Discount chain Dollar Tree will buy rival Family Dollar for about $8.5 billion, in a surprise deal that will help it fend off increasing competition from big-box retailers such as Wal-Mart.
Dollar stores have struggled in a weak U.S. economy as Wal-Mart and other large retail chain chase penny-pinching consumers by offering more items priced at $1 or less.
The deal will give Dollar Tree more than 13,000 stores across the United States and Canada, vaulting the company ahead of Dollar General to become North America's biggest discount retailer, with more than $18 billion in annual sales.
"It's not great news for Wal-Mart," said Canaccord Genuity analyst Laura Champine. "Dollar Tree is generally better-run than Family Dollar was, so it could mean that Family Dollar has better products and more consistent merchandising."
Family Dollar's sale is a big win for its largest shareholder, Carl Icahn, who has been urging the company to sell itself. He had touted Dollar General as a potential buyer.
A counter bid from Dollar General was "possible," Champine said.
Family Dollar's shares rose to $75.44 in afternoon trading. Dollar Tree's cash and stock offer valued Family Dollar at $74.50 per share.
Dollar Tree shares were up 2.7 percent at $55.67. Dollar General was up 2 percent. Wal-Mart shares were slightly down.
Icahn stands to make a profit of about $200 million based on the price at which he bought his 9.4 percent stake in the company, according to Reuters calculations.
Family Dollar, which mostly sells lower-margin consumables such as food and household products in lower-income neighborhoods, has been struggling to reverse declining sales and earnings.
"With a new sheriff in town, Family Dollar will be a much sharper competitor," Sterne Agee & Leach analysts wrote in a note.
The company, which also sells many items at more than $1, has slashed prices on 1,000 basic items, cut jobs and shut hundreds of stores to try and turn its fortunes around.
Dollar Tree, whose products cost $1 or less, sells a mix of food products as well as discretionary items such as gifts, party goods and greeting cards. Most of its stores are in the suburbs.
"This acquisition will extend our reach to lower-income customers," Dollar Tree CEO Bob Sasser said.
Dollar Tree offered $59.60 in cash and the rest in stock for each Family Dollar share, in a deal with an enterprise value of about $9.2 billion.
The company said it expects to save about $300 million annually by 2018, three years after the deal is likely to close.