Jeremy Steinberg
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Dollar Tree Raising Offer Means Playing to Lose

Dollar Tree Inc. may find it’s not worth it to keep pursuing one of its rivals.

Dollar General Corp. topped its smaller competitor’s takeover proposal for Family Dollar (FDO) Stores Inc. with a $78.50-a-share offer yesterday. While some traders are betting Dollar Tree will boost its offer, Northcoast Research Holdings LLC said the chances of the $11.2 billion company winning a bidding war are so slim that it probably won’t get too aggressive.

Even if it doesn’t increase its bid, Dollar Tree has already forced Dollar General to counter a near-record price. Walking away now would also give Dollar Tree a $305 million breakup fee that almost doubles its cash stockpile. Albert Fried & Co. says those resources could be used to buy the 700 stores that Dollar General plans to divest to satisfy regulators.

“If they increase it, they’re not likely to win because Dollar General is not going to say, ‘Oh OK, you increased it, see you guys later,’” Sachin Shah, a special situations and merger arbitrage strategist at Albert Fried, said in a phone interview. “If Dollar General is going to follow you to that level and exceed that level, what do you really gain?”

Matthews, North Carolina-based Family Dollar said its board would review the Dollar General offer and hasn’t changed its recommendation supporting the Dollar Tree deal. A representative for Dollar Tree declined to comment.

‘A Surprise’

Family Dollar has attracted takeover speculation since 2011 when Trian Fund Management LP’s Nelson Peltzmade an offer in an attempt to draw other suitors. Although Dollar General was analysts’ buyer of choice at the time, it hadn’t publicly made an offer for the $9.1 billion company until now.

The retailer re-evaluated its options after Dollar Tree’s bid sparked concern that Family Dollar may soon be out of reach for good, according to people familiar with the matter this month.

“This is somewhat of a surprise,” Nick Mitchell, a Cleveland-based analyst at Northcoast Research, said in a phone interview. “Probably Dollar General underestimated the opportunities that Family Dollar had to sell itself to someone besides Dollar General. (DG)”

Wal-Mart Stores Inc., another potential suitor, is unlikely to bid after determining the target wouldn’t be a good fit with its smaller-format stores, a person familiar with the situation said.

Higher Offer

For Dollar General to get a shot at buying the discount chain now, it had to top Dollar Tree’s $8.5 billion cash-and-stock offer, which already valued Family Dollar near a record. Coming late to the bidding also means Dollar General will have to pay a breakup fee.

That leaves Dollar Tree in a tough spot. The Chesapeake, Virginia-based company probably has the ability to counter Dollar General’s bid, and with Family Dollar shares closing $1.31 above yesterday’s offer, some traders are betting it will. The company would be playing to lose though, said Keith Moore, an event-driven strategist at MKM Partners LLC.

“It’s one of these things where they’ve made the decision to go strategically in this direction and if you think about it, $78.50 is not a huge amount,” Moore said in a phone interview. “That being said, I’ll tell you that I still think, in the end, Dollar General will ultimately prevail.”

Shares of Family Dollar fell 0.1 percent to $79.70 today. Dollar Tree rallied 0.8 percent to $54.71, while Dollar General dropped 0.9 percent to $63.59.

Bigger Buyer

Dollar General, based in Goodlettsville, Tennessee, is in a better position to battle for Family Dollar, according to Paul Trussell of Deutsche Bank AG. With a market value of $19.5 billion, it’s almost twice as big and has “enormous dry powder” to draw from, the analyst wrote in a report yesterday.

The potential for more revenue benefits and cost savings adds to Dollar General’s firepower. Both it and Family Dollar sell low-cost goods at a range of prices, while Dollar Tree primarily focuses on products valued at $1 or less.

Dollar General could probably raise its offer to as much as $85 a share and still have the deal add to earnings, according to Peter Keith of Piper Jaffray Cos. Facing off against a competitor like that, Dollar Tree “would best serve shareholders by taking the $305 million breakup fee and moving on,” the analyst wrote in a report yesterday.

Other Options

The fee would boost Dollar Tree’s estimated cash per share to $4.66 from $3.19, which could fund additional stock buybacks, according to Denise Chai of Bank of America Corp.

Another option for Dollar Tree is to try to purchase the stores that Dollar General is planning to divest in order to thwart potential antitrust objections to a Family Dollar takeover, said Shah of Albert Fried.

“They’re going to get the $305 million, but why not get the $305 million and those stores?” he said. “It seems very plausible that they’re interested in those units. Dollar Tree wants to get bigger, and that’s why they’re doing this deal to begin with.”

Although Dollar Tree could keep bidding just to force Dollar General to pay more, that’s a dangerous move, said Mitchell of Northcoast Research.

“It’s like a game of hot potato,” he said. “You don’t want to be the one left overpaying for the asset because you thought someone else would be able to pay more.”