The Walgreens-Rite Aid Deal Hits Another Roadblock

In this segment from Market Foolery, Chris Hill is joined by Taylor Muckerman and Jason Moser as they discuss the latest news from Walgreens' (WBA -0.23%) bid to acquire Rite Aid (RAD 5.26%). The nation's largest pharmacy chain buying out the No. 4 player was always expected to raise regulatory, anti-competition eyebrows, but with word that the divestitures the pair had planned would be insufficient, the value of the deal in whatever its final form turns out to be is on the decline.

A full transcript follows the video.

This podcast was recorded on Jan. 30, 2017.

Chris Hill: Let's move on to Rite Aid. If there is a stock that's making Fitbit feel better itself today, it is Rite Aid. Shares are hitting their lowest point since 2014 after Walgreens lowered the buyout price by nearly $2 billion. And just to refresh everyone's memory, October of last year they agreed to a buyout at $9 a share, today that gets lowered to $6.50, maybe as much as $7.00 a share, which is a pretty big haircut.

Taylor Muckerman: Yeah it is. It is really dependent on the amount of stores that they would have to divest in order to make this deal happen. If they have to divest 1,000 or less, they will probably get $7, if they have to divest up to 1,200, which is what many people are thinking, likely $6.50 per share. But when you are looking at it, you see Fred's, I think was a Tennessee-based pharmaceutical store that said they would originally buy the stores when the deal was thought to be approved. But now the FTC is coming out and saying that there is still some question marks here. Maybe having to divest more than the original 867 stores, so seeing that haircut immediately . . . and shares weren't even trading up to the $9 level to begin with.

Hill: Right.

Muckerman: Some uncertainty right from the very get go.

Hill: Just to be clear, what is driving this is that Walgreens is looking, "How do we get this deal done?" If there is a silver lining for the shareholders of Rite Aid, it's that Walgreens is committed to getting this deal done. It is going to be at a lower price.

Muckerman: They extended the deadline. I think the deadline was this past Friday. They extended it out to July 31st. There has been a private equity firm, Cerberus, that has come out and said that they would like to potentially buy these stores if Fred's can't make it happen. There is some action on that side of things to help get the deal done, but you are still looking at what price Walgreens is going to pay and what price Rite Aid shareholders are willing to accept.

Hill: Isn't Cerberus the mythical three-headed dog who guards the gates of hell?

Muckerman: That is their logo, I think, as well.

Hill: If you're a business, and a company called Cerberus is calling you up and wants to do a deal. You're in trouble.

Muckerman:  Scratching your head.

Hill: Either run the other way or you're in trouble.

Muckerman: They have the money though.

Jason Moser: What's going on right now shows you that Rite Aid is in a position of total weakness. They are at the mercy of a suitor and it needs the suitor more than the suitor needs them. We are seeing a lot of consolidation in this sector. Walgreens buying Rite Aid, CVS buying Target's pharmaceutical division. You go back and you read the 8-K that the press release that came out when this deal was initially announced, I think back in late 2015, it was really interesting to see more or less the termination fees here involved. It basically all falls on Rite Aid's shoulders.

I think Walgreens knew going into this, that there were going to be some antitrust concerns at least or some questions. So that initial price was one where they set that mark and said "Okay, we may have to divest some here and if that is the case, we will be able to make all of this stuff happen." In most cases, the onus really fell on Rite Aid's shoulders to make sure this deal happened. If it doesn't happen, most scenarios result in Rite Aid actually having to pay Walgreen a termination fee regardless. So when you think about it from that perspective.

Muckerman: Wow, that's kind of backwards.

Moser: Walgreens is a much bigger company. It has close to three times as many stores, a much bigger market gap, more financial resources. At the end of the day, this is a deal that is going to happen. They are going to divest what they need to divest. If you are a Rite Aid shareholder, there is light at the end of the tunnel from that perspective. It goes to show you, Rite Aid has been in a position of weakness for some time.