This chapter explains how finance functions in the real world. The battle between Dollar General and Dollar Tree for Family Dollar is used as our illustration. “Getting to yes,” the execution part of an investment or merger, can follow either a simple or tortuous path. The story of Family Dollar includes many obstacles to getting a merger deal done. A few of the pertinent obstacles are included in the following list:

• First, there were three bidders (Trian Partners, Dollar Tree, and Dollar General), which generated multiple bids.
• Second, there were a number of activist shareholders and proxy advisory firms trying to influence the outcome. These included Carl Ichan, Paulson and Company, Elliot Management, Glass Lewis, and Institutional Shareholder Services.
• Third, Family Dollar had second-generation family management that sought to maintain control of the firm.
• Fourth, the U.S. government—and in particular the Federal Trade Commission—had to approve any merger after evaluating if it was anticompetitive.
• Fifth, the shareholders had to vote on any merger, and factions of the shareholders filed three lawsuits in this merger.

Let’s look at how it all came together by adding more detail to the above list.

The Time Line

There were three bidders for Family Dollar.¹ Trian Partners was the first. As noted in Chapter 18, in late July 2010, Trian Partners disclosed that it owned 8.8% of Family Dollar’s outstanding shares. Then, on February 15, 2011, Trian made an offer to purchase Family Dollar for $55 to $60 per share. Management resisted, and a standstill agreement was enacted: Trian agreed to limit its ownership to 9.9% for two years and in return was given a seat on Family Dollar’s board. Trian then worked with Family Dollar’s management, at first trying to improve operations and later to secure the sale of the firm to another bidder.

On February 28, 2013, there was a meeting between Howard Levine (Family Dollar’s CEO) and Michael Calbert (a Dollar General board member). There is some dispute about which firm initiated the meeting. Regardless of how it came about, Family Dollar used the meeting to discuss the merits of a possible merger with Dollar General. Mr. Levine implied that Family Dollar was not really for sale but that a substantial premium over the current stock price might convince the current shareholders to sell. Family Dollar also indicated that if a merger were to happen, Family Dollar’s management expected that it would run the combined firm with its headquarters in Charlotte, North Carolina (the location of Family Dollar’s headquarters). Mr. Calbert informed Mr. Levine that Dollar General’s board was unlikely to view these requests favorably.

Several more informal talks between the two firms were held. Then in November 2013, Family Dollar expressed its interest to meet again to discuss a merger, and a date was set for December 2013. Dollar General then delayed the meeting until sometime in the spring of 2014 (perhaps playing hard to get).

Dollar Tree was the second formal bidder. Through its investment banker, J.P. Morgan, Dollar Tree contacted Family Dollar about a possible merger in late February 2014. After some back and forth, a meeting between the CEOs of the firms occurred in mid-March 2014, with the management teams meeting shortly thereafter.

On May 14, 2014, Mr. Sasser (Dollar Tree’s CEO) provided Mr. Levine (Family Dollar’s CEO) a broad outline of a bid for Family Dollar, including a price of between $68 and $70 per share with 75% in cash and the rest in Dollar Tree stock. A special feature of the bid was that it included the requirement for Mr. Levine to continue as CEO of Family Dollar after the merger. In response to this requirement:

Mr. Levine explained that he would be unwilling and unable to negotiate the terms of his post-closing contractual arrangements while material terms for a business combination transaction remained open and before he had instructions from his board to proceed with such negotiations.²

A week later Morgan Stanley, Family Dollar’s investment banker, informed Dollar Tree the offer was:

inadequate and not worthy of further consideration and that Family Dollar remained not-for-sale, but that Family Dollar would at least consider a more competitive offer in line with multiples and premia for precedent transactions of this type.³

On June 6, 2014, Carl C. Icahn (a well-known shareholder activist/corporate raider) disclosed that he owned approximately 9.4% of the then-outstanding shares of Family Dollar common stock. He also stated, both privately and publicly, that he sought a sale of Family Dollar. Around this time, several investment banks started writing that Family Dollar was likely to be sold in the near future.

