Dayton Hudson unloads Lechmere; Target parent unlikely to use proceeds to purchase Caldor

Discount Store News, August 7, 1989 by Richard C. Halverson

Dayton Hudson Unloads Lechmere

Target Parent Unlikely to Use Proceeds to Purchase Caldor

MINNEAPOLIS -- Dayton Hudson won't use the $350 million or so it will get for selling its Lechmere chain to buy Caldor for a swift expansion of Target into the Northeast.

At least that's how retail analysts view Dayton Hudson's announcement last month that it has reached a definitive agreement to sell the 29-unit Lechmere chain, in a leveraged buyout, to Berkshire Partners, a Boston investment group.

Lechmere management, including chairman and chief executive officer George Scala, will receive an undisclosed equity share of the business. That word came a month after May Department Stores put Caldor and Venture on the block (see DSN, July 17, 1989, page 1).

Following the Lechmere announcement, Salomon Brothers analyst Bruce Missett reiterated in an investment advisory his belief that D-H won't bid for either Caldor or Venture.

Missett estimated that Lechmere will fetch between $300 million and $350 million, or about half of its 1988 sales of $769 million.

Previously, Missett estimated that May would demand about $820 million for Caldor as an ongoing business and $680 million for Venture, for a total of $1.5 billion.

That would make Caldor too costly for D-H to buy as real estate for expanding Target as it did when it bought stores of the defunct Gemco chain in 1986 and the Gold Circle stores last year, analysts said. Gold Circle was split up as a real estate deal, rather than sold as an ongoing business.

The most D-H would be willing to spend for Caldor is $600 million, estimated David Poneman, analyst for Sanford C. Bernstein & Co.

Book Value for Lechmere

Although D-H refuses to disclose the price until the Lechmere deal closes, it will receive no more than book value (about $360 million), Poneman speculated. The sale would result in no material loss or gain for D-H, he said.

That compares with a $35 million loss reserve D-H created when it scrapped its Branden's home furnishings chain this May, selling the 10 stores to Marshalls. D-H launched the chain in Florida and Georgia in 1985.

But the probable wash on Lechmere, which D-H bought in 1969 in a stock-swap valued at $35 million, fares poorly with the $82 million pretax profit D-H made when it sold its B. Dalton Bookseller chain in 1986. D-H founded B. Dalton in 1966.

The decision to sell Lechmere was independent of any decision to buy Caldor, Poneman said, it "was no signal that the acquisition of much or all of Caldor is any likelier than it had been."

D-H recently announced plans to establish a $400 million leveraged employee stock ownership plan, Poneman said. If the House Ways & Means Committee fails in its attempt to kill the tax benefits of such plans, D-H likely would use the Lechmere proceeds for the ESOP, he said.

Lechmere proved to be a poor fit for D-H, Poneman said, resulting in a negative cash flow of $200 million over the past four years.

Even though Lechmere tripled in size under D-H ownership, earnings stagnated.

Lechmere's sales spurted to $769 million in 1988 from $349 million in 1984. But operating profit inched up to $22 million last year from $20 million in 1985. Profits actually dipped from $23 million in 1987.

And after allocating interest expense and corporate overhead, Lechmere probably contributed nothing to net income for D-H, speculated Missett from Salomon Brothers.

Accordingly, any reasonable use of the proceeds from Lechmere's sale would be positive for D-H, Missett said.

In 1989, Lechmere is opening two units of its new 60,000-square-foot prototype, both in a new market, Birmingham, Ala. The first is set to open the end of this month and the second in October. In addition, Lechmere replaced this June its 112,000-square-foot, three-story flagship store in Cambridge, Mass.

Including the two new Alabama stores, 11 units of Lechmere are in new Southeastern markets, including Florida, Atlanta, Greenville, S.C., and Raleigh and Charlotte, N.C.

"It's clear that the Southern stores do worse as a group," Poneman said. Sales productivity proved mediocre once Lechmere moved out of its home territory of New England, he said.

Lechmere, which specializes in major appliances, consumer electronics, sporting goods and other leisure products, is engaged in a tough, low-margin business, Poneman said. Commission sales costs for big-ticket appliances are high, he said.

Ann Barkelew, corporate relations vp for D-H, declined to comment on speculation that D-H might be interested in Caldor. (Analysts dismiss Venture as overlapping Target in the Midwest.) D-H will use the proceeds from Lechmere to expand Target, Mervyn's (its promotional soft goods chain), and its department stores, Barkelew said.

Barkelew said the 4.5 percent return on Lechmere equity in 1988, compared to 11.4 percent at Target, was satisfactory to D-H and not a factor in the sale. D-H scrapped Branden's because it wasn't getting a return on the investment, she said.

Lechmere's operating profit margin also trailed Target: 2.9 percent in 1988, compared to 5.4 percent. At Mervyn's, operating profit as a percentage of sales rose to 7.5 percent last year, while the department stores logged a 9.4 percent operating profit margin.