by Jason Kelly
Calbert had been something of an experimental hire, though in a typically deliberate way for KKR. While he was in talks to join the firm, KKR had decided to start a new division, an internal consulting firm known as Capstone, which would allow KKR to offer operational advice it normally would have to pay McKinsey, Bain & Co., or Boston Consulting Group for. To run that business KKR hired Dean Nelson, who had worked at BCG as well as Shell Oil.
But they wanted some deal partners with real-world experience instead of just fancy MBAs, and Calbert fit the bill. Once on board, he started ginning up retail ideas, the highest-profile being the 2005 takeover of Toys R Us, with Bain Capital and Vornado. The Dollar General deal was percolating inside KKR for at least a year before the company sprang its offer in the fall of 2006. From his perch at KKR’s Menlo Park office, Calbert marshaled a group of analysts to come up with a thesis around dollar stores.
Running numbers only gets you so far, so Calbert went on the road himself. He enlisted industry contacts, including former Dollar General executives, to visit stores with him, usually down South, where Dollar General stores were concentrated. He’d chat up store managers and customers, gathering anecdotal evidence to match the quantitative analysis performed back in New York and California. By 2005, he wanted to buy Dollar General, but it was too expensive. So he waited.
It didn’t take long. The following year turned out to be a disastrous one for the chain. Amid a booming economy, dollar stores were far from in vogue. Dollar General had more specific problems. Many stores were disorganized, and a long-standing practice of keeping leftover inventory on hand backfired, Calbert said. Already rumors about a takeover were swirling. In late November, CNBC reported that buyout firms Bain Capital and Cerberus were weighing offers, sending the stock higher.
The market got the clearest sense of the company’s woes on November 29 of that year, when it told investors the day after CNBC’s report it would close 400 stores the following year. The company estimated the closures, plus the cost of selling off excess inventory at deep discounts, would cost $138 million. The stock dropped 6 percent that day.
There was no mention at the time of KKR, but Calbert already had been working the halls of KKR and making his case. Not everyone mirrored his enthusiasm. Most investments can clear KKR’s investment committee with five or six meetings; Dollar General took eight. Calbert’s partners asked for more information, including a presentation from outside consultants on the business, as well as further consultation with a former chief executive of a KKR-backed retailer. Finally, they were convinced.
On October 5, 2006, Calbert made his approach, meeting with then-CEO David Perdue, former CEO Cal Turner Jr., and David Wilds, a director on Dollar General’s board. Calbert told the trio that KKR was interested in conducting official due diligence ahead of a potential formal offer. As a public company, Dollar General’s board had a responsibility to consider the proposal and the following day the board’s governance committee was notified of KKR’s approach; it was decided that the full board should be informed and consider its options.4
The board formed a committee, which then hired Lazard to give advice, adding the investment bank to a roster of counselors that already included Lehman Brothers.
KKR originally was teamed with TPG in its pursuit. Blackstone and Bain emerged as another potential bidding pair. As various investors and bankers trooped into Goodlettesville, anxiety swept through headquarters. “Confusion was the No. 1 thing,” CFO Tehle said. “People are saying, ‘What does this mean for me personally?’ Everyone was very nervous, thinking ‘I’m sure my job will be eliminated.’”
In late February, Lazard gave the bidders a deadline for “best and final offers.” KKR, now without TPG, offered $22 a share, a 31 percent premium over the company’s share price on Friday, March 9, when it submitted its offer. An analysis by Lazard had come up with two scenarios to value the stock, the high end of the range in the more aggressive scenario was $21.25 a share.
Dollar General, its lawyers, and bankers huddled in person and over the phone that day and Saturday. Blackstone and Bain asked for more time. Dollar General and its bankers consulted, then demurred and voted unanimously to accept KKR’s offer on Sunday, March 11.
