All in the family   ira sohn conference.2011
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All in the family   ira sohn conference.2011 All in the family ira sohn conference.2011 Presentation Transcript

  • All in the Family May 25, 2011Pershing Square Capital Management, L.P.
  • DisclaimerThe analyses and conclusions of Pershing Square Capital Management, L.P. ("Pershing Square") contained inthis presentation are based on publicly available information. Pershing Square recognizes that there may beconfidential information in the possession of the companies discussed in the presentation that could leadthese companies to disagree with Pershing Square’s conclusions. This presentation and the informationcontained herein is not a recommendation or solicitation to buy or sell any securities.The analyses provided may include certain statements, estimates and projections prepared with respect to,among other things, the historical and anticipated operating performance of the companies, access to capitalmarkets and the values of assets and liabilities. Such statements, estimates, and projections reflect variousassumptions by Pershing Square concerning anticipated results that are inherently subject to significanteconomic, competitive, and other uncertainties and contingencies and have been included solely forillustrative purposes. No representations, express or implied, are made as to the accuracy or completeness ofsuch statements, estimates or projections or with respect to any other materials herein. Actual results mayvary materially from the estimates and projected results contained herein.Funds managed by Pershing Square and its affiliates have invested in common stock of Family Dollar StoresInc. (“FDO”). Pershing Square manages funds that are in the business of trading – buying and selling –securities and financial instruments. It is possible that there will be developments in the future that causePershing Square to change its position regarding FDO. Pershing Square may buy, sell, cover or otherwisechange the form of its investment in FDO for any reason. Pershing Square hereby disclaims any duty toprovide any updates or changes to the analyses contained here including, without limitation, the manner ortype of any Pershing Square investment.
  • Family Dollar Ticker: FDO Stock Price: $54 Market Cap: ~$6.6B EV: ~$6.7B FY2012 P/E¹: 14x (August FY)________________________________________________Note: ¹Pershing Square EPS esimtate of $3.88 2 All stock prices and financials are as of May 24, 2011 close
  • Business Overview
  • Business Description Family Dollar Mix Pricing Customers Real Estate■ ~65% of sales ■ Lower prices ■ ~55% of sales ■ ~7,000 stores are consumables than drug stores, are to <$40k ■ ~7k selling sq ft■ ~13% home gas stations, and income per unit products grocery stores households ■ $8.50/sq ft avg.■ ~11% apparel ■ Comparable to ■ ~68% are over rent, short-term mass merchants age 45 leases■ ~11% seasonal ■ Avg. basket is ■ ~60% of sales in■ High velocity, ~$10 and 4 to 5 generally non- rural or small items town locations discretionary SKUs 4
  • Value Proposition: Price and ConvenienceDollar stores offer pricing comparable to Wal-Mart in a more convenient format.Dollar stores offer pricing comparable to Wal-Mart in a more convenient format.Lower income customers use dollar stores as weekly fill-in trips betweenLower income customers use dollar stores as weekly fill-in trips betweensupercenter destination shopping. The average FDO store visit is 8 minutessupercenter destination shopping. The average FDO store visit is 8 minutes Concept Price Index Store Size (000) Dollar Stores 100 7 Drug Stores ~120 40 Grocers ~115 40 Mass Merchants ~95 125 Wal-Mart and dollar stores can coexist. Management believes FDO has ~3% Wal-Mart and dollar stores can coexist. Management believes FDO has ~3% share of their core customer’s wallet compared to WMT’s ~35% share share of their core customer’s wallet compared to WMT’s ~35% share 5
  • Share Gain in Retail High unit and same store sales growth have led to significant share gains for High unit and same store sales growth have led to significant share gains for the dollar store channel the dollar store channel Public Dollar Stores Share of Core Retail Sales (Rolling 4Q Avg.) Recession Recession________________________________________________Source: Bernstein, 2009 6
