Friday, May 29, 2009

Target versus Ackman......VERY interesting activist situation



AlphaNinja - Great debate here about a company's focus - monetize assets or not? Let an activist shareholder gain board representation or not? Is said activist's ownership stake sturdy enough to warrant such representation?

It's been an ongoing battle here. William Ackman, through his Pershing Square hedge fund, has been agitating for change at Target (TGT) for quite some time. His aggressive use of derivatives instead of strictly owning common stock (he does own both) has CRUSHED him and his investors, while at the same time giving management an argument that he is not "in it" for the long haul, since much of his ownership stake expires within 18months.

Ackman's main argument is that Target has significant, unrecognized real estate value that can be unlocked through sale-leaseback transactions. Secondarily, he believes the company needs a better food product strategy to combat category leader Walmart. AlphaNinja agrees with him on both counts, but in this case we think his aggressive stance is unwarranted, as Target has performed admirably in a tough industry.

Target's stock performance vs. Walmart:





The final verdict in this debate is the market, so what is it saying? TGT yields 1.2%. NOT CHEAP. Target trades at a PE of 12 - cheap, but it's a retailer in a recession competing against Walmart and the rest of the world. Free Cash Flow is CLOBBERED by huge capital expenditures, so they don't have that going for them ( that is the best argument going for Ackman - the real estate transaction would free up much cash to pay for expansion). The point is, Target is pretty well received and valued by the market - especially back at the $60 level, when Ackman was making the same argument.

Whether or not Target raises cash in a real estate transaction, the company must continue to invest heavily, to the detriment of free cash flow. Ackman's push is a "recapitalization" of sorts - an attempt to monetize something he sees as unrecognized by the market. I bring up this example because the market is not stupid - investors add value to a stock price for under priced real estate, the same as you would with a sizable cash balance. Tinkering with the capital structure usually creates less stockholder value than one would by increasing earnings, but in this case it might not be so. The market doesn't value Target on a book value basis, so why not monetize some of that real estate and do something with the cash? Both sides in this case have good arguments:

"There are few proxy battles actually won by the outside activist, and Target exhibited few characteristics of a poorly managed company despite current performance," says Neil Stern, senior partner at retail consultancy McMillan Doolittle. However, Stern added that "Ackman's push for a more skilled board was not all wrong."

Today we see that Target shareholders have rejected Ackman's nominees to the board. The best outcome here would be a compromise - Ackman should back off, and Target should monetize (depending on market conditions) some of its real estate portfolio.

Some of Ackman's TGT holdings, as well as other positions:


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