Dollar Stores Buck Up

KKR's buyout of Dollar General sends the sector soaring.
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Updated from 7:54 a.m. EDT

Dollar General

(DG) - Get Report

surged Monday after the discount retailer had agreed to be acquired by private equity heavyweight Kohlberg Kravis Roberts in a deal valued at about $6.9 billion.

Shares were up $4.37, or 26%, to $21.15 in recent trading. Meanwhile, the news sent shares of rival

Family Dollar

(FDO)

up $2, or 7%, to $30.66, and

Dollar Tree

(FDO)

up $1.13, or 3.2%, to $36.79.

Dollar General shareholders will receive $22 a share in the buyout, representing a 31% premium to Friday's closing price and a roughly 29% premium over the stock's average closing share price during the previous 30 trading days.

Including the assumption of debt, the deal is worth about $7.3 billion.

In a statement, KKR member Michael M. Calbert described Dollar General as "an outstanding company with a strong market presence and a rich legacy."

"We have worked closely with many retail companies in driving success and unlocking value and we look forward to partnering with the Dollar General team to position the company for future growth," Calbert said.

The news comes as the Goodlettsville, Tenn., dollar-store retailer was struggling to update stores and turn around an inconsistent sales performance.

Michael Appel, a restructuring specialist with Quest Turnaround Advisors, questioned KKR's interest in Dollar General, since lower-income customers, such as those who shop at

Wal-Mart

(WMT) - Get Report

, have been hurting due to an increase in gas prices and other issues.

"Maybe they feel it's a good time to buy," he says. "Obviously KKR does their homework and they must feel there's some value there that they can unlock."

Morningstar analyst John Gabriel says Dollar General is in the midst of a turnaround, having recently implemented a new inventory management system that is offering fresher merchandise.

Gabriel says the dollar stores don't necessarily compete head to head with Wal-Mart, as they are geared as toward neighborhood customers who want to pick-up something quickly without having to go into a super-store. He also suggested the company could benefit from middle class customers who would "trade down."

Mark Miller, an analyst with William Blair & Co., wrote in a research report that "small-format value retailers have a strong price and convenience proposition."

"In a world of more supercenters, the consumer's need for fill-in trips -- as an alternative -- should only increase over time," he wrote.

Miller encouraged investors to buy shares of other value retailers as a result of the Dollar General sale. He said Family Dollar likely is best positioned to benefit operationally from the Dollar General takeout given the significant store overlap, which he estimated at 50% to 55%.

"In the short term," he wrote, "potential clearance sales related to additional

Dollar General store closings could impact sales and margins at competitors, although we believe this transaction should be viewed as a clear benefit to the sector over the intermediate to long term."

Meanwhile, KKR was rebuffed in another retail bid Monday. British drugstore chain

Alliance Boots

rejected the firm's buyout offer of $18.8 billion, saying it "does not believe it reflects the fundamental value of the company." Alliance Boots' executive deputy chairman, Stefano Pessina, had joined KKR in the offer.

KKR also recently headed a consortium making a bid for the Australian retailer Coles Group, according to published reports, and Sainsbury's, the U.K.'s largest retail group.