Why Dollar General Corp.'s Shares Surged Today

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Dollar General (NYSE: DG  ) are trading 10% higher Monday on news that the company has entered a bidding war with rival Dollar Tree (NASDAQ: DLTR  ) to acquire third-place small-box discount retailer Family Dollar (NYSE: FDO  ) . Shares of Family Dollar have also moved higher after Dollar General's offer -- representing a 5% gain for the day so far -- while Dollar Tree's share price has slipped by roughly 2%.

So what: First-place small-box discounter Dollar General's $8.95 billion bid, which works out to $78.50 per share, upstages Dollar Tree's current $8.5 billion (or $74.50 per share) bid, which was already agreed to last month. If the deal is completed, it would create a 20,000-store retail behemoth with $28 billion in annual sales, but Dollar General is willing to divest up to 700 stores to obtain regulatory approval. Dollar Tree was also willing to divest a similar number of locations to get the deal done. Dollar General proposed a more ambitious level of cost synergies from the combination, as it should save $550 million to $600 million annually within three years, compared to roughly $300 million in savings for Dollar Tree.

Family Dollar's shares are now trading at a roughly 2% premium to Dollar General's offer, which indicates that investors now believe the price will be pushed higher. Family Dollar is obligated to pay $305 million in "breakup fees" if it does not complete the Dollar Tree buyout process, but this is smaller than the difference between the initial bid and the new one.

Now what: It seems inevitable that Family Dollar will merge with one of its rivals, but at the moment no one (except perhaps the executive teams of these three companies) is quite certain which it will be. However, it seems clear that Dollar General would pull off a major coup and hamstring rival Dollar Tree if it completed the acquisition, as Dollar Tree's revenue growth has deteriorated in recent quarters, while Dollar General's position is stronger:

DG Revenue (Quarterly YoY Growth) Chart

DG Revenue (Quarterly YoY Growth) data by YCharts.

However, it's also worth noting that Family Dollar's EPS growth rates have been the weakest of the pack for some time, while Dollar Tree has generally been the most consistent grower of EPS. That could indicate that Dollar Tree has more to gain from a buyout, provided it can implement the same practices in Family Dollar's stores that have worked in its own:

DG Normalized Diluted EPS (Quarterly YoY Growth) Chart

DG Normalized Diluted EPS (Quarterly YoY Growth) data by YCharts.

Investors in dollar-store stocks probably will come out ahead no matter how the deal ends. All three of these companies have enjoyed roughly three-bagger returns over the past five years.

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