Ackman’s Real Estate Deal is Off-Target

A hedge fund manager who owns just shy of 10% of Target’s shares is asking the nation’s #2 discounter to consider a plan to spin-off its real estate assets into a separate company as a way to boost its sagging stock price. Once high-flying Target has seen its stock sink more than 40%, from about $59 per share last November to a low of $32-and-change on Monday. (It has since recovered a bit to trade at about $40 per share.) Target recently valued its real estate before depreciation at $25 billion, not too far below its current market capitalization of $30 billion.

Spinning off its real estate holdings to form a separate publicly traded real estate investment trust (REIT) would create long-lasting value for the chain, argues activist investor William Ackman who runs the hedge fund Pershing Square Management. Under his plan, the newly formed tax-free spin-off would own the land under Target’s stores, while the retailer would retain ownership of the buildings and rent the ground underneath them back from the REIT.

Target responded on Wednesday by saying that it has “serious concerns” about the proposal. I should hope so! Target execs need only look at Mervyn’s experience with sale-leaseback deals to see the perils these transactions may present. Indeed, Target, which used to own Mervyn’s, is being sued by the going-out-of-business retailer over a similar type of deal.

In a suit filed in September, Mervyn’s alleged that it was the victim of a plot by its private equity owners to strip it of its valuable real estate assets and then lease the properties back to the company at “substantially increased rates.” Mervyn’s claimed that its rent increased dramatically after the sale. The filing goes on to say that by “separating the firm’s real estate assets from its retail operations, its new owners made sure that any residual value or upside in the real estate assets were reserved for themselves and not for Mervyn’s.” Mervyn’s unfortunate experience should serve as a cautionary tale for Target.

Indeed, Target has cited a long list of concerns, including reduced financial flexibility, the large expense obligation created by the proposed lease payments (subject to annual increases!), and potentially negative effects on its debt rating, borrowing costs, and liquidity. Given the volatile state of the retail industry, the tight credit markets, and depressed valuations for commercial real estate these days, which could limit the selling price of Target’s real estate assets, Target has many good reasons to be cautious.

The company has bowed to pressure from Ackman before by selling 47% of its credit card division to JPMorgan Chase for $3.6 billion in May. But Target should balk at this turkey of a proposal.