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Morningstar | Starboard's Quest for a Family Dollar Deal, Multiple Price Points at Dollar Tree Could Add Value

We do not plan to change our $89 per share fair value estimate for no-moat Dollar Tree after activist investor Starboard's push for a Family Dollar divestiture and the introduction of more price points at Dollar Tree-bannered stores. However, the move, which came as the fund nominated a slate of seven new directors to the board, could add value if the efforts succeed, though we view the high end of Starboard's $120-$150 per share valuation range of outcomes as somewhat optimistic.

With about a 1.7% stake, Starboard called on management to explore "all strategic alternatives … including a sale" of Family Dollar. We have been disappointed with results at the banner, which was bought for $9 billion in 2015, with its lack of differentiation and dependence on competitive urban markets overwhelming Dollar Tree stores' better standing, leading to our no-moat rating. While we believe performance should improve (segment adjusted operating margins expected to rise to around 6% long term versus 4% on average from fiscal 2016-17), we expect the chain will struggle to match Dollar General's high-single-digit margin due in part to the latter's superior locations, often rural areas with little competition. A sale could refocus resources on the better-positioned Dollar Tree banner.

The push for multiple price points at Dollar Tree could also add value, though we are cautious as completely abandoning a relatively low price cap could erode protections against digital rivals. Dollar Tree's low-priced, impulse-friendly assortment leads to small basket sizes with little room for shipping costs. We believe meaningfully higher prices could invite greater competition from Amazon and mass merchandisers. In this vein, we are encouraged that Starboard seeks to keep most products priced at $1, with a few new prices at higher increments (up to roughly $2). Still, while the move could unlock value, it should put a premium on stronger execution in a difficult retail environment.

At the time of the acquisition, we believe management underestimated the complexity associated with operating two different business models targeting two distinct customer pools. Dollar Tree caters to middle-income consumers looking for bargains that are somewhat more discretionary, while Family Dollar appeals to low-income shoppers seeking value on basic essentials. We believe this would have made Dollar General a better suitor for Family Dollar, as it shares a similar consumables-focused orientation directed toward consumers of modest means. Dollar General's bid for Family Dollar was higher than Dollar Tree's, but concerns about antitrust challenges led the target to pursue the alternative offer. We believe subsequent unit growth at Dollar General likely exacerbates concerns about overlap between the two chains, and expect the need for a long-term turnaround at Family Dollar suggests a private buyer. Dollar Tree and Family Dollar are not new to activist investors; Carl Icahn acquired a stake in Dollar Tree in late 2018 and, as a large Family Dollar shareholder, had pushed that chain to seek a sale in 2014.

Our stewardship rating for Dollar Tree remains Standard, with the troubles at Family Dollar counterbalanced by relatively steady execution at the namesake banner.

We have been favorably disposed to past efforts by Starboard in retail. For example, we have supported efforts by narrow-moat Advance Auto Parts' new management team (which was installed after Starboard took a stake in the firm and pushed for a leadership change) to boost performance and efficiency. While activist investors can put too much attention on short-term results at the expense of long-term corporate health, we believe the accountability that Starboard's presence offers will be positive for other Dollar Tree shareholders.