In Part One we showed why we believe antitrust concerns are a non-issue in the battle to acquire Family Dollar. In Part Two, we assume that both Dollar General and Dollar Tree could overcome any potential attempts by the FTC to block their acquisition of Family Dollar, and focus entirely on the question of which bid Family Dollar’s Board should support. Certainly Dollar General’s higher, all cash bid seems more attractive in terms of immediate return for Family Dollar shareholders. But which suitor would make integration easier? Which suitor is more likely to ensure operational and financial success once the companies are combined? Again, we look to our data for answers.
Product Assortment and Pricing
When we look at product assortment, Dollar General and Family Dollar have the most overlap in terms of items they sell, with a significant emphasis on grocery items such as chips, soft drinks, milk, pet food, paper products, and candy at both retailers. As we saw previously, their pricing models are also closely aligned. Dollar Tree on the other hand, depends more on party supplies and seasonal items, while sticking to the $1 price point. There is assortment overlap between Dollar Tree and Family Dollar in categories such as candy, soft drinks, paper products, and household cleaning products.
Dollar General’s wide assortment overlap with Family Dollar would give it several advantages over Dollar Tree. For one, it would potentially lead to better purchasing power with its existing vendors given the higher volumes it would be ordering. This could allow it to save costs and/or lower prices for consumers (again the FTC is going to have a tough time arguing that prices will rise for dollar store consumers!). Further, the combined Dollar General & Family Dollar supply chain would be less complicated than with Dollar Tree due to increased volumes with fewer vendors, resulting in more full truckload logistics for lower costs as well as having less dependence on hard to plan seasonal and closeout merchandise.
Lastly, if Dollar Tree wins and decides to migrate Family Dollar stores to its pricing and assortment model, that could potentially drive away existing customers or introduce operational risk at the very least. Perhaps instead, Dollar Tree sees a Family Dollar acquisition as a path to reducing its own dependence on managing constantly changing seasonal and closeout merchandise – a strategy that must be difficult to scale much further. Either way Dollar Tree seems to be at a disadvantage from a merchandising integration standpoint given its very different assortment and pricing model.
As a recent Bloomberg Businessweek article points out, Dollar General and Family Dollar also share a high degree of geographic overlap. We ran our own analysis based on store zip codes and found that 65% of Family Dollar stores share their zip code with at least one Dollar General store. On the flip side, only 35% of Family Dollar stores share their zip code with a Dollar Tree store. It is to Dollar Tree’s advantage to have lower geographic overlap, because it means they will be getting access to more new territories. Of course it’s what also allows them to say that they have fewer chances to remove competition from markets they operate in after the acquisition. That all being said, even with higher existing overlap, a Dollar General-Family Dollar combo would reach 2,400 more distinct zip codes in total than a Dollar Tree-Family Dollar combo because of sheer size.
Of course what really matters is not just proximity, but the extent to which consumers already cross-shop the potentially merged retailers. As we saw in Part One, many dollar store chain shoppers tend to stick to one chain in any given month – despite shopping for groceries several times each month. According to our data, while Dollar General and Family Dollar have significant geographic overlap, only 21% of Dollar General shoppers also shop at a Family Dollar store in a given month.
The financial ramifications of either deal will be interesting. The goal of nearly every acquisition is to obtain synergies, both on the revenue side and the cost side. Dollar General has promised nearly double the cost synergies as Dollar Tree, with a target of $600 million by year three. Revenue synergies will be more difficult since price hikes are a non-starter for dollar stores, but perhaps synergistic promotional opportunities exist. For example the merged entity should garner more trade funds from vendors, allowing greater economies of scale to be achieved through each promotional dollar spent. By virtue of its assortment variety and different pricing model, Dollar Tree might have an edge with cross promotions across, except that it has less geographic overlap and its shoppers are less likely to also shop at Family Dollar. The Dollar General deal would lead to a combined company with a higher initial debt level of about 4.3X net debt to EBITDA (Earnings Before Interest Taxes and Depreciation & Amortization) versus roughly 3.75X with Dollar Tree.
The good news is that either Dollar Tree or Dollar General will likely bring operational efficiencies and margin enhancement to Family Dollar because both chains have higher annual revenue per store and higher operating margins than Family Dollar. That would help either combined company pay down debt faster with increased operating income. Dollar General’s commitment to sell a significant number of overlapping Family Dollar stores while shuttering significantly under-performing stores would seem to increase the likelihood of its ability to improve Family Dollar’s operating margins. In addition, our data indicates that among dollar store buyers, the dollar store channel has seen a slight “share of wallet” increase so far this year. That bodes well for all three chains.
Our Closing Thoughts
Though it depends how you weight each decision factor, it appears the the Family Dollar board is going to have a hard time justifying its rejection of the higher Dollar General bid to its shareholders based on what we have shown here in part two of our Family Dollar Saga blog series. If you are curious to know more about what our data shows, give us a shout at email@example.com!