Why a Family Dollar-Dollar General merger is like a McDonald’s-Burger King tie-up


Jonathan Ratner | June 12, 2014 | Last Updated: Jun 12 9:30 AM ET
Carl Icahn wants a merger between Family Dollar Stores Inc. and Dollar General Corp., but a tie-up may be like asking McDonald’s Corp. and Burger King Worldwide Inc. to join forces.

Mr. Icahn’s disclosure that he has acquired a 9.4% stake in Family Dollar sent the stock soaring this week. Investors anticipate that since another activist investor, Nelson Peltz, holds a significant stake, the discount retailer could be in play.

Most scenarios suggest Dollar General could create an accretive transaction while also keeping the chain from falling into a competitor’s hands, said RBC Capital Markets analyst Scot Ciccarelli. However, there are plenty of hurdles.

For one, Family Dollar and Dollar General are highly competitive, so it’s likely that the former’s board of directors does not want to sell.

Dollar General would also probably need to lever up its balance sheet, likely leading to a loss of its investment-grade rating.

Mr. Ciccarelli notes a merger carries high execution risk since a lot of synergies would be required to justify a deal versus the opportunity cost associated with an aggressive share buyback program.

“The company would also have to manage cultural difference and manage a very different real estate portfolio than what they’re accustomed to,” the analyst said, highlighting Family Dollar’s urban footprint and Dollar General’s historical focus on rural and suburban locations.

Despite these challenges, Mr. Ciccarelli raised his target prices on both companies (Dollar General to US$66 from US$63, and Family Dollar to US$62 from US$55) due to the higher possibility of a deal.

“While Family Dollar is surely frustrated with their own performance and may be more open to strategic alternatives than they were three years ago, Dollar General has had a chance for a long-term look at Family Dollar and has obviously chosen to avoid a transaction thus far,” he said.

Private-equity firms might consider buying Family Dollar, but the analyst noted they lack the same synergy opportunities, and the typical goal of cost reductions doesn’t appear to be what the company needs right now.

“As a result, while we believe that a deal is certainly possible (even logical) we are not convinced this combination is the ‘layup’, it was proposed to be earlier in the week,” Mr. Ciccarelli said.



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