All those dollar-store offers add up

Dollar General Corp. offered about $9 billion for Family Dollar Stores Inc., excluding debt, setting off a bidding war for a company that had agreed to a $8.5 billion takeover by Dollar Tree Inc. last month.

Dollar General plans to pay $78.50 a share in cash, compared with Dollar Tree's bid of $74.50 a share in cash and stock, according to a Monday statement. The deal will generate $550 million to $600 million in cost savings annually three years after its completion, Dollar General said. Including debt, the purchase is worth $9.7 billion.

Dollar General, based in Goodlettsville, Tenn., is fighting to keep its perch at the top of the dollar-store industry. A merger between its two rivals would have created a new market leader, escalating competition at a time when Wal-Mart Stores Inc. also is looming with new smaller-format stores.

"Dollar General didn't need to do this, because they could have grown nicely without Family Dollar," said Patrick McKeever, managing director with MKM Partners in Stamford, Conn. But the combination of Family Dollar and Dollar Tree "would represent a marginal long-term threat to market share."

The Dollar General chain is more similar to Family Dollar's, meaning it may be able to extract bigger benefits from a takeover than Dollar Tree, according to Poonam Goyal, a senior retail analyst for Bloomberg Intelligence. The company's $600 million in annual cost savings from the merger is twice what Dollar Tree estimated in its deal to buy Family Dollar.

Supplier pressure

The pursuit of cost savings could put pressure on the combined chain's suppliers. If Dollar General and Family Dollar merge, one vendor — Orchids Paper Products Co., which sells toilet paper and napkins — will rely on the company for almost 60 percent of revenue, according to data compiled by Bloomberg. Other suppliers include Clorox Co., Dean Foods Co. and Procter & Gamble Co.

While Dollar Tree caters to middle-class consumers and sells most items for $1, the other two dollar chains both focus on low-income shoppers and offer more food at various price points. If combined, Dollar General and Family Dollar would have about $28 billion in annual revenue.

"Dollar General can more easily justify a higher price because of the greater potential operating synergies," said Erik Gordon, a professor at the University of Michigan's Ross School of Business. Still, Dollar Tree may have incentive to come back with a counteroffer, he said. "The acquisition would do more to transform Dollar Tree's business."

Family Dollar to review bid

Dollar General surged 12 percent to $64.14 at the close in New York, underscoring that investors want the company to consolidate the industry. Family Dollar shares rose 4.9 percent to $79.81, while Dollar Tree fell 2.4 percent to $54.26.

Monday's offer is 5.4 percent higher than Dollar Tree's bid and 29 percent above Family Dollar's stock price on the last trading day before the earlier deal was announced on July 28.

Family Dollar's shares have traded at or above the Dollar Tree offer over the past three weeks, signaling that investors were expecting a higher bid. Bloomberg News also reported on Aug. 5 that Dollar General was weighing an offer after earlier passing on making one.

Family Dollar, based in Matthews, N.C., confirmed Monday that it had received Dollar General's offer, saying it would carefully review the bid.

Randy Guiler, a spokesman for Chesapeake, Va.-based Dollar Tree, declined to comment on Dollar General's offer or to say whether his company planned to continue pursuing Family Dollar. Based on the potential earnings of a combined company, Dollar General could probably afford to make a bid of as much as $85, McKeever said.

Combining 20,000 locations

The battle for Family Dollar began after activist investors Carl Icahn and Nelson Peltz took large stakes in the retailer and then pushed for a sale. Icahn still owns about 3.6 percent of the shares, while Peltz's Trian Fund Management LP has a 7.3 percent stake.

The proposed combination of Dollar General and Family Dollar would add to earnings by a low double-digit percentage in the first full year, excluding implementation and transaction costs, Dollar General said. The deal's estimated expenses would include a $305 million termination fee payable to Dollar Tree.

The combined company also would be prepared to sell as many as 700 stores to gain antitrust approval, according to the statement. A combined company would have almost 20,000 locations, making it the nation's largest retail chain in terms of locations. Wal-Mart, which generates far more sales per store, is the biggest retailer by revenue.

Spun-off stores

"If Dollar General wins, Dollar Tree might end up acquiring many of the stores Dollar General spins off," Gordon said.

Dollar General, which is being advised by Goldman Sachs Group Inc., is "confident it can quickly and effectively address any potential antitrust issues."

To help see the deal through, chief executive Rick Dreiling, 61, will remain in the CEO and chairman roles through May 2016. Beyond that date, he'd be willing to remain chairman if asked by the board and elected by shareholders, according to the statement. He had previously said he would retire in May of 2015.

Dreiling's pending retirement led analysts to speculate that an offer for Family Dollar wouldn't happen until his successor was in place.

Try, try again

Dollar General had expressed interest in combining with Family Dollar repeatedly over the past few years to no avail, Dreiling said Monday on a conference call with analysts. So he was surprised by the Dollar Tree agreement and said if he had known Family Dollar was open to a deal, he probably would have postponed his retirement.

Monday's actions prove once again the relevance of activism, Icahn said in a statement.

Family Dollar and Dollar Tree are the No. 2 and No. 3 dollar-store chains by number of outlets, while Dollar General is the largest. Sales at the chains, which specialize in cheap household goods, have slowed since the U.S. economy began improving and consumers became less focused on finding bargains. Still, they're outpacing the growth of bigger discount retailers, including Wal-Mart and Target Corp.

Wal-Mart is spending $600 million this year to add more Neighborhood Market and Express stores, aiming to get a larger piece of the neighborhood discount market. The smaller-format outlets have outperformed its supercenters and Sam's Club locations.