KKR Seals a Deal for Dollar General

Shares of the discount retailer jumped nearly 26% on news of the buyout

Dollar General (DG) said Mar. 12 that it will be bought by the private equity firm Kohlberg Kravis Roberts & Co. for around $7.3 billion plus $380 million of net debt, as the Goodlettsville (Tenn.) discount retailer revamps its struggling business.

Under the agreement, Dollar General investors will receive $22 in cash per share, representing a premium of around 31% over the stock's closing price on Mar. 9. The stock rose 25.6% to $21.07 on the New York Stock Exchange March 12.

The merger, subject to approvals, is expected to close in the third quarter of 2007. "We are very pleased to announce a transaction that provides excellent value for our shareholders," Dollar General's CEO David A. Perdue said in a press release Mar. 12.

Dollar General had focused so much on putting in new stores during recent years that its sales began to languish. The company's sales growth at stores open more than a year fell from above 7% in 2001 to 2% in 2005, according to the investment research firm Morningstar. The retailer finally announced in November that it would remodel around 300 existing stores and close more than 400 of them during fiscal 2007.

Among other things, Dollar General plans to stop selling seasonal products that hadn't sold during their first year, but then got put back on the shelf during the next holiday. Now Dollar General tries to get rid of such inventory instead by having clearance sales.

"We think KKR sees an opportunity to strengthen DG's financial performance through more disciplined merchandise and inventory management, and aggressive closure of underperforming store," Standard & Poor's equity analyst Jason Asaeda said in a research note. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Cos.) S&P raised its 12-month target price on the stock by $7 to $22.

But debt investors weren't so keen. Goldman Sachs and Lehman Brothers are providing debt financing for the deal, which means more payments that Dollar General will owe in the coming years. Moody's Investors Service put Dollar General's Ba1 debt rating on review for a possible downgrade, explaining that the merger with KKR "will result in a significant increase in the company's leverage and a corresponding weakening in credit metrics at a time when the company's operating performance has been weak."

At least KKR feels confident. Dollar General isn't KKR's first foray into the discount retail industry. The private equity firm's other recent investments include the Wayne (NJ)-based Toys "R" Us in 2005 and the European store operator Maxeda in 2004.

"We look forward to partnering with the Dollar General team to position the company for future growth," KKR's CEO Michael M. Calbert said in the press release.