Target strikes back

MMR, May 18, 2009 by David Pinto

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MINNEAPOLIS -- On the eve of Target Corp.'s May 28 annual meeting, it is becoming increasingly apparent that William Ackman, the activist investor who is challenging several of the retailer's policies and positions, is tilting at windmills. The reality appears to be that Target, despite a subpar performance of late, one closely tied to the current economic environment, is on as solid a footing as at any time in its 47-year history.

"We truly believe that Target today is a vibrant, dynamic, forward-looking retailer, one that offers long-term shareholder value," says Gregg Steinhafel, the company's chairman, president and chief executive officer. "As we've always been, we're consistently innovative today in terms of our stores, our brand and the quality of the shopping experience we offer. We believe our demographics are perfectly positioned between Wal-Mart and Costco, and that our guests view shopping at Target as more than looking for the lowest possible price."

Ackman, whose Pershing Square Capital Management hedge fund is Target's third-largest shareholder with an approximate 3.3% stake in shares and 4.5% in options, is attempting to replace four Target board members up for reelection with a five-man slate of his own choosing (including himself), proposing the fifth candidate as a replacement for Bob Ulrich, who retired from the board earlier this year and has not been replaced.

The competition for board seats has emerged as the key point in Ackman's campaign to "bring insight, accountability and fresh and relevant perspectives to the Target board," as he put it in a recent statement.

Additionally, Ackman has complained that Target's food presence is not as compelling as that of some of its competitors, that the retailer might consider placing its land holdings in a Treasury inflation-protected real estate investment trust (TIP REIT) that would lease back the properties to the retailer, and that the company should monetize its credit card portfolio.

Steinhafel rejects Ackman's view of the retailer's food business. "Our food presence is stronger today than it has ever been," says Target's CEO. "Anyone who doesn't understand that isn't paying attention.

"We've been operating Super-Targets for 15 years, so we've learned our way around food. We've consistently expanded our food footprint. And our 'perishables' concept stores, which we began opening last fall and intend to roll out with our July and October store cycles, will, we believe, make Target a destination store for grocery shopping. Specifically, 90% of the grocery categories are now represented in our mix. Viewed another way, 15% of our mix is devoted to food."

In a recent research note, Citigroup analyst Deborah Weinswig finds reason for optimism on that front.

"Initial results from the company's P-Fresh pilot have been positive, and expansion of the concept could drive meaningful same-store sales improvement beginning in 2010.... Management has been very pleased with the improvement in sales performance thus far and noted that higher frequency has resulted in increased sales across the store. If successful, we believe P-Fresh could be rolled out to 1,000 of the company's discount stores."

Target has similarly rejected Ackman's sale and leaseback suggestion. "We view our real estate as an important asset," says Steinhafel. "Besides, the sale/ leaseback concept is not new. It has been around for 30 years. Simply put, we believe that this idea is detrimental to the health of our company."

Bill Dreher, an analyst with Deutsche Bank Securities Inc., sees risk to Target in Ackman's proposal. In a recent research note, he pointed out that if Target executes the TIP REIT strategy, credit rating agencies might well respond with ratings downgrades (possibly to sub-investment-grade), which would be a serious concern in the current economic environment. Additionally, the retailer would burden itself with a $1.4 billion annual lease obligation while reducing its asset base and its financial flexibility.

Target did respond to Ackman's proposal that the company divest itself of its credit card portfolio last year, when it sold 47% of its credit card business to JPMorgan Chase & Co.

"We're test-driving our relationship with JPMorgan Chase," says Steinhafel. "Thus far, it has been a fabulous relationship. And we're committed to selling the balance of our credit card business, given the right macroeconomic environment and the right economic proposition for us and our partner."

All of which brings the matter back to board representation. Ackman believes that his slate of candidates has more food knowledge and experience, specifically stating that "despite the fact that Target's two principal business lines are retail and credit cards, Target currently has no independent directors with senior, executive-level experience in these two businesses."

More specifically, he points to Jim Donald, the former Pathmark and Starbucks CEO who is one of his nominees, as an executive with extensive experience in food retailing. Steinhafel counters that three of Target's current board members--Mary Dillon, global chief marketing officer for McDonald's Corp.; Stephen Sanger, retired chairman of General Mills Inc.; and Lion Capital LLP partner Mary Minnick--provide at least as much food experience as does Donald.