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Dollar General Investors Face Win-Win Prospect in Family Dollar Bid

NEW YORK (TheStreet) -- Dollar General (DG - Get Report)  reportedly put its odds of making a counterbid for Family Dollar (FDO)  at about 50% after the discount retailer announced a $8.5 billion merger with Dollar Tree (DLTR) in late July. Now, it appears Dollar General investors will come up a winner no matter how the company's M&A coin flip goes.

Dollar General said Monday it would pay $78.50 a share in cash for Family Dollar, in a deal valued at about $9.7 billion. The bid, while only marginally higher than Dollar Tree's offer, indicates there are many ways Dollar General shareholders will benefit from the Family Dollar sweepstakes. That's even the case if Dollar General doesn't eventually buy Family Dollar.

Analysts and hedge fund investors have long believed Dollar General was the best possible buyer of Family Dollar, citing significant cost synergies between the two companies in the event of a merger and a better management of what would be one of the nation's largest retailers. Dollar General on Monday surpassed even optimistic assessments of cost synergies, disclosing between $550 million and $600 million in forecast annual synergies within three years of an acquisition of Dollar General.

Given Dollar General's all-cash offer for Family Dollar, shareholders would stand to benefit entirely from achieving those synergies. Meanwhile, Dollar General's well-regarded CEO Rick Dreiling said on Monday he would stay on with the company through May 2016 if it did negotiate an acquisition of Family Dollar. Dreiling had announced his upcoming retirement earlier in 2014.

Even if Dollar General doesn't win the sweepstakes for Family Dollar, shareholders could be a major beneficiary.

Dollar General may well cause Dollar Tree to increase its offer for Family Dollar. Given an apparent ability for Dollar Tree to improve its offer either with cash or stock, or both. A rising price for Family Dollar could increase leverage within the combined company. That might put a combined Dollar Tree and Family Dollar at an operational disadvantage.

A meaningful increase in the stock quotient of Dollar Tree's offer, meanwhile, might dilute some benefits of its merger, further distinguishing Dollar General as the blue chip stock within discount retail.

Finally, some analysts believe Dollar General will significantly increase share buybacks in the event it loses out on Family Dollar. Dollar General's all-cash offer indicated to some analysts' flexibility to further leverage its balance sheet. While rising leverage is currently stipulated as a means to buy Family Dollar, it could also be used for share buybacks if a deal doesn't materialize.

Sterne Agee analysts said they believe Dollar General would conduct a leveraged recapitalization of its balance sheet in the event it doesn't buy Family Dollar, potentially increasing earnings per share by 50 cents.

Regardless, Dollar General's emergence as a bidder for Family Dollar looks like a win for its shareholders. The deal, at current prices, looks highly additive to earnings over the long-term. A rising price of Family Dollar for Dollar Tree, meanwhile, could work in Dollar General's favor, especially if the company reacted to a losing offer by significantly boosting share buybacks or dividend payments.

Were the price of Family Dollar to rise too high, Dollar Tree may also benefit from leaving the bargaining table. The company is due a $305 million breakup fee, which analysts at BMO Capital Markets believe could be used to help fund $1 billion in total share buybacks in 2015, boosting EPS by 6%.

-- Written by Antoine Gara in New York

Follow @AntoineGara

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