A lot of investors were left wondering after the Walgreens announced its purchase of Rite Aid for $17.2 billion. While it would increase Walgreens size, the increase in debt is so high as to almost be unmanageable.
Prior to its latest purchase Walgreens had been doing relatively well, even paying a small dividend and its stock was up 38 percent YTD. After the announcement, the stock initially jumped and then fell back once analysts realized that this new purchase adds $7.3 billion of Rite Aid’s debt to Walgreens’ already existing $11.7 billion of long term debt.
While before the acquisition this debt did not represent an issue as Walgreens had $3 billion in cash and positive annual operational cash flow of $5.66 billion. However with combined debt of the two companies and not much growth potential to be seen from the deal, this may now be an issue.
Rite Aid’s stock did well over the last several years as investors saw the potential of small companies in the bull market and cheap money era. However, as an overleveraged merged behemoth it is not so attractive. In an environment of deflation in the pharmacy market where costs are constantly being cut in line with product prices, even with bigger economies of scale, the combined company will struggle to grow quickly enough to service its existing debt.
Government as Last Resort
For now, Walgreens investors can hope that the government blocks the deal for antitrust reasons as Walgreens has a 31 percent of market share in the pharmacy industry, while Rite Aid controls 10.30 percent. This means the newly formed company would emerge in a dominant position which may give the government pause for thought especially when considering the sensitive nature of the industry. With the deal not looking wise for either consumers or investors, the government hopefully sees this and nixes the whole thing.