  • Consistent Same Store Sales Growth Family Dollar, like other dollar store retailers, has consistently grown SSS over Family Dollar, like other dollar store retailers, has consistently grown SSS over the last decade even during recessions the last decade even during recessions Same Store Sales Growth 9.0% 8.0% 7.0% Recession Recession 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________Note: Years are Fiscal Year Ending August 7
  • Sales MixConsumables make up a growing percentage of Family Dollar’s sales volume.Consumables make up a growing percentage of Family Dollar’s sales volume.Growth in consumables is responsible for most of FDO’s recent traffic andGrowth in consumables is responsible for most of FDO’s recent traffic andsame-store sales growthsame-store sales growthSales by Category Consumables Sales Mix Seasonal & Electronics, 11% Consumables, 67.0% Apparel and 65% Accessories, 65.0% 11% 63.0%Home Products, 61.0% 13% 59.0% 57.0% 2007 2008 2009 2010 8
  • Substantial Long-Term Growth Opportunity The three major dollar store retail chains (Family Dollar, Dollar General, Dollar The three major dollar store retail chains (Family Dollar, Dollar General, Dollar Tree) operate ~20k units today. We believe there is room for 10k to 12k Tree) operate ~20k units today. We believe there is room for 10k to 12k additional stores¹ or a decade of store growth at the current industry build rate additional stores¹ or a decade of store growth at the current industry build rate________________________________________________Source: ¹For research see Morgan Stanley, 2010; Bernstein, 2009; Dollar General management comments 9 Map: UBS, 2010
  • High Rates of Return onCapital
  • Historical Returns on Capital Family Dollar has a strong track record of earning high returns on capital Family Dollar has a strong track record of earning high returns on capital Percent Return on Capital (without capitalizing leases) 30.0% 25.0% 20% Avg. 20.0% 15.0% 10.0% 5.0% 0.0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________Note: Years are Fiscal Year Ending August ROIC Defined as: (Taxed EBIT)/Average (Assets – Cash – A/P – Accrued Expenses) 11
  • Shareholder-Oriented Capital Allocation StrategyIn FY2011, Family Dollar plans to invest $300-$350mm of capex and repurchaseIn FY2011, Family Dollar plans to invest $300-$350mm of capex and repurchasenearly $750mm of stocknearly $750mm of stock New Store Growth (~$60mm Capex, ~$15mm SG&A): 300 new store openings and 80-100 store closings, 3% net growth Long-term, management expects to grow store count 5-7% annually Store Renovation Program (~$60mm Capex, ~$30mm SG&A): Over 800 stores in FY2011 Going forward, management expects to renovate 1,000+ stores per year Share Repurchases & Dividends: Management has committed to buyback $750mm of shares by fall 2011 FDO raised its dividend this year to $.72/share ($85mm) 12
  • New Unit Growth New unit growth is accelerating after a pause that allowed management to New unit growth is accelerating after a pause that allowed management to refocus on improving core operations. Management now believes that with the refocus on improving core operations. Management now believes that with the current model FDO can grow units 5-7% per year by FY2013 current model FDO can grow units 5-7% per year by FY2013 Ending Unit Count 14.0% 7,500 12.0% 10.0% % Annual Growth 5,000 8.0% Accelerating to # Units 5% -7% growth 6.0% 2,500 4.0% 2.0% - 0.0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E________________________________________________ 13Note: Years are Fiscal Year Ending August
  • New Unit EconomicsNew units are generally inexpensive to build and highly profitable. On average,New units are generally inexpensive to build and highly profitable. On average,units are 90% productive in their first yearunits are 90% productive in their first year Estimated New Store Investment Capex $ 200,000 SG&A 50,000 Inventory, net 75,000 Estimated Investment $ 325,000 New Store Earnings Low High Mature Revenue $1,200,000 $1,200,000 Estimated Mature 4-wall EBIT Margin 10.00% 15.00% Estimated EBIT $ 120,000 $ 180,000 % Pre-Tax Return 37% 55% 14
