Updated from 9:43 a.m. EDT with Family Dollar comment and additional analyst commentary.

NEW YORK (TheStreet) -- Family Dollar (FDO)  shareholders may be a little bit disappointed even after Dollar General (DG)  surprised some on Wall Street by offering $78.50 a share in cash for the company, topping a $74.50 a share cash and stock merger offered by Dollar Tree  (DLTR)  in late July.

Dollar General isn't offering Family Dollar shareholders any stock in the combined company, a contrast to Dollar Tree's offer, which includes $59.60 a share in cash and a remainder in stock. Because there are hundreds of millions of dollars in annual synergies assumed by both Dollar Tree and Dollar General in their bids for Family Dollar, it makes the two competing offers hard to compare.

Dollar Tree is offering Family Dollar investors a significant stake in a combined company they believe can generate upward of $300 million in annual cost savings by the third year after their deal's close. Dollar General sees as much as $600 million in cost savings, however, it isn't offering Family Dollar investors any stock in the combined company.

"This is one-plus-one equals two," Dollar General CEO Rick Dreiling said of his offer on Monday; a contrast to mergers that often promise and fail to live up to synergy forecasts.

While Dreiling urged Family Dollar to cancel its deal with Dollar Tree, the company's bankers may well resist Dollar General's slightly higher nominal offer on Monday. One point in resisting a bidding war may be Family Dollar's analysis on the future value of the synergies that Dollar Tree is offering to its shareholders.

Family Dollar hasn't yet said whether its board would support Dollar General's offer. "Consistent with its fiduciary duties, Family Dollar's Board of Directors, in consultation with its legal and financial advisors, will carefully review and consider the proposal," Family Dollar's board said on Monday afternoon.

Dollar General Surfaces

Dollar General's emergence as a buyer for Family Dollar has been speculated upon for years and Monday's offer may make sense for its shareholders, who are poised to see the full benefit of forecast synergies.

Their offer stipulates about 700 store closings and will be financed with cash, debt and revolving credit lines. While Dollar General will take on significant debt in the deal, it expects to hold an investment grade bond rating within three years of the deal's closing.

Overall, a combined Dollar General and Family Dollar would have $28 billion in annual revenue and 160,000 total employees in 46 states. CEO Dreiling, who announced his pending retirement earlier this year, would stay on with the combined company until May 2016.

Dollar General said it would convert the Family Dollar to its own branded store footprint, a contrast to Dollar Tree's offer, which stipulates the maintenance of the Family Dollar brand. Dollar General didn't say whether Family Dollar CEO Howard Levine would have a role in the combined company.

Price Conscious Dollar Stores

Monday's offer has set off a new round of speculation about the value of dollar stores. Now, instead of hedge funds angling about the eventual sale of Family Dollar, the only question appears to be price. Depending on how Family Dollar's board views the Dollar General offer, it could set off a bidding war between Dollar Tree and Dollar General.

BMO Capital Markets analysts said on Monday they believe Dollar Tree has the financial flexibility to top Dollar General's bid, possibly around $80 a share. Analysts at BMO, however, believe Dollar General has more financial firepower than Dollar Tree and can bid as over $85 a share in cash before a deal becomes prohibitively expensive.

While there are hundreds of millions of dollars that both Dollar General and Dollar Tree see in a Family Dollar deal, it is the loser of this year's dollar store sweepstakes that may come out the best. BMO calculates that Dollar Tree could use a $305 million breakup fee in the event Dollar General wins Family Dollar to repurchase $1 billion in stock in 2015, boosting earnings per share by 6%.

Dollar General, if it loses, could conduct a leveraged recapitalization of its balance sheet, potentially adding 50 cents to its EPS, Sterne Agee analysts said on Monday. 

Squeezing a Penny from Dollar Stores

For Family Dollar CEO Levine, the timing of Dollar General's bid is yet another twist in what has been a rocky few year at the helm of the discount retailer.

Levine is the son of Family Dollar founder Leon Levine. He took over as CEO from his father in 1998 and after years of Family Dollar's growth through booms and busts, Wall Street hedge funds began playing an increasingly prominent role in the management of the company starting in 2011.

By 2014, Family Dollar had taken one hedge fund onto its board and two other large funds were calling for the company's sale. When Dollar Tree's offer for Family Dollar was announced in late July, it appeared a way for Levine to exit his CEO role graciously, taking an executive role within the combined company and a board seat.

Family Dollar's Sale Process 

Family Dollar, at the urging of activist investors like Trian Management, Paulson & Co. and Carl Icahn, ran a half-year sale process that began in February and began to take shape in March.

Trian executive Ed Garden, a Family Dollar board member since late 2011, was given a role on a committee tasked with running the company's sale prospects. At various stages in Family Dollar's strategic review, filings indicate that Levine approached Dollar General about a bid.

An August filing with the Securities and Exchange Commission shows that informal talks between Family Dollar and Dollar General initiated in the fall of 2013 led nowhere. After Family Dollar began negotiating a merger with Dollar Tree in March and April, and billionaire activist investor Carl Icahn disclosed a near 10% stake in the company and called for its sale in June, Dollar General remained lukewarm about a deal.

On June 19, the company formally declined to begin M&A negotiations with Family Dollar. Just over a month later, Dollar Tree surprised Wall Street by announcing its cash and stock deal for Family Dollar, which stipulated that the Family Dollar brand would be left intact and CEO Levine would take an executive role and board seat within the combined company.

Ultimately, Trian Management decided to back Family Dollar's merger with Dollar Tree. Both Trian Management and Family Dollar CEO Howard Levine agreed to vote their shares in favor of the transaction, representing about 16% of the company's outstanding shares.

Nevertheless, analysts who had forecast about $500 million in cost savings were Dollar General and Family Dollar to merge continued to argue that the a deal between the two companies was possible. Carl Icahn said on July 28 he was supportive of Family Dollar's deal with Dollar Tree, but also "hopeful" a competing bid would emerge. By August, Icahn pared his Family Dollar stake from nearly 10% of the company's outstanding shares to just 3.61%.

Despite being repeatedly approached by Family Dollar about a merger, Dollar General CEO Rick Dreiling said on Monday "there was no one more surprised than us" when Dollar Tree announced its $8.5 billion cash and stock deal on July 28. "If I thought this asset was in play, I probably wouldn't have announced my retirement," he added.

While Family Dollar and Dollar Tree did sign confidentiality agreements in their deal in March, analysts had publicly said they believed Dollar General was aware of the brewing deal between the two companies.

Perhaps, Dreiling isn't as surprised as he may state. Family Dollar, Dollar General and Dollar Tree declined to comment beyond their public statements.

Dollar General shares surged over 10% in Monday afternoon trading, while Family Dollar shares rose to $79.89, above Dollar General's cash offer.

Bottom Line: Family Dollar's sale process isn't over, raising new questions about the motives of all parties involved.

-- Written by Antoine Gara in New York

Follow @AntoineGara


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