Dollar Tree buying rival Family Dollar for $8.5 billion

Dollar Tree (DLTR) is buying its larger rival Family Dollar (FDO) in a cash and stock deal valued at about $8.5 billion. "This acquisition will extend our reach to lower-income customers and strengthen and diversify our store footprint," Dollar Tree CEO Bob Sasser said in a statement.

Discount chains have been struggling to boost sales as Walmart (WMT) and other retailers invaded their space by offering more items for a buck or less to lure more low-income consumers.

Family Dollar, in particular, has struggled to remain competitive among the deep discounters. Earlier this year, the company slashed prices and announced it would close 370 stores, in an effort compete with rivals like Dollar General (DG) and Walmart, which is diversifying its own retail strategy by building smaller stores that target a different audience that the giant mega-stores.

Family Dollar CEO Howard Levine abandoned the strategy the company had been using: discounting only certain items, while others remained at full price, and embraced the “everyday low price” strategy favored by Walmart and other rivals. But the strategy failed. Cost increases more than canceled out the revenue boost from the steep price cuts. Family Dollar recently reported a 6.1% sales decline during its second quarter.

With its focus on the lowest end consumers, Family Dollar has borne the brunt of what many still maintain is an economic recovery that has ignored lower income households. 

Those weak results made Family Dollar the weakest of the Big Three dollar stores. Dollar Tree, with its focus on slightly higher-end customers than Family Dollar and stores in more suburban areas saw net sales grow 7.2% for the quarter ending May 4th. Same-store-sales and average transaction size also improved for Dollar Tree. Dollar General, which had been thought to be the most likely purchaser of Family Dollar, just posted its 25th straight quarter of improving traffic and overall sales growth of 7%.

The relatively weak results led Family Dollar’s stock to badly lag the other players in the industry. Prior to takeover chatter picking up last month, FDO shares were down more than 15% compared to slight gains for Dollar Tree and Dollar General.

The New Landscape for discounters

Post-merger Family Dollar and Dollar Tree will be better positioned to compete with Dollar General but the 800 pound gorilla is still Walmart. 

The new combined company will have more than 13,000 stores in the U.S. and Canada and more than $18 billion in sales. That will give the chain some leverage with suppliers but nothing like what Walmart is able to command with its 11,000 stores that average roughly 10x the size of a Family Dollar. 

The merger doesn’t impact Walmart quite as directly as you would think. Together, the new company and Dollar General add up to only 15% of Walmart’s U.S. revenue. It is hard to move the needle when you go up against a company like Walmart with more than $260 billion in annual sales and 1.3 million employees in the U.S. alone.

That said, Walmart has been having a tough time in the U.S. market. In May, it reported its fifth straight quarter of negative sales. Just last week, it announced that the CEO of its U.S. division Bill Simon will step down and be replaced by Walmart’s head of Asia, Greg Foran.

Walmart has recently announced plans to accelerate its roll-out of Walmart Neighborhood Market as well as its even smaller Walmart Express operations. Walmart doesn’t have a choice but to expand smaller footprint stores. Its Neighborhood Markets are growing sales at stores that have been open more than a year at a greater than 4% rate, a rare bright light with the larger-box Super Stores struggling to stay flat. 

None of which addresses Target (TGT) which has CityTarget stores of 80,000 feet in urban areas and last week announced a TargetExpress prototype that will be the same 20,000 foot size as the dollar stores.

The Big Winner: Carl Icahn

However, the Dollar Tree/Family Dollar combo will turn up the heat on Dollar General which was activist investor Carl Icahn’s first choice for a merger partner. Icahn, who owns a 9.4% stake in Family Dollar, has been pressuring Family Dollar to put itself up for sale. Icahn’s stated choice to pair Dollar General and Family Dollar was stymied by the retirement of Dollar General’s long-time CEO but as this deal proves yet again, it’s a mistake to underestimate Icahn’s ability to get things done.

And Icahn still comes away a winner. Based on SEC filings, Icahn will likely make $180-million dollars from the deal assuming he retained the stake he announced in late May. Not a bad haul for less than 4 months of work.

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