  • High Return on Renovation CapitalManagement began an ambitious renovation program this year. While theManagement began an ambitious renovation program this year. While thecompany has not disclosed detailed data, it has revealed that renovated storescompany has not disclosed detailed data, it has revealed that renovated storesachieve at least a 10% sales liftachieve at least a 10% sales lift Renovation ROIC Estimate Capex $ 77,000 SG&A 38,000 Estimated Investment $ 115,000 Low Mid High Base Store Sales $ 1,200,000 $ 1,200,000 $ 1,200,000 Lower than company average Sales Lift % 10.00% 12.50% 15.00% (35.7%) to account Incremental Gross Margin 30.00% 30.00% 30.00% for increased Estimated Incremental EBIT 36,000 45,000 54,000 consumables mix % Pre-Tax Return 31% 39% 47%FDO plans to renovate 6,000 storesFDO plans to renovate 6,000 stores 15
  • Productivity Opportunity
  • Family Dollar vs. Dollar General In many ways, Family Dollar and Dollar General are very similar companies: In many ways, Family Dollar and Dollar General are very similar companies: Number of Stores ~7,000 ~9,500 Sales per Store ~$1.2mm ~$1.4mm Size of Average Store ~7k sqft ~7k sqft Consumables Mix 65% 72% Properties Leased, Leased, Mostly rural Mostly rural & suburban & suburbanDespite these similarities, the two business’ performance has diverged…Despite these similarities, the two business’ performance has diverged…
  • Family Dollar vs. Dollar General (Cont.) For many years, the two companies had very similar performance: For many years, the two companies had very similar performance: EBIT per square foot $14.00 Dollar General Dollar General Family Dollar Family Dollar $12.00 $10.00 $8.00 $6.00 $4.00 $2.00 $- 2000 2001 2002 2003 2004 2005 2006________________________________________________Note: Family Dollar results are calendarized to year end Feb. 18
  • Family Dollar vs. Dollar General (Cont.) In July 2007, KKR bought Dollar General. Less than four years later, let’s In July 2007, KKR bought Dollar General. Less than four years later, let’s compare the two companies: compare the two companies: EBIT per square foot $25.00 Dollar General Dollar General Family Dollar Family Dollar $20.00 KKR Buyout July 2007 $15.00 $10.00 $5.00 $- 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________Note: Family Dollar results are calendarized to year end Feb. 19
  • And the Winner is: Dollar General EBIT per square foot $25.00 Dollar General Dollar General Family Dollar Family Dollar $20.00 KKR Buyout 37% July 2007 Performance $15.00 Gap $10.00 $5.00 $- 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________Note: Family Dollar results are calendarized to year end Feb. 20
  • Productivity Gap Family Dollar’s lower profitability is a result of both lower sales per square foot Family Dollar’s lower profitability is a result of both lower sales per square foot growth and lower margins growth and lower margins Sales Per Square Foot EBIT Margin FDO 8% lower FDO 15% lower FDO 70bps higher FDO 250bps lower 11.0% $220 DG DG $200 10.0% 9.0% $180 FDO FDO DG $160 8.0% DG FDO FDO $140 7.0% $120 6.0% $100 5.0% 2003 2010 2003 2010 Dollar General Family Dollar Dollar General Family Dollar________________________________________________Note: 2003 Family Dollar results are calendarized year end Feb. 2004 21
  • Relative Margin Trends Under KKR’s ownership, Dollar General has dramatically improved margins Under KKR’s ownership, Dollar General has dramatically improved margins EBIT Margin 12.00% Dollar General Dollar General Family Dollar Family Dollar 10.00% KKR Buyout 8.00% July 2007 6.00% 4.00% 2.00% 0.00% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________Note: Family Dollar results are calendarized to year end Feb. 22
  • Relative Sales TrendsAfter years of similar SSS results, since the KKR deal, Dollar General hasAfter years of similar SSS results, since the KKR deal, Dollar General hasgrown at a much faster rate than Family Dollargrown at a much faster rate than Family Dollar Same Store Sales10.00% Dollar General Dollar General Family Dollar 9.00% Family Dollar 8.00% 7.00% KKR Buyout July 2007 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010________________________________________________ 23Note: Family Dollar results are calendarized to year end Feb.
