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Dollar Tree Most Profitable as Cheapest of LBO Targets: Real M&A

A Customer Enters A Family Dollar Stores Inc Store
While private-equity firms circle Family Dollar Stores Inc., 99 Cents Only Stores and Big Lots Inc., a leveraged buyout of Dollar Tree Inc. may offer the biggest bang for the buck. Photographer: Jin Lee/Bloomberg

While private-equity firms circle Family Dollar Stores Inc., 99 Cents Only Stores and Big Lots Inc., a leveraged buyout of Dollar Tree Inc. may offer the biggest bang for the buck.

Dollar Tree, which sells everything from toys to pet food and cleaning supplies for $1 or less, holds three times as much cash as Family Dollar, is more than twice as profitable as 99 Cents and generates 55 percent more income per dollar of sales than Big Lots, according to data compiled by Bloomberg.

Chief Executive Officer Bob Sasser has rewarded Dollar Tree shareholders with a 225 percent advance in the past three years, more than its biggest competitors, as the worst U.S. recession since the Great Depression drove shoppers to lower-priced goods. While Dollar Tree’s rivals climbed as much as 40 percent this year after being approached by buyout firms, the Chesapeake, Virginia-based company has dropped 3.7 percent, leaving it the cheapest on a free cash flow basis.

“Conspicuous consumption is out and saving money and value is in,” said Anthony Chukumba, a New York-based analyst at BB&T Capital Markets, who has a “buy” rating on Dollar Tree. “Dollar Tree is the market leader in a lot of ways. There’s no reason it wouldn’t attract the same interest from financial sponsors that the other players at this point have.”

Timothy Reid, a spokesman for Dollar Tree, didn’t return a telephone call requesting comment. The company’s shares advanced for a fifth straight day, climbing 59 cents, or 1.1 percent, to $54.03 on the Nasdaq Stock Market today.

Cheaper Shopping

Discount retailers are luring LBO firms after their sales and profits withstood the 18-month recession that ended in June 2009, the longest since the Great Depression. Shoppers are still seeking cheaper alternatives during the recovery.

Wal-Mart Stores Inc., the world’s largest retailer, said last week it’s considering acquisitions to boost revenue from smaller stores as shoppers who prefer quicker trips when buying toothpaste and packaged foods turn to dollar merchants. Shares of the Bentonville, Arkansas-based company slipped 3 percent this year.

Family Dollar, the Matthews, North Carolina-based retailer that rejected an unsolicited bid by Nelson Peltz’s Trian Fund Management LP hedge fund this month, rose 3.4 percent this year.

Trian urged Family Dollar to reconsider its rejection of the offer, saying it’s confident of raising the capital necessary. The New York-based fund also asked Family Dollar for a confidentiality agreement so it can perform due diligence, according to a Securities and Exchange Commission filing today.

Founding Family

99 Cents, based in City of Commerce, California, gained 23 percent. Members of the Schiffer-Gold founding family and Leonard Green & Partners LP offered last week to take the company private for $19.09 a share.

Big Lots, the Columbus, Ohio-based retailer of closeout and overstocked brand-name goods, had the biggest jump, surging 40 percent. The company hired Goldman Sachs Group Inc. of New York to study its options after Boston-based firms Bain Capital LLC and Thomas H. Lee Partners LP approached it about a possible sale, a person with knowledge of the situation, who declined to be identified because the matter was private, said last month.

“The sector is in play,” said Matthew Kaufler, a money manager at Federated Clover Investment Advisors in Rochester, New York, which oversees $3 billion. “You look at Family Dollar Stores, 99 Cents stores and Big Lots. Wal-Mart wants to step up its acquisitions, and I doubt it’s moving upscale.”

Today’s Trading

Wal-Mart slipped 27 cents, or 0.5 percent, to $52.32 today. Family Dollar gained 13 cents, or 0.3 percent, to $51.40. 99 Cents advanced 8 cents, or 0.4 percent, to $19.66. Big Lots retreated 30 cents, or 0.7 percent, to $42.75.

While Dollar Tree’s shares have declined this year, the operator of more than 4,000 stores in malls and shopping centers across 48 states and Canada outranks the competition on managing for net cash, return on equity and operating margins.

“Private equity sees these companies generating cash flow and having room to grow,” Kaufler said. “The peak in the economic cycle is still in the distance, allowing private equity to pick off these companies at a fairly attractive premium and then possibly bring them public again when the economy is operating at an even higher level of activity.”

