October 30, 2008
Investor Wants Target to Spin Off Real Estate Holdings
Target has said it would seriously consider investor William Ackman’s recommendation to spin off its real estate assets to a newly created and separate company that would then lease those properties back to the retailer.
Mr. Ackman, whose Pershing Square Capital Management hedge fund holds just under 10 percent of Target, said that the new entity called Target Inflation Protected REIT (TIP REIT) would unlock the value of the chain’s holdings, which he estimates to be $39.1 billion.
“We’ve asked the company to do something that’s transformational,” Mr. Ackman is quoted by Reuters. He estimates that TIP REIT would increase Target’s value by roughly $30 a share.
Target has not dismissed Mr. Ackman’s recommendation but has expressed some reservations. The retailer’s management has questioned whether a spin off would lead to higher expenses for the company and reduce its financial flexibility.
There is also concern that the spin off could damage Target’s debt ratings, make it more costly to borrow money and reduce its liquidity. Further, there is the danger that it could divert the company from focusing on its core business.
Mr. Ackman acknowledged that TIP REIT could pose problems for Target but there’s a quick fix if it doesn’t work. “The beauty is you just put the genie back in the bottle and just merge the two companies,” he said.
Discussion Question: Would the creation of TIP REIT be the right move to make Target a stronger retailing business?
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I am a great believer that companies should identify their core business and “outsource” everything else. I believe the retailer is a merchant, not a land holder. However, some of the questions and concerns in the article are very real.
The retailer’s management has questioned whether a spin off would lead to higher expenses for the company and reduce its financial flexibility: YES!
Could damage Target’s debt ratings: MAYBE
Make it more costly to borrow money: PERHAPS
Reduce its liquidity: DEPENDS ON DEBT STRUCTURE.
It could divert the company from focusing on its core business: UNLIKELY
Assuming the Target stockholders become TIP REIT stockholders pari-passu, the increase in the sum value of the two issues should offset any structural financial problems that Target the retailer experiences. Though Target uses the real estate as collateral for debt financing, they are not likely getting the full value out of that collateral. Despite the fact that they own the real estate, they should be charging themselves an implied rental expense to determine their real operating income. To not do that foolishly inflates their level of income and leads to poor business decisions.
And let’s remember something that is often forgotten in U.S. business–it is the stockholders who own the business, not the managers. Clearly, the best alternative for the stockholders is to split these entities.
I agree with the comment made about Mervyns. The net impact of the transaction would be to reduce Target stores’ profitability. The value is created because Target’s leases (at least to some extent) are valued below market. If those leases were restated through new transactions with a new entity, Target’s operating costs would increase significantly.
Creating pseudo independent entities to handle distinct aspects of the value chain is neither new nor effective. Enormous problems exist in creating, monitoring and adjusting the transfer pricing for the goods or services the “middle company” manages. And false metrics are generated which lead to bad decision making.
I realize that Target has a fiduciary responsibility to seriously consider and investigate this proposal. It is my hope that their due diligence, if done exhaustively, will prove conclusively that it is NOT in the best interests of the stockholders.
This was a fantastic idea two years ago when they could have sold at the peak of the market. Now, selling near the bottom of the market would be a mistake. Target should be buying sites now, not selling them.
I agree that while REITs may be a better known/established financial instrument than, say, credit swaps, they still smell in this day and age a lot like “off balance sheet financing” which is what got us into the financial mess in the first place.
I actually think that there is a world of opportunity to rethink real estate in retail. Retailers invest in stores with 30 or 50 year time horizons, but what neighborhoods really retain their demographics or their overall attractiveness during that amount of time? I would say few do if any, and there are many retailers who have gotten into trouble by not paying attention to the demographic shifts in the neighborhoods they serve. Owning an asset is the best defense–because if the neighborhood doesn’t match your targets any longer, you can at least recoup some of the investment by selling the property to someone who does match up. Leasing is OK–but only if the terms are flexible enough or the lease is short enough that you have the opportunity to get out of it on a 15-year type horizon, rather than 50 years. But then you don’t really recoup any of the investments or improvements that you’ve made in the property.
This is not a good idea for Target. The refocusing of critical assets, to create this, especially in this recessionary year, is poor timing. Add to this the volatility of the real estate market and the skepticism of valuation of properties by many financial institutions, and you have the potential to radically decrease or devalue the stock. Finally, once valued, you cannot just re-absorb the company, since investors will still have a benchmark evaluation (even if it is not current or correct) which will continue to damage the company, for many years to come.
William Ackman’s assertion that if it doesn’t work you can put the two companies together again is clear enough evidence that his interest is not in building on Target’s strengths as a retailer for the long haul, but simply looking for a quick return on his investment buck.
Bad idea–even worse timing.
