Carl Icahn May Be Fighting A Losing Battle With Family Dollar
Family Dollar (NYSE: FDO) is in the news after Carl Icahn disclosed a 9% position in the company and announced his intention to try to force a sale of the company. Factoring in Trian Management and Paulson & Co.'s existing stakes, activist investors now own 23% of the company.
Reports suggest that Dollar General (NYSE: DG) could be a potential partner, but that a private takeover by a P-E firm is more likely. FDO has responded to that possibility by introducing a poison pill plan with a 10% ownership threshold.
Whatever course Icahn pursues, shakeups in management looks like a positive development for the company. FDO has struggled in recent years, and its return on invested capital (ROIC) has fallen from 15% in 2011 to 11% in 2013. More recently, same store sales dropped 4% in 2Q14 and FDO announced it would be closing 370 stores.
FDO's financial performance compares poorly to the results of a competitor such as Dollar Tree (NASDAQ: DLTR), which has maintained a steady 15% ROIC for the past three years. DLTR also increased same store sales by 2% in the most recent quarter. DG has a lower ROIC than FDO but has managed to maintain same store sales growth.
The question is not whether a shakeup is needed at FDO, but whether Icahn will be able to make a positive impact. A potential acquisition by DG faces several issues, most notably:
Taking the company private involves some of the same issues. FDO was reasonably cheap at ~$60/share before Icahn disclosed his stake, but management's hostility to an activist buyout, as evidenced by the poison pill plan, means a significant premium would likely be required.
More importantly, taking FDO private doesn't inherently solve its problems. Analysts have suggested that a private company would be more effective at slashing costs, but that's only half the battle. FDO's SG&A as a % of revenue is higher than its competitors at 28%, but it also earns significantly less revenue per square foot than DG and FDO. Solving that problem would require a much more comprehensive and involved overhaul of store layouts and locations.
Icahn bought into FDO because he believes that the stock is cheap due to poor management. On that point I agree with him. However, I'm less convinced that he will be able to fix the company's woes. Icahn might be able to engineer a sale to DG or someone else that will earn himself and other shareholders a quick profit, but unlocking long-term value will be a much more difficult task.
Sam McBride contributed to this report.
Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.
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