Dollar General Acquisition Buys Restructuring Time

JON SPRINGER

GOODLETTSVILLE, Tenn. — The sale of Dollar General to a private buyout firm may provide some near-term competitive relief to supermarkets, industry observers said last week.

The impending privatization of the country's largest small-box discounter is likely to accelerate the closure of existing Dollar General stores and slow the opening of new ones, analysts said.

“Marginally, it probably helps supermarkets,” Andrew Wolf, an analyst for BB&T Capital Markets, Richmond, Va., told SN. “[When a store closes,] it's one less competitor selling food.”

Pending shareholder approval, the New York-based buyout firm Kohlberg Kravis Roberts will become Dollar General's new owners in the third quarter. KKR said it would pay $7.3 billion, including assumption of $380 million in debt, for the 8,260-store, $8.6 billion retailer. The price, $22 per share, is roughly 12 times EBITDA and represents a 29% premium above the average share price over the prior 30 days, but it's less per share than what the stock was trading for two years ago.

“The deal shows the appetite for risk that some private investors have, and how much money is out there,” said one analyst, who asked not to be identified. He termed the deal “a high price for low quality,” but potentially lucrative for KKR given Dollar General's cash flows.

The deal nevertheless generated some shareholder lawsuits last week, one complaining of “grossly inadequate” value and the timing of the announcement ahead of the scheduled announcement of fiscal year-end results.

Analysts said the upside for KKR is to take the retailer out of the glare of the public markets so it can accelerate the restructuring that management began late last year. The company said then it would close 400 stores in the next fiscal year, reduce the number of stores it opens and change its inventory practices. Private ownership would allow these initiatives to take root while also weathering current economic conditions that are not favorable to the dollar store channel, sources said.

“While the public market is based on monthly sales and quarterly earnings pressures, [KKR has] a longer-term plan in mind,” Mark Miller, an analyst who follows Dollar General for William Blair in Chicago, told SN. “The industry is currently facing headwinds of weak wage growth and rising energy costs, but looking out over a multiyear period, I think the passage of the federal minimum wage increase should be squarely benefiting the Dollar General customer, so it's reasonable to look on the other side and conclude the business can be more profitable than it is today.”

One profit opportunity Miller said Dollar General will explore is replacing its current universal pricing strategy with zone pricing initiatives, or pricing items based upon store location and competition. “There's no reason you should be priced in downtown Chicago, where there is no Wal-Mart competition, the same way you're priced in rural Mississippi,” he said.

Analysts said they were uncertain what the deal might mean for Dollar General Market, Dollar General's nascent expanded-store concept incorporating more perishables offerings.

“I don't get the impression they're satisfied with the performance of it yet, but it remains to be seen what they'll do about it,” Neil Stern, senior partner with McMillan Doolittle, New York, told SN. “The dollar store tends to be a high-margin, low-turn business, and the grocery is a low-margin, high-turn business. Getting those two concepts to work together is the challenge.”

Burt P. Flickinger III, managing director of Strategic Resource Group, New York, said KKR will ultimately help Dollar General better compete against Wal-Mart — particularly as the latter struggles to define its customer niche. “They have a great management team, and they're already very competitive with Wal-Mart but have better relationships with some suppliers,” Flickinger said.