  • Dollar General Post KKRDespite similar sales mix, geography, unit count, and store size:Despite similar sales mix, geography, unit count, and store size:Dollar General has -Dollar General has - Higher sales per square foot Higher margins Faster profit growth 24
  • Management is Working toClose the Gap
  • FDO is Playing Catch UpFDO has launched gross margin enhancement initiatives that are similar to theFDO has launched gross margin enhancement initiatives that are similar to theones DG has successfully implementedones DG has successfully implemented Private Label Penetration Dollar General’s consumable private label penetration is ~22% Family Dollar’s consumable private label penetration is ~14% Family Dollar’s goal is to get to 20% Global Sourcing Bypassing a broker and directly sourcing unlabeled and private labeled goods can offer 1,000bps to 1,500bps of margin improvement Currently, only 9% of FDO’s goods are directly imported. We believe this number could approach 15% in the future Improved Pricing FDO recently implemented sophisticated pricing software allowing management to better manage regional pricing zones and elasticity data Reduced Shrink 26
  • FDO is Playing Catch Up (cont). We estimate FDO will benefit significantly from its gross margin initiatives We estimate FDO will benefit significantly from its gross margin initiatives Estimated Gap 2010 Potential Global Sourcing 9% 15% Private Label - Consumables 14% 20% Estimated Margin Improvement % of Sales Delta Total Global Sourcing 6% 1250 bps 75 bps Private Label - Consumables 4% 1250 bps 50 bps Shrink, Pricing 100 bps Offsets - Private label reinvestment, inflation, mix ? Total <225 bps FDO’s substantial gross margin opportunity and high percentage of sales in low- priced necessities, provide a margin of safety against commodities inflation________________________________________________ 27Note: Consumables are ~2/3 of sales – a 6% change in consumables sales corresponds to a 4% change in total sales
  • SG&A: Highly LeverageableTwo thirds of Family Dollar’s SG&A expense is composed of occupancy andTwo thirds of Family Dollar’s SG&A expense is composed of occupancy andstore payroll costs, which are highly leverageable. Management believes corestore payroll costs, which are highly leverageable. Management believes coreSG&A costs, excluding growth initiatives, will grow modestly at 2 to 3% perSG&A costs, excluding growth initiatives, will grow modestly at 2 to 3% peryearyearSG&A Composition (FY 2009) SG&A includes ~$45mm (~50bps of sales) of renovation and new store pre-opening expense 28
  • Sales Growth OpportunityFamily Dollar has several initiatives in place to support management’s 4-6%Family Dollar has several initiatives in place to support management’s 4-6%medium-term SSS growth guidancemedium-term SSS growth guidance Expanded hours FDO completed its expanded hours rollout Q2 FY2010 New store growth and renovations Could contribute 1.5% to 2.0% SSS at the current build rate New stores can contribute a ~10% comp in the second year Renovated stores are growing SSS at a double digit rate New fixtures to support continued consumables growth FDO’s consumable mix trails DG by ~700bps Managing to lower stock outs Improved marketing 29
  • Valuation
  • FDO Shares are Cheap What you get What you pay Stable, secular sales growth A modest forward multiple on consensus numbers The opportunity to invest in (7.6% EBIT margin) an existing store base at high rates of return 14.7x FY2012 EPS ………(August) 10+ years of high return new unit growth Nothing – FDO trades at nearly the same consensus The option that FDO closes forward EBIT multiple as a large productivity gap DG (~9x), a company with with its closest competitor, similar growth prospects, Dollar General excluding the productivity gap 31
