November 1, 2008

Acman's value idea:Target Spin-off

One of Target (TGT) largest shareholders, Ackman, the hedge fund manager of Pershing Capital, have proposed a transaction to unlock value in TGT. You can view his presentation here. I have to say that I always enjoy Ackman's work; it is always detailed and a learning experience.

I have to say that the transaction does not make much sense to me. It is a lot of financial engineering that, most likely, will not create any value to shareholders.

The core of the transaction is to spin-off of the land that TGT's stores are build on, TGT keeps owning the buildings, into a REIT that will charge TGT rent and perform building maintenance and development of new stores. The REIT pays dividends to shareholder and because it is a REIT it does not pay any taxes. According to Ackman TGT will be $70 after the transaction and $83 in a year, somehow. What the transaction boils down to is : tax. That is it. The new structure eliminate some taxes, actually, redistribute it to you , the shareholder.

My problem with this is creating value by tax redistribution only is tax policies are outside management control. Tax policies can change therefore relying on a tax policy to create value can disappear very quickly. Management can create better sustainable value by using some of the levers it can actually control: revenue, expenses and cost of capital. The transaction is a lot of ado about nothing in my opinion.

A company value is the perpetual discounted present value of its free cash flow. Then, there are two way to create value for shareholders.
  1. increase free cash flows, and that can come from two things:
    1. increase revenues
    2. increase operational efficiencies or decrease operating expenses and capex.
  2. decrease the discount rate or the cost of capital, a company can accomplish this by:
    1. decreasing borrowing costs,
    2. optimize the company's capital structure.
None of Ackman financial wizardry do any of the above. TGT is an excellent retailer with good management but I do not think the transaction adds much to the pie.

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