KKR announced that it would buy the company the next morning. Tehle stood in the area outside the Dollar General conference room where much of the deal had been negotiated and watched CNBC as the deal was announced via press release at 8 a.m., 7 a.m. Nashville time. Within what felt like seconds to Tehle, the commentators were discussing the deal, instantly analyzing the price. They deemed it a fair price. Tehle exhaled.
Calbert and Agrawal arrived and spent the next three days in Goodlettesville, first conducting a town hall for employees, then sitting with the management team in the board room and going through it “in a very calm and measured fashion,” Tehle says. “We agree with your numbers,” Calbert told the executives. “These ideas are coming from what you guys are giving us.”
Everyone was excited, but they still had to close the deal. The first step was the cash portion, about $2.8 billion. With TPG out of the picture, the entire nut fell to KKR to circle up. Simply writing a check wasn’t an option, since a commitment of that size could trigger issues related to how much of one fund could be in a single deal. KKR needed other people with money.
Craig Farr is an affable Canadian who ventured south of the border to work on Wall Street and never left. As head of U.S. equity capital markets at Citigroup, KKR was a key client and his relationship at 9 West was cemented through his work on the public offering of KPE, the firm’s European fund. When Kravis and Roberts were mulling the notion of starting their own capital markets unit, they hired Farr, with a vague mandate to figure out how money should better flow into and around the firm and its deals. No one, Farr included, knew exactly what that meant. Inside KKR, he was like the new kid in school. Everyone was intrigued, but not quite sure what to make of him and his new assignment. Deal guys, used to handling all their own financings through existing Wall Street relationships, were uneasy.
As the Dollar General deal moved toward completion, Farr got his chance to prove his worth. “George (Roberts) called and said, ‘Can we get this done?’” Farr said. “I’d been here for less than a year. Of course I said yes.” Farr tapped Canada Pension Plan, with its hearty appetite for so-called co-investments that give investors the ability to put more money into a deal, for lower fees. Farr additionally convinced Wellington Capital Management, an existing public shareholder of Dollar General, to buy into the new deal. Goldman Sachs and Citigroup, which were helping arrange debt financing, ponied up cash from their private-equity arms. KKR had the money it needed. “Everyone saw tangibly how this could work,” Farr said. “Before that, there were a lot of skeptics.”
The combined equity was about 37 percent, a substantial portion by historical standards (in KKR’s seminal RJR deal, the company put up less than 10 percent), but it still left more than 60 percent of the deal to be funded through borrowed money. The souring economy that was part of KKR’s Dollar General investment thesis hit home fast, and uncertainty in the credit markets almost derailed the deal altogether.
“We assumed it was going to get done,” Tehle said, “until we went on the road.”
The debt for most LBOs is a mixture of loans and bonds, and the bonds are marketed to institutional investors by a team that includes salespeople from the underwriting banks (in this case Goldman and Citi) and executives from the company. Tehle and David Bere, the president and interim CEO, were tapped to represent Dollar General.
In the course of two weeks in late June, Tehle and Bere gave presentation after presentation for the road show. While they were confident they could pull off the plan, Tehle admits they were pitching a leap of faith through their PowerPoint slides, or “deck” in Wall Street-ese. “It was a great deck, a great story, but it wasn’t a proven story,” Tehle said. “People would say, ‘You haven’t done any of this yet.’”
During the call, one banker suggested they might have to pull them off the road and wait six months.
Tehle rang Bere in his room after the conference call and voiced his concern. Then he called Calbert and expressed anxiety about postponing the road show and the bond sale. “That’s not going to happen,” Calbert told Tehle.
In the end, the deal got done, with Goldman and Citi reducing some fees for buyers, holding some of the debt on their respective balance sheets. “They took some pain,” Calbert said. Like KKR, though, they were all in, given their choice to not only underwrite the debt, but participate on the equity side as well. The deal closed on July 6. Now Calbert had to find someone to run the company.
Calbert and David Perdue, the Dollar General chairman and CEO at the time of the deal, had agreed from the beginning that Perdue would leave once the deal closed. With Bere as the interim CEO, Calbert began a methodical search for a new leader.
