Tuesday, February 7, 2023
HomeValue InvestingIn Unique Acquisition Talks w/Kohls

In Unique Acquisition Talks w/Kohls

Franchise Group (FRG) is considered one of my largest positions, naturally I really feel obligated to submit one thing on the headline grabbing information that FRG is the obvious winner of the public sale for struggling retailer Kohl’s (KSS).  Kohl’s could be a transformative acquisition, FRG is at the moment a $2.7B enterprise worth firm and press studies have them paying $8B for KSS ($60/share).  FRG is at the moment guiding to $450MM in 2022 EBITDA, TIKR has the consensus KSS estimate at $2.1B.  The mixture of FRG being smaller than the goal, little recognized exterior of sure worth/event-driven circles and fears of credit score markets tightening appear to have the market doubting this deal will get finished (KSS final traded for $45.75).  However I place confidence in CEO Brian Kahn, FRG entered my portfolio as a particular scenario when it was then known as Liberty Tax, which went a few sophisticated merger and tender provide transaction that regarded novel and attention-grabbing from an outsider perspective.  Right here is FRG’s most latest investor presentation for what the corporate appears like immediately, quite a bit has modified, together with FRG promoting the unique Liberty Tax to a SPAC (sponsored by NexPoint).  My thesis within the final two years has largely revolved round “in Kahn we belief”, given the information leaks round credit score suppliers being lined up, it seems this deal is getting finished.  I’ve added some KSS as a small speculative merger arbitrage place alongside FRG.

Taking a couple of steps again, in April, information broke from Reuters that FRG was becoming a member of the bidding for struggling retailer Kohl’s (KSS), I used to be a bit stunned however not totally, Kahn is a inventive deal maker and sure appears at many acquisition alternatives that do not match Franchise Group’s acknowledged technique of “proudly owning and working franchised and franchisable companies”.  My guess is the “franchise” half is extra aspirational than fact, it’s a generic title and technique, they simply search for engaging offers.  Kohl’s definitely would not appear to suit the franchise mildew, exhausting to think about somebody working a division retailer as a franchise, however the deal does resemble different latest FRG acquisitions because the non-core property may very well be used to finance the transaction.

Final November, FRG entered right into a transaction to purchase southeastern furnishings retailer W.S. Babcock for $580MM.  Subsequently, FRG went on to promote Babcock’s credit score accounts receivables to B Riley (RILY) for $400MM, the retail actual property for $94MM, and the distribution facilities and company headquarters to Oak Road Actual Property Capital for $173.5MM.  Greater than paying for the acquisition with asset gross sales and nonetheless anticipating to obtain $60MM in proforma LTM EBITDA.  An identical transaction appears to be in retailer for Kohl’s, the division retailer chain owns their company headquarters, virtually all of their distribution and e-fulfillment facilities, and personal 410 of their retail shops outright and one other 238 of them owned however on floor leases.

Reviews have FRG re-teaming up with Oak Road Actual Property Capital (a part of Blue Owl’s platform) to offer $6B in financing based mostly on the company headquarters and distribution amenities actual property (may additionally embody the retail actual property, so my 6% cap quantity beneath is likely to be too low), and $2B (fuzzy, Searching for Alpha quantity) from Apollo in non-recourse Kohl’s degree time period mortgage financing, with FRG kicking within the extra $1B through an upsized time period mortgage.  Apollo is not the best lender, however since they are a direct lender and are not counting on syndicating the mortgage instantly like a big regulated financial institution, the financing appears safer within the present unsure surroundings.  It’s an attention-grabbing construction, FRG is utilizing no fairness, financing all of it with debt and can absolutely personal a levered fairness stub KSS.

Placing collectively a fast again of the envelope proforma, I give you the beneath:

As at all times, in all probability a couple of errors above, be happy to level them out, and clearly, that is all excluding the capitalized leases which is actual leverage even whether it is non-recourse, however even should you did an EBITDAR valuation, the proforma firm could be extraordinarily low cost.  However I feel it reveals the creativity of Kahn and FRG, they’re making a diversified sequence of levered bets through non-recourse sale leaseback financing.

Different ideas:

  • Whereas not a “wager the corporate” deal, it’s fairly shut and definitely dangerous.  The market would not like extremely leveraged corporations, FRG will probably commerce cheaply for some time as they bring about down the debt and ultimately additional diversify away from Kohl’s with future offers.  Kohl’s is definitely a weak enterprise, it’s within the center floor of not likely having an id, I can not consider something you will need to purchase at Kohl’s that you simply could not get elsewhere. There’s numerous debt right here, issues may go horribly unsuitable.
  • There’s some political strain to reject the deal, significantly in Kohl’s house state of Wisconsin, probably if FRG acquires KSS, long run this can be a sluggish movement liquidation.  FRG typically companions with B Riley, the 2 are intertwined some, B Riley has a retail liquidation enterprise and sometimes invests in these distressed retailers.  Promoting to FRG in all probability cements Kohl’s as a declining enterprise and which may face political backlash.
  • FRG is closely into house furnishings (beforehand talked about Babcock, in addition they personal American Freight which sells clearance home equipment and Buddy’s, a rent-to-own retailer), based mostly on the latest Goal stock debacle, folks aren’t shopping for house furnishings anymore now that covid is generally within the rear view mirror.  Cynically, FRG is likely to be doing this deal to distract from points on the core enterprise.  Nevertheless, Brian Kahn has sounded sober via the pandemic relating to stock, provide chain, going ahead expectations, he hasn’t sounded stunned by the slowdown and to date hasn’t needed to drastically change steerage.
  • Macellum Capital Administration has been participating in an activist marketing campaign in opposition to Kohl’s, they misplaced their proxy struggle not too long ago, however have been placing important strain on the corporate to promote themselves.  Kohl’s administration believed they have been value $70+, however with the latest downturn and disappointing Q1 earnings, bids have are available decrease, so it is likely to be an opportunistic time for FRG to swoop in and be the white knight.  FRG additionally runs a decentralized administration construction, so it may very well be seen as a most popular purchaser for administration as they might maintain their jobs.
  • FRG did not too long ago put a $500MM buyback in place (after it was reported they have been a KSS bidder), issues may get fairly wild in the event that they use the KSS money flows to buyback shares versus paydown debt given their Debt/EBITDA ratio would probably stay inside there goal vary instantly upon closing of the transaction.
  • Brian Kahn has by no means been shy about shopping for shares within the open market (did quite a bit throughout that preliminary Liberty Tax/Buddy’s transaction, signed massive boy letters with anybody that may promote him shares) and his non-public fairness agency, Classic Capital, owns 25+% of the corporate.

Disclosure: I personal shares of FRG and KSS



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