Dollar Tree increased its offer price on June 13, 2014, to $72 a share on June 13, 2014. Family Dollar again called the offer “inadequate.” Then, on June 20, 2014, Dollar Tree proposed a price of:

$74.50 per share of Family Dollar common stock as Dollar Tree’s best and final price and conditioned this price on Family Dollar’s agreeing to a six-week period of exclusivity to permit Dollar Tree to conduct due diligence and negotiate the transaction.⁴

A key part of Dollar Tree’s offer stipulated that it be “exclusive,” and this was non-negotiable, which means Dollar Tree did not want to get involved in a bidding war.

With only one other likely bidder, Dollar General, Family Dollar’s board faced a dilemma. If they formally put the firm up for bid and Dollar General decided not to bid, Dollar Tree would have a clear advantage in the negotiations. Even worse, Dollar General might decide to make a bid for Dollar Tree, leaving Family Dollar as the odd man out.

The board’s solution was to obtain a binding agreement from Dollar Tree to acquire Family Dollar if the due diligence did not reveal anything significant. Family Dollar and Dollar Tree signed an agreement giving Dollar Tree exclusivity through July 28, 2014. As part of the agreement, Family Dollar could not actively seek any other bidders (but could consider unsolicited offers), nor could it reveal the exclusivity deal itself. Thus, the agreement allowed Family Dollar to accept another bid (and thereby fulfill the board’s fiduciary duties).

Why would Dollar Tree agree to this? The answer was because Dollar Tree received the right to match any bid as well as receive a termination fee of $305 million if Family Dollar did a deal with someone else. Remember, Dollar Tree also understood that Family Dollar’s board was trying to get the best deal and comply with all its fiduciary duties.

On July 25, 2014, Dollar Tree and Family Dollar reached a merger agreement. Family Dollar’s board met and voted on its approval two days later. Then, on July 28, 2014, in a joint press release, Dollar Tree and Family Dollar announced the merger agreement at $74.50 a share that included a $305 million break-up fee (an amount Family Dollar would have to pay Dollar Tree if the deal fell through because Family Dollar was sold to another party).

The merger announcement between Dollar Tree and Family Dollar finally propelled Dollar General to act. Faced with the prospect of competing with a larger competitor with more stores than its own, on August 18, 2014, Dollar General made an offer of $78.50 for Family Dollar’s shares. The offer was not only $4.00 per share higher than the Dollar Tree offer, but it was also a 100% cash offer. The offer also included paying the $305 million Dollar Tree break-up fee. The offer was, however, contingent on due diligence and regulatory approval. Dollar General indicated it would be willing to divest up to 700 stores to gain FTC approval.

The number of stores to be divested, as discussed more fully later in this chapter, became a key issue in whether Dollar General’s bid could gain regulatory approval.

On September 2, 2014, Dollar General raised its bid to $80.00 per share in cash (a premium of $6.00 per share over the Dollar Tree cash-and-stock offer). It also agreed to divest up to 1,500 stores. In other words, the deal would go through as long as the FTC’s approval came with an order to divest 1,500 or fewer stores.

On September 5, 2014, Family Dollar issued a press release that its board of directors unanimously rejected Dollar General’s bid because the board believed the FTC would require Dollar General to divest far more than 1,500 stores as a condition to approve the merger. Family Dollar and Dollar Tree then issued a joint announcement that they expected their own merger to close as early as the end of November.

On September 10, 2014, Dollar General commenced a hostile tender offer to acquire all of Family Dollar’s shares at $80 per share ($9.1 billion total), stating the firm remained committed to acquiring Family Dollar. A tender offer bypasses the Board of Directors and goes directly to the shareholders. If enough shares were acquired in the tender, Dollar General could use them to vote for the merger over the objections of the Board.

The reader may recall from Chapter 8 on Marriott that tender offers are more expensive than open-market purchases but quicker to execute. An additional benefit of the tender offer is that it allowed Dollar General to begin discussions with the FTC on what would be required to gain approval for a merger.⁵ The risk for Dollar General in tendering for Family Dollar’s shares is that it was trying to take over the firm without first performing due diligence (i.e., without gaining access to the target firm’s confidential information to ensure there was nothing material that would cause the bidding firm to back out of a deal).

