How to Turn $1 Into $1.6 Billion

Fifteen years ago, I walked into a 99 Cents Only store. Being an unemployed
graduate student, I was eager to save as much money as I could while buying the
things one needs to live ones life. I discovered that you get what you pay for.
After loading up on dish soap, paper towels and other staples, I found the
quality to be absolute garbage. I vowed never to waste my time or money again.
But a few years ago, I sauntered into a Dollar Tree (NASDAQ: DLTR ) because the
stock had been doing well and I couldnt fathom why that was the case. How could
there by tens of thousands of these dollar stores when all they sold was junk?
As it turns out, they didnt sell junk anymore. They sold brand-name merchandise.
I became a fan. Evidently, so has the world of private equity and hedge funds.
Theyve taken notice of these stores great margins, increasing market share and
growing earnings (some at 20% annually). I thought it was amazing when hedge
fund manager Bill Ackman purchased a ton of stock in Family Dollar (NYSE: FDO ).
Warren Buffett also took a stake in Dollar General (NYSE: DG ). These, however,
are nothing compared to the $1.6 billion private buyout of 99 Cents Only Stores
that recently just closed. What does this tell us about the present valuations
of the dollar stores and whether any of them are buys? The $1.6 billion price
tag for 99 Cents Only was 21.6 times 2011 earnings of $74 million, and 1.1 times
sales. Dollar Trees trailing 12-month earnings are $463 million, so a 21.6
multiple puts its present value right at $10 billion, or exactly what DLTR
trades at today, although that is 1.5 times sales. Family Dollar has $394
million in TTM earnings, and giving it a 21.6 multiple yields $8.5 billion,
which is 1 times sales. With only $250 million in net debt, that suggests Family
Dollar presently trading at a market cap of $6.46 billion might be undervalued
by as much as 30%. With the stock trading at $55, it suggests the stock might be
worth closer to $70. Perhaps Mr. Ackman is on to something here. Dollar General
is the big kahuna, with TTM net income of $698 million. That 21.6 multiple would
make it worth a whopping $15.08 billion, also representing about 1.07 times
sales. The present market cap is $14.04 billion, suggesting a modest premium of
7% exists, which might make the stock worth $44. But hang on DG carries $2.6
billion in net debt, so that wipes out that premium and then some. Strictly
examining the stores on the basis of the buyout, then, it appears Family Dollar
is drastically undervalued . It certainly has room for improvement
operationally, and Mr. Ackman is known for finding companies that could use
fresh eyes and a different approach. I think if you put your faith in Mr.
Ackman, you wont be disappointed. Ive always liked Dollar Tree because of its
consistency, however, so given its expected 20% earnings growth, its likely you
wont go wrong there, either. As of this writing, Lawrence Meyers did not hold a
position in any of the aforementioned stocks.