NEW YORK (TheStreet) -- Analysts believe a Family Dollar (FDO) merger with Dollar General (DG - Get Report) would create meaningful cost synergies and help unlock value at both dollar store chains. Speculation of a possible merger has heated up after Carl Icahn disclosed on Friday he's taken a 9.4% stake in Family Dollar and seeks talks with the company's management.
Icahn joins a list of activist investors who have taken large stakes in Family Dollar including Trian Management with a 7.35% stake in the company's shares and John Paulson-run Paulson & Co. with a 5.68% stake, according to Bloomberg data. The prominence of activist hedge fund investors, in addition to Icahn's apparent efforts to consult with Family Dollar over its operations and possible strategic transactions, is giving fodder for analysts to speculate on merger scenarios.
A merger of the nation's two biggest dollar stores could create large cost synergies that would create significant value for both companies, Jefferies analysts said in a Monday client note that upgraded both Family Dollar and Dollar General shares to "buy."
Jefferies believes synergies could run between $950 million and $1.2 billion in the event of a Dollar General takeover of Family Dollar. Were Dollar General the acquirer of Family Dollar, Jefferies calculates the merged company would earn between $5.50-a-share and $6-a-share in 2014.
The most obvious synergy of a Family Dollar and Dollar General merger would be a reduction or slowing in the growth of square footage in the dollar store industry, Jefferies said, mitigating growing risk of overcapacity across the industry. Analysts at the firm said the Federal Trade Commission might review such a merger, however, they expressed confidence a deal would get approved.
An approval would hinge on regulators treating Walmart (WMT) as a competitor to Dollar General on price and scale, but not Family Dollar.
"Dollar General pricing is close to Walmart on like items and is meaningfully lower versus Family Dollar. This supports the view that DG believes it needs to be competitive on price or run the risk of losing share to Walmart, which is predominantly not serving the customer in the same local way DG is. Hence, the combination of DG and FDO, should not put the consumer at a disadvantage," Jefferies said.
"Simply put, the industry has matured, there are clear performance gaps between the number one and two players, we think the pace of capacity increases are out of balance, new competition is coming and we see potential for large synergies," Jefferies concluded of its analysis of a potential merger.
The firm gives a $79 a share price target to Family Dollar and a $75 a share price target to Dollar General.
In the event of a merger, it appears analysts believe that Dollar General's management would be the best to lead the combined company, given Family Dollar's struggles to benefit from a down-market move by consumers toward dollar stores.
Perhaps, if Carl Icahn isn't successful in propelling a merger between Family Dollar and Dollar General, he might look for some kind of management or board shakeup.
Family Dollar shares were rising nearly 15% to $69.52 in early Monday trading. Dollar General shares were rising over 10% to $64.27.
Family Dollar Adopts 'Poison Pill'
On Monday, Family Dollar said it would adopt a shareholder rights plan, or so-called "poison pill."
The rights plan would allow the Family Dollar to dilute investors taking an over 10% stake in the company's shares and is intended to "protect shareholders against any person or group gaining control of the Company by open market accumulation or otherwise without paying a control premium for all shares," Family Dollar said on Monday.
"The Family Dollar Board of Directors and management team are open to dialogue with all shareholders and welcome input toward the shared goal of enhancing value. As previously announced, we are taking steps to strengthen our value proposition, increase operational efficiencies and improve financial performance," Family Dollar said in a Friday statement.
The company has hired Morgan Stanley as a financial advisor and law firm Cleary Gottlieb Steen & Hamilton as legal counsel, the company said.
Representatives for Family Dollar declined to comment beyond the company's public statements. Dan MacDonald, a Dollar General spokesperson, said the company doesn't comment on market rumors or speculation.
-- Written by Antoine Gara in New York.