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Target, the discount retailer nicknamed "Tar-zhay" by affectionate shoppers who regularly peruse its aisles for "cheap chic" designer goodies, may soon have a new bargain to offer: prime real estate at marked-down prices.
Unlike most retailers, Target (TGT, news, msgs) owns virtually all of the land underneath its 1,600 stores. And it's some of the best retail land around, because Target has been careful over the years to buy in areas with the best demographics.
Now, as dismal retail-sales trends weigh heavily on Target's bottom line and haunt its shareholders, many of them want the retailer to carry out a massive land sale of sorts to reap the value of those real-estate holdings.
Mind you, you wouldn't be able to buy parcels and build on them. You would be able to buy shares, and Target would pay you rent.
On paper, the proposal has its merits. Spinning off its land to a separate company with stock that would be given to Target shareholders might bring the following benefits:
- The value of Target's land might get more respect in the market, creating $10 billion to $15 billion in value out of thin air for Target shareholders.
- The restructuring could net huge tax savings, in essence creating an annual half-billion-dollar taxpayer bailout plan for Target.
- The move could significantly increase profits by freeing up more cash for share buybacks.
A shareholder bonanza
All told, the real-estate spinout plan could double the value of Target shares within a year and triple it three or four years. That's the view of William Ackman of Pershing Square Capital Management, who's leading the charge for this change.Ackman is an "activist" investor -- the kind who likes to buy a big stake in a company then use the position to pressure management into applying new tactics that drive up the stock to make him and his investors richer. Ackman's Pershing Square controls about 10% of Target stock.
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If Target stock doubles, he and his investors stand to gain $3 billion.
So far, Target has raised a few objections to the plan but has held back on saying if it will go along. If history is any guide -- Ackman has a record of pressuring Target -- the retailer may agree to some new tactics that draw from the plan and drive up the stock, but won't go along 100%.
That outcome, combined with the sheer cheapness of Target's stock, a well-run company with a solid brand whose business will snap back in a healthy way once the economy recovers, makes Target a buy here. Target stock is down more than 30% from its 52-week high of $61 near the start of the year.
Ackman's plan has all the complexity of a business school final exam. I'll spare you the details and sum up the three main advantages:
No. 1: Get full credit for the value of the land
Right now, the stock market values Target's land the same way shoppers size up one of the retailer's "cheap chic" handbags -- at a big discount.Ackman believes that the market puts a value of just $13 billion on Target's land. He gets that number by first calculating the value of Target's retail business and the stores that it owns. He then subtracts that amount from Target's total market cap, now just under $30 billion. The remainder, $13 billion, must be the value the market assigns to the land.
That looks way too cheap. Judging by transactions on similar real estate, Ackman calculates the replacement value of that land is much higher, around $19 billion.
It could be worth much more to Target shareholders if it were transferred to a Real Estate Investment Trust (REIT) that would be spun off to Target shareholders. A REIT invests in real estate and isn't taxed on its profits, as long as it distributes virtually all of the profits to shareholders.
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Ackman's tip for Target Insight on the benefits of Target creating an inflation-protected real estate investment trust, with William Ackman of Pershing Square Capital Management and Larry Lindsey of the Lindsey Group.
Target's land would be worth more in the REIT because of this tax savings. It would also be valued on the basis of its earnings potential over the next several decades. And related businesses would also be tucked inside that REIT, doing the job of maintaining the land and buying more land each year so that Target could expand.
Ackman estimates the Target REIT could be worth as much as $29 billion. That would work out to about $38 a REIT share if the land is spun off, while the value of Target stock would drop to $32 from recent levels of around $39. After a year, the two companies could trade for a combined value above $80 a share, more than doubling the value for current shareholders.
Target would still own the stores on the land transferred to the REIT. This is unusual, but it makes sense for two reasons. First, retailers like to have complete control over their stores. Second, buildings depreciate in value over time, and Target could take advantage of that for tax purposes. The REIT couldn't, because it doesn't pay taxes to begin with.
Continued: A taxpayer bailout for Target
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