Bill Ackman, an activist investor from Pershing Square Capital Management, recently disclosed that he now holds a 9.6% stake in trendy retailer Target (NYSE:TGT). Ackman said he thinks the shares are undervalued and intends to engage in constructive talks with management to unlock their value.
Activist investors tend to seek out companies with languishing stock prices. But Target has been a superb company as of late. Over the past 12 months, insiders -- including CEO Bob Ulrich, whom Chief Executive Magazine recently named CEO of the year -- have been selling off blocks of stock as share prices have risen by more than 45%.
So, what is it about Target that Ackman sees as having room for improvement?
Right on Target
For his most recent deal, Ackman created a special entity with $2 billion to invest in Target. His total stake cost $1.98 billion, in the form of $158 million for nearly 2.5 million shares and $1.6 billion for options on 79.2 million more shares. He reported that his firm collectively owns 81.76 million shares of Target, including call options exercisable from last December through April of 2009. Ackman began accumulating his stake in mid-April, and transactions were made at per-share prices ranging from about $58 to $67 per share.
With Target's current stock price at around $69, Ackman is obviously seeing green someplace other than in the company's operations. Perhaps he's considering that with operating margins of nearly 9%, Target easily topples Wal-Mart's (NYSE:WMT) 6%. Or perhaps he's aware that Target services more prosperous middle-class customers than Wal-Mart does. The company has also set standards for its effective marketing and its ability to create affordable fashions.
It makes more sense when you realize that Ackman is widely known for looking beyond improving operating performance at the companies he, well, targets. Pershing Square has a long history of engaging in management-friendly activism in an attempt to unlock shareholder value. In this case, the 13-D filing reveals that Pershing said Target is "headed by the strongest operating management in the retailing industry" and still has "significant growth opportunities."
Let's consider what those growth opportunities might be.
Ringing up the assets
Target has some valuable assets on its balance sheet. For one, it has a credit card business that could be sold off to unlock some value, and Ackman may try to persuade management to consider the possibility. That may not be easy, since Target thinks the credit card portfolio is an integral part of maintaining the company's strong relationship with its customers.
The other valuable asset is real estate. Target operates 1,500 stores across the United States and owns about 85% of them. Most likely, they're located in some of the most desirable locations across the country. Selling off this real estate could generate tons of cash for the company -- cash that it could then use to buy back shares or even pay a special dividend.
In any case, since Ackman was buying shares at around $60 or so, he clearly sees a lot more upside to the stock. And since he has publicly praised Target for its first-rate operational performance, he must see most of the hidden value as residing on the balance sheet and not on the income statement.
Ackman's past endeavors have revealed similar asset plays. A few years back, he began accumulating shares in Wendy's (NYSE:WEN). His efforts resulted in Wendy's spinning off its Tim Hortons (NYSE:THI) chain, and led to a very profitable return for all involved. Before that, he convinced McDonald's (NYSE:MCD) management that they should begin a large share buyback and eventually spin off Chipotle (NYSE:CMG) (NYSE:CMG-B). Since then, McDonald's shares have more than doubled, and Chipotle has been hotter than a habanero pepper.
You can catch more flies with honey ...
I think Ackman's reputation for friendly activism has been a tremendous competitive advantage for Pershing Square. His reputation enables him to easily approach company executives and get their attention. He tends to unlock value without disrupting the lives of the people involved.
In an unusual move, but certainly a move characteristic of his goodwill, Ackman has said Pershing Square would donate a third of any after-tax profits resulting from its investment in Target to its charitable foundation, which helps fund inner-city development and human-rights work.
I remember Warren Buffett telling me that he will work only with people he likes. That's an easy thing to say, but it's not so easy when you get focused on making money. The funny thing is, Buffett's mantra has made him lots of money. It appears to be working for Ackman as well, and it may even benefit Target shareholders.
For more on the bull's-eye retailer, check out:
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Fool contributor Sham Gad runs the newly launched Gad Partner's Fund, a value centric investment partnership based on the philosophies of Graham, Buffett, and Pabrai. He has no positions in the companies above. The Fool has a friendly disclosure policy.