Dollar General Corp., the biggest U.S. dollar discount retailer, was taken private by New York-based KKR & Co. in July 2007 for $7.3 billion including net debt. The Goodlettsville, Tennessee-based company’s initial public offering in November 2009 gave Dollar General an enterprise value of about $11 billion, data compiled by Bloomberg show.

‘More Moderate’

Dollar General slid 17 cents, or 0.6 percent, to $28.65.

While other discount retailers were hampered by locations in rural and urban areas, Dollar Tree’s suburban locales and more attractive storefronts drew shoppers, according to Joan Storms, an analyst at Wedbush Securities in Los Angeles. In the past few years, rivals played catch-up with store renovations, customer service and national brands, she said.

“Dollar Tree has always had nice stores because they’re a little bit more moderate customer base,” Storms said. “If you walked into a Family Dollar or Dollar General five years ago, you would have felt poor. They used to be sort of dumpy stores in rural markets with no name brands.”

Storms has an “outperform” rating on Dollar Tree and Dollar General and rates Family Dollar, 99 Cents and Big Lots “neutral.”

Net Cash

Dollar Tree’s shares climbed 225 percent from the end of 2007 through last year, outpacing Family Dollar, Big Lots and 99 Cents by an average of 108 percentage points, according to data compiled by Bloomberg.

Net cash at Dollar Tree totaled $220 million as of Jan. 29, the highest of any dollar store, and more than all discount retailers except Issaquah, Washington-based Costco Wholesale Corp., data compiled by Bloomberg show. Dollar Tree had $486 million in cash and short-term investments, versus $137 million for Family Dollar, the data show.

Dollar Tree’s return on equity, a measure of how much it earns for each dollar invested, was also the highest of the group. Its 27.5 percent return in the last fiscal year was more than double 99 Cents’ return of 10.8 percent, which ranked last.

Of the U.S. discount stores with more than $1 billion in market value, Dollar Tree also retained the most operating income for each dollar of sales. Its operating margin of 11.2 percent topped even Wal-Mart, which had a 6.1 percent margin. Big Lots had a margin of 7.2 percent.

‘Squeeze Out’

Dollar Tree’s profitability may deter private-equity firms because the company could command a higher price tag with less room for improvement, according to James Dunigan, chief investment officer in Philadelphia for PNC Wealth Management, which oversees $108 billion and owns Dollar Tree shares.

“The business model that they run is very strong and the margin would present less of an opportunity for a financial buyer to squeeze out some of those costs,” Dunigan said.

Dollar Tree’s shares sell for $19.63 per dollar of free cash flow, or its cash from operations in the past 12 months after deducting capital spending. That’s cheaper than 99 Cents at 62 times, Dollar General at 28 times and Family Dollar at 21 times, data compiled by Bloomberg show.

Joshua Braverman, a spokesman for Family Dollar, 99 Cents’ Angela Thurstan, Timothy Johnson of Big Lots and Dollar General’s Tawn Earnest didn’t return telephone calls outside of normal business hours requesting comment.

Credit Ratings

Dollar Tree is currently rated A1, the sixth-highest investment-grade ranking, according to Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, market capitalization, profitability and other financial ratios. That’s two levels above Big Lots’ rating of B3H and three higher than Dollar General’s B3 ranking, the data show.

If Dollar Tree’s long-term liabilities, which include operating leases, were to increase by 50 percent in a leveraged buyout, its credit rating would drop to B3H, which would still match Big Lots and remain one step above Dollar General, Bloomberg’s ratings show.

“All of the dollar stores at this point are targets,” said Flavia Araujo, a San Francisco-based manager at Highmark Capital Management, which has $17 billion in assets. Dollar Tree’s “growth profile is attractive,” she said. “It would be more attractive to a private-equity group.”

Elsewhere in mergers and acquisitions, Warren Buffett’s Berkshire Hathaway Inc. agreed to buy Wickliffe, Ohio-based Lubrizol Corp., the world’s largest producer of lubricant additives, for about $9 billion.

Berkshire will pay $135 a share in cash, 28 percent more than Lubrizol’s closing price on March 11, Omaha, Nebraska-based Berkshire said in a statement today.

Overall, there have been 4,568 deals announced globally this year, totaling $457.2 billion, an 13 percent increase from the $403.7 billion in the same period in 2010, according to data compiled by Bloomberg.

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