The Fight Over Family Dollar: Why the Winner Will Actually Lose

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Last week, Dollar Tree Stores (DLTR) made big news by announcing the potential purchase of Family Dollar Stores (FDO) for $8.5 billion. As I noted before the announcement, the sale of FDO was widely expected, but news of the purchase of FDO on July 28 by DLTR was somewhat of a surprise, because the speculation was that a large hedge fund or possibly Dollar General would be the purchaser.

family dollar tree fdo stockOn the news, FDO stock immediately skyrocketed from $60.66 to $74.25, before closing at $75.74. Dollar Tree, which closed the previous day at $54.22, soared $6 higher off the opening bell, only to sell off the rest of the day, to finish only 1.2% higher at $54.87.

According to the agreement, FDO shareholders will receive $74.50 for each share owned — a combination of $59.60 in cash and $14.90 in DLTR stock.

The next day, investor Carl Icahn cashed out a chunk of his investment in FDO, cutting his stake from 9.39% to 6.03%. He told the media that “better returns can be achieved by deploying capital elsewhere”. Icahn, who bought shares at an average price of $58.20 per share was said to be selling them for $75.50, a cool profit of nearly 30%.

Investors Bring the Lawsuits

That same day, a lawsuit against the FDO board of directors was filed by Harwood Feffer, LLP, stating:

“Our investigation concerns whether the Family Dollar board of directors is fulfilling its fiduciary duties, maximizing the value of the Company, disclosing all material benefits and costs, and obtaining full and fair consideration for Company shareholders.”

Two days later, a private investor, Shiva Stein, also filed a lawsuit against FDO in a Delaware court, claiming that the company failed to maximize potential shareholder value by not shopping around for the best deal possible. Other law firms have since jumped onto the bandwagon.

Apparently the 24.8% one-day boost in FDO stock price was not substantial enough. But come on, you have to shop around. Would you expect anything less from a dollar store?

Now this week comes word that Dollar General (DG) is mulling an offer that would challenge DLTR for the purchase of FDO.

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Shares of FDO stock closed at $76.50 on Wednesday, as investors speculate that a higher bid may be forthcoming.

The question is, why do both DG and DLTR want to fight over FDO? While it’s true that by taking over the FDO stores, either store would immediately become the largest discount dollar store in the country, is the value really there?

FDO’s recent track record has been dismal, losing ground on comparable same-store sales and missing earnings estimates handily now for three consecutive quarters. Carl Icahn’s large purchase and pressure on the board has certainly helped to boost the FDO stock price; however, the company’s bottom line is still the same with consumers.

Drive by most FDO stores, and as famed Fidelity money manager Peter Lynch liked to do, take a count of the cars in the parking lots. These days you can often count them on two hands.

The “Logic” Behind the FDO Acquisition

So why does DLTR want this merger so badly? Ken Perkins, an analyst for Morningstar says it will create $18 billion in sales in more than 13,000 locations. He also feels it will give DLTR the opportunity to cut costs and get better prices from suppliers, while competing better with DG and Walmart (WMT) stores.

Sounding even more bullish was Burt Flickinger, the managing director at Strategic Resource Group, a retail consulting firm, saying:

“Dollar stores were perfectly positioned for the recession, and are still well positioned for the moderate growth we’re in now.”

But this makes no sense, given the statement by Family Dollar CEO Howard Levine after the last earnings report that a “bad economy” was to blame for FDO’s struggles. You can’t have it both ways. Either the bad economy helps or it hurts the dollar stores, and so Flickinger’s analysis is clearly at odds with CEO Levine.

Levine also expected sales to be flat going forward, and has talked of closing stores, lowering prices, and reducing new store openings. While cost cutting in business is usually a positive, Levine’s forecast is not exactly a solid endorsement for the future success of his business.

Bottom Line

In reality, DLTR didn’t need this acquisition to compete favorably with DG. It has historically outperformed all of its dollar store rivals. However, if DG purchases FDO, it could then boast a considerable advantage over DLTR in market share. Therefore, DG’s interest in FDO practically forces DLTR’s hand, possibly resulting in a bidding war in which either discount retailer is likely to overpay.

Acquiring FDO may be a pyrrhic victory for one of these two companies. Someone will indeed win the battle but lose the long-term war.

It’s only the FDO stockholders, including Mr. Icahn, who will ultimately be the big winners when this plays out.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2014/08/fdo-family-dollar-tree/.

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