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The case study focuses on the leveraged buy-out deal of Dollar General, a leading deep-discount retailing company, offered by affiliates of private-equity firm Kohlberg Kravis Roberts & Co. The transaction value was $7.3 billion and an assumption of the outstanding debt of the company. The Board of Directors agreed to the deal, whereas some shareholders had other opinions, and they filed a lawsuit against the proposed deal. The shareholders had to decide in the annual shareholders meeting on whether to vote in favor of the buy-out or not.
Harvard Business Review (108015-PDF-ENG)
August 12, 2007
Case questions answered:
- Why are public firms such as Dollar General going private? Provide at least 3 explanations.
- Based on Exhibits 5, 6, and 7, what is your assessment of Dollar General’s performance over time and relative to its peers? What metrics would you focus on? Why?
- How do you explain the performance decline during the year ended February 2, 2007?
a. What was the change in strategy?
b. How did it (in part a) affect the reported financial results? How will it affect future financial results?
c. Should Sadayo adjust operating income and net income to account for special items? If so, which special items?
d. How would these adjustments affect the transaction multiples? Specifically, how would you calculate the “adjustment” enterprise value/EBITDA multiple? (Assume that the enterprise value remains $7,300 million.)
- As a shareholder of Dollar General, should Sadayo vote to approve the deal with KKR? Why?
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Case answers for Dollar General Going Private
Executive summary – Dollar General Going Private
The report analyzes the leveraged buyout deal of Dollar General, an American leading deep-discount retailing company, offered by affiliates of private-equity firm Kohlberg Kravis Roberts & Co. The transaction value was $7.3 billion ($22 per share in cash) as well as they would assume the outstanding debt of the company. The Board of Directors agreed to the deal whereas some shareholders had other opinions and they filed a lawsuit against the proposed deal.
The purpose of the report is to outline the financial performance of the firm in the recent past as compared to its competitors and help shareholders like Irina Sadayo make an informed decision. Dollar General had a relatively stable financial situation in the years leading up to the buyout proposal.
The company experienced a drastic drop in its stock price in 2006 as a result of poor performance. This led the company to initiate major strategic changes, which influenced its financial statements of 2007. The uncertainty about the effects of these changes gave rise to a disagreement between shareholders about the company’s fair value. These changes also distorted the company’s financials with several one-off items.
Therefore, the approach adopted in the report was to adjust the financial statements in a way that would reflect the company’s long-term perspective. The result of the analysis is a sell recommendation for Dollar General. The common shareholders should vote in favor of the deal as the premium offered is higher than the recent Mergers and Acquisitions (M&A) transactions in the retail industry. Although the unadjusted multiples lead to a strong sell recommendation, the readjustments prove that the proposed transaction value and premium are just fair.
Introduction – Dollar General
Dollar General was founded in 1939 in Kentucky, U.S.A. The company was a leader in the deep-discount retail channel and a part of the Fortune 500 companies with a presence in around thirty-five states through over 8000 stores. The company had gone public in 1968 after mastering the dollar-concept.
Their target market was lower income bracket families to whom they provided basic consumer needs products with low prices and placed effective cost control measures, especially on operating costs. The industry was highly competitive and, at the same time, the market size between 2000-2005 had nearly tripled to $33.2 billion with predictions to exceed $48 billion by 2010. The firm had two major competitors in the extreme value retailer channel in which they operated in and these were Family Dollar and Fred Inc.
The company was not performing well in the recent past. This led to speculations of a takeover. At the same time, the firm announced its plan to close down underperforming stores which pushed its stock price to $12.1 by September 2006. This prompted the management to bring about a change in their business model by selling their old inventory through the use of end-of-season sales and other strategies with the help of marketing streams. The actions resulted in an increase in revenues in excess of expectations which also increased the stock price to $16.89.
In February 2007, Dollar General was approached for a buyout by Kohlberg Kravis Roberts & Co. (KKR) for $6.9 billion in cash ($22 per share) and they would also assume $380 million in debt. The Board of Directors agreed to the deal in March since they believed the deal would provide excellent value for shareholders.
On the other hand, there were some shareholders who did not share the same beliefs, one of the shareholders William Hochman filed a lawsuit against the company. The objections that were raised by William were as follows:
- The ‘no-shop’ provision with a termination fee of $225 million potentially discouraged the management of the company to find other interested parties to enter into the race. They could have gotten a higher transaction value if there was competition.
- The merger was announced before the earnings announcement. After the announcement, this would have increased the share price, and the subsequent offer KKR would then have to make to acquire Dollar General would be much higher than the current agreed price of $22 per share.
- The ratings on the bonds issued by Dollar General were already low (Ba1) which was also under review in the future. The LBO transaction and the significant increase in financial leverage would make matters worse.
Hearing both sides of the argument, the shareholders had to decide on whether to vote in favor of the buy-out or not in the annual shareholders meeting. Amongst one of the many undecided shareholders was Irina Sadayo who decided to wait until the release of the latest annual statements in order to review them in detail before making a decision.
The report is, therefore, written with an aim to help Sadayo reach a decision. One of the first questions that would interest a shareholder of any company is their decision of taking a company private and what does it mean. This is a process when a public listed company delists from the stock exchange and buys back all of the outstanding shares by paying out cash.
Why Go Back to Private?
There can be a number of reasons for a public company to decide to go private. Usually, companies decide to go back to private when being public is no longer beneficial for them, meaning when the cost of being public exceeds benefits. In the case of Dollar General, the value of going back to private can be created in different ways.
Firstly, the managers will be motivated to run the company with an eye to long-run profitability without worrying about short-term movements in the stock price. They would be able to focus more on improving the business’s competitive positioning in the marketplace by shifting their priorities from achieving quarterly earnings expectations to creating and building long- term shareholder wealth.
They would also be able to make tough decisions without worrying about negative market reactions as they did in 2006. The speed at which these decisions would be taken would also increase since there would be no need for shareholders meetings. Moreover, the company does not have to meet the reporting requirements anymore as in the case of publicly-traded companies. This is a cost-saving in terms of both monetary terms and time for the firm and the managers respectively.
Also, Dollar General had recently paid out $10 million with regards to manipulate earnings and inadequate internal accounting controls by the Securities and Exchange Commission (SEC). This kind of situation can be avoided after going private.
Lastly, a company can go private through a Leverage Buyout Transaction (LBO), as in the Dollar General case. LBO is a financing technique for acquiring companies. The acquirer is usually a private equity firm that borrows a large percentage of the purchasing price in order to finance the acquisition. The shareholders of the firm being acquired are usually paid out in cash.
In the US, the leverage buyouts have been successful under all kinds of market conditions delivering good returns to the investors and these transactions are believed to be a key driver of an increase in companies’ value in the long run (Kohlberg Kravis Roberts & Co., 1989). The motivation for taking a company private through an LBO is related to agency theory.
An LBO can be viewed as a tool to make managers act in the best interest of the shareholders (Djama et al., 2014). One of the outcomes of an LBO is that the management would act in the best interest of shareholders and maximize the value of the firm as they would be required to meet specified repayment plans agreed upon with the financial institutions and other concerned parties that initially provided credit for the LBO transaction. This requirement would force the management to run the company more efficiently in order to deliver the required cash flows for interest and principal payments.
Another benefit of an LBO is the investors’ experience in identifying weak areas of the company and planning on improvements in order to achieve efficiency (Kohlberg Kravis Roberts & Co., 1989). Considering Dollar General’s recent failure in changing strategy, the experience from KKR would certainly be helpful because they have been part of similar LBOs within the retail industry. Hence, it can be assumed that they have knowledge and experience in managing and growing such businesses.
There is also a need to understand the drawbacks of such transactions. The investment in private companies is relatively illiquid and the invested capital is tied for a couple of years. Moreover, if an LBO results in a company being taken private, the high leverage may cause financial distress in the future. High leverage may also have a negative effect on the company’s credit rating due to increased interest payments.
One of the main reasons KKR approached Dollar General was their deteriorating financial performance in the recent time. This was also on a firm-level as well as on an industrial level. In assessing Dollar General’s performance, we first must conduct an internal comparison and a peer comparison afterward using ratio analysis. In order to perform peer analysis, the report would only take into account…
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