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No. 2: Create a taxpayer bailout for Target
Next, the restructuring provides a big tax bailout of sorts for Target. It would do this by converting taxes paid to the government into dividends paid to shareholders.Here's how this would work. Target would have to pay about $1.4 billion a year in rent to the REIT for the land. But Target could deduct the cost of rent from taxes and save around 38%, or $538 million a year. (This isn't a special tax break by the way; home businesses can do it, too.)
That would reduce Target's tax bill by nearly a third. It set aside $1.85 billion for taxes last year.
As for the other $868 million in rent that Target would not otherwise be paying, much of that money would find its way right back to shareholders. First, it would go to the REIT. The REIT would then distribute most of it back to shareholders -- without paying any tax on it -- in the form of an annual dividend of $1.85 per REIT share.
REIT shareholders would pay tax -- probably around 35% -- but they would still come out ahead, given how much they get plus the value of the tax deduction of the rent to Target.
No. 3: Increase earnings growth
Ackman proposes several related cost savings inside Target. He would have Target use the money to buy back more stock, boosting earnings per share.- First, presumably because Target shareholders who kept the REIT would be getting such a big dividend, Ackman would have Target slash its own dividend to a penny a share from 60 cents a share.
- Next, Target would save money because it wouldn't have to fund loans of over $1 billion a year to buy land to expand. The REIT would take care of this.
- Finally, Ackman also wants Target to sell its credit card operation to pay down debt and reduce interest expenses.
With all the savings, Target could step up its share buyback program enough to increase annual earnings growth over the next five years to 17.6% from 14.7%. That would make Target the fastest-growing retailer among its peers.
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On target?
Will Target go for all of this?Judging by recent trends, it sure looks like the retailer needs to do something. Even before the economic storm hit, Target's growth was slowing considerably.
Sales at stores open more than a year grew by just 3% last year, compared with 4.8% in 2006 and 5.6% in 2005. For the last three quarters, sales growth at stores open more than a year has hovered around zero, putting Target in the middle of the pack for retailers.
But as good as Ackman's restructuring plan sounds, it may be too much to swallow -- especially for new Target chief Gregg Steinhafel. On the job for just six months, Steinhafel is still fresh enough to have his own agenda. I doubt he wants to give up his own plan so early, especially to an outsider who happens to own a lot of stock.
Steinhafel's plan is to use more technology, tweak pricing, sell more food and make some strategic acquisitions -- all to improve the "Tar-zhay" experience and bring in more shoppers. He hasn't been shy about pointing out that a key part of his strategy involves maintaining Target's solid credit ratings, which would take a hit under Ackman's plan.
So Target's initial cool response to Ackman's plan, unveiled in public last week, is no surprise. "We have concerns, but we are still considering and evaluating it," a Target spokeswoman said.
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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.
In the end, however, even if Target rejects Ackman's plan, the activist will likely "keep pushing until he gets management to do something to boost the stock," says Wachovia Capital Markets analyst Shannon Joseph. "Historically Bill Ackman has been able to achieve some sort of watered-down version of his proposals to Target."
A year ago, he pushed the retailer to launch a $10 billion share buyback program, which Target is now halfway through. Target also sold half of its credit card business to JPMorgan Chase (JPM, news, msgs) last May, as a result of pressure from Ackman to unload that business.
"Target could potentially come back to Pershing Square with some sort of appeasing proposal," predicts Joseph. Even if it's not the full monty, it's likely to be good for Target shareholders.
At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.
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