99 Cents Only Stores: Thinking Like a Private Equity Firm

 |  Includes: DG, DLTR, FDO, NDN
by: Wall Street Strategies

By Brian Sozzi

Investors in 99 Cents Only Stores (NYSE:NDN) awoke on Friday to news that the new private equity king of retail buyouts, Leonard Green, had joined forces with the Schiffer/Gold family to bring the company private for $1.34 billion. Anyone else take notice of the $19.09 per share offer price? Talk about clever, but unsurprising (NDN typically runs new store opening giveaways of general merchandise priced at $0.99 for a limited time), marketing.

It was a long overdue outcome for NDN, a company that boasts a very attractive dollar store model (variable product pricing plus the highest sales per square foot in the sector) but has never truly been viewed on par with Family Dollar (NYSE:FDO), Dollar Tree (NASDAQ:DLTR), and Dollar General (NYSE:DG) due to its lack of a broad geographic footprint. In addition to the deal being overdue, it comes at an opportunistic time in NDN's lifecycle as it invests in infrastructure to support square footage growth outside of its core California market, and at an opportunistic price by the most interested parties.

Using out year consensus financials on NDN, in other words FY12 and FY13, the $1.34 billion offer price values the company at a mere 16.3x and 14.0x on a P/E basis respectively, or 8.48x and 7.6x, respectively, from an EV/EBITDA perspective. While these are premium trading multiples to where Family Dollar's bid put it (12.2x/6.3x and 10.7x/5.86x using forward two-year consensus and the low end of the $7.0 billion to $7.6 proposed transaction price), an argument exists that NDN is poised to showcase greater earnings power than FDO in future years as a result of (1) aggressive new unit growth; and (2) leverage on investments that are presently hampering operating margins.

What Leonard Green is seeing:

* Concept with the highest sales per square foot in the sector at $289.
* First mover advantage in offering fresh food to consumers.
* Many investments in infrastructure out of the way.
* Variable pricing model met with success, a key during bouts of inflation.
* Poised to blanket the U.S. with the NDN banner.

Is the deal price too low? I can certainly justify a price in the range of $22 to $24. The pivotal question now is whether the deal has a good chance of being done. I think it gets done as the willingness of the Schiffer/Gold family to surrender a sizable chunk of stock to tap the balance sheet of Leonard Green to fund future growth for the company indicates a friendly dialogue. It could be that $19.09 is a starting point for something, say $20.99 per share, but all signs suggest this is a deal with strong rationale given long-term considerations.

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