Three Hurdles for Dollar General in Its Family Dollar Bid

NEW YORK (TheStreet) -- There is roughly a 50% chance that Dollar General (DG) tries a competing bid for Family Dollar (FDO) after the company agreed to an $8.5 billion merger with Dollar Tree (DLTR) in late July, Bloomberg reported. If Dollar General does move forward on a flip of the coin bid for its primary competitor in discount retail, it will face three major hurdles.

Carl Icahn, once Family Dollar's largest shareholder and a major advocate of a Dollar General takeover, sold most of his shares in the company last week. Icahn pared his Family Dollar stake from nearly 10% to just 3.61% in the wake of Dollar Tree's offer. While Icahn couldn't immediately be reached for comment on Tuesday, he cast lukewarm support of the Dollar Tree offer on July 28. However, Icahn stated he was "hopeful" another bidder for Family Dollar would emerge.

Meanwhile, Family Dollar CEO Howard Levine and activist hedge fund Trian Management have agreed to vote their shares in favor of Dollar Tree's offer. Combined, Levine and Trian own 16% of Family Dollar's outstanding shares.

Finally, as part of their July 28 merger agreement, Family Dollar agreed to pay Dollar Tree $306 million were it to accept an outside bidder. Those three factors will make it much harder and more costly for Dollar General to launch a counterbid for Family Dollar.

Bloomberg also confirmed on Tuesday that Dollar General had been approached about a bid for Family Dollar but that it decided to pass on a deal. Only after Dollar Tree emerged as a bidder is the company weighing a counteroffer.

Family Dollar CEO Howard Levine, the son of company founder Leon Levine, launched a strategic review in the winter of 2013 and after considering a number of bidders and alternatives for the struggling retailer, he began negotiating a merger with Dollar Tree in March.

If Dollar General does move forward, it will have to pay an expensive breakup fee and also have a tougher hurdle to climb with shareholders. In that sense, the company's reticence to enter Family Dollar's sale process might be seen as a strategic misstep.

Family Dollar and Dollar General declined to comment.

Wall Street is hoping for a competing offer for Family Dollar.

"[W]e see the possibility of a competing bid from Dollar General, so Dollar Tree may have to pay more if it really wants the asset," Credit Suisse analysts wrote on July 28, reacting to Dollar Tree's $8.5 billion offer.

Credit Suisse gave Family Dollar shares an $80 price target, above Dollar Tree's $74.50 cash and stock offer, which valued the company at $8.5 billion, or 11.3 times its trailing 12-month earnings before interest, taxes, depreciation and amortization (EBITDA). To reinforce its perspective, Credit Suisse downgraded Dollar Tree to "neutral."

JPMorgan is advising and providing financing to Dollar Tree, while Morgan Stanley is advising Family Dollar, leaving plenty of other Wall Street firms looking for a piece of any counter-offer.

Bank of America Merrill Lynch analysts see the fit of Family Dollar with Dollar General as so strong it could boost the company's earnings per share by 50% in the first year after a deal is closed. That projects synergies in excess of $500 million, well above the $300 million synergy target Dollar Tree believes it can achieve within three years of its Family Dollar acquisition.

"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," Bank of America wrote.

If Dollar General does emerge as a bidder, it might be able to trump Dollar Tree.

According to FBR Capital Markets analyst Dutch Fox, a combined Family Dollar and Dollar Tree would carry $7.5 billion of debt, potentially putting overall annual interest expense near $300 million. That debt may constrain Dollar Tree's ability to increase its offer in the face of a competing bidder.

FBR's Fox said in a July 28 e-mail note to clients he never believed Dollar General would want to buy Family Dollar and involve itself in the turnaround of a worse-performing competitor. Antitrust hurdles are also seen as higher for Dollar General, given its larger geographical overlap with Family Dollar.

Family Dollar's brand will survive under Dollar Tree with current CEO Levine at its head. The deal is expected to generate large cost savings, helping the company complete a turnaround it began last year, Levine said on July 28.

Levine took over the company's reins from his father in 1998 and for about a decade, he was seen as a savvy manager of the homegrown company -- then Wall Street came knocking.

KKR (KKR) bought Dollar General in 2007 and sold its investment within a few years at a huge profit after the company's 2009 IPO. Hedge fund investors turned their sights to Family Dollar, and Levine has been under attack ever since. A poor pricing strategy, over-expansion and infrastructure issues across Family Dollar only added to the pressure in recent years.

Now, Levine has figured out a way to pass Family Dollar on, and in a transaction that Icahn acknowledges comes at a significant premium. In fact, Levine was given a seat on Dollar Tree's board of directors and it appears he will continue to have sway over Family Dollar.

His plans may yet be trumped by a competing offer from Dollar General. Dollar General shares were rising over 3% to $57.72, while Family Dollar shares were rising over 2.3% to $77.54.

-- Written by Antoine Gara in New York

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