Late Wednesday night the expected merger between pharmacy company Rite Aid (RAD) and grocery chain Albertsons was called off ahead of Thursday's scheduled shareholder vote. Understandably, this caught many investors off guard even though a cohort of shareholders were less-than-enamored with the planned marriage of these two companies.
From my vantage point, I saw the coming together of Rite Aid and Albertsons as delivering cost synergies as well as helping ward off the looming pain points that each are poised to feel in the coming quarters. Absent those benefits, however, we have renewed uncertainty for Rite Aid shares, especially following a weaker-than-expected outlook from competitor CVS Health (CVS) earlier this week. Indeed, as co-portfolio manager of TheStreet's Stock Under $10 portfolio, we exited our RAD position this morning.
What are those pending pain points?
For Rite Aid it's the move by Amazon (AMZN) to disrupt the pharmacy industry following its acquisition of online pharmacy PillPack. And Amazon's move is likely just the beginning and as the online behemoth tends to play the long game.
Given the aging domestic population that is boosting demand for healthcare and pharmaceuticals, look for Action Alerts PLUS holding Amazon to strategically scale into this growth market leveraging its world class logistics along the way. Factor in a subscription business model and why would a person wait in line at the pharmacy when they know they can have their monthly prescription in a matter of hours or a day or two?
Amazon is also leading a charge at front-of-store retail at Rite Aid and other pharmacy names, along with Walmart (WMT) , Target (TGT) and Costco Wholesale (COST) , which per its July sales figures continues to win consumer wallet share.
As for Albertsons' pain points, it's facing the adoption of digital grocery being escalated as Amazon spreads its Prime business across Whole Foods. Indeed, Whole Foods is already benefiting from price cuts that no longer have it being called "Whole Paycheck." Other names such as Wegman's and Costco have partnered with Instacart for digital grocery ordering and delivery, adding to the changing landscape.
A combined Rite Aid-Albertsons entity would have had revenue of about $83 billion and approximately 4,900 stores, 4,350 pharmacies and 320 in-store health clinics across 38 states and Washington, D.C. This new company would have been the nation's second-largest supermarket operator and the third-largest drug chain, giving it the needed scale to compete against CVS Health, Walgreens Boots Alliance (WBA) and other grocers.
Aside from cost savings, one of the other synergies to be had from the merger would have been the complementary traffic between the combined grocery and pharmacy. According to Rite Aid, after examining several scenarios the company's board of directors saw this path as one of the best strategies to accelerate its business transformation and drive shareholder value.
What are likely seeing here is two companies calling off the merger in response to a lukewarm, at best, shareholder reception that centers on the economics of the deal, not the potential synergies, and could have resulted in a "no" vote by shareholders. Under the merger pact unveiled Feb. 20, Rite Aid shareholders -- in exchange for every 10 shares of Rite Aid common stock -- could elect to receive one share of Albertsons Cos. common stock plus about $1.83 in cash or 1.079 shares of Albertsons Cos. stock.
In effect, Rite Aid shareholders would have owned a 28%-30% stake and Albertsons' shareholders would have owned a 70%-72% interest in the combined company. As one might suspect, the surviving company would have been Albertsons. Not quite a merger of equals, but then again Rite Aid was not exactly in a position of strength following several botched attempts to shrink its footprint by selling portions of itself to Walgreens.
The real question now is how strong is Rite Aid's footing to fend off this increasingly competitive challenge? The answer is most likely "not very," which explains the share price reaction we are seeing in RAD.
There has been no shortage of companies that have seen the changing landscape in front of them and failed to respond (Blockbuster, Palm, BlackBerry (BBRY) ). But none of those faced the disruption that Amazon has unleashed, something that has upended entire industries, not just companies.
On its own, at a minimum, Rite Aid will have a difficult time and odds are it could very well be the next Blockbuster as consumers pivot to digital shopping not only for general merchandise but pharmaceuticals as well.