Let's look at some of the numbers behind each company in turn:
- 10 yr revenue growth rate = 10% CAGR;
- PE (TTM) = 23.4x
- Net margin = 6-8% over last 5 years
- ROE = 26% average over 10 yrs
- Balance sheet - Cash & Equivalents = $408 million; Debt = $757 million; Net debt = $349 million
- Shares outstanding = 20% buyback over last 5 yrs
- Enterprise value = $14.4 billion; Revenues = $8.4 billion; EV/sales = 1.7x
- 10 yr revenue growth rate = 6% CAGR
- PE = 32.0x
- Net margin = 2.7-4.5% last 5 yrs
- ROE = 23% average over 10 yrs
- Balance sheet - Cash & Equivalents = $149 million, Debt = $500 million; Net debt = $351 million
- Shares outstanding = 19% buyback over last 5 yrs
- Enterprise value = $9.5 billion; Revenues = $10.5 billion; EV/ Sales = 0.9x
Also, market focus is similar but somewhat different - DLTR sells most things $1 or less; FDO sells household and consumable goods and range of low prices, so compete more with likes of Wal-Mart (NYSE:WMT) and competitive bidder, Dollar General.
What does this suggest?
DLTR is buying a company with:
- slower historical growth rate (revenue over 10 years)
- more expensive valuation multiple
- lower net margins
- comparable ROE, net debt (so no cash benefit), and buyback history
- less well-defined niche with tougher competitive market
Perhaps management think they can improve operational efficiency and increase net margins, thereby gaining profit growth on account of FDO's lower EV/Sales ratio? Maybe, but it would have to outsmart Wal-Mart in the process (net margin = 3.5% 10 yr average).
Stated objective for the acquisition is to consolidate the market serving low income shoppers. But looks like a less than optimal route to grow bigger at the expense of operational expertise and performance. Could it be a case of Peter Lynch's "Diworseification?"
Is It A Good Deal For Shareholders?
Looks like a good deal for FDO shareholders. Not so good for DLTR; it will need an unproven strategy to work well.
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. The author has no business relationship with any company whose stock is mentioned in this article.