Wednesday, March 29, 2023

In Unique Acquisition Talks w/Kohls

Franchise Group (FRG) is one among my largest positions, naturally I really feel obligated to submit one thing on the headline grabbing information that FRG is the apparent winner of the auction for struggling retailer Kohl’s (KSS).  Kohl’s can be a transformative acquisition, FRG is presently a $2.7B enterprise worth firm and press reviews have them paying $8B for KSS ($60/share).  FRG is presently guiding to $450MM in 2022 EBITDA, TIKR has the consensus KSS estimate at $2.1B.  The mix of FRG being smaller than the goal, little identified exterior of sure worth/event-driven circles and fears of credit score markets tightening appear to have the market doubting this deal will get performed (KSS final traded for $45.75).  However I place confidence in CEO Brian Kahn, FRG entered my portfolio as a special situation when it was then called Liberty Tax, which went a few difficult merger and tender supply transaction that seemed novel and fascinating from an outsider perspective.  Right here is FRG’s most recent investor presentation for what the corporate seems like as we speak, lots has modified, together with FRG promoting the unique Liberty Tax to a SPAC (sponsored by NexPoint).  My thesis within the final two years has principally revolved round “in Kahn we belief”, given the information leaks round credit score suppliers being lined up, it seems this deal is getting performed.  I’ve added some KSS as a small speculative merger arbitrage place alongside FRG.

Taking a number of steps again, in April, news 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 artistic deal maker and certain seems at many acquisition alternatives that do not match Franchise Group’s said technique of “proudly owning and working franchised and franchisable companies”.  My guess is the “franchise” half is extra aspirational than reality, it’s a generic identify and technique, they only search for enticing offers.  Kohl’s actually does not appear to suit the franchise mildew, laborious to think about somebody working a division retailer as a franchise, however the deal does resemble different current 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 furniture retailer W.S. Babcock for $580MM.  Subsequently, FRG went on to promote Babcock’s credit accounts receivables to B Riley (RILY) for $400MM, the retail real estate for $94MM, and the distribution centers and corporate headquarters to Oak Street Real Estate Capital for $173.5MM.  Greater than paying for the acquisition with asset gross sales and nonetheless anticipating to obtain $60MM in proforma LTM EBITDA.  The same 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.

Experiences 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 services actual property (may additionally embrace the retail actual property, so my 6% cap quantity beneath is perhaps too low), and $2B (fuzzy, Seeking Alpha number) from Apollo in non-recourse Kohl’s stage time period mortgage financing, with FRG kicking within the extra $1B by way of an upsized time period mortgage.  Apollo is not the perfect lender, however since they seem to be 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 atmosphere.  It’s an fascinating construction, FRG is utilizing no fairness, financing all of it with debt and can totally personal a levered fairness stub KSS.

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

As at all times, most likely a number 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 in the event you did an EBITDAR valuation, the proforma firm can be extraordinarily low cost.  However I believe it reveals the creativity of Kahn and FRG, they’re making a diversified collection of levered bets by way of non-recourse sale leaseback financing.

Different ideas:

  • Whereas not a “wager the corporate” deal, it’s fairly shut and definitely dangerous.  The market does not like extremely leveraged firms, FRG will doubtless commerce cheaply for some time as they create down the debt and ultimately additional diversify away from Kohl’s with future offers.  Kohl’s is actually a weak enterprise, it’s within the center floor of probably not having an identification, I can not consider something you need to purchase at Kohl’s that you just could not get elsewhere. There’s numerous debt right here, issues might go horribly flawed.
  • There’s some political strain to reject the deal, notably in Kohl’s dwelling state of Wisconsin, doubtless 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 most likely cements Kohl’s as a declining enterprise and which may face political backlash.
  • FRG is closely into dwelling 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 current Goal stock debacle, individuals aren’t shopping for dwelling furnishings anymore now that covid is usually within the rear view mirror.  Cynically, FRG is perhaps doing this deal to distract from points on the core enterprise.  Nevertheless, Brian Kahn has sounded sober by the pandemic relating to stock, provide chain, going ahead expectations, he hasn’t sounded stunned by the slowdown and to this point hasn’t needed to drastically change steerage.
  • Macellum Capital Administration has been partaking in an activist marketing campaign towards Kohl’s, they misplaced their proxy combat just lately, however have been placing important strain on the corporate to promote themselves.  Kohl’s administration believed they have been value $70+, however with the current downturn and disappointing Q1 earnings, bids have are available decrease, so it is perhaps 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 well-liked purchaser for administration as they might hold their jobs.
  • FRG did just lately put a $500MM buyback in place (after it was reported they have been a KSS bidder), issues might 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 doubtless 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 lots throughout that preliminary Liberty Tax/Buddy’s transaction, signed large boy letters with anybody that may promote him shares) and his personal fairness agency, Classic Capital, owns 25+% of the corporate.

Disclosure: I personal shares of FRG and KSS

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