A $2.30 Stock that is Worth Sprint’s $7.00 Buy Offer

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The acquisition spree for Sprint Nextel (NYSE: S) continues to heat up, as Dish Networks makes a bid to acquire. The latest offer would be to purchase the company for $7 per share, a premium of more than 200% from its January 2012 low. While Sprint continues to catch the market’s eye late, Rite Aid (NYSE: RAD) is another acquisition target that is worth the same $7 per share, or more.

How Do you Compare Rite Aid to Sprint?

Rite Aid and Sprint are two completely different companies. Sprint is a telecom company and Rite Aid operates in the pharmacy retail business. The two companies share very few common bonds, with the exception of both having individual catalysts that are attractive to potential acquirers.

Back in early 2012, very few would have considered Sprint an acquisition target. It had posted many years of lost revenue, continued to lose subscribers, and had significant debt. Yet with the addition of the iPhone the company was once again competitive. And since then, subscribers have increased, and revenue saw a gain of more than $1.5 billion over the previous year. The company has become attractive due to its fundamental improvements, its large subscriber base, and its network.

For Rite Aid, the company is now profitable! It has been six years since Rite Aid posted a profitable year, and this accomplishment comes thanks to both a macro shift to generic drugs and also a multi-year restructuring strategy to lower costs and eliminate unprofitable locations. Yet still the company’s margins are barely producing a profit and because of the upside in margins that exists, combined with its large market presence, it is very possible that this undervalued company could become highly attractive as an acquisition target.

The Market’s Major Concern with these Two Companies

The one knock on both companies has been debt. Yet despite a large debt position of more than $24 billion, Sprint has commanded significant interest from acquirers. Sprint has a debt-to-assets ratio of almost 50% to compliment an accumulated deficit of nearly $45 billion (which is often hidden in the balance sheet).

Just to be clear, Sprint’s large debt position clearly shows years of inefficiency on behalf of management. However, investors often forget that the company operates in a high debt industry. Its largest competitors AT&T and Verizon have debt of $69.84 billion and $51.99 billion, respectively. Therefore, considering Sprint’s operational presence, its $24 billion in debt doesn’t seem that bad.

Now, using the same formula, investors’ chief concern with Rite Aid has been debt, as it has $6 billion on its balance sheet. But much like telecom, the pharmaceutical space carries a lot of debt, as Walgreens has $6.36 billion and CVS has almost $10 billion in debt on their balance sheets. However, much like Sprint, you can clearly see the years of operational struggles, although with Rite Aid being profitable it is now making strides to clean up its debt without the help of a partner or an acquirer.

The point is that despite high debt, Rite Aid is still highly attractive as an acquisition target. The nature of the business must be considered, and both Sprint and Rite Aid operate in high debt sectors of the market. With that said, $6 billion in debt for Rite Aid is quite minimal considering the amount of margin upside that exists in the space.

Valuation

One final point to consider is the level of value being presented in shares of Rite Aid for a potential acquirer. Seeing as how Sprint is not profitable, it might be best to view its acquisition on a sales/valuation basis. Most assume that Sprint can achieve profitability and does have positive EBITDA, but still has not crossed the crucial line into net profit, nor is it close.

“If” Sprint is acquired for $7.00 per share then it would be purchased for about 0.70 times sales. The company has sales of $35.34 billion and a $7 purchase would be $25.15 billion. Compared to both Verizon and AT&T, Sprint at $7.00 is still a 35%-50% discount to sales. Obviously, the discount is due to margins, as AT&T and Verizon trade with operating margins that are 10-12 times greater than Sprint. Therefore, an acquirer of Sprint validates the offer by assuming that there is room for improvement.

Looking at Rite Aid, the comparison at $2.30 is so far off from its competitors that it’s not even worth comparing. With that said, at $7.00 a share Rite Aid would trade with a market cap of $6.20 billion and a price/sales of 0.24. Remember, this is at $7.00 a share, which would be a premium of more than 200%, and even with this premium, Rite Aid still trades at a deeper discount to its largest competitors CVS and Walgreens (by 50%-70%) than Sprint Nextel at $7.00.

Conclusion

Just to make sure you understand, Rite Aid with a 200% premium on top of its six month 100% gains it is still cheaper than Sprint when compared to each company’s respective industries. Not to mention, Rite Aid is now profitable, Sprint is not, and Rite Aid has had no offers to note. There is two points to this comparison: First, Rite Aid has a tremendous amount of upside from this point forward, second, Rite Aid is highly attractive as an acquisition target despite its debt. As a result, I would watch the stock closely, and would set a price target for $7.00, whether it be by acquisition or in stock performance, I think Rite Aid is clearly worth it and will reach the price target. 


Brian Nichols is long ALU. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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