The tie-up could worsen the position for shoppers in local areas owing to a cut in quality, fewer promotions and store closures, an initial probe found.
Poundland wants to buy its closest rival in an agreed deal worth £47.5m in cash and £7.5m in shares.
The Competition and Markets Authority (CMA) said this could hit 80 areas.
These were where the companies, which have a combined network of 800 stores, currently overlap. There was a further 12 areas where they would be competitors in the near future.
Following an initial investigation, the CMA said there was "a realistic prospect of substantial lessening of competition" in these areas.
The authority said it would now move to a more in-depth investigation unless these concerns were addressed in a "clear-cut manner" by the companies.

However, dozens are still being held in centres on the Pacific island of Nauru.
Those on the mainland will now be able to move more freely in community detention as their claims are processed.
Australia's tough immigration policy turns back seaborne migrants or puts them in offshore camps.
Officials in Australia say the last group of children ranged from a baby to a 17-year-old. They were brought from Nauru because family members needed medical treatment.
However, their asylum claims will still be checked and they will be deported if they fail.
Doctors and activists have pressed the government to release all the children, citing health grounds including mental problems.
The number of asylum-seeking children hit a record high of 2,000 in June 2013 and Immigration Minister Peter Dutton said the latest releases represented a "significant achievement".
However, some 1,700 adult asylum seekers remain in detention on the mainland.
The average time they are held is now at a record high of 464 days, immigration figures show.
Why is Australia's asylum policy controversial?
Discount store Poundland's proposed purchase of rival 99p Stores for £55m faces an in-depth investigation by competition authorities.
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The Australian government says the last remaining asylum-seeking children being held in mainland detention centres have been freed.