For how long is a tender offer open? Twenty business days. Before 1968, tender offers could be open for any period (as long or short as the bidder wanted). After 1968, the Williams Act required tender offers to be open for at least 20 days and that they could no longer be conducted on a first-come, first-served basis. It was believed that first-come, first-served—which meant that shareholders that tendered first would be accepted first—pressured shareholders to tender (and tender early). Since 1968, tenders have had to be pro rata. Pro rata tenders mean that once all shares are tendered, they are purchased proportionally: If 80% of the shares that are tendered are purchased, the acquiring firm buys 80% of the number of shares that each individual tendered, regardless of when during the tender offer.

Dollar General had trouble getting enough shares to tender and extended its tender several times. By late December 2014, they had only received about 3.4 million of the 114.3 million outstanding shares.

Managerial Discretion

Howard Levine (then 44 years old) became CEO and chairman of the board of Family Dollar in August 1998 upon the retirement of his father, the firm’s founder. When Trian Partners arrived 12 years later seeking to take over the firm, he and the board resisted. The standstill agreement discussed in Chapter 18 removed Trian Partners, at least for a while, as a potential bidder for the firm.

Then, with operating results well below those of its two competitors (Dollar General and Dollar Tree) and activist shareholders pushing for the sale of the firm, management essentially gave in and put the firm up for bid, as chronicled earlier.

After the Dollar General bid, Family Dollar’s board had to choose either Dollar Tree’s bid or Dollar General’s. Dollar Tree’s offer was $74.50 in cash and stock, while Dollar General’s offer was $80.00 and all in cash. The Family Dollar board asked shareholders (who had to vote on any merger agreement) to approve the Dollar Tree offer. Why would management and the board argue for a lower offer, especially when the higher offer was all cash?⁶

The reason presented by the Family Dollar board was the risk that the FTC would not approve a merger with Dollar General. Family Dollar and Dollar General had a large number of stores in close geographic proximity. As part of its revised offer, Dollar General committed to divest up to 1,500 stores to gain FTC approval. However, the Family Dollar board argued Dollar General would have to divest over 2,000 of Family Dollar’s 8,000 stores to gain FTC approval. Thus, the probability of a successful deal with Dollar General was very low. By contrast, Dollar Tree had a much smaller geographic overlap with Family Dollar. Family Dollar’s board argued Dollar Tree would only have to divest about 350 stores to gain FTC approval. Thus, while the offer from Dollar General was higher, there was a lower probability it would ever be concluded.

So, why not just take the Dollar General offer first, and if it failed then take the Dollar Tree offer? Family Dollar was worried that if they accepted a deal with Dollar General that fell through, any subsequent offer from Dollar Tree would be at a much lower price.

There was also a second potential reason Family Dollar may have preferred the Dollar Tree bid. Dollar Tree repeatedly offered Family Dollar’s management a role in the merged firm, whereas Dollar General made no so such promises. To counter the image of potential self-dealing, Howard Levine (Family Dollar’s CEO) argued this would not be part of any deal.⁷ While it is not clear this had any actual impact on Family Dollar’s management, it did leave an appearance of potential bias. For example, Carl Icahn, who favored the Dollar General deal, wrote, “How far will crony Boards go (and get away with it legally) to protect the CEO at the expense of the shareholders?”⁸

How far can management go to secure its own interests? They can go pretty far. Managers, as do all human beings, first protect themselves. Are there mechanisms to limit managerial discretion (and perhaps replace management)? Yes, and they include the board of directors, lawsuits, proxy contests, the stock market, and takeovers. Do any of them work? Only partially. The board of directors is a stronger check on management today than in the past. However, there are still limitations. Lawsuits rarely work. Proxy contests almost never work. The stock market does allow a shareholder to walk away (by selling shares, often at a loss), but this is not really a control on management. This leaves takeovers as the main method to enforce discipline on management. A poorly run firm can eventually be taken over and management replaced. The best method for managers to prevent a takeover is: run the firm well (so well that it will not be worth more if purchased and run by any other firm)!