  • What Is the Productivity Gap Opportunity Worth? If Family Dollar’s square footage were as productive as Dollar General’s, the If Family Dollar’s square footage were as productive as Dollar General’s, the company would earn ~$6 of EPS and be worth ~$90 per share at a 15x P/E company would earn ~$6 of EPS and be worth ~$90 per share at a 15x P/E Consensus DG FDO % Diff 12 EPS FY 2012 Sales/sqft $ 210 $ 180 17% $ 0.65 FY 2012 EBIT Margin 10.5% 7.6% 38% 1.46 EBIT/sqft $ 22.05 $ 13.65 62% $ 2.36 FY 2012 EPS - Consensus $ 3.68 FY 2012 EPS - Pro Forma $ 6.03 Price at 15x EPS (Including 1.5yrs of dividends) $ 92 % Return 70%________________________________________________Note: Estimates for DG are FY ending Jan. 2013, and for FDO FY ending Aug. 2012 32
  • What if FDO only Partly Closes the Gap? % of DG Profit Gap Closed FDO 2012 EBIT Build 0% 50% 100% 2012 Selling Sqft (mm) 51 51 51 Sales/sqft $ 180 $ 195 $ 210 EBIT Margin 7.6% 9.1% 10.5% Pro Forma FY 2012 EBIT $ 692 $ 893 $ 1,118 Pro Forma FY 2012 EPS $ 3.68 $ 4.79 $ 6.03 2012 P/E 14.7x 11.3x 8.9x Price @ 15x EPS $ 56 $ 73 $ 92 % Return 4% 35% 70%________________________________________________Note: Estimates for DG are FY ending Jan. 2013, and for FDO FY ending Aug. 2012 Price includes 1.5yr of dividends 33
  • Strategic Alternatives
  • FDO is Under Pressure to PerformDisappointing first quarter results and the rejection of Trian’s $55 - $60 perJCP shares arefirst quarter since early 2007. At this point, cash$55 balance sheetDisappointing down 75% results and the rejection of Trian’s on - $60 pershare offer have raised shareholder’s performance expectationsshare offer have raised shareholder’s performance expectations Historical Stock Price $60 Trian makes a hostile Board rejects offer between $55 - $60 Trian’s offer $55 $50 Trian Files 13-D $45 Trian files a letter urging management to $40 Management accept its offer or reports Q1 earnings commit to closing the $35 and reduces top end performance gap with of FY2011 guidance Dollar General $30 $25 $20 1/4/2010 4/4/2010 7/4/2010 10/4/2010 1/4/2011 4/4/2011 35
  • Family Dollar’s Shareholder Base is Changing Since Trian’s February 15th bid, the shareholder base has changed to more Since Trian’s February 15th bid, the shareholder base has changed to more opportunistic investors: opportunistic investors: Change Since Holder Name Shares Held % Of Company 12/31/10 TRIAN FUNDS 9,966 8.2% 1,130 Pershing Square HOWARD LEVINE (CEO) 9,691 7.9% 0 purchased its position PERSHING SQUARE CAPITAL MGMT 8,369 6.9% 8,369 starting in February at VANGUARD GROUP INC 6,725 5.5% 36 prices between $43 and BANK OF AMERICA CORP 5,654 4.6% (498) $54 LONE PINE CAPITAL 5,633 4.6% 900 FRANKLIN RESOURCES 5,288 4.3% 208 STATE STREET CORP 4,661 3.8% (167) CREDIT SUISSE AG 4,657 3.8% 489 PAULSON & CO 3,455 2.8% 3,455 BLACKROCK 3,272 2.7% 228 INTECH INVESTMENT 3,164 2.6% 824 ADAGE CAPITAL 2,448 2.0% (970) BANK OF NEW YORK 2,248 1.8% 528 YORK CAPITAL MANAGEMENT 1,962 1.6% 1,962 ETON PARK CAPITAL 1,782 1.5% 1,782 RENAISSANCE TECHNOLOGY 1,782 1.5% (602) D E SHAW & COMPANY 1,476 1.2% (1,248) NORTHERN TRUST 1,350 1.1% (93) FDO has implemented a poison pill at 9.9% that expires on March 2, 2012. FDO has implemented a poison pill at 9.9% that expires on March 2, 2012.________________________________________________ 36Note: Pershing Shares as of May 24, 2011
  • There are Multiple Ways to Achieve Full Value: Current management Operational Opportunity Margin improvement initiatives and renovation program Capital Structure Opportunity FDO remains under leveraged. A leveraged buy back would create meaningful value for shareholders Sale of the company Strategic Buyer Another retailer would bring synergies to the combined company and possibly accelerate the closing of the productivity gap Financial Buyer A private equity firm could optimize the capital structure and work with management to improve the business 37
