A Look at Ackman’s Plan for Target

Target Corporation (NYSE: TGT) shares are a bargain right now according to at least one activist investor - is it time for investors to jump onboard? Pershing Square’s William Ackman unveiled his plan to unlock value at the troubled retailer at a conference earlier this week in a move that could help Target shares rise substantially. The activist estimates that shares of Target could trade as high as $70 per share within the first year the plan was enacted.

Pershing Square estimates Target’s real estate portfolio to be worth around $39.1 billion. However, this value is clearly not reflected in the market where Target as a whole trades for just $28.97 billion. The activist recommended that Target spin-off its land assets into a real estate investment trust (REIT) that would own the land under Target’s stores. The discount retailer would then sign a 75-year lease for the land and would maintain ownership and control of its buildings.

Under the agreement, Target would own its buildings on 75-year ground leases that could be renewed while outsourcing its facilities management services. The REIT would lease the land to Target, provide facilities management services, and become Target’s exclusive land developer for the first two years and a preferred vendor thereafter. This means that future land purchases would be made through this entity for the first two years and they would have first option thereafter.

Pershing Square estimates that this transaction would substantially increase Target’s ahre price. Target’s $40 per share value now would have $7 per share added in incremental earnings generation, $17 per share added from the REIT’s multiple expansion, and $5 per share added from Target’s multiple expansion. This assumes that Target would trade at 14.2x earnings and the REIT would trade at 21.3x earnings, which are both conservative estimates given the new financials that these entities would possess.

Target is in a better position because of its improved free cash flow and financials. Store level return on invested capital would increase because of lower real estate costs as it would no longer have to finance acquisitions. This, combined with the elimination of the dividend (which will be transferred to the REIT), will result in substantially higher free cash flow and a more efficient capital strucutre that will allow its growth rates to exceed today’s rates to justify a higher multiple.

The REIT is unique in that it would be land-only and extremely secure with $20 billion in Target buildings available for re-possession upon default. The 75-year lease is also inflation-protected in that Target’s lease payments are coordinated with CPI and the payment dates are set to TIP payment dates. As a result, any discrepencies in valuation would be resolved through arbitrage between these two securities until it is eliminated. The size of the REIT will also make it a must-own security.

Pershing Square first initiated its investment in Target in April 2007 and now owns slightly less than 10% of the company. Since meeting with management in 2007, the hedge fund has enjoyed a very constructive relationship with the reatiler. Target recently raised some concerns, but is likely still reviewing the proposal. Investors interested in investing alongside Ackman, but awaiting approval by the company, may want to purchase LEAPS options in the meantime.

LEAPS options can be purchased for a fraction of the cost of purchasing Target shares outright and enable investors to own the rights to the stock at a set price for a year or more in the future. Assuming Pershing Square’s estimates were correct, investors can purchase a $60 January 2010 contract for just $3.80. This means that they would have the right to purchase 100 shares of Target at $60 for just $380 upfront (instead of $3,839 now). If shares hit $70, they would make $1,000 on their $380 investment - a return of nearly 300% compared to a return of just 82% purchasing the underlying without risking nearly $4,000.

Want to learn more about LEAPS? Sign-up for our web site and check out our education section.

 Email This Story
Join LEAPSInvestor.com