In the case of Family Dollar, all of these techniques were used by various parties, but it was a merger takeover that eventually replaced the management team. As we continue with this story of merger execution, we will encounter these methods.

Activist ShareholderS

As mentioned previously, on June 6, 2014, almost immediately after disclosing that he owned 9.4% of Family Dollar’s outstanding shares, Carl Icahn began pushing Family Dollar to explore a sale to Dollar General. In response, Family Dollar adopted a one-year shareholder rights plan, commonly known as a “poison pill,” with a trigger of 10%.

What is a poison pill? It is a legal strategy to restrict another firm from obtaining control of the outstanding shares and taking over. How does it restrict the other firm? A share-diluting event is triggered at a set control threshold. To explain, assume another firm or individual buys shares of Family Dollar’s stock. When the other firm’s ownership exceeds a set threshold, say 10%, this triggers an automatic issue of additional shares, say two for one, for all current shareholders other than the one who triggered the event. So if another firm buys 10% of the shares, then the other 90% of the shareholdings get a two-for-one stock split. This means the new shareholder is automatically diluted to 5%. If an outsider bought 40% and current stockholders get a two-for-one split, the outsider is diluted to 20%.

A poison pill is designed to discourage hostile takeovers. Are poison pills legal? Actually, they are legal. The courts have ruled that if this type of poison pill mechanism is in place prior to when an outsider purchases shares, then the outsider is agreeing to this structure by buying the shares. In other words, if a firm had a poison pill and investors bought stock knowing full well their ownership would be diluted if they bought the stock, then it is legal for the firm to dilute them. However, the poison pill cannot be set up after the fact: once an outside investor buys 20% of a firm’s shares, the firm can’t then say it will dilute them by creating a poison pill.

So why doesn’t every firm create a poison pill to prevent takeovers? At one time, most firms did have poison pills in place. Martin Lipton of the law firm Wachtell, Lipton, Rosen, and Katz created the poison pill in 1982, and investment bankers marketed the product to get business. However, there are ways to get around poison pills (i.e., it is possible to turn a poison pill into a placebo).

The most direct way to get around a poison pill is to use the fiduciary responsibility of the board of directors. All boards have a fiduciary responsibility to enhance shareholder value. Furthermore, to allow for a friendly takeover, almost all poison pills allow the board of directors to void the pill. Because a board can void a poison pill, and because their fiduciary responsibilities require them to accept the highest offer, a properly structured offer made to the board will often cause the board to rescind the pill and accept.

As an aside, most public firms (over half of all public firms and 64% of S&P 500 firms) are incorporated in the State of Delaware.⁹ Why do so many firms incorporate in Delaware? Because Delaware is the most corporate-friendly jurisdiction in the United States (in the sense of antitakeover, antilawsuit, antistockholder suits, etc.). Corporations can incorporate in any state they choose regardless of whether they have business operations in the state or not. The Delaware Chancellery court is an entire court system that just deals with corporate law. Delaware has civil courts, criminal courts, and chancellery courts, which are basically courts for corporate law. Delaware is a state that specializes in corporate governance. Family Dollar was incorporated in Delaware, whereas Dollar Tree was incorporated in Virginia and Dollar General in Tennessee.

In addition to the encouragement of Carl Icahn and other activist shareholders for Family Dollar to merge, Dollar General also started a proxy contest.

What is a proxy contest? A proxy is an authorization allowing one person to represent another in a vote. A proxy contest is where an outsider competes with management to select the board members. (The board of directors is chosen regularly by shareholder vote at annual meetings.) Management puts up a slate of directors, and someone else—in this case, Dollar General—puts up another slate. Each side then solicits votes from the current shareholders. The board of directors is tasked with protecting the stockholders’ interests and choosing the management team. So, control of the board means control of management. Furthermore, if management is not performing well, the board has the right to replace the current management. In practice, they rarely do.

