How Will Dollar Tree-Family Dollar Merger Impact Wal-Mart?

Two of the three dollar chains in the U.S. have joined hands to take on the retail giant Wal-Mart ( WMT ). In an $8.5 billion deal, Dollar Tree bought Family Dollar last week, to create a massive retail chain of over 13,000 stores. After its boom of 2008-2009, the dollar concept is once again gaining popularity in the U.S. due to changing shopping patterns. Dollar stores' convenient locations give them a competitive edge over traditional Wal-Mart stores, that are usually located on the outskirts of cities. The retail giant has also ramped up its own small store expansion, which could be one of the reasons to have prompted Dollar Tree to buy its counterpart.

As a single company, Dollar Tree-Family Dollar is at a much better position to compete against Wal-Mart. The merger is expected to create cost synergies at a $300 million run rate by the end of 2018, which can help the dollar chain pass on some savings to its customers. With competitive prices, Dollar Tree-Family Dollar can become a formidable threat to Wal-Mart. Moreover, with Family Dollar becoming a part of Dollar Tree, Wal-Mart has missed out on a substantial growth opportunity. The retail giant could have considered buying Family Dollar to immediately enhance its small store reach in the U.S. This would have helped the company eliminate significant competition in the small store arena and rapidly expand its omni-channel services. The price paid by Dollar Tree for Family Dollar is only slightly higher than Wal-Mart's annual domestic capital expenditure. Hence, buying Family Dollar wouldn't have been an expensive deal for the mega retailer.

Our price estimate for Wal-Mart stands at $79.30 , which is less than 10% ahead of the market price.

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Together, Dollar Tree-Family Dollar Pose a Bigger Threat

Dollar Tree and Family Dollar have slightly different operating models. While almost all of Dollar Tree's products are priced under $1, Family Dollar sells its products at different price points, which weakens its competitiveness against the price leader Wal-Mart and other dollar chains. Family Dollar has been struggling with its sales and profit growth for some time now, owing to stiff competition from larger dollar chains - Dollar General and Dollar Tree.

However, with the prospective merger, Family Dollar will be able to procure goods from Dollar Tree's vendors at better prices. Also, both of them can use the same distribution centers and delivery trucks that can help them reduce costs. Overall, this can help Family Dollar offer products at competitive prices, which can position it better against Wal-Mart. Also, Dollar Tree-Family Dollar can use the cost synergies to invest in new store openings. The company is already far ahead of Wal-Mart in terms of retail store presence in the country. Moreover, while both the dollar concepts will run independently to start with, Dollar Tree will look to eventually switch to the more profitable option of the two. Therefore, we believe that the combined company is a formidable threat for Wal-Mart.

A Missed Opportunity For Wal-Mart

Although Wal-Mart is looking to expand its small store network aggressively in the U.S., it will be a while before it has a presence comparable to the dollar stores. In order to get to that level quickly, the retailer could consider buying one of the dollar chains. However, with the recently announced Dollar Tree-Family Dollar merger, the most lucrative option for Wal-Mart is gone. Earlier this year, industry expert and Credit Suisse analyst, Micheal Exstein, had advised Wal-Mart's CEO to acquire Family Dollar. Dollar Tree paid $8.5 billion for Family Dollar, which would have been a small transaction for Wal-Mart. In fact, this figure is close to Wal-Mart's annual budget for domestic expansion. If the retail giant had bought Family Dollar, it would have received 7,500 stores spread across the U.S. with minimal locations of store overlaps. According to Exstein's report, only 19% of Wal-Mart stores are within one mile radius of a Family Dollar store. On the other hand, this figure is 29% in case of Dollar General and 49% in case of Dollar Tree.

Buying Family Dollar would have given Wal-Mart an already setup network of smaller stores with fewer concerns of self-cannibalization. Moreover, it would have reduced the retailer's potential competition considerably in urban markets. However, Wal-Mart no longer has that option and the merger has only raised concerns for the company. The retail giant will now have to rely on its own store expansion to take on dollar chains on their turf.

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

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

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