Market Overview

The Drama Continues In The Dollar Store Space

The Drama Continues In The Dollar Store Space

Family Dollar (NYSE: FDO) on Monday confirmed it received an offer to be acquired by Dollar General (NYSE: DG) for $8.9 billion.

Family Dollar said in a statement hat it "remains subject to the merger agreement with Dollar Tree, and the Company's Board of Directors has not changed its recommendation in support of the merger with Dollar Tree."

Family Dollar on July 28 entered into a definitive merger agreement with Dollar Tree (NASDAQ: DLTR). Under the terms, Family Dollar shareholders would receive $59.60 in cash and $14.90 equivalent in Dollar Tree shares for each share of Family Dollar owned.

Related Link: Carl Icahn: I'm Not Going To Be Involved In Family Dollar

Dollar General is offering $78.50 per share in cash, implying a $9.7 billion total deal value -- a 5 percent premium to Dollar Tree's 80 percent cash, 20 percent stock offer that implies a $9.2 billion valuation.

Consistent with its duties, Family Dollar's board of directors will review and consider Dollar General's proposal.

MKM Partners Breaks Down The Facts

Patrick McKeever of MKM Partners broke down the numbers and stated, "If Dollar General acquires Family Dollar, a combined company would have nearly 20,000 stores in 46 states and generate more than $28 billion in annual sales. Prior to any realized synergies, the combined company would see $2.9 billion in adjusted EBITDA.

"By comparison, a Dollar Tree and Family Dollar combination would have 13,500 stores in the U.S. and Canada, generating close to $20 billion in sales with an EBITDA of only $2.2 billion prior to any synergies."

Who Will Emerge As The Winner?

In a conference call on Monday, Dollar General CEO Rick Dreiling claimed that the acquisition will "solidify Dollar General's position as the leading small box discount retailer."

Dreiling also stated that the company expressed interest in a combination with Family Dollar "multiple times over the last few years."

Dollar General laid out a strong case during its conference call. The company sees synergies of $550 million to $600 million by year three, with 40 percent of the synergies coming from cost of goods sold (COGS), 40 percent coming from SG&A costs and 20 percent coming from sales productivity improvements.

Dollar General's synergies are $300 million higher than what Dollar Tree is expecting out of a combination of the two companies. In addition to higher synergies, Dollar General expects a merger to be low-double-digit percentage accretive to its EPS in year one, compared to a low-single-digit accretion Dollar Tree expects should it combine with Family Dollar.

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There are two scenarios that could play out: Dollar Tree submits a counter-bid and a bidding war begins or Family Dollar continues to prefer pursuing a merger with Dollar Tree given lower antitrust risks.

Dollar General has previously stated that it is prepared to divest up to 700 stores to avoid any antitrust issues.

Bottom Line

It's possible that both Dollar General and Dollar Tree could present a higher bid, but it may come down to how much of the synergies the companies want to spend doing it.

Dollar General demonstrated it has the greater synergy potential and resources to win any potential battle. Family Dollar would be left with a consolation prize in the form of a $305 million breakup fee. The company could use these funds to buyback shares.

What matters most, perhaps, is a potential deal could benefit the dollar store consumer who continues to struggle in a difficult economic environment. In a note to clients on Monday, Jefferies' Daniel Binder wrote:

"Bottom line, the consumer is better off with a [Dollar General] deal since Family Dollar pricing is several hundred basis points above Dollar General and would likely come down to Dollar General levels under any turnaround scenario for the Family Dollar stores. Further, Dollar General pricing is already tight with Wal-Mart, often within two percent to three percent, and it is unlikely that Dollar General is going to raise its prices to compete with Wal-Mart."


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