  • How Accretive Would a Leveraged Buy Back be?If FDO raised an incremental $1.5bn of debt, bought back stock at $60, andIf FDO raised an incremental $1.5bn of debt, bought back stock at $60, andclosed only half the productivity gap, the company would earn ~$5.50 of 2012closed only half the productivity gap, the company would earn ~$5.50 of 2012EPS and trade in the high $70s at a 14x P/EEPS and trade in the high $70s at a 14x P/E Leveraged Buy Back Accretion Analysis: Incremental Debt Raised ($mm) $ 1,000 $ 1,500 $ 2,000 Base EPS: Consensus FY2012 EPS $ 3.91 $ 4.04 $ 4.19 Accretion $ 0.23 $ 0.37 $ 0.51 Value per share at 14x EPS $ 55 $ 57 $ 59 Base EPS: Pro Forma Closing 50% of Productivity Gap FY2012 EPS $ 5.22 $ 5.47 $ 5.76 Accretion $ 0.42 $ 0.68 $ 0.96 Value per share at 14x EPS $ 73 $ 77 $ 81 Assumptions: Incremental Debt Raised $ 1,000 $ 1,500 $ 2,000 Total Net Debt (End FY2011) 1,385 1,885 2,385 Net Debt/EBITDAR 3.8x 4.2x 4.6x Assumed Cost of Total Debt (Gross) 5.6% 5.9% 6.1% Trian has sourced $5bn dollars of debt financing for their proposed deal Trian has sourced $5bn dollars of debt financing for their proposed deal 38
  • What Could a Strategic Buyer Pay?A strategic buyer could justifiably pay a ~50% premium to marketA strategic buyer could justifiably pay a ~50% premium to market Low Mid High Credit for Productivity Gap (% of total) 25% 50% 75% $ Value per share @15x EPS $ 9 $ 18 $ 27 ~15% of SG&A is corporate expenses. Reduction in Overhead 20.0% 30.0% 40.0% Distribution expense is % Shared with Seller 50.0% 50.0% 50.0% also a potential source of SG&A synergy $ Value per share @15x EPS $ 3 $ 5 $ 6 Gross Margin Expansion 0.5% 1.0% 1.5% Possible COGS % Shared with Seller 50.0% 50.0% 50.0% synergies include: consolidating direct $ Value per share @15x EPS $ 2 $ 4 $ 6 sourcing operations, private label brands, Total $ Premium to Market $ 14 $ 26 $ 38 and national brand % Premium to Market 26% 48% 71% buyer power Implied Takeout Price $ 68 $ 80 $ 92 39
  • Financial Sponsor’s EconomicsA financial buyer could pay 40% to 55% above the current stock price and stillA financial buyer could pay 40% to 55% above the current stock price and stillearn a high teens to low 20s% rate of return over four yearsearn a high teens to low 20s% rate of return over four years IRR Sensitivity (2015 Exit) Exit EBITDA Multiple (FY2016) 40.3% 7.0x 7.5x 8.0x 8.5x $ 67 9.5x 24% 27% 30% 33% Entry Multiple 70 10.0x 21% 24% 26% 29% (FY2012) EBITDA 74 10.5x 17% 20% 23% 26% 78 11.0x 15% 17% 20% 23% 81 11.5x 12% 15% 17% 20% 85 12.0x 10% 13% 15% 17% 88 12.5x 8% 10% 13% 15% Returns assume a 10% terminal EBIT margin, $230 sales sqft in 2015, and Returns assume a 10% terminal EBIT margin, $230 sales sqft in 2015, and $5bn of leverage (7x FY2011 EBITDAR) at 7.5% $5bn of leverage (7x FY2011 EBITDAR) at 7.5% 40
  • Valuation Summary Even if we’re wrong on both the value of the standalone operating opportunity and the Even if we’re wrong on both the value of the standalone operating opportunity and the transaction value, we believe shareholders will still make money owning FDO due to the transaction value, we believe shareholders will still make money owning FDO due to the company’s attractive growth opportunities and modest forward earnings multiple company’s attractive growth opportunities and modest forward earnings multiple $100 $95 $90 $85 $80 $75 $70 $65 $60 Trian Bid $55 Current Stock Price $50 Operating Operating Strategic Buyer LBO Improvements Improvements (50% to 100%¹) & (50% to 100%¹) $1.5bn Buy Back Decreasing Timing and Execution Risk¹% of performance gap closed