I realize it may be a contrarian and unfashionable stance, but I just voted my modest Rite Aid (RAD 25.83%) stake in favor of the chain's proposed merger with Albertsons. We'll see how the vote plays out when the tally is counted at the Aug. 9 shareholder meeting, but it's shaping up to be an uphill battle.
The combination of the meandering drugstore operator and the sprawling supermarket giant isn't exactly gaining traction on Wall Street. Rite Aid is making a last-ditch effort to woo shareholders, which it wouldn't be doing if it thought shareholder acceptance was a slam dunk. There are too many naysayers, and well-regarded advisory firms are shaking their heads at the plan that would create a $24 billion drugstore and supermarket behemoth.
I disagree with the deal bashers, naturally. Let's go over the reasons why I voted in favor of the combination of Rite Aid and Albertsons.
Image source: Rite Aid.
1. Rite Aid's getting a fair share
Advisory firm Institutional Shareholder Services (ISS) recommended voting against the deal late last week. ISS is pretty influential with mutual funds and other institutional investors holding large blocks of Rite Aid stock, so it's an opinion that matters. Glass Lewis -- another advisory firm tastemaker -- also spoke out against the deal.
The most common argument is that Rite Aid shareholders will be getting just 28% to 29.6% of the merged entity. They feel that Rite Aid stakeholders should get a thicker slice of the combined company. Rite Aid defends the ownership ratio, pointing out that its assets will contribute just 19% of this fiscal year's projected EBITDA, 27% of the revenue, and 24% of the equity value.
It's easy to demand more, especially since it seems as if Albertsons is going this route after facing a lukewarm reception as it considered going public on its own last year. Rite Aid's balance sheet may not be perfect, but its partial asset sale makes it a less leveraged situation than Albertsons finds itself in these days. However, Rite Aid was never going to get the lion's share of the combined company. A nearly 30% slice is fair enough.
2. The synergies are real
Rite Aid and Albertsons are jagged puzzle pieces that fit in place rather nicely. Albertsons will be able to expand the Rite Aid name by rebranding its supermarket pharmacies. Rite Aid will be able to stock some of Albertsons' brands. Each company will expand the sales and presence of the other.
The pitch claims that the combination will result in $375 million a year in cost synergies and $3.6 billion in incremental annual revenue opportunities. The combination creates legitimate value, as the whole is greater than the sum of its parts.
3. Rite Aid is dead on its own
It's been a long way down for Rite Aid shareholders since plans to be acquired by Walgreens Boots Alliance came undone. Rite Aid settled for $4.375 billion in a partial asset sale of 1,932 of its stores and three distribution centers, but the past two years with the drugstore operator in limbo left a mark. Rite Aid stock is selling at a third of where it was before Walgreens stepped up as a suitor in late 2015.
The recovery process has been slow. Rite Aid -- like other pharmacies -- is struggling with diminishing reimbursement rates. Consolidation among health insurance companies and generic manufacturers is eating away at Rite Aid's margins. Its latest quarter treated investors to another adjusted net loss from continuing operations on flattish revenue growth.
It's too late to call Albertsons' bluff, hoping that walking away from this deal will result in Albertsons coming back to offer 35% or 40% of the combined company to Rite Aid shareholders. There's also little reason to believe that the now-smaller Rite Aid will fare any better in the future than when it had 1,932 more stores. The naysayers may win next week's showdown, but Rite Aid will only be that much more desperate to sniff out a new exit strategy.
