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A Somber Look at What's Next for Rite Aid

Call it "Plan C" for Rite Aid (NYSE: RAD).

Plan A was for Walgreens Boots Alliance (NASDAQ: WBA) to buy Rite Aid for $9.4 billion. That was the deal announced in October 2015. However, the Federal Trade Commission (FTC) didn't like that plan. As a result, the merger agreement was modified to lower the price tag from $9 per share to between $6.50 and $7 per share, with up to 1,200 shares being sold to Fred's (NASDAQ: FRED). The FTC didn't like that option, either.

So now Walgreens and Rite Aid have scrapped the acquisition deal. Instead, Walgreens plans to buy 2,186 of Rite Aid's stores for almost $5.2 billion in cash, with Fred's being cut out of the picture. Where does this Plan C leave Rite Aid? Here's a somber look at what could be next for the pharmacy retailer.

Image source: Getty Images.

The bad news

There's a lot of bad news for Rite Aid. The most obvious is that its stock took a shellacking, with shares plunging nearly 30% after the announcement that the acquisition wouldn't happen. Rite Aid stock is now trading at its lowest level since the middle of 2013.

Rite Aid will also emerge from the latest agreement (assuming approval by the FTC) as a much smaller company. It will have significantly less revenue and cash flow.

The worst thing about its size being pared down is that Rite Aid must still compete against big pharmacy retailers like Walgreens. Lower volume from fewer stores could put Rite Aid at a disadvantage in negotiating for prices. The company could also have less money to fund new initiatives to remain competitive with larger rivals.  

The good news

However, there is some good news from the new deal. Most important is that Rite Aid will be able to reduce its debt. As of March 4, 2017, the company had debt totaling $7.3 billion. Rite Aid CEO John Standley said that the sale of the stores to Walgreens allows Rite Aid "to significantly reduce debt, resulting in a strong balance sheet and improved financial flexibility moving forward."

Rite Aid expects to use "a substantial majority" of the proceeds from the Walgreens deal to pay down debt. Another positive is that it shouldn't have to pay much in federal taxes on the gain from the sale, since the company will be able to largely offset that gain with its net operating loss carry-forwards.

John Standley also thinks that Rite Aid will be able to increase its profit margins after the sale to Walgreens is finalized. Part of this improvement will stem from lower interest rate expense. In fiscal year 2017, Rite Aid spent nearly $432 million in interest expense. Its net income was barely over $4 million, so freeing up cash from paying interest will be huge for the company. 

It's also important to understand that Rite Aid is actually getting more per store than it would have originally. With the latest deal, Walgreens will pay Rite Aid nearly $2.4 million per store. The 2015 agreement priced Rite Aid's stores at just over $2 million each.                                                  

What lies ahead?

There are two perspectives about Rite Aid's future. One is that the company will be a mere shadow of its former self after selling the stores to Walgreens. Under this view, Rite Aid faces bleak prospects of competing against larger rivals.

The other take is that Rite Aid will be in better position financially than it's been in a long time. Reduction of the interest expense by lowering debt just might allow become more profitable than its been in a while -- even with fewer stores. If that happens, the current stock price could look like a bargain down the road.

There's also the possibility that a slimmed-down Rite Aid with less debt could be more attractive to other potential acquirers. The possibility that Amazon could be interested has even been floated. I wouldn't count on that, but who knows?

The deal with Walgreens still isn't a foregone conclusion yet, since the FTC still has to give its thumbs-up. It also remains to be seen exactly how much Rite Aid will be able to slash its debt, how much its profits will really improve, and whether it can be viable competitively. For now, investors are left mainly with questions. 

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Keith Speights has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.