Sometimes the market whispers a message that is hard to hear, but sometimes, like this morning, it screams at the top of its lungs. The announcement that there is to be some consolidation in the deep discount dollar store market in the U.S. probably didn’t come as too much of a surprise to most people. The idea had been bandied about in general terms for a while. Still, when Dollar Tree (DLTR) announced this morning that they intended to buy Family Dollar Stores (FDO) in a cash and stock deal worth $8.5 billion, or $74.50 per share, there was an immediate reaction.
Family Dollar stock immediately jumped to above the stated deal price and has remained there throughout the early morning. FDO is trading at around $75.90 as I write. This move above the deal price is a clear signal that traders believe that a better offer, presumably from the biggest company in the sector, Dollar General (DG), is likely. Interestingly, DLTR, the buyer, also reacted positively to the news, gaining around 10 percent in early trading. What the market is screaming at us here is that we haven’t heard the last of this deal. The fact that the stock of the buyer is up significantly tells us that, in the eyes of Wall Street at least, Dollar tree is getting a bargain if the deal goes through as announced.
Wall Street may believe the deal undervalues Family Dollar but initial reports are that it has been approved by both companies’ boards. If it is so evident to outsiders that Dollar Tree is getting a bargain here, why would the Family Dollar board lie down meekly and accept the offer? It could be that following the very public campaign for a sale by Carl Icahn, who owns over 9 percent of the company, the board felt under pressure to accept the deal. If so, then Icahn’s reaction here will be key.
So far there has been no comment from Icahn, but his blessing or lack of it will most likely decide whether the deal is completed or not. That the decision of one shareholder who owns less that 10 percent of the company is so influential is, I guess, indicative of the power of publicity, but whether this particular deal survives or not, there are lessons for us about the broader market and the state of the economy.
We are in the middle of a huge boom in M&A, but not all deals are created equal. Some are prompted by tax concerns; the so called “inversions.” Some, such as the rash of small deals in social media, are the natural consolidation of what is still a relatively new industry. Some, however, are just old fashioned buyouts with an eye to economies of scale and synergy. The DLTR/FDO deal definitely falls in the last category, and this suggests two things to me.
Firstly there will be store closures and job losses. Part of the problem that these stores face is that Wal-Mart (WMT) have announced their intentions to shift towards smaller stores in direct competition with Dollar General, Family Dollar and Dollar Tree. Some rationalization in an already highly competitive sector was inevitable in the light of that move. The buyout creates a company with over 13,000 stores initially, but that number is certain to fall.
Conversely though, the fact that there is so much movement in the discount retail space can be taken as a good sign for the economy overall. These stores, understandably, tend to do well in tough times and the fact that both boards in this deal see now as a good time to consolidate would suggest that they don’t perceive an economic environment that is conducive to organic growth for their companies. In other words, they see the gradual improvement in U.S. economic conditions continuing for some while.
This deal itself and the market reaction to it are both sending messages that we would do well to heed. The current and perceived future struggles of discount retailers suggest that the bull market that we are in may continue for quite some time. The reaction of the individual stocks involved, though, tells us that this particular M&A saga is probably not over.