Has Rite Aid Become A Lottery Ticket Trade?

A lottery ticket trade is one in which a trader takes a small risk in a bid to pocket a highly uncertain but highly rewarding return.

For a trade to qualify as a lottery ticket trade:

• The return should be notably higher.
• A high degree of uncertainty should characterize the return.

On a Downward Spiral

Rite Aid Corporation RAD shares have fallen since mid-January, shedding 35 percent in January alone. The negative catalysts that plotted its downfall were whispers the company's impending acquisition by Walgreens Boots Alliance Inc WBA may not come to fruition. With Bloomberg reporting a possible antitrust roadblock for the merger, and the company subsequently confirming the rumor by pushing back the deadline for the completion of the merger to April instead of the original January 27 deadline, uncertainty remains.

The uncertainty forced a downward revision in the deal price to $6.5-$7 per share from the $9 per share Walgreens proposed in October 2015. And traders moved out of the stock in droves. From the January levels, the stock has lost an incremental 13 percent. The stock is now at the lowest level in over two years. The 14-day relative strength index, a momentum indicator, is currently at 29.62, suggesting extremely oversold levels.

RAD Source: Y Charts

A Done Deal Could be Salubrious For Rite Aid Shares

Now to the returns part.

If the deal does materialize by going through the FTC vetting without any inordinate delay, the stock, which is trading at a discount (24-30 percent) to the offer price of Walgreens, could be in for a strong rebound before the closing. Thus, the returns would be enormous for the small risk assumed. If the deal doesn't go through, Walgreens might be forced to implement a plan B, as it has to find some investment avenue for the dollars it has earmarked for a Rite Aid buy.

The company's 2017 guidance, which incorporates a small contribution from a Rite Aid purchase, might be at risk. Additionally, the $1 billion synergies the company envisages might not materialize.

For Rite Aid, the ramification might be even more serious.

The company would be left to lock horns with its pursuer to get its share of the retail pharmacy cake. This could be an extremely unpalatable proposition, especially given its debt-heavy balance sheet.

How Certain Is The Expected Outcome?

There has been considerable uncertainty surrounding the consummation of the deal. The extension of the closure date was announced even with Walgreens' offer to divest 1,200 Rite Aid stores in favor of Fred's, Inc. FRED, up from 865 stores it agreed to sell in December. However, the FTC may be inching closer to bless the proposed combination, if a report in the New York Post is to be believed.

Editor's note, March 20: A previous version of this story described a lottery-ticket trade as "risk involved in the bet should be minimal; Another way of looking at it is that downside should be limited." Further, the story said Rite Aid's "current trading levels confirms satisfaction of one-criteria for a lottery ticket trade, namely the risk involved in investing being very minimal." This was an inaccurate description of a lottery-ticket trade and we apologize for any confusion this may have caused.

Related Links:

A Positive View On Walgreens Doesn't Depend On Rite Aid Deal

Rite Aid Poised To Close Under $5.00 For The First Time Since October 2014

Image: Mike Mozart, Flickr