The Kohl’s Saga Continues – TheOASG

Kohl’s has told its customers for years that “the more you know, the more you Kohl’s” and to “expect great things”. But do either of those apply when they’ve found themselves in a less-than-enviable financial position?

Franchise Group Enters the Scene

I wrote about Kohl’s at the end of May, talking about how sales and the stock price have been on the decline. Some activist investors have been pushing for Kohl’s to sell itself while the company has been resistant to putting itself up for sale. But Kohl’s decided to at least entertain some offers, and the private equity firms behind JCPenney and Hudson’s Bay were among those interested.

On June 6th, Kohl’s announced they were going to talk with one potential buyer exclusively for the next three weeks: Franchise Group.

Franchise Group

According to its website, “Franchise Group, Inc. was established to build a world-class franchising platform for an diverse collection of market-leading and emerging brands.” Franchise Group’s companies include The Vitamin Shoppe, Pet Supplies Plus, and Sylvan Learning. The company was looking to buy Kohl’s for $60 a share. The day the news broke, Kohl’s stock price rose to about $45.50 a share. In the weeks prior, Kohl’s was near its low for the past year.

However, while Franchise Group’s bid was above the current stock price, Kohl’s had previously assumed offers around the $64-65 mark too low, and they may have also turned down offers around $70 a share earlier as well. Thus, Kohl’s initiated the “poison-pill” to prevent a takeover to force a sale.

But it seems the competition dropped out or submitted lower offers after Kohl’s bad first quarter results, and so even though Kohl’s could have had more earlier in the year, Franchise Group was the winner.

A Mismatch?

However, the news was met with skepticism from many analysts.

Franchise Group, as it name suggests, focuses more on franchise businesses — ie collecting royalties from business owners who want to open their own location rather than opening and running stores themselves. Franchise Group does have brands dealing in fields like appliances and home decorations, but they do not have a department store or fashion business.

But it wasn’t just the companies operated differently or didn’t have perfectly comparable merchandise. Franchise Group’s entire portfolio is valued around $1.6 billion. Their bid for Kohl’s would put its worth around $8 billion. Franchise Group’s volume is around $3 billion; Kohl’s is about $19. No matter how you calculate it, Franchise Group would be buying a much larger company.

To finance the deal, Franchise Group reportedly turned to a global alternative asset management firm instead of a traditional bank to the tune of $2 billion; While Franchise Group would contribute about $1 billion, the rest would be covered by selling Kohl’s real estate which then they would rent.

Due to the current market with high inflation, one source told The New York Post Apollo Management Firm was “either being advantageous or pretty stupid”. But Kohl’s real estate was valued earlier in the year at around $8 billion, so as one analyst noted, “If Franchise Group can get the $7 billion or $8 billion out of the real estate, they’re only paying about $1 billion for the assets . So it’s pretty cheap.”

Kohl's Logo

But while Kohl’s stock continued to hover around the $40-42 mark and with analysts having reservations about the deal, according to The New York PostFranchise Group’s CEO did not intend to lower his bid.

Reuters later revealed Franchise Group were also in discussions to have Kohl’s keep their current executives, including the CEO. Around the same time, reports emerged that Franchise Group was indeed planning to drop its offer to around $50 a share.

The End of Talks

While the three week window ended on June 24th, neither company provided any update. But Kohl’s did a week later: Franchise Group would not be buying Kohl’s, and, in fact, Kohl’s would no longer be up for sale.

However, Kohl’s is looking to sell off some of real estate. They did so on a small scale during the pandemic, but they are reversing their stance on saying no to a bigger sale.

Selling its property gives a company like Kohl’s cash upfront, but they are also forced to honor leases which may last for years and are subject to volatility.

There have been reports from the start that Kohl’s didn’t really want to sell itself, so the fact Kohl’s isn’t being purchased won’t come as a surprise to many individuals.

Perhaps it is even less surprising considering who the most interested buyer was. Sure, Franchise Group could have some synergy with Kohl’s with, say, somehow allowing shoppers at its furniture stores be able to order new bedding at Kohl’s to go with their new mattress. But how often do you hear about a company buying a much larger one? Even if you argue Kohl’s could open small specialty vitamin or pet sections in their current stores a la Sephora, Franchise Group’s core business model does not match with Kohl’s, as they are not franchised.

Kohl’s stock price has plummeted, selling for under $29 a share. These numbers haven’t been seen since it was even lower in 2020 due to the pandemic, and before that, in 2008 during the Great Recession. Kohl’s probably won’t go down to the sub-$15 price it had back in April 2020, but just think: this April Kohl’s was trading for around $60. So it has a 50% drop in about three months.

Kohl's stock price July 2022
From Google

The real intrigue is what activists like Engine Capital and Macellum Capital are thinking right now. They must be pretty angry that Kohl’s stock is cratering when they have been arguing Kohl’s has been on the wrong track for months. Perhaps they are content with Kohl’s selling off its real estate, but I wouldn’t be surprised if they once again try to find ways to pressure the chain even further.

Speaking of the selling real estate, while this may essentially cut out the middle man from what Franchise Group wanted to do, leasebacks are still risky. According to CNBC, “Kohl’s said in its annual filing that a typical store lease has an initial term of 20 to 25 years, with four to eight five-year renewal options.” They also cited how this same sort of deal gave Big Lots the money needed to navigate the pandemic, but on the other hand, Bed Bath & Beyond is in a bleak financial situation and just recently fired its CEO despite also selling its real estate in 2020 Like Big Lots.

So while Kohl’s potentially could get billions by selling its properties and then paying rent to the new owners, that money is a one-time infusion. And paying whatever the negotiated rent payment for 20, perhaps even 25 more years may be higher than what they would have paid as a mortgage, and they can’t easily alter or abandon the property.

Kohl’s also has to use that money to invest in its company, and management has to agree on how to alter the course the chain is on. Should they improve their online division or sell it as well? More electronics or less? Change their discount strategy? Franchise Group wasn’t interested in replacing the executives, but as Reuters stated, “Franchise Groups have signaled confidence in Gass and members of her management team, the sources said, noting that Franchise Group is known to buy businesses that have operating teams in place and does not specialize in bringing in new management teams.”

But we know some investors certainly don’t have that sort of confidence in Kohl’s leadership and have been jumping to put new members on the board.

So while Kohl’s isn’t selling itself — for better or for worse — this is far from the end of its saga. Kohl’s is still at a crossroads, and while I don’t think leasebacks are the answer, that cash won’t do any good without finding ways to woo customers back.

Are you a Kohl’s shopper? Do you think they should have sold itself? If Kohl’s gets some cash from selling its real estate, what should they do with it?

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