DG began acquisition discussions with its smaller competitor,
FDO, last summer. Another smaller rival, DLTR, emerged with an $8.7B mix of
stock and cash offer-representing a 22% premium to its 7/25/14 price. DG
responded with a $9.1B all cash offer. Ordinarily, a higher all cash offer
would prevail as its value is clear. Nonetheless, DG’s offer contained a
substantial risk of not closing due to real antitrust concerns.
DG was the largest of the three major players in the
“dollar” retail industry at $4.7B in revenues and 11,700 stores compared to
DLTR’s $2.1B and 5200 stores and FDO’s $2.6B and 8100 stores. Whenever the #1
buys the #2 in the same industry- antitrust issues become a real concern. It
was estimated DG needed to jettison over 1500+ stores to may be satisfy the FTC;
while DLTR with less overlap would close less than 500 stores. Recognizing this-
DG offered a $300 mln+ breakup fee. Perhaps, DG wanted to remain the dominant
industry participant and prevent the formation of a larger rival.
Last week, FDO shareholders accepted the lower priced DLTR offer given its
greater chance to close. Interestingly, the market was positive for all three
firms. The stock price increase for DLTR and FDO is somewhat understandable. It
signals belief in the synergy benefits of the combination and removal of
uncertainty for FDO’s shareholders. Additionally, DLTR appears to have a better
chance of turning around the struggling FDO which had suffered a 47% drop in
earnings for the 11/14 quarter end.
Looking at the 3.7% increase in DG’s stock rise one can
conjecture the following reasons:
1)
The price was too high relative to the possible
benefits it could extract. Another way of saying it is DLTR is the better
owner.
2)
Closing 1500+ stores given the premium offered
makes you wonder what’s in it for DG’s shareholders. That is a lot to give up
relative to DLTR.
3)
DG foregoes the possibility of paying a $300 mln
breakup fee if the deal failed to obtain antitrust approval.
Yes, DG is smaller than it would be if the acquisition
proceeded, but its shareholders are richer- better off. Yes, DG faces a new and
larger combined DLTR-FDO competitor. The new DLTR, however, faces real
integration and turn around issues. Furthermore, it will be saddled with a
heavy debt load comprised of $5.4B in term debt plus another $2.8B in new
senior unsecured notes. Well- in any event the market has spoken. My gut tells
me DG’s shareholders dodged a bullet on this one and should thank the FDO shareholders
for rejecting their offer and thereby preventing a forced DG managerial error.
J
