Ackman: Target Shares Worth $37/Share

Target Corporation (NYSE: TGT) shares fell sharply despite an activist investor’s plan to unlock value. Pershing Square’s William Ackman unveiled plans today to unlock the real estate value by spinning off the firm’s land into a real estate investment trust that would then lease back the land to Target stores via a land lease. The plan initially drew sharp criticism from both the company and investors, but today’s conference call detailed a revised plan addressing the issues raised.

Pershing Square’s plan was designed to improve Target’s free cash flow and access to capital, increase the retailer’s ROIC and lower its cost of capital, maintain its investment grade rating, increase its EPS growth rate, and minimize tax leakage and friction costs while retaining complete control of its buildings, brand, and flexibility with respect to construction, remodeling and relocation plans. Ackman proposed that this could be accomplished through a spin-off of Target’s owned land into an REIT.

Target expressed concerns over the original plan, including concerns about valuation, the reduction in Target’s financial flexibility, credit ratings, borrowing costs, frictional costs, and management diversion. The revised transaction would address these concerns through a six step process: (1) formation of the REIT, (2) primary IPO of <20% of the REIT shares, (3) sale of remaining 53% interest in Target’s receivables, (4) pay down $9 billion of debt using proceeds, (5) spin-off remaining REIT sharholders, and (6) purge retained earnings and profits.

Pershing Square believes that this plan would immediately boost Target’s standalone value to $31 per share while creating a new REIT that would be worth an estimated $37 per share. Therefore, the combined value of the REIT would be $65 per share with the 12-month value being closer to $79 per share. Clearly, this represents a significant amount of value that could be unlocked for shareholders who are now grappling with a share price hovering around $27 per share.

A turn in the economy would also be good news for Target’s new structure. Improved retail sales would generate explosive earnings growth at Target given recent expense reductions. Meanwhile, heightened inflation expectations would increase demands for the REIT given the inflation-protected income stream. In the end, Pershing Square believes that the revised transaction addresses all of Target’s concerns and achieves enormous value creation.

Investors interested in taking advantage of today’s low prices may want to consider purchasing Target LEAPS. Currently, the $27.50 January 2011 LEAPS are trading for just $12.34 a piece. That means that for just $1,234 down now, you can have the right to purchase 100 shares of TGT at $27.50 per share anytime before Janaury 2011. The breakeven would then be $39.84 per share during the next 793 days. Considering the potential value of this transaction, this may represent a good risk/reward trade.

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