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Do Not Bet on a Family Dollar and Walmart Merger

Jon C. Ogg

Sometimes Wall Street can think of the simplest or most complex things in the world. Credit Suisse's Michael Exstein issued a review on Wal-Mart Stores Inc. (WMT). While the firm maintained an Outperform rating and $87 price target, the real news is that Exstein's report is a supposition article on how and why Walmart should acquire Family Dollar Stores Inc. (FDO). The report was even titled "Exploring a Family Dollar Acquisition: The Small Store Could Start Here."

As a new president at the helm, it was noted in the research report, one of McMillon's top priorities will be to come up with a small store strategy, and then to aggressively pursue that strategy. Exstein said:

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WalMart has signaled a need to fill the small format hole in its store portfolio to compete for its core customer in the "fill-in" trip. In October 2013, the company announced its plans to open 120-150 small format stores in 2014 (including its 38,000 square foot Neighborhood Markets and 15,000 square foot Express stores), with the ultimate goal of expanding the concept to 700 stores by 2017.

Where this one research report gets interesting is that Exstein said this is still a proverbial drop in the bucket compared to the dollar stores. He showed that the store bases of Family Dollar, Dollar General Corp. (DG) and Dollar Tree Inc. (DLTR) currently number more than 23,000 domestic units.

Exstein did admit that Walmart has chosen organic growth in the United States, while saving acquisitions for foreign markets. He believes that an internal "buy vs. build" debate would rest on how long it would take Walmart to catch up to the dollar stores.

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When we first saw this report mentioned on Wednesday, the first issue that arose in our minds was serious antitrust considerations. Walmart is literally fought by neighborhoods and communities at what seems to be every single new store it wants to open. If Walmart goes into any now retail format, the established players in this retail segment are almost certain to be out filing FTC suits to block the deal.

It seems that Dollar General and Dollar Tree should both have some serious concerns, as well as some serious arguments to make to regulators, if this tie-up was ever moved beyond a mere hypothetical gesture. Dollar General just saw a rare downgrade on this same day, with its stock rating cut to Market Perform (from Outperform) at Wells Fargo.

Exstein did at least mention the antitrust and FTC risks. Still, he said:

Our proprietary geographic analysis suggests that acquiring Family Dollar could be the most logical way for WalMart to significantly jumpstart the small store effort. Compared to Dollar General and Dollar Tree, WalMart has the lowest overlap in store locations with Family Dollar. As this is a proxy for market share, we think the WalMart-Family Dollar combination could have the least risk of opposition from the FTC. We think WalMart could pay a 20% to 30% premium for Family Dollar in an immediately accretive deal.

The long and short of the matter is that Exstein believes that premium would value Family Dollar at $76 to $82 per share in a buyout. Family Dollar shares are up 1.8% at $65.78, and the 52-week range is $54.06 to $75.29. The consensus price target from Wall Street analysts is closer to $61, and the highest price target from a Wall Street analyst is up at $75.

If you want to know why we are concerned that this notion may be a bit silly in regulatory terms, take a look at our decade outlook when we penned that the Dollar Store theme was effectively building the next Walmart. The difference is that they will still be dwarfed by Walmart. If Walmart were to acquire one of the chains, that sub-sector in retail will not go down without a fight.

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Our bet is that Walmart may have a hard time with regulators in acquiring a single company in the United States in any sector.

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