Who normally ends up picking the board of directors? The board typically contains both internal and external members. Internal members include the CEO and members of his management team. Candidates for outside directors are usually proposed by current board members or by the firm’s current management. In addition, many boards are interrelated, with management from one firm sitting on the other firm’s board. As a result, how do board members usually vote? Board members usually vote with management and are reluctant to replace management unless their performance is egregious.

Dollar General, with its proxy contest and/or tender offer (a successful tender offer would have given Dollar General enough votes to replace the board as well), was hoping to replace Family Dollar’s current board with one that would approve Dollar General’s bid. The proxy contest was set for Family Dollar’s annual shareholder meeting on December 11, 2014.

In mid-October, Elliott Management (another activist shareholder) disclosed that it held a 4.9% stake in Family Dollar and joined in the proxy battle on the side of Dollar General.

The Federal Trade Commission (FTC)

The FTC was created in 1914 to prevent unfair (anticompetitive) competition. Additional laws were passed over the years giving the FTC broad authority over “unfair and deceptive acts or practices” as well as the administration of certain consumer protection laws.¹³ Opposition by the FTC to a merger usually meant it would fail.

A key issue in the offers made by Dollar Tree and Dollar General centered on which was more likely to gain approval from the FTC and under what conditions. Dollar General initially offered to divest up to 700 stores and then increased it to 1,500. However, Family Dollar’s board felt this would be well below the number required to gain FTC approval.

It was speculated that, given the methodology the FTC uses in cases involving overlapping market share, Dollar General would have to sell close to 4,000 stores to gain approval (i.e., Dollar General would be forced to divest the equivalent of half the stores it would be purchasing).¹⁴

The FTC ultimately required Dollar Tree to dispose of 330 stores to gain approval for its bid.¹⁵

Shareholder Lawsuits

After Family Dollar’s board voted for the Dollar Tree bid, there were three separate shareholder lawsuits against the Family Dollar board (they were consolidated into one case).¹⁶ The lawsuits alleged that the Dollar Tree deal “offers unfair and inadequate consideration that does not constitute a maximization of stockholder value.”¹⁷

In particular, the lawsuit argued the price was too low and that the board’s acceptance of the $74.50 offer from Dollar Tree did not maximize shareholder value. The lawsuit also claimed the board wrongfully gave Dollar Tree the right to match another offer and should not have given Dollar Tree a $305 million break-up fee.

What did the stockholders want in their lawsuit? They wanted Family Dollar to accept the higher, all-cash offer from Dollar General. They were asking the judge to block the shareholder vote on the Dollar Tree offer.

Let’s ask the following questions: In stockholder lawsuits, whose money do the stockholders spend when they sue management? The stockholders’ own money. And whose money does the firm (the board and/or management) spend to defend itself? The stockholders’.

Who wins the lawsuits? Management normally wins shareholder suits because of a doctrine called “prudent business judgment.” Essentially, the U.S. jurisprudence system recognizes that firms make decisions all the time. Some decisions are right, some decisions are wrong, and people often sue when they are wrong.

The fact that a decision is wrong in hindsight will not win a shareholder lawsuit, however. The courts have basically said they do not want to decide whether management’s business decisions are right or wrong. The courts will only decide against management if the business decision was not in line with prudent business judgment. To win, a shareholder lawsuit must prove the business decision was imprudent or involved fraud or negligence. The prudent business judgment rule is therefore enough for the firm to win most shareholder lawsuits.

Almost by definition, if a firm’s investment bankers recommend a decision and the board approves it, the decision is prudent. So (to stretch the point), even if the shareholders can prove that management repeatedly makes incorrect decisions, the shareholders will lose the court case. The fact that management is repeatedly wrong does not mean the decisions were imprudent. (Perhaps, if the shareholders could prove that management knew they were incompetent and continued to manage anyway, the shareholders would have a chance at winning the suit.)

