Rite Aid Corporation (RAD -10.00%) keeps on taking hits. The pharmacy retailer has lost around 80% of its market cap so far this year, after a planned acquisition by Walgreens Boots Alliance (WBA 0.57%) fell through. Just when it seemed Rite Aid might be able to rebound a little after the sale of a large chunk of its stores to Walgreens was finalized, another hit came along.
All of the major pharmacy stocks nosedived after the St. Louis Post-Dispatch reported last week that Amazon.com (AMZN -1.32%) has obtained wholesale pharmacy licenses in at least 12 states. But Rite Aid stock tanked the most, for one big reason: Amazon's likely entrance into the pharmacy business makes Rite Aid stock riskier than ever before.
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Investing rationale for Rite Aid
To understand why competition from Amazon is especially worrisome for Rite Aid, we need to first recognize why anyone would buy Rite Aid stock right now. One reason is that Rite Aid might somehow turn things around. The other is that Rite Aid could still be acquired.
Walgreens' deal to purchase 1,932 of Rite Aid's stores made both of these premises possible. Although Rite Aid will be much smaller after selling its stores to Walgreens, the stores that it's retaining are more profitable than the ones it's losing. The company's debt will also be significantly reduced after receiving $4.375 billion in the transaction. As a bonus, Rite Aid gets to use Walgreens' network to buy generic drugs for the next 10 years. All these factors could help Rite Aid become more competitive in its remaining markets.
The "new" Rite Aid, at least in theory, could also be a more attractive acquisition target. For one thing, it's a whole lot cheaper than it's ever been. There will also be less debt to scare away potential suitors. My thought not long ago was that Rite Aid could even be a gold mine for bargain hunters if management positions the company for a sale to a private-equity firm (or, less likely, to another pharmacy chain).
The Amazon effect
But with Amazon now apparently serious about entering the retail pharmacy business, Rite Aid could face more trouble than its larger peers. CVS Health (CVS 0.87%) makes 70% of its total revenue from its pharmacy services segment, which provides pharmacy benefits management (PBM) and other services. In addition, CVS Health is making a bid to acquire large health insurer Aetna, which would diversify its business even more. One major reason an acquisition of Aetna makes sense for CVS Health is the threat from Amazon.
Walgreens Boots Alliance is more dependent on retail sales than CVS Health is. However, the company still generates nearly 18% of its total revenue from its wholesale drug-distribution business. Walgreens' size, even greater with the gain of the Rite Aid stores, could also allow it to compete more effectively against Amazon.
But what about Rite Aid? It also operates a PBM business that pulls in nearly one-fifth of the company's total revenue. Like Walgreens, though, Rite Aid is much more dependent on its retail pharmacy operations -- and that's where Amazon will focus its efforts. And despite access to Walgreens' network for generic-drug pricing, Rite Aid doesn't enjoy the same economies of scale that Walgreens does.
If Amazon is as successful in selling prescription drugs as it has been with other products, the retail pharmacy market could undergo an upheaval. As the weakest of the large pharmacy chains, Rite Aid is likely to suffer the most. In my view, the probability of a successful turnaround is lower with the threat from Amazon.
Amazon's entrance into the pharmacy business could also reduce the potential that private-equity investors will want to buy Rite Aid and take it private. The reality is that the prospects of having to compete against Amazon scares many people. And other pharmacy chains are probably more likely to look at diversifying (as CVS Health wants to do) instead of expanding their retail pharmacy operations.
Kindling hope?
As I see it, there are three reasons to still have some hope that buying Rite Aid stock could make investors handsome profits. First, Amazon might not emerge as a big threat. The company still could choose not to move into the retail pharmacy business. It's also easy to overlook sometimes that the e-commerce giant has experienced its share of failures, including a credit card processing service for retailers that folded last year.
Second, Rite Aid's valuation is so low that it could still be an acquisition target. After all, the company's revenue over the last 12 months is a whopping 20 times its market cap. Amazon or no Amazon, somebody just might think Rite Aid is too great of a deal to pass up.
The third reason is an extension of the second one: Maybe Amazon will buy Rite Aid. Crazy? Maybe so. But Amazon has already demonstrated its willingness to move into brick-and-mortar retail. The company could certainly afford to buy Rite Aid, even at a nice premium to its current price.
The problem, though, is that reasons No. 1 and No. 3 appear to be huge long shots. An acquisition of Rite Aid, by someone other than Amazon, is probably still the best opportunity for investors to win by buying the stock. But, thanks to Amazon, the risk that won't happen is now higher than it's been.
