Meaningful Upside: Big Lots, Family Dollar Buyout Updates

Includes: BIG, FDO
by: NakedValue

Comparisons between Big Lots (NYSE:BIG) and Family Dollar (NYSE:FDO) are unavoidable. Both companies cater to low end discount consumer groups, operate with similar margins and are involved in buyout talks. Family Dollar Stores is the subject of an unsolicited buyout proposal from Nelson Peltz’ investment firm, Trian Group. (Big Lots hired Goldman Sachs to explore strategic alternatives.)

Family Dollar Update

Family Dollar announced today that the board of directors unanimously agreed that the $55 to $60 per share cash buyout offer from Trian Group substantially undervalues the company. The company will continue to pursue the strategic plan announced in September 2010. The company has already repurchased $400 million shares out of the $750 million allocated in their strategic plan. The board also instituted a shareholders rights plan with a term of 12 months and a ownership threshold of 10%.

Considering that the Family Dollar board was unhappy with the Trian Group cash offer, which would have valued the company at a trailing EV/EBITDA of almost 10, it seems hard to believe that anyone will come back with a better offer. In addition to the high price hurdle, the shareholder rights plan will only further inhibit further buyout interest from other entities as it sends a signal that the board may not be interested in selling the company.

Big Lots Update

There have not been any updates to Big Lots’ exploration of strategic alternatives, but the developments in the Family Dollar Stores deal have been important in setting a buyout valuation for Big Lots. The consequences of Family Dollar’s rejection of the Trian Group on Big Lots is unclear. On the one hand, it takes away a potential buyout market multiple that would have given Big Lot shareholders sizable upside. On the other hand, the Family Dollar board is essentially saying that the already high multiple implied by the Trian Group offer wasn’t enough and that Family Dollar (and Big Lots) are worth much more.

Big Lots reported strong sales and earnings for the fourth quarter. Earnings per share came in at $2.83 per diluted share for the 2010 fiscal year. The company also provided strong guidance with 2011 fiscal year earnings from continuing operations of $3.05 to $3.15 per diluted share. These strong results can only strengthen the value of Big Lots. Based on yesterday’s close, the forward P/E is now 13.

In an earlier article, we noted that the Trian Group buyout offer midprice would have valued Family Dollar at an EV/EBITDA of around 9.75. Considering that Big Lots currently trades at a trailing EV/EBITDA of 7.25, a buyout proposal at those levels would imply a price of $56 per share of Big Lots. In addition, unlike Family Dollar, the Big Lots board of directors is clearly open to the idea of strategic change. Finally, the Big Lots’ earnings today only reinforce the company’s operating strength.

Big Lots shares should be purchased on weakness. The buyout possibilities provide meaningful upside and the operating strength and reasonable valuation multiples provide a margin of safety even if a buyout falls through.

Disclosure: I am long BIG.