One of the key lessons of Mervyns’ demise is that the spinoff of its real estate holdings to its private equity buyers took a critical tangible asset off its balance sheet. And one of the larger lessons of the current economic crisis is that solid companies have measurable assets. Too many businesses, financial and otherwise, are folding because nobody can define the value of their assets compared to the mountains of debt they have accumulated.
So I would be very leery (if I were an investor in Target) about a move that might appear to prop up the company’s stock price in the short run but turns out to be harmful long-term. (It’s not as easy to stuff that genie back in the bottle after you have uncorked it.) Target will withstand the current economic slowdown, and its stock price will recover over time, because it is a fundamentally sound company with a good concept and good execution, with financial prudence being part of the formula.
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I am a great believer that companies should identify their core business and “outsource” everything else. I believe the retailer is a merchant, not a land holder. However, some of the questions and concerns in the article are very real.
The retailer’s management has questioned whether a spin off would lead to higher expenses for the company and reduce its financial flexibility: YES!
Could damage Target’s debt ratings: MAYBE
Make it more costly to borrow money: PERHAPS
Reduce its liquidity: DEPENDS ON DEBT STRUCTURE.
It could divert the company from focusing on its core business: UNLIKELY
Assuming the Target stockholders become TIP REIT stockholders pari-passu, the increase in the sum value of the two issues should offset any structural financial problems that Target the retailer experiences. Though Target uses the real estate as collateral for debt financing, they are not likely getting the full value out of that collateral. Despite the fact that they own the real estate, they should be charging themselves an implied rental expense to determine their real operating income. To not do that foolishly inflates their level of income and leads to poor business decisions.
And let’s remember something that is often forgotten in U.S. business–it is the stockholders who own the business, not the managers. Clearly, the best alternative for the stockholders is to split these entities.
I agree with the comment made about Mervyns. The net impact of the transaction would be to reduce Target stores’ profitability. The value is created because Target’s leases (at least to some extent) are valued below market. If those leases were restated through new transactions with a new entity, Target’s operating costs would increase significantly.
Creating pseudo independent entities to handle distinct aspects of the value chain is neither new nor effective. Enormous problems exist in creating, monitoring and adjusting the transfer pricing for the goods or services the “middle company” manages. And false metrics are generated which lead to bad decision making.
I realize that Target has a fiduciary responsibility to seriously consider and investigate this proposal. It is my hope that their due diligence, if done exhaustively, will prove conclusively that it is NOT in the best interests of the stockholders.
This was a fantastic idea two years ago when they could have sold at the peak of the market. Now, selling near the bottom of the market would be a mistake. Target should be buying sites now, not selling them.
I agree that while REITs may be a better known/established financial instrument than, say, credit swaps, they still smell in this day and age a lot like “off balance sheet financing” which is what got us into the financial mess in the first place.
I actually think that there is a world of opportunity to rethink real estate in retail. Retailers invest in stores with 30 or 50 year time horizons, but what neighborhoods really retain their demographics or their overall attractiveness during that amount of time? I would say few do if any, and there are many retailers who have gotten into trouble by not paying attention to the demographic shifts in the neighborhoods they serve. Owning an asset is the best defense–because if the neighborhood doesn’t match your targets any longer, you can at least recoup some of the investment by selling the property to someone who does match up. Leasing is OK–but only if the terms are flexible enough or the lease is short enough that you have the opportunity to get out of it on a 15-year type horizon, rather than 50 years. But then you don’t really recoup any of the investments or improvements that you’ve made in the property.
This is not a good idea for Target. The refocusing of critical assets, to create this, especially in this recessionary year, is poor timing. Add to this the volatility of the real estate market and the skepticism of valuation of properties by many financial institutions, and you have the potential to radically decrease or devalue the stock. Finally, once valued, you cannot just re-absorb the company, since investors will still have a benchmark evaluation (even if it is not current or correct) which will continue to damage the company, for many years to come.
William Ackman’s assertion that if it doesn’t work you can put the two companies together again is clear enough evidence that his interest is not in building on Target’s strengths as a retailer for the long haul, but simply looking for a quick return on his investment buck.
Bad idea–even worse timing.
One of the key lessons of Mervyns’ demise is that the spinoff of its real estate holdings to its private equity buyers took a critical tangible asset off its balance sheet. And one of the larger lessons of the current economic crisis is that solid companies have measurable assets. Too many businesses, financial and otherwise, are folding because nobody can define the value of their assets compared to the mountains of debt they have accumulated.
So I would be very leery (if I were an investor in Target) about a move that might appear to prop up the company’s stock price in the short run but turns out to be harmful long-term. (It’s not as easy to stuff that genie back in the bottle after you have uncorked it.) Target will withstand the current economic slowdown, and its stock price will recover over time, because it is a fundamentally sound company with a good concept and good execution, with financial prudence being part of the formula.