Dollar Tree's Family Dollar Buy Forges Discount Giant

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Dollar Tree's agreement to buy Family Dollar Stores in a cash-and-stock deal valued at about $8.5 billion would create a new No. 1 in the deep discount retail market.

The deal, announced early Monday, would give the combined company clout to compete not only with No. 1 dollar-store chainDollar General ( DG ) but also with big-box discounters such asWal-Mart Stores ( WMT ) andTarget ( TGT ), which are increasingly targeting bargain shoppers.

"This is a transformational opportunity,"Dollar Tree ( DLTR ) CEO Bob Sasser said in a statement.

With the buyout ofFamily Dollar Stores ( FDO ), he added, Dollar Tree will "become a leading discount retailer in North America," with more than 13,000 stores in 48 states and five Canadian provinces, annual sales above $18 billion and more than 145,000 employees.

Target: Wal-Mart

It would top both Wal-Mart and Dollar General in store count, although Wal-Mart's annual revenue of about $478 billion a year dwarfs both Dollar Tree and Dollar General.

Last week, Wal-Mart ousted its U.S. CEO, Bill Simon, after several quarters of declining U.S. same-store sales. The world's No. 1 retailer has struggled in the difficult post-Great Recession economy.

In recent years, Wal-Mart has moved away from its big-box store model and begun expanding into cities with smaller stores that increasingly compete with dollar stores.

Now Wal-Mart will find itself competing against a new giant in the deep discount sector, should the Dollar Tree-Family Dollar merge sail through with no problems.

Under the terms of the deal, Family Dollar shareholders would receive $74.50 per share -- $59.60 in cash and $14.90 equivalent in Dollar Tree shares.

The purchase is expected to close in early 2015.

Shareholders are the big winners in this merger, Deutsche Bank analyst Paul Trussell told IBD.

"Family Dollar has been struggling with operations. Shareholders not only get paid handsomely right away but get to participate in upside of this deal" long term, Trussell said.

Operational prowess is not a problem at Dollar Tree, he added. "The Dollar Tree management team has done a good job executing. They are strong in the merchant market and good at managing expenses."

As a result, Trussell said, "the combined company is definitely going to be a formidable competitor not just to Dollar General, but it helps them compete with some of the bigger companies like Wal-Mart."

In a conference call with analysts, Dollar Tree outlined synergies in purchasing and distribution that could save the combined company $300 million a year within three years. It expects the purchase to be accretive to earnings within a year.

"The $300 million in synergies they outlined are very achievable," Trussell said.

He has a buy rating on Dollar Tree with a 60 price target. Trussell rates Family Dollar a hold with a 59 target and Dollar General a hold with a 60 target.

The agreement came after Family Dollar was pressured by activist investors Carl Icahn and Nelson Peltz, who own large blocks of the company's shares, to merge with another company.

Icahn has accumulated a nearly 9.4% stake in Family Dollar, according to a recent regulatory filing. He had publicly urged a Family Dollar merger with Dollar General. Peltz disclosed a large position in Family Dollar in 2010 and later landed one of his partners on the company's board.

However, Family Dollar later adopted a shareholder-rights plan -- aka a poison pill -- that would limit investors from acquiring more than 10% of the company and also deter hostile takeovers.

In a statement on his website lauding the purchase announcement, Icahn indicated that additional buyers might bid shares up further.

"While we continue to believe there are a handful of potential buyers who could realize greater synergies through a combination with Family Dollar and are hopeful that one or more of them will surface as a result of today's announcement, we are extremely pleased with Dollar Tree's intention to acquire Family Dollar," Icahn said.

In another indication more bidders might join the fray, Family Dollar shares jumped 25% to 75.74, closing above the proposed purchase price in Monday trading on the stock market today . Dollar Tree rose as much as 10% in early Monday trading but retreated to a 1.2% gain by close. Dollar General closed down fractionally.

A Negative For Dollar General

Meanwhile, Sterne Agee analyst Charles Grom sees a pairing with Family Dollar as a "net negative" for Dollar General.

"First and foremost," he wrote in a report Monday, "Dollar General has clearly benefited from Family Dollar's struggles over the past decade." That benefit could quickly end if Dollar Tree were to take Family Dollar under its wing, Grom said.

He also noted that Dollar General CEO Rick Dreiling is expected to step down soon, "and the future for Dollar General is a bit more cloudy at this juncture."

"With a new sheriff in town" in Dollar Tree, "Family Dollar will be a much sharper competitor going forward," Grom said.

The deal was not all that surprising to Grom, who said that Dollar Tree "has historically been acquisitive."

Dollar Tree intends to finance the acquisition through a combination of cash on hand, bank debt and bonds.

Few details of how the post-merger company would operate were provided initially, but Dollar Tree indicated that Family Dollar would continue to operate as a separate unit.

Family Dollar CEO Howard Levine would stay with the company and report directly to Sasser.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: DG , WMT , TGT , DLTR , FDO

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