Rite Aid is a retail pharmacy business headquartered in Philadelphia, with now less than 2,000 stores throughout the US, when in 2012 they had over 4,300 stores. What happened to Rite Aid? Well a combination of fierce competition along with secular industry headwinds has seen the trading prices of their equity and debt tumble as they have filed for chapter 11 bancruptcy last year.
The decline of Rite Aid was, like always, due to a multitude of reasons with a few specific catalysts. primarily the drying up of liquidity, the considerable increase in leverage, and strong industry headwinds in both their retail pharmacy business as well as their pharmacy benifit manager (PBM) business. First I’ll talk about the headwinds faced with the business, becuase thats where all their problems stemmed form. First the retail pharmacy business has recently been feeling margin compression due to the increased competition from online pharmacies like Amazon and Walmart who serve as fierce new compeditors in this market primarily due to their large existing cusotmer base and their existing delivery inferastructure. Increased competition along with the reduction in retail spend on medical supplies after the pandemic has caused significant margin compression for retail pharmacies that are not able to benifit form economies of scale like CVS and Walgreens, although they have recently seen financal stress as well. Their PBM business has also seen significant industry headwinds primarily due to the lack of negotiating leverage of being a regional PBM, especially when competing against the three largest PBMs that make up 80% of the market.
But these operational difficulties (reductions in EBITDA) along with the continued drawdown of their revolver saw leverage increase to around 13x in September 2023 with around $4 billion in total debt. Not to mention that they had $320mm of 7.5% senior secured notes maturing in 2025, along with a $2.2bn revolver due in 2026 with a springer covenant that will see the whole amount come due one month before the 2025 secured notes if Rite Aid is not able to refinance or extend out those 2025 secured notes. And with Rite Aids deteriorating credit quality the capital markets looked highly unlikely to be willing to refinance those 2025 notes. So at this point bancruptcy looked inevitable, but Rite Aid did explore some out-of-court possibilities.
They explored the asset sale of their PBM, Elixir around this time. Seeking to drop it into an unrestricted subsidiary and seek new financing using Elixer as collateral for the new source of fianncing to entice creditors. Although that was blocked becuase the credit docs only allows for a maximum basket capacity of $175 million to be dropped into a new entity. Their second out-of-court attempt at raising capital was blocked under the general lien basket covenant that sets the amount of collateral that a borrower can offer to seek additional secured financing at 0.75% of the total assets. And at the time that was only about $53mm of the $7.13bn asset base as of September 2023. And the third was additional sale leasebacks, which they advised against although they could have potentially raised $600mm at the cost of higher operating expenses—becuase they would consider these operating leases to keep debt low—in the future, further restricting liquidity that they desperately need to conserve. After exploring these options they eventually filed for bancruptcy.
They officially retained Krikland & Ellis, A&M, and Guggenheim as their bancruptcy advisors. And one of the first actions they took was entering into a restructuring support agreement (RSA) with an Ad Hoc group of secured 2L noteholders represented by Paul Weiss, FTI, and Evercore. Their capital structure is displayed below:
1L Secured Debt (spring maturity)
$2.2bn SOFR + 3.000% ABL Revolving Credit Facility, due 2026
$400mm SOFR + 3.000% FILO Term Loan, due 2026
2L Secured Debt
$320mm 7.500% Senior Secured Notes, due 2025
$850mm 8.000% Senior Secured Notes, due 2026
Unsecured Debt
$186mm 7.700% Notes, due 2027
$2mm 6.875% Notes, due 2028
Along with Rite Aid recieving $3.45bn in DIP financing shortly after filing from existing 1L creditors. with $2.85bn ABL revolver for working capital and other liquidity needs, while $400mm went to the FILO TL.
The RSA and POR laid out a reorganization based restructuring where the 1L ABL claims would see full recovery, and the 2L notes would be completely equitized into 100% Rite Aid post-reorg equity. Although the majority of the unsecured creditor groups were justifiabily frustrated at the cancelation of their debt without recovery value. So the comapny had to conduct multiple rounds of settlement talks to balance the interests of three primary unsecured creditor groups. The Official Committee of Unsecured Creditors (UCC) primarily consisting of landlords, pension represenatives, unions and more. They also delt with The Official Committee of Tort Claimants (TCC) that consisted of groups and individuals seeking settlement claims to opioid overperscription and distribution. And the last group are the government agencies, most notably the state of Maryland seeking more compensation for affected opioid victims. The unsecured creditors heavily argued that the DIP financing was structured to benifit the secured creditors due to the super-priority status that they continously paid off, keeping capital at the top of the capital structure. Not to mention that the new DIP financing saw a hefty SOFR +7.5% vs the existing 1L notes of SOFR +3%. But at the same time the unsecured creditors argued that Rite Aid still had a multitude of unencumbered assets they could have monetized before the DIP financing, particularly the sale of Elixir and its real estate.
In Janurary 2024 Rite Aid reached an agreement to sell Elixir in a 363 asset sale, with MedImpact serving as the stalking horse bidder. The sale finalized at $575mm with the proceeds going to the DIP lenders, showing why the unsecured creditors opposed the financing. But the sale did offload $200mm in debt associated with Elixir and simplified Rite Aid’s business model to focus on its core business of operating the retail pharmacy stores.
The final recoveries for each class of debt consisted of a 100% recovery for the 1L secured lenders, financed primarily through the new DIP financing. The 2L creditors will recieve 90% of post-reorg common equity and $350mm takeback notes at SOFR +15% PIK debt. The 2L creditors were able to get a SOFR +15% PIK debt form the debtor becuase they allowed a significant covenant hole to remain in the indentures, a negative covenant allowing the company to potentially raise new debt on 20% of excess collateral. Potentially reducing the future recoveries of the equity holders in the future. And the debtors wanted to remain friendly with the new holders of 90% of the common shares of the business. The unsecured claims will recieve 10% of Rite Aid post-reorg common stock along with $40mm in cash. The common equity went to the non-tort claims, while the cash went to the tort claims to settle the litigation with the state of Maryland and other litigation from opioid related incidents.
To reflect, Rite Aid emerged from chapter 11 on the 3rd of Sempember, 2024 after reducing debt to $2bn from $4bn when it entered bancruptcy, along with $2.5bn in exit financing to support operations into the future. The company has gone private and has made their previous CFO their new CEO. This deal shows how messy valuation fights on valuation between secured and unsecured creditors can find solutions in bancruptcy court. Not to mention the value of “automatic stay” that allowed Rite Aid to significantly preserve liquidity, renegotiate leases, and pause litigation against them, all preserving value for the bancruptcy estate. Although Rite Aid emerged from bancruptcy with significantly less debt and with management optimistic about the future. They still face significant industry headwinds and fierce competition in a changing landscape, so Rite Aid will need to remain lean and only keep profitable locations in order to thrive in the future.