There are a lot of pennies to be made in dollar stores. Maybe that's why private equity firm Kohlberg Kravis Roberts offered to buy discount retailer Dollar General (NYSE: DG ) for $7.3 billion.
The attraction of these retail operations is that they generate lots of cash and sport relatively little debt. When an investor like KKR comes in and takes a company private, it can then use its capital and control to make the necessary changes. A not-uncommon result is that the debt-laden company is then spun back off either by bringing it public again or selling off the various parts.
Dollar General has generated healthy cash flows while maintaining a relatively strong balance sheet. It typically produces around $200 million in annual owner's earnings (net income plus depreciation minus capital expenditures) and has had between $250 million and $300 million in outstanding debt.
Over the past 12 months, however, the General's cash flow declined as a result of significant purchases of inventory in anticipation of the holiday season, but also because of changes in how it handles inventory. That led to hefty markdowns which, in turn, affected Dollar General's bottom line. At the same time, the retailer expanded its debt load to nearly a half billion dollars to purchase the new inventory, which will include more name-brand items.
|
2003
|
2004
|
2005
|
2006
|
TTM
|
|
Free Cash Flow
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$267.1
|
$161.6
|
$219.0
|
$252.2
|
$142.0
|
Source: Author's calculations and Capital IQ, a division of Standard & Poors.
At 0.3, Dollar General's debt-to-equity ratio is nearly 50% higher than Family Dollar's (NYSE: FDO ) and significantly more than Big Lots' (NYSE: BIG ) , as the newly resurgent company recently paid off its debt. In addition, it also has an expanded credit facility that gives it access to greater financial flexibility if necessary.
The approximate $22 per-share deal with KKR offers investors a 31% premium to where the stock was trading prior to the announcement. That seems like a pretty hefty price tag, valuing Dollar General at 25 times normalized earnings, whereas Family Dollar and Dollar Tree (Nasdaq: DLTR ) trade at 19 and 18 times earnings, respectively.
Perhaps the deal shouldn't have been a surprise. The General had said it was exploring "strategic alternatives" in its last quarterly report. Those are usually code words for "shopping the company around," but management had tempered that by stating the alternatives related to its inventory management and real estate policies.
The board of directors has already approved the merger, and while no financial conditions need to be met to close the deal, it's subject to typical regulatory scrutiny and shareholder approval. Should the deal not be consummated, KKR would be entitled to a $225 million termination fee, but there doesn't seem to be any reason to think that the Dollar General deal will not become money in the bank.
Dollar Tree is a former recommendation of
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
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