Dreiling wasn’t an immediate candidate despite some shared history. The two men had known each other from their supermarket days, and Dreiling had worked for KKR as a senior executive at Safeway. He was at Safeway when the grocery chain bought Randalls, where Calbert was the CFO. They kept in touch for a few years after that deal, in 2000, when Calbert went to KKR and Dreiling went on to serve as chief operating officer of Longs Drug Stores. He went on to run Duane Reade, the New York-based drugstore chain owned by fellow private-equity firm Oak Hill Partners.
Dreiling hadn’t paid a huge amount of attention to the Dollar General deal, or not much more beyond reading the headlines with everyone else. At around $7 billion it was only a biggish deal for early 2007. After all, KKR had bought TXU for six times that and bankers were fantasizing about a $100 billion leveraged buyout. A discount chain down in Tennessee was a one-day story.
A headhunter who wasn’t working on the Dollar General search suggested that the two men connect. Calbert liked the idea and rang up Dreiling. Dreiling’s reaction to Calbert: “You want me to run what?” He was flattered but relatively firm. He had a job and wasn’t looking for a new one. “Do me a favor,” Calbert said. “Go out to New Jersey and visit four or five stores and tell me what we need to do.”
Dreiling complied, and reported back to Calbert. The KKR partner kept wooing. Calbert asked Dreiling to meet him in Phoenix in the fall of 2007 and spend a day touring stores, part of his standard procedure in assessing a CEO candidate. He was still proceeding with the quickly fading façade of asking Dreiling’s advice. Dreiling was the fourth or fifth would-be chief he’d squired around. “You can tell a lot about how they act in the store,” Calbert said. “Are they condescending to the staff? What do they look at?”
In the first store they walked into, he lost Dreiling in the relatively small store (most Dollar Generals are 7,200 square feet), and found him a few minutes later, chatting with the store manager. At another outlet, Dreiling called Agrawal over and pointed to the Gatorade display. “You have green and red, where’s orange? Orange is the number-two seller and there’s not even a tag here, so they clearly don’t carry it. Why would you stock No. 1 and No. 3?” Agrawal didn’t have an answer. In another store, Dreiling and Calbert were walking through the hardware aisle and saw a display of toilet seats. Dreiling asked Calbert: “When was the last time you bought a toilet seat?”
Halfway through the day, the two KKR executives walked out of a store ahead of Dreiling. Calbert said to Agrawal in the parking lot: “You’ve just met the new CEO of Dollar General.”
Despite Calbert’s certainty, Dreiling wasn’t sold and KKR protocol dictated that a hire of this magnitude needed to be vetted by Kravis and Roberts.
The courtship was delicate. Calbert was positioning the meetings to Dreiling as a series of favors, casual conversations among friends about how to deal with this new company KKR had bought. After all, Dreiling had once been a part of the KKR family via Safeway, and had clear admiration for Kravis and Roberts personally. Over Thanksgiving, which Dreiling was spending in California, Calbert asked him to have lunch with Roberts, with the same instructions: “Just tell him what you think.” The two men talked about their kids and life, and a little about Dollar General. Dreiling wasn’t stupid; he knew this was at least a quasi-job interview and the more he talked about Dollar General, the more he wanted the job. Roberts asked him, on a scale of 1 to 10, how Dreiling would fit as Dollar General’s chief. Dreiling said, “I’m a 12.” Roberts was stonefaced. Later, he told Dreiling it was the first time in decades of asking people to rank themselves that anyone had rated themselves off the chart.
Now a full-on candidate, Dreiling was required to go through a battery of psychological tests administered by an outside firm, an hours-long exercise in a hotel suite with not much more than carrots to much on, anathema to Dreiling, who prefers potato chips. A couple of weeks later, Calbert called and said Kravis wanted to meet. Arriving at 9 West late one afternoon, he was ushered into the small conference room adjacent to Kravis’s office. While he waited, Dreiling noticed that a blue folder with the pysch consulting firm’s name was sitting on the table, with his name on it. Kravis came in and the two men talked for an hour, a wide-ranging conversation similar to the Roberts lunch. As they walked out of the meeting room, Dreiling couldn’t help but glance down at the blue folder Kravis now had in his hand. Kravis looked at the folder, looked at Dreiling and said, “By the way, you passed.”
