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U.S. dollar bills.
U.S. dollar bills.

Initial Public Offering

Dollar General's new shares aren't cheap Add to ...

Dollar General Corp.'s merchandise is low-priced, but its shares are not - and that says a lot about what kind of companies are succeeding in a warming IPO market.

The U.S. discount retailer begins trading today on the New York Stock Exchange in the largest initial public offering for a U.S. retailer in 17 years, according to Bloomberg data. Thursday night, the company priced its stock at $21 (U.S.) per share, the bottom end of its own forecasted range of $21 to $23, making it a $716-million offering.

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At $21, Dollar General's price-to-earnings and price-to-sales ratios will exceed retail giant Wal-Mart Stores Inc. and approach Target Corp.'s, said analyst Francis Gaskins of IPODesktop.com. Its P/E, which Mr. Gaskins estimates at 18.5, will also exceed competitors Dollar Tree Inc., Family Dollar Stores Inc. and Fred's Inc., trailing just 99 Cents Only Stores. (Mr. Gaskins' estimates are based on an annualized version of the most recent six months' results, and he excludes the interest payments on certain Dollar General debt that will be paid off by IPO proceeds.)

The attraction to Dollar General is reminiscent of Canada's biggest new issue of the year, Dollarama Inc., which began trading Oct. 9. After selling its shares at $17.50 (Canadian), the discount retailer has seen its stock rise above $19, closing yesterday at $19.05.

Dollarama is the high point of what has been a bone-dry market for new Canadian equity issues. Ross Sinclair, who leads PricewaterhouseCoopers LLP's Income Trust and IPO Services practice, said that until 2009's second quarter, there were no new Canadian IPOs for five consecutive quarters. That was a first in the 10 years of the firm's survey, he said.

The phase out of income trusts, combined with the chaos in equity markets of the past two years, "has been sort of a double or even triple whammy for the Canadian IPO market," Mr. Sinclair said.

The United States equity markets, free of the distortion of the income trust policy change, have seen a rebound in new issues from a similarly fallow period. According to Renaissance Capital, a research firm that tracks IPOS, there were 21 filings in October, up from zero the year before. It was the first 20-filing month since March, 2008, and just the second month in 2009 where filings topped the previous year's period.

Still, with just 82 filings so far in 2009, the U.S. numbers remain far below the 374 in 2007, the biggest year for filings in the post-bubble 2001 to 2009 period.

Enter the dollar stores. In an economy where many blue chips are reporting falling sales, the retailers who sell inexpensive goods to suddenly cost-conscious consumers have a compelling growth story to tell.

Dollar General is able to bill itself as the largest discount retailer in the United States by number of stores, with 8,577 in 35 states. Over the 40 years since its 1968 rebranding from J.L. Turner & Son Inc. to Dollar General, it has built annual sales from $40-million (U.S.) to $10.5-billion, a compound annual growth rate of 14.9 per cent.

Its recent numbers are even more compelling in today's market place. Same-store sales (sales at locations open at least 12 months) grew 10.8 per cent in the first six months of 2009. This, at a time when other well-known names were posting negatives. (Target said same-store sales were down 4.7 per cent through June, while Wal-Mart, which reports on a different calendar, said same-store sales were down 1.9 per cent for the six months ended in July.)

Dollar General's sales pitch is that it will expand its operating margins, continue boosting store sales, and open more locations. The company said it believes that its 8,577 stores can grow to as many as 12,000, with the majority of new locations in its current footprint. (Dollar General has yet to enter the U.S. West Coast and northwest, including California, and the far northeast.)

Investors will likely need to buy into the growth pitch to justify the valuation, note the Renaissance Capital analysts. And there is another issue, says IPODesktop.com's Mr. Gaskins: Dollar General is not doing the offering to obtain growth capital, but to pay off debt incurred in a 2007 leveraged buyout by Goldman Sachs Group Inc., Citigroup Inc. and Kohlberg Kravis Roberts & Co. Wellington Management Co. and the Canadian Pension Plan Board are also owners.

Some or all of the company's current owners have taken out roughly $300-million in fees and dividends since September, but the company has no plans to pay dividends to its public shareholders after its IPO. (Dollarama, owned by Bain Capital and its management prior to its IPO, had a similar history and use of proceeds.)

In this, these companies have been rare recent victories for the buyout shops, who have had difficulty employing their exit strategies in this down market. Some companies forced to cancel their IPOs had similar buyout-style leverage, but didn't have the story of the dollar stores.

"The ones that got pulled, their future looked cloudy," said Mr. Gaskins. "Dollar General has a visible, understandable growth plan."

 
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