Deutsche Bank analyst George Hill recently sounded a dire warning for Rite Aid (NYSE:RAD) if the proposed Walgreens Boots Alliance (NASDAQ:WBA) acquisition falls through. Hill predicted that Rite Aid's share price could fall to $2.25 per share. That's nearly 50% below the current share price.
Could this gloomy prediction really happen?
The power of negative thinking
I wouldn't dismiss the Deutsche Bank projection out of hand. Investors can sometimes react in surprising ways. When the herd mentality kicks in, an initial decline can mushroom into a huge plunge. I suspect that's what George Hill thinks could happen.
We've already seen this phenomenon occur to some extent with Rite Aid stock. At the beginning of the year, Rite Aid shares traded around $8.50 per share. Walgreens was proposing to buy the company at $9 per share, so that level made perfect sense.
However, when Walgreens changed the terms of the proposed deal in an effort to convince the Federal Trade Commission (FTC) to give it a green light, the price tag was reduced to a range from $6.50 to $7 per share. You'd think that Rite Aid's share price would have dropped to perhaps the $6.50 level. Instead, the stock price immediately plunged to below $5.50 per share.
And when reports first surfaced that Walgreens could certify compliance in its application for the acquisition, a move that would force the FTC to finalize a decision within 30 days, investors panicked yet again. Rite Aid's stock dropped down to close to $4.25 per share.
Worries about what might happen have wiped out around half of Rite Aid's market cap in less than three months. It's not out of the question that negative thinking about Rite Aid's future if the Walgreens acquisition collapses could erase another 50% or so of the company's valuation.
No pessimism from Pessino
Despite investors' concerns that the acquisition won't happen, Walgreens Boots Alliance CEO Stefano Pessina recently said that he remains optimistic. Pessino also confirmed that Walgreens was seeking to certify compliance as earlier reports indicated. He stated that clearance of the deal was expected by July.
I suspect that the involvement of Fred's (NASDAQ:FRED) in the deal will be key in swinging the FTC to a positive decision. In December, Fred's agreed to buy 865 Rite Aid stores for $950 million. This purchase would instantly catapult Fred's into position as one of the largest pharmacy retailers in the country.
But didn't Walgreens increase its offer to the FTC to sell off between 1,000 and 1,200 Rite Aid stores? Yes, it did. However, the terms of the agreement with Fred's covers that scenario. Fred's agreed to buy even more Rite Aid stores if the FTC required additional divestitures.
According to Pessino, it could take a few more weeks for Walgreens Boots Alliance to certify compliance with the FTC. The agency will then have to make its decision.
If the FTC gives a thumbs-down, Rite Aid is back to where it was in 2015 before Walgreens proposed the deal. The company will have to shift back to the mindset of going solo. The key for what happens after that would be dependent entirely on how Rite Aid performs. If the company can return to earnings growth, the future for Rite Aid should be much better than naysayers think. That's not too far-fetched, especially if Rite Aid's investments in store remodeling and acquisition of pharmacy benefits manager EnvisionRx pay off.
Although Rite Aid's share price stood close to $6.25 per share prior to Walgreens initially announcing its acquisition plans, don't expect investors to remember that if the FTC doesn't approve the deal. There would likely be a huge sell-off of the stock, even if Rite Aid's share price doesn't drop as low as George Hill predicts.
Of course, if Stefano Pessina's optimism about the deal going through proves true, we'll never find out how accurate Hill was or wasn't.