Now it was up to Calbert. As Christmas approached, he suggested he and Calbert get together, with their respective wives, who already knew each other. The men would play golf while the wives visited “and then we’d meet the girls for dinner,” Dreiling said. On the course, Calbert gave him the offer.
Private-equity deals can be wildly lucrative for those involved, and the managers of the companies are no exception. It’s an element any buyout manager will stress amid the talk of “aligning interests.” In Dreiling’s case, his salary is $1 million a year, relatively modest for the CEO of a large publicly traded company. The big money is in the stock. A government filing in April 2012 showed that Dreiling, who has sold a small portion of his stock, still owned about 1.54 million shares of Dollar General. Trading at $46 a share, that stake was worth roughly $70 million.
Back in 2007, all that was theoretical. Dreiling asked for some time to think it over. After all, he had a job that he liked, working for another private-equity firm, to boot. While he wasn’t planning on returning to New York for another week, he called the partner at Oak Hill who chaired Duane Reade and said he was coming back early from vacation and wanted to meet. “Anyone knows that if your CEO calls saying that, you’ve got some sort of problem,” Dreiling told me, laughing. Oak Hill asked for the weekend to put together a counteroffer to keep him at Duane Reade and Dreiling agreed.
He left his office near Penn Station in midtown Manhattan and stopped by Uncle Jack’s, a local steakhouse, for his usual wind-down glass of wine. While he was chatting with the bartender, his cell phone rang. It was George Roberts, pressing his case with a personal appeal.
Dreiling, still slightly starstruck by the KKR mystique, assured Roberts he was thinking about it carefully. The next Monday, he accepted the job.
I wanted to see a Dollar General store through Dreiling’s eyes, so we hopped in my rental car and drove to an outlet you can practically see from the conference room where we’d been sitting earlier, just up the hill at headquarters.
Clearly this was a showcase store and I felt a twinge of sympathy for the poor store manager who has to deal with folks from corporate popping in with visitors in tow. Dreiling walke
d me through the store, talking about changes small and large. Small: The strips that hang merchandise off the shelves vertically are now fixed to the shelf, preventing stockers from knocking them off when they replenish the shelves at night. Large: Store managers across the chain used to have autonomy over about 20 percent of what the store carried, meaning if you had a store run by an avid Elvis fan, it was stuffed with Elvis merchandise. Now store managers have autonomy over exactly zero.
They also have very little say about what goes where. Dreiling found that there often was little thought, or maybe different theories, about what should go where. Spices would be sitting on the same aisle as underwear and bras.
Every foot is accounted for. As we walk through, Dreiling notes that candles aren’t big sellers, so next year they’ll have four feet of shelf space instead of eight feet. Everything is about real estate here. Dreiling repeats “7,200 square feet” like it’s a mantra.
There were no toilet seats in sight.
When he took over, Dreiling asked Tehle to rent about 50,000 square feet of empty retail space to create three prototype layouts that they could fiddle with. The byproduct of those experiments is what we see in stores today. “Now it’s all tweaks,” Dreiling said. Apparel has been elusive and they’ve conducted research to figure out how to get their core customer to buy. One result is less for women, despite women being the overwhelming majority of the Dollar General shopping public. They shop for their kids first, their husbands second, themselves third.
Another insight was understanding how categories of products dictated what brought shoppers in as well as what they ultimately bought. “Consumables drive the visit, non-consumables drive the basket,” Dreiling said, in retailer-speak. Translation: You get them in to buy some eggs, you make money when they realize they need a birthday present, a new shirt for their son, and some school supplies. With that in mind, every store now carries milk. As we walk through, he notes that they also have orange-flavored Gatorade.