The only time your authors know of a board of directors ever being found personally liable for a merger decision was when the board did not use an outside advisor. In the 1985 TransUnion merger with Marmon Group, the TransUnion board did not use an outside investment banker to do the valuation, were sued, and were found personally liable.¹⁸ This is part of the value of using an investment banker: it qualifies as having performed due diligence and protects you from lawsuits.¹⁹

In mid-December 2015, Judge Andre Bouchard of the Delaware Chancery court ruled against blocking the shareholder vote on the Dollar Tree bid. In his ruling, the judge stated:

The board’s decision reflects the reality that for the company’s shareholders, a financially superior offer on paper does not equate to a financially superior transaction in the real world if there is meaningful risks that the transaction will not close for antitrust reasons.²⁰

Case closed.

The Vote

All in favor? 84 million. All opposed? 10 million. On January 22, 2015, 84 million shareholder votes were cast in favor of the Dollar Tree deal (73.5% of the 114.3 million outstanding shares, and 89% of those who actually voted).²¹

Summary

This chapter has explained the execution of a particularly interesting multiple-bidder takeover battle. The nature of who bids, how, and when were all explored. Management often fights off bidders using standstill agreements (discussed in Chapter 18) and poison pills (discussed in this chapter). Being sensitive to management’s interests may improve a bidder’s chance of success (e.g., Dollar Tree consistently stated their intention to have Mr. Levine stay on after the merger). Today, activist investors, shareholder proxy advisory firms, and government agencies like the FTC are all-important actors in mergers and acquisitions.

We began the discussion in Chapter 18, with the strategic fit between Family Dollar, Dollar Tree, and Dollar General. Next, Chapter 19 presented a financial valuation of Family Dollar as a takeover target, computing free cash flows to the firm discounted at the WACC. Chapter 20 then presented the cash flows to equity. This was done not only to provide another valuation technique but also to explain how the cash flow formulas are derived. Finally, this chapter showed that a merger’s outcome does not just depend on who made the highest bid, but that the execution is important as well.

Coming Attractions

This chapter ends the section on how to make good investment decisions. The next chapter, our last, provides a review.

Appendix 21.A: Key Events in the Bidding for Family Dollar during 2014 and 2015

• May 14, 2014: Dollar Tree outlines a nonbinding proposal to acquire Family Dollar for between $68 and $70 per share, with 75% in cash and the remainder in Dollar Tree common stock.
• May 21, 2014: Family Dollar informs Dollar Tree the bid is “inadequate” and that Family Dollar is “not for sale,” but that Family Dollar would consider a more competitive offer.
• June 6, 2014: Carl Icahn announces he owns 9.4% of Family Dollar and starts pushing for a sale to Dollar General.
• June 13, 2014: Dollar Tree raises bid to $72.00 per share, with the same terms as above.
• June 16, 2014: Family Dollar’s board tells Dollar Tree its bid is still “inadequate.”
• June 20, 2014: Dollar Tree raises bid to $74.50, with the same terms.
• June 25, 2014: Family Dollar and Dollar Tree sign an exclusivity letter.
• July 25, 2014: Family Dollar and Dollar Tree reach an agreement.
• July 28, 2014: Family Dollar and Dollar Tree issue a joint press release.
• August 18, 2014: Dollar General bids $78.50 per share in cash, contingent on due diligence and regulatory approval. It says it will divest up to 700 stores.
• September 2, 2014: Dollar General raises bid to $80.00 per share in cash and agrees it will divest up to 1,500 stores.
• September 5, 2014: Family Dollar’s board unanimously rejects Dollar General’s bid.
• September 10, 2014: Dollar General commences a tender offer.
• December 23, 2014: Initial merger date vote, delayed when board recognizes it does not have the votes.
• January 15, 2015: Dollar General concedes defeat.
• January 22, 2015: The Family Dollar shareholder vote takes place: 84 million votes in favor of the Dollar Tree deal (73.5% of the 114 million outstanding shares, 89% of those who voted).
• July 7, 2015: Deal closes and Dollar Tree takes control of Family Dollar. FTC requires Family Dollar and Dollar Tree to sell 330 stores.