Dollar Tree May Soon Emerge As the No. 1 Dollar-store Chain

The No. 3 dollar store chain, Dollar Tree (DLTR, Financial), has agreed to take over discount store chain Family Dollar (FDO, Financial). Market leader Dollar General (DG, Financial) initiated a higher bid for Family Dollar just few days after the deal with Dollar Tree was announced. But Family Dollar rejected Dollar General’s bid citing some antitrust issues. This puts Dollar Tree in an advantageous position as the likely acquisition could strengthen its position in the overall U.S. retail industry. Let’s try and get the complete picture and see how Dollar Tree stands to gain.

Placing the bid

In July, Dollar Tree agreed to acquire Family Dollar by paying roughly $8.5 billion (excluding debt). Under the initial terms of the deal approved by both companies’ board of directors, Dollar Tree would pay $74.50 per share in a cash and stock deal to buy Family Dollar.

Activist investors Carl Icahn (Trades, Portfolio) and Nelson Peltz, part owners of Family Dollar, wanted the company to be sold since it had been underperforming consistently compared to its peers and facing intense competition.

In the latest quarter, Family Dollar reported 33% drop in net income on restructuring charges and fewer customer transactions. This set off warning bells and the company “immediately” put itself for sale. Dollar Tree was the first to grab this opportunity, aspiring to gain from the synergic effect, post the takeover.

Counterbid of Dollar General

Soon after Dollar Tree submitted its bid, Dollar General offered a counterbid to acquire Family Dollar for $9 billion (excluding debt) in mid August. The largest dollar-store chain agreed to pay up to $78.50 per share in an all-cash deal.

Dollar General thinks a combination would lead to higher cost synergies as both the companies sell products at different price points and are more heavily concentrated in rural markets, targeting low-income shoppers.

As per Euromonitor, Dollar General held a 35% share in the variety stores category in 2013, compared to 22.9% by Family Dollar and 16% by Dollar Tree. A merger, therefore, would clearly give Dollar General’s revenue a good boost. According to Dollar General officials, the deal would generate $550 million-$600 million cost savings on an annualized basis almost three years after the deal is completed.

Dollar Tree in, Dollar General out

Though the bid placed by Dollar General was more lucrative than Dollar Tree, Family Dollar’s management rejected it citing anti-trust issues and went with the lower bid.

It had been earlier estimated that the Dollar General offer would merge the two largest U.S. dollar-store chains, thus creating a fleet of 20,000 stores. After the rejection news flew in, Dollar General’s CEO, Rick Dreiling, commented that he believes that if the antitrust issues are reviewed and managed, their deal remains superior to the current transaction agreement with Dollar Tree.

But going by the current developments, Dollar Tree is emerging as the winner and its marriage with Family Dollar could create the largest U.S. dollar-store chain in terms of store count.

Dollar Tree’s fortunes on the high

If Family Dollar comes into the equation, Dollar Tree’s store count would increase to 13,000 across 48 states and five Canadian provinces. This would put a merged ‘Dollar Tree-Family Dollar’ ahead of sole rival Dollar General, which has more than 11,500 stores in 40 states.

Also, the buyout will result in cost-synergies for Dollar Tree of around $300 million on an annual basis that could be realized by the end of the third year of deal closing. Annual sales on a combined basis are projected to exceed $18 billion, slightly above Dollar General, which reported about $17.5 billion in sales in the recent fiscal year.

The merged entity would be better equipped to take on Dollar General and perhaps more importantly, Wal-Mart stores. As low income Americans continue to seek out bargains, the growth of such dollar stores is looking promising. Getting bigger will aid Dollar Tree to move into the rural markets where it has limited presence, enhance negotiation skills to win bigger discounts from suppliers, and help in finding appropriate ways to further cut costs.

In the recent quarterly results, Dollar Tree has included $7.5 billion as cost of acquisition for the quarter, which will also have an impact on the remaining quarters of the year, till the acquisition goes through. However, after achieving synergies by the third year, Dollar Tree would be in a better position in terms of bottom line.

Final thoughts

The final outcome of this bidding battle would be worth taking note of and we might see a new chapter opening up in the dollar-chain market place. The sequence of events seems to be favoring Dollar Tree, but as they say, it ain’t over till the fat lady sings.