Why the merger deal sees concerns over potential synergies
Concerns over potential synergies
Activist investor Carl Icahn’s hedge fund Icahn Capital trimmed its stake in Family Dollar (FDO) last week after the deep-discount retailer agreed to a takeover deal from rival Dollar Tree Inc. (DLTR) for $8.5 billion. Icahn, who disclosed a stake in FDO in June, had threatened a proxy war if the company wasn’t “put up for sale immediately.”
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Icahn welcomed the merger deal and said in a statement that “While we continue to believe there are a handful of potential buyers who could realize greater synergies through a combination with Family Dollar and are hopeful that one or more of them will surface as a result of today’s announcement, we are extremely pleased with Dollar Tree’s intention to acquire Family Dollar in a transaction that values the company at $74.50 per share. This is a big win for all shareholders of Family Dollar and yet another validation of the activist investment philosophy in general.” Icahn had previously said that larger peer Dollar General (DG) would be a good fit for Family Dollar stores.
Both Dollar Tree and Family Dollar believe that its merger has a “compelling strategic rationale” as outlined below.
- Creates a leading discount retailer in North America. The transaction will create a leading discount retailer in North America based on number of store locations, operating more than 13,000 stores in 48 states and five Canadian provinces, with sales exceeding $18 billion and over 145,000 associates.
- Complementary business model across fixed- and multi-price point. Dollar Tree operates fixed-price point stores, selling everything for $1 or less, and Family Dollar operates multi-price point stores providing value-conscious consumers with a selection of competitively priced merchandise in convenient neighborhood stores. Dollar Tree intends to retain and grow each of its brands. The Family Dollar brand going forward and will optimize the combined real estate portfolio.
- Targets broader range of customers and geographies. Dollar Tree targets customers within a broad range of middle America with stores located primarily in suburban areas and Family Dollar targets low- and lower-middle income households through its urban and rural locations. The transaction will enable Dollar Tree to serve a broader range of customers and deliver even greater value to them.
- Leverages complementary merchandise expertise. Dollar Tree’s assortment consists of a balance between consumable merchandise and variety or seasonal merchandise. Family Dollar’s assortment consists primarily of consumable merchandise and home products. The complementary assortments will enable the Dollar Tree and Family Dollar brands to expand category offerings and to deliver a broader and more compelling assortment to all customers.
Dollar Tree said in a conference call on the merger that industry tends and outlook are positive for the combination as “low and middle income customers are continuing to look for ways to balance their budgets and stretch their dollars, the discount retail segment is vibrant and expected to grow in relevance.” The acquisition merges companies with “complementary business models, complementary target customer profiles, and complementary real estate strategies.” According to Family Dollar CEO Howard Levine, the combination will benefit customers in the form of store format optimization, improved purchase efficiencies, enhanced customer service, and shared merchandise expertise.
Dollar Tree expects to generate significant efficiencies through sourcing and procurement, selling, general, and administrative expense (or SG&A) leverage, distribution and logistics efficiency, and format optimization. Dollar Tree anticipates that the transaction will result in an estimated $300 million of annual run-rate synergies to be fully realized by the end of the third year post-closing.
The transaction is estimated to be accretive to cash earnings per share (or EPS) within the first year post-closing, excluding one-time costs to achieve synergies. Dollar Tree will be better positioned to invest in existing and new markets and channels and to grow its store base across multiple brands. The combined company expects to generate significant free cash flow, enabling it to pay down debt rapidly.
Could lack of synergies be a concern?
The merger, which brings together the second and third largest discount retailers in the U.S., saw mixed reactions from analysts who were expecting a deal between Family Dollar and Dollar General (DG). Some analysts expect a possible rival bid from Dollar General considering the lack of potential synergies between Family Dollar and Dollar Tree. Bank of America Merrill Lynch analysts said “In our view, Dollar Tree and Family Dollar’s models, customer bases, locations, and assortments are very different, with limited overlap and, therefore, limited opportunity to obtain synergies.”
Icahn also said in an interview with Reuters back in July that he believes “Family Dollar and Dollar General (DG) should merge as they would make for perfect partners” adding that Family Dollar needs to improve its performance and effectively compete against big-box retailers such as Walmart (WMT), Costco (or COST), and Target (TGT). However, he said that the retirement announcement of Dollar General CEO Rick Dreiling’s is a “setback” because it would delay any acquisition plans “but it doesn’t mean it’s insurmountable on a long-term basis.”