Will This Pharmacy Company be Acquired, and Is It Needed?

Rite Aid (NYSE: RAD  ) got a pop on Wednesday, September 11, to a new high of $3.75 as CNBC's Halftime Report analyst suggested an eventual takeover in Rite Aid's future . This rumor has been whispered before; investors must wonder if it is likely, and if an acquisition is needed to create larger gains for Rite Aid.

Will it be acquired?
Since Rite Aid turned profitable late last year, and began to see increased same-store sales , investors and analysts alike have entertained the idea of a potential Walgreen (NYSE: WAG  ) or CVS (NYSE: CVS  ) takeover. Strategically, it makes sense.

Rite Aid has a market cap of just $3.3 billion, yet the company has annual revenue of more than $25 billion. Therefore, either CVS or Walgreen could acquire Rite Aid's revenue at a fairly cheap price, and the acquisition would provide significant growth.

Because of the fact that new generic introductions are boosting margins for pharmacies at a rapid rate – generic drugs have higher payouts to pharmacies – it seems more likely that one of the large pharmacies would take a serious look at Rite Aid, now more than ever. Moreover, the rate at which new generic drug introductions are expected to increase over the next three years makes this interest even more appealing. But unfortunately, I don't see it ever happening.

To explain, think back to AT&T's (NYSE: T  ) attempted acquisition of T-Mobile. The Federal Communications Commission – or the government – blocked its proposal, finding that the merger would create an unfair advantage and negatively impact the competitive effect of the free market. Specifically, the FCC's comment was, "the transaction would decrease competition, innovation and investment, and harm consumers ."

Of course, AT&T argued against the FCC's response, but ultimately AT&T lost. For an industry comparison, there are much fewer telecom companies than small pharmacies in the U.S. CVS, Walgreen, and then Rite Aid are the top three pharmacies, but it's difficult to imagine a scenario where the government allows the merger of either CVS or Walgreen with Rite Aid due to the reasons noted in the AT&T/T-Mobile deal.

Hence, it is possible that we see a proposal of sorts and that rumors continue to build, but the likelihood of Rite Aid being acquired is slim to none.

Does an acquisition matter?
Thankfully, it really doesn't matter for current investors if Rite Aid is acquired or not.

It's no secret that Rite Aid has lower margins, a higher debt-to-assets ratio, and its growth is not nearly as impressive as either Walgreen or CVS. In fact, Walgreen and CVS are both exploding with comparable-script growth , while Rite Aid's script revenue is flat to slightly lower year over year.

However, these Walgreen and CVS strengths have little impact on the future of Rite Aid's stock. The reason is that Rite Aid is now profitable, as last year was its first full year of profitability in more than half a decade.

In the first two quarters of 2013, Rite Aid's profit is nearly double 2012's full-year profit , and what's impressive is that new generic introductions are only going to help improve margins . As a result, Rite Aid's price to sales ratio comes into play, because I would challenge that Rite Aid could double in price without seeing any revenue growth, and without being acquired.

Valuation equals upside
The reason Rite Aid could double without any revenue growth is that it trades at just 0.13 times sales. In comparison, CVS and Walgreen trade at 0.59 and 0.67 times sales, respectively. Granted, both Walgreen and CVS are more efficient companies, but as Rite Aid's margins improve and it pays its debts, it becomes more deserving of the premium that has been awarded to its industry peers.

Thus, if Rite Aid trades at 0.3 times sales and continues to restructure its business and profit from new generic introductions, its stock would be more than double its current price. Moreover, at 0.3 times sales, Rite Aid would STILL trade at a 50% discount to its peers! As a result, I hardly believe that an acquisition is necessary as the next catalyst for Rite Aid.

However, because of Rite Aid's valuation relative to its peers, I think it is clear to see why both Walgreen and CVS might bid to acquire Rite Aid. Either way, it's setting up to be an interesting and potentially lucrative year(s) ahead.

 

Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 13, 2013, at 12:40 PM, masterwallstreet wrote:

    In my opinion only, I agree with you 100% on your article. Either CVS or Walgreens will try to buy Rite Aid. That store that buys Rite Aid will become the #1 drug store. There is a lot more competition that may acquire Rite Aid like Walmart or Target. Even with or without a buyout the stock has potential of doubling or tripling. I can not wait for earnings to come out and the conference call. I think they are trying to hold this thing down before conference call. Hopefully we get some surprise news bfore or on earnings.

  • Report this Comment On September 13, 2013, at 12:47 PM, KrisShankar wrote:

    Brian,

    While CVS/WAG may not be potential acquirers, I think there is a higher likelihood by someone like Walmart, Costco or Target. These retail giants have their own pharmacies but have not been able to make meaningful inroads against CVS/WAG/RAD for several reasons. With consumer sentiment continuing to languish, the retail pharma sector looks attractive due to macro tailwinds (generics, ACA, etc). Another possibility, although unconventional, could be further consolidation in the vertical food chain. Someone like Cardinal Health or McKesson may see a threat from the WAG/Amerisource alliance and make a run for RAD.

    Kris.

  • Report this Comment On September 13, 2013, at 5:37 PM, Mayvau wrote:

    I would throw out another possible acquirer in Fomento Econ. Mexicano. (FMX). It has a massive convenient store presence in Mexico but might consider adding pharmacies to grow throughout Latin America. And FMX could certainly afford it either in cash or stock.

    RAD would dramatically lower FMX's sales per share figures.

  • Report this Comment On September 14, 2013, at 6:07 PM, BrianNichols wrote:

    Mexicano is a good suggestion, but Target, Wal-Mart, or Costco are unlikely, unless any wanted to pursue mini stores, which is an idea.

  • Report this Comment On September 16, 2013, at 6:03 PM, bestinsiderinfo wrote:

    It will not be bought out. I used to work there. They can pad their balance sheet all they want. It is still a company with billions in debt. CVS if they bought it out might be looked at strongly for creating a monopoly of pharmacies on the East Coast alone. Walgreens doesn't have the money nor the risk ability to take on such massive debt. The company has made strides in making money solely due to one thing and one thing only: the massive profit margin on immunizations. Rite Aid was one of the first to jump start advertising and forcing its pharmacists to be immunizers. CVS just started. Once all the chains and supermarkets compete for that easy 15 to 20 dollar a shot profit, Rite Aid will be back where it was before at 1.50 or less a share. I would not wish this stock on my worst enemy. Make a profit on it while you can, sell within a year's tops. Keep in mind when the stock had to undergo a five fold split years ago before being delisted from the stock exchange, nobody wanted this mess and trust me, nobody will ever want this company. Add to that the high level of incompetence at the helm of this company too. It's not like CVS. There is no forward thinking just an overabundance of management duplicating duties.

Add your comment.

DocumentId: 2636883, ~/Articles/ArticleHandler.aspx, 4/18/2014 5:09:25 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement