deal price to $7–$6.50 per share. The price range meant that the price would be fixed at $7 if the FTC seeks divestment of 1,000 or fewer stores, and a lower price of $6.50 would come into play if about 1,000–1,200 stores were to be divested. The companies said the deal would take another six months to close.

The delay prompted Walgreen to slash the upper end of its 2017 adjusted earnings per share guidance to $5.08 from $5.20.

On May 8, the companies said they have certified substantial compliance with the second request from the FTC. As per a January 2016 agreement with the FTC, the companies have agreed not to close the deal before 60 full calendar days following the compliance with the second request, giving the FTC time for either approving or blocking the deal. The 60-day period beginning May 8 would end on July 7.

However, there is still no clarity on the status of the deal.

Parties Relay Pessimism

The situation now looks grim, according to a report in TheStreet.com. The report quoted a SEC filing by Rite Aid, which carried a communication from John Standley, the chairman and CEO of Rite Aid, and Ken Martindale, the CEO of Rite Aid Store, to the employees. The tone concerning the completion of deal was somber, as they stated that they expect a decision soon. This is in stark contrast to the company's earlier statements that an approval is likely.

Walgreens also relayed its apprehension concerning the consummation of the deal by deciding not to issue additional debt securities to replace the notes to be redeemed if the Rite Aid deal did not go through by June 1.

However, if there is one, who is still optimistic, it is Fred's, which said on its earnings call that it is working collaboratively with Walgreens, Rite Aid and the FTC to win approval for the purchase of Rite Aid stores, earmarked for divestment.

How The Stocks Fared Amid The M&A Drama?

Walgreens shares, which tumbled in the aftermath of the deal announcement, losing over $20 in the process, recouped some of the losses and have been locked in a trading range of $77.50–$87.50 since then.

Meanwhile, Rite Aid shares soared about 43 percent on the day of the deal announcement. The rally, however, did not take it past the then-offer price of $9. In anticipation of the deal closure, the stock held between $6 and $8 mark until January 2017, when the companies postponed the deal closure date for the second time and also trimmed the offer price.

From a high of $8.67 on January 13, 2017, the stock has come off notably to $3 on June 9, losing 65 percent of its value in the bargain.

Source: Y Charts

That said, the sell-off has made Rite Aid shares an attractive proposition, especially if the deal does go through at $7 dollar per share of Rite Aid stock. The intrinsic value of Rite Aid, according to X-fin.com is $3.13, while GuruFocus estimates it to be $1.89.

The intrinsic value, according to Investopedia, is the actual value of a company, taking into consideration all aspects of the business. It is the value derived out of fundamental analysis of a company.

Given that the current market price is closer to its intrinsic value, there is more upside potential for owners of Rite Aid stock than the downside risk, given the $7 offer price. Even if the stock falls to $1.89 (GuruFocus' intrinsic value estimate) in the eventuality of the deal being blocked, a person who is invested in Rite Aid stands to lose roughly 40 percent. However, if the deal is finally approved after all the twists and turns, the investor could profit to the tune of 124 percent, as the stock would trade up close to the offer price when the hurdles are cleared.

Any takers willing to assume the risk of the deal falling through?