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Target: Piggybacking on Someone Else's Idea

Bill Ackman, of Pershing Capital,  thought that Target was worth at least $60 a share, having bought some stock around there. He had a reason, although one that we don't necessarily agree with. We weren't about to pay anything like $60 a share for Target, but "knowing" it was worth at least $40, we were pleased to buy  it at $27 after last year's fall.

Ackman noted correctly that Target owned, rather than leased, most of its stores. Therefore, the company could profitably break up into a REIT to manage the properties, and a retailer to occupy them. By having the retailer pay the normal rent to the REIT, Target could transfer the bulk of its operating income to an entity (the REIT) that would pay no corporate taxes. The resulting tax savings could bring