The Downfall of Rite Aid (RAD)

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Welcome to the 110th Pari Passu newsletter.

Last week, we understood the history and sources of financial distress across the broader retail pharmacy industry, comparing the business models of CVS, Walgreens, and Rite-Aid.

The previous article culminate in today’s grand finale – the downfall of Rite Aid, the hurdles that limited pursuing out-of-court solutions, and the strategic levers pulled from filing for Chapter 11 and navigating complex creditor dynamics. 

A good understanding of Rite Aid’s business model will help contextualize why debtors and creditors often have conflicting perspectives on the company’s true value after emerging from bankruptcy, often the reason behind long, messy valuation fights.

Let’s get to it.

Table of Contents

• Brief Overview of Rite Aid

• Early Signs of Financial Distress 

• Possible Alternatives to Chapter 11

• Rite Aid Files for Chapter 11

  • Rite Aid 2.0 Plan

  • Conflicts with McKesson

  • Negotiations With Unsecured Creditors

  • 363 Asset Sale of Elixir

• Final Recoveries

• Key Takeaways and Future Outlook 

Brief Overview of Rite Aid

As we saw last Friday, Rite Aid Corp. is a Philadelphia-based retail drugstore and pharmacy chain operator [1]. With more than 2,100 locations across 17 states and generating $24bn of revenue in FY 2023, the company operates in two main business segments:

• Retail Pharmacy (70%): sells prescription drugs and provides various other pharmacy services, such as administering immunizations against COVID-19, shingles, the flu, etc.

• Pharmacy Services (30%): provides an integrated suite of pharmacy benefit management (PBM) offerings through its mid-market PBM Elixir. These offerings include technology solutions, mail delivery services, specialty pharmacy, network and rebate administration, claims adjudication, and pharmacy discount programs. Check out last week’s post to learn more about the industry structure and the role of PBMs. 

Founded in 1962, Rite Aid rapidly grew through acquisitions to become the third-largest retail pharmacy in the U.S. For example, in 2007, they acquired Brooks and Eckerd drugstore chains for $3.4bn. In 2014, they acquired Health Dialog, which provides personalized healthcare coaching and disease management services. Then, in 2015, they entered the PBM business by acquiring Elixir for $2bn. In 2020, they acquired Bartell Drugs, a 67-location Seattle-area chain. However, this strategy put their leverage high at above 7x since pre-pandemic, which peaked at 13x in September 2023. 

To scale back from this aggressive expansion strategy, Rite Aid began to find ways to monetize its assets for cash. For example, between 2021 to 2023, they sold off parts of the Center of Medicare and Medicaid (CMS) receivables to Bank of America for ~$2bn under their Elixir business. This was a quick way to monetize future reimbursement payments they would have received from government health insurance programs such as Medicare and Medicaid. Rather than tying up these receivables, they could use this upfront cash to pay down debt or reinvest into the business. In 2015, Walgreens announced a $17.2bn acquisition of Rite Aid, but it was scaled down due to the Federal Trade Commission’s antitrust regulations. Instead, Walgreens purchased 1,932 stores, approximately half of the then-store count, including some of Rite Aid’s strongest performing locations, and three distribution centers for $4.38bn.  

Like most retail pharmacies, Rite Aid saw a temporary boost in revenue from the increase in demand for COVID test-kits and services. However, Rite Aid was the most vulnerable against long-term industry headwinds, such as competition from online pharmacies and retailers selling generic products and reduced demand for pharmacies post-pandemic. Their smaller scale made it difficult to negotiate attractive pricing for prescription drugs with manufacturers, and they had less operating leverage compared to their bigger competitors. 

Early Signs of Financial Distress 

As a quick recap, Rite Aid had multiple ongoing issues building up to filing for Chapter 11 in October 2023. In September 2023, their quarterly revenue declined by 6% YoY at $5.6bn and recorded a net loss of $1bn. They had $408.8mm of total liquidity including $390mm of available RCF but only $18.8mm cash on hand. From a capital structure perspective, they were highly leveraged at 13x with $4bn of total debt that generated $261mm of annual interest expense. From a timing perspective, $320mm of 7.5% senior secured notes were maturing in 2025 and more than $2bn of prepetition secured debt were maturing in 2026. In fact, maturity walls could come up at once in 2025 as the secured debt would ‘spring forward’ if the senior secured notes could not be refinanced, which seemed very likely from the notes trading at distressed levels [1]. Usually, if it seems a junior piece of debt with an early maturity date cannot be refinanced, the springing maturity will make sure the senior piece of debt, like a revolver, gets refinanced or repaid first. Given Rite Aid’s continued level of distress building up to its bankruptcy, it seemed like filing for Chapter 11 was inevitable by the end of September 2023. Before filing for Chapter 11, Rite Aid explored a few out-of-court solutions. This said, the situation was tragic with a combination of high-leverage, low liquidity, a deteriorating business, and massive tort liabilities. 

Rite Aid’s corporate decisions clearly signaled a high level of distress to the market. One sign was drawing down their revolving credit facility (RCF), which is a type of loan organized by banks for working capital and business operations that occupies the most senior position of the capital structure. Before filing in 2023, Rite Aid had already drawn down $1.6bn out of the $2.7bn maximum capacity. While a borrower can flexibly draw and repay the RCF as long as it is under the credit limit, it’s considered more as a backup source of funding, so drawing it down implies extremely low liquidity and an inability to raise new capital. 

Historically, Rite Aid has been able to push out maturities to buy more time for a turnaround. As long as investors were open to refinancing existing debt with new debt, borrowers would rely on this amend and extend strategy without addressing the core issues of their deteriorating businesses. In July 2020, they exchanged their outstanding $1.125bn of 6.125% Senior Notes due in 2023 for $849.9mm of 8.00% Senior Notes due in 2026 and $206.4mm in cash. Despite recording a quarterly net loss of $73mm, Rite Aid successfully encouraged 87% of the existing noteholders to participate with some sweeteners they wouldn’t want to miss out, such as a higher coupon rate and pari-passu status with the existing ‘25 notes. Furthermore, in August 2021, Rite Aid amended the pricing on their senior secured credit facilities by reducing the coupon rate from LIBOR+300 to LIBOR+275bps while extending the maturity date from 2023 to 2026 [1]. Through these out-of-court transactions, Rite Aid was able to extend the maturity date by 3 years, buying more time in expectation of a potential turnaround. 

However, in 2023, the market was already pricing in the high likelihood of Rite Aid’s filing. Despite being secured, the ‘25 and ‘26 notes were trading around sixty cents as they were junior to the $2bn of RCF, which had a priority claim over Rite Aid’s deteriorating collateral base. Not to mention, the unsecured notes were trading at twenty cents. To take advantage of the notes trading at a significant discount, in November 2022, Rite Aid launched a $165mm tender offer of ‘25 notes at 75 cents on the dollar to retire outstanding debt and reduce its interest payments [2]. Realistically, however, deleveraging by $280mm barely helped to address the 10x total debt-to-EBITDA leverage without a significant growth in EBITDA. For example, to satisfy the requirements of rating agencies targeting a 5x leverage ratio, they would have to reduce the debt by $900mm to $1bn. Rite Aid’s operating margins have been depressed since pre-COVID and recovered slightly during COVID due to an industry-wide surge in prescription volumes and favorable reimbursement rates. However, before their filing in 2023, Rite Aid began to lose clients, recorded negative growth in the front-end stores segment that sells generic products, and an increased medical loss ratio led to heightened costs for their insurance business, Elixir. 

Possible Alternatives to Chapter 11 and their Limitations 

Realistically, Rite Aid would have also explored creative liability management transactions, but there were limitations within the boundaries of the credit docs. Credit docs include covenants, which are restrictions imposed by lenders over borrowers to preserve collateral value and ensure debt repayment. Considering the covenants in the indentures of the secured 2025 and 2026 senior notes, here are some out-of-court solutions that would have been considered to raise new capital. 

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