The stated facts aren't wrong, to be fair. Shares of department store chain Kohl's (KSS +1.36%) have mostly underperformed their rivals' stocks of late. And the strangely low earnings multiple suggests investors aren't stoked about its apparent future.
On the flip side, simply selling real estate or spinning off a seemingly successful e-commerce business is a short-term, short-sighted means of "unlocking value." That's why Kohl's isn't on board with either idea, according to Tuesday's official response to recent criticisms of the retailer.
Image source: Kohl's.
Activist investors attack!
On the off chance you're reading this and aren't familiar, here's the quick and dirty catch-up: Activist investors are targeting Kohl's.
Engine Capital LP took interest last year, penning in a public letter delivered in December that "a stand-alone Kohl's e-commerce business could be conservatively valued at $12.4 billion or more," versus the entire company's current market cap of only $7.1 billion. Macellum Advisors GP, LLC said its piece on Tuesday, echoing another sentiment voiced by Engine Capital by explaining "a properly optimized balance sheet (e.g., by monetizing $4 billion of its real estate and returning the proceeds to shareholders through a buyback program) could translate to at least $100 per share." Engine's suggested per-share value was a more modest "at least $75," though both figures -- numbers that might be seen if the department store chain were to open itself up to acquisitions -- are still well above the stock's present price near $50.
It almost goes without saying both funds were highly critical of Kohl's current management team as well; "leadership's failure to create value" and "another year materially mismanaging the business" are phrases that were also used in the effort ultimately meant to spur change.
Given Macellum's and Engine Capital's messaging, it would be easy to support their plans to monetize Kohl's $7.3 billion real estate and equipment portfolio, and/or spin off the e-commerce operation that Engine estimates accounts for around a third of its annual revenue on the order of $20 billion, and/or put itself up for sale.
That argument, however, dramatically simplifies the rather complicated situation Kohl's, as well as all other retailers, find themselves in.
Two truths stand out among several.
1. Easy and fast comes at a steep price
First (though not foremost), selling the $4 billion worth of owned real estate suggested by Macellum to fund a stock-buyback program isn't a cost-free deal.
Just like any individual that avoids paying rent on a place to live by virtue of homeownership, Kohl's isn't fiscally burdened by lease payments made on stores and supporting properties. If it were to sell this real estate to a real estate investment trust (REIT), it would then become a tenant, paying market rates.
Although its exact lease payments are impossible to predict before such a sale, the so-called 1% rule of the real estate business implies selling $4 billion worth of property would incur nearly half of $1 billion in new annual rent obligations.
For perspective, Kohl's earned operating income was $769 million in pre-COVID 2019, down from 2018's non-GAAP income of $927 million. At the very least, a long-term cost analysis of any such deal-making would need to be considered.
As for spinning off its e-commerce operation, this idea is also problematic in that it sets the stage for a likely conflict of interest. Kohl's online and in-store operations are tightly entwined, with each supporting the other. While the retail chain is working toward moving more of its order fulfillment out of stores and into dedicated warehouses, stores themselves are still doing much of this work.
Then again, the company doesn't entirely mind its stores occasionally assuming this role, promoting a buy online/pickup in store (BOPIS) option to shoppers who want something sooner than tomorrow. Its brick-and-mortar locations can also accept returns of any item purchases at Kohls.com, giving the company a chance to save a sale, if not upsell or expand the total ticket size. It's in the retailer's best interest to meet its customers where and how they shop, wherever and however they shop.
If Kohl's stores are forced to compete with Kohls.com, it ultimately leads to a less-than-great experience for both venues' customers.
Image source: Kohl's.
2. Skip the gimmicks and think bigger picture
Don't misread the message: Macellum Advisors and Engine Capital both have valid points, particularly as it pertains to the stock's poor performance. Investors haven't shown the sort of enthusiasm for Kohl's prospects that they have for its peers and competitors. As Engine put it, this weakness reflects "investors' lack of confidence in the management team."
The problem is, their proposed ideas are all short-term fixes that spur longer-term problems. And even then, there's no assurance any additional value will be created by putting them in place. The prospects of an e-commerce spinoff, a sale of real estate, or an outright sale of the entire company has been on the market's radar for some time now.
But not even the idea of it appears to have nudged the stock price. Moreover, if Kohl's e-commerce operation was truly worth $12 billion and a suitor could have bought it -- and Kohl's real estate, and Kohl's brick-and-mortar operations -- for half that price, it would have happened already. Activist investors don't have access to any information prospective buyers don't.
Rather, the smart long-term move for Kohl's here is the one it's making: continuing to do what it's doing as it stands right now, with all of its real estate as well as its e-commerce business that supports and is supported by its stores. They're all parts of a much bigger strategic mission that, if you look for it, is showing progress.
Kohl's next Investor Day is March 7. Look for more insights about this overhaul then.
