There are usually two simple reasons one company seeks to acquire another company - either for synergies that lead to cost reduction, opportunities for growth, or both. In the case of Dollar General (NYSE:DG) making a big scene about wanting to acquire Family Dollar (NYSE:FDO), there may be a less-obvious reason: fear of Dollar Tree (NASDAQ:DLTR) getting its hands on it.
I propose that perhaps more important than the benefits Dollar General would receive from the acquisition is the fear of the disadvantage it could find itself in if Dollar Tree snags it instead. Consider this. Up until recently, Dollar General competed only somewhat with Dollar Tree. True, they both offer many household products such as cleaners, toiletries, and snacks but they do (or did) so at mostly entirely different price points. Dollar Tree prices its products exclusively at $1 or less while most products at Dollar General are $1 or more as they are of different sizes, styles, and brands.
For Dollar General, this has been in the process of changing. Turn to the most recent Dollar General conference call for details. During it, CEO Richard Dreiling stated,
"We are continuing to add items under our smart and simple brand at entry level price points, and we continue to strategically introduce new $1 price point items in key consumable categories such as food, home cleaning and paper products that are focused on affordability. New items include a combination of national brands and our private brands. We currently have approximately 2,500 core $1 items in our stores, which is up 5.5% from last year. Sales of core $1 SKUs increased over 13% in the second quarter with over 44% of customer transactions including a core $1 item."
It sounds like Dollar General is evolving in part more and more toward at least a larger section of its store being more like a traditional dollar store and competing more directly with Dollar Tree head on. If Dollar Tree gets its hands on Family Dollar first, Dollar Genera's $1 price point business may come under greater direct threat. After all, who knows more about the $1 price point business of the three better than Dollar Tree?
During the Q&A of the call, Dreiling mentioned Dollar General has been selling some items that it traditionally sold for $1.50 or $2 a year ago all the way down to $1 today. Apparently the company is figuring out the "magical $1 price point" (as Family Dollar once referred it as) is a hook to get customers in the stores then they buy more expensive items as well.
Dollar General is planning a large assortment of high-margin $1 price point items for the Christmas shopping season. The company may feel it needs to stop Dollar Tree's reach or it shareholders could end up finding a lump of coal in their stocking this year.
My actionable advice? Consider buying Family Dollar. The bidding war heat may turn to fire. Worst case is the original Dollar Tree bid goes through and you have a single-digit percentage loss. Best case you see a much higher bid come in for Family Dollar when all is said and done.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.