Does Dollar General have Family Dollar takeover in mind?

(THE TENNESSEAN) On Oct. 5, Dollar General Corp. will celebrate the opening of its 11,000th store, in Murfreesboro, as the small-box retailer continues to deliver on a promise to add 650 new stores this year.

But analysts are buzzing over the possibility that Goodlettsville-based Dollar General, founded in Scottsville, Ky., in 1939, could instantly bring an additional 7,600 stores into its fold by acquiring its biggest direct competitor, Family Dollar Stores Inc.

Such a deal would make good business sense, reasons the investment firm Credit Suisse, which recently published a report analyzing a possible Dollar General-Family Dollar combination.

Based in the Charlotte suburb of Matthews, N.C., Family Dollar opened its first store in Charlotte in 1959 under the auspices of its then 21-year-old founder, Leon Levine.

Since then it has grown into a national chain of stores patterned after the Dollar General formula of providing discount food, homeand clothing products that serve as a "fill-in" for consumers between trips to big-box stores such as Wal-Mart and supermarkets such as Kroger.

Now nipping at Dollar General's heels, Family Dollar, with its 7,600 stores in 45 states and a total of about 50,000 employees, has posted $8.5 billion in sales in 2012. That compares with Dollar General's nearly 11,000 stores in 40 states, nearly 100,000 employees, and 2012 sales of more than $16 billion.

"Market interest in a potential (Dollar General-Family Dollar) combination has increased given the recent struggles of (Family Dollar), comments from (Family Dollar) management about succession planning, and ever-present activist involvement," Credit Suisse wrote in its report, headed by research analyst Edward J. Kelly in New York.

Kelly declined to speak to The Tennessean about the possibilities of a combination of the two companies but did provide a copy of the report. In it, Credit Suisse said it believes that a deal "would make compelling strategic sense even with a large premium."

"Dollar General could pay $90-100 (per share) for (Family Dollar) and still create plenty of shareholder value," the Credit Suisse report said, adding that it had found "cost synergies of at least $550 (million)-650 million, based on discussions with industry experts and our analysis of other complementary deals."

As of Friday, publicly traded Family Dollar (FDO) was trading at about $75 a share, with a market cap of about $8.6 billion. Dollar General (DG) was at about $58.50, with a market cap of about $19.15 billion.

Credit Suisse said benefits of a combined company would include:

• "Creation of the dominant convenience-based retailer in the U.S. catering to the fill-in trip as consumers shift to more needs-based purchasing.

• "Reduced competition for new dollar store locations and a prolonging of the oversaturation threat.

• "Elimination of the 'reactive' management style that has developed and creation of a more-rational competitive environment.

• "Potential to unlock significant cost and revenue synergies.

• "Creation of the next leg to the DG story following diminishing internal opportunities."

The combination also should produce a 12 percent to 13 percent pretax return on investment, Credit Suisse said.

"Ultimately, we see the combination leading to an 18,000-store company with $27 billion in sales, an EBIT margin post-synergies of about 11 percent, $4.50 in (pro forma) earnings, and annual free cash flow of $1.2 billion," the report said.

Far from done deal

There are hurdles to such a combination, though, Credit Suisse said, including "management appetite" and possible antitrust objections from the Federal Trade Commission.

"It's unclear if (Dollar General) management has the appetite for a deal and if (Family Dollar) management would be interested in relinquishing control," Credit Suisse said. "FTC approval also may be somewhat of a risk given the importance of dollar stores in small, rural markets."

Dollar General declined to comment on the idea of acquiring Family Dollar. "We don't comment on rumors or speculation," spokesman Dan MacDonald said.

As for whether Dollar General might even be interested, that's questionable, other analysts said, citing comments Dollar General Chairman and CEO Rick Dreiling made during a question-and-answer session in a Sept. 3 conference call with analysts on the company's second-quarter earnings report.

Responding to a question from Credit Suisse's Kelly about whether the company might be looking at growth through acquisitions, Dreiling told the analysts:

"We still have over 10,000 opportunities out there in the marketplace … in the United States today for (new) Dollar stores. And we have a very proven format that generates the best returns in retail that I have ever seen in my career. … It's much easier to manage that than it is to try and manage an acquisition."

Mark Montagna, an analyst for Avondale Partners in Nashville who follows Dollar General and Family Dollar, doesn't foresee a combination of the two.

"I do not expect that to happen," he said. "It takes a lot of work to merge two companies … and a lot of things can go wrong. When Dollar General is doing so many things right, I would not expect them to try it.

"They have so much growth ahead of them," he said. "They claim there are 10,000 potential new locations available nationwide. With such possibilities ahead, it's easier to grow on their own. They don't need an acquisition to grow. They produce a ton of cash, and they can use that to invest in the business."

Competing stores

If a combination were contemplated, one issue might be an overlap of stores, as there are many cases where Family Dollar or Dollar General moved in and built close to the other as a competitive move, Montagna said.

"There is real estate overlap," he said. "Do you need two stores within a tenth of a mile of each other? Maybe if it's on a road where it's difficult to turn left. But otherwise, they probably would have to close a bunch of stores, and that would mean dealing with leases that could have terms of up to 20 years."

But if the two were to combine, Montagna doesn't see a major antitrust issue.

"It wouldn't raise prices," he said. "Family Dollar has higher prices than Wal-Mart, while Dollar General's prices are similar to Wal-Mart's. A combination would give them greater buying power and allow them to reduce prices at Family Dollar. They can't raise prices, because they would lose business to Wal-Mart. The combination would actually benefit the consumer, but I still don't think they're going to go there."

A combination of the two would create a company that would completely dwarf the remaining major national competitor in the small-box realm, Dollar Tree Inc., a Chesapeake, Va.-based operator of nearly 4,800 stores in 48 states and Canada. Its roots go back to a Ben Franklin variety store in Norfolk, Va., in 1950, but it became Dollar Tree in 1986, and now has about 55,000 employees and annual sales of $7 billion (2012).

But Dollar Tree's retail concept differs significantly from that of Dollar General and Family Dollar, in that all prices are $1 or less. Dollar General and Family Dollar have some $1 items, but prices vary considerably, with many items ranging much higher.

There are smaller players, of course, including the Memphis-based Fred's Super Dollar, which operates more than 700 stores in the Southeast and Midwest, including some with pharmacies.

But Dollar General believes its biggest competitor really is Wal-Mart, and even a combined Dollar General-Family Dollar would have a long way to go to reach that company's status. Wal-Mart is the world's second-largest public company, with annual revenue of about $470 billion, and 2.2 million employees.


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