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Icahn Stake incites Talk of Family Dollar, Dollar General Merger

Tickers in this article: DG FDO

NEW YORK ( TheStreet) -- Analysts believe a Family Dollar merger with Dollar General would create meaningful cost synergies and help unlock value at both dollar store chains. Speculation of a possible merger has heated up after Carl Icahn disclosed on Friday he's taken a 9.4% stake in Family Dollar and seeks talks with the company's management.

Carl Icahn Takes 9.4% Stake In Family Dollar, Seeks Talks

Icahn joins a list of activist investors who have taken large stakes in Family Dollar including Trian Management with a 7.35% stake in the company's shares and John Paulson-run Paulson & Co. with a 5.68% stake, according to Bloomberg data. The prominence of activist hedge fund investors, in addition to Icahn's apparent efforts to consult with Family Dollar over its operations and possible strategic transactions, is giving fodder for analysts to speculate on merger scenarios.

Family Dollar and Dollar General Get Upgrades
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A merger of the nation's two biggest dollar stores could create large cost synergies that would create significant value for both companies, Jefferies analysts said in a Monday client note that upgraded both Family Dollar and Dollar General shares to "buy."

Jefferies believes synergies could run between $950 million and $1.2 billion in the event of a Dollar General takeover of Family Dollar. Were Dollar General the acquirer of Family Dollar, Jefferies calculates the merged company would earn between $5.50-a-share and $6-a-share in 2014.

The most obvious synergy of a Family Dollar and Dollar General merger would be a reduction or slowing in the growth of square footage in the dollar store industry, Jefferies said, mitigating growing risk of overcapacity across the industry. Analysts at the firm said the Federal Trade Commission might review such a merger, however, they expressed confidence a deal would get approved.

An approval would hinge on regulators treating Walmart  as a competitor to Dollar General on price and scale, but not Family Dollar.

"Dollar General pricing is close to Walmart on like items and is meaningfully lower versus Family Dollar. This supports the view that DG believes it needs to be competitive on price or run the risk of losing share to Walmart, which is predominantly not serving the customer in the same local way DG is. Hence, the combination of DG and FDO, should not put the consumer at a disadvantage," Jefferies said.

"Simply put, the industry has matured, there are clear performance gaps between the number one and two players, we think the pace of capacity increases are out of balance, new competition is coming and we see potential for large synergies," Jefferies concluded of its analysis of a potential merger.

The firm gives a $79 a share price target to Family Dollar and a $75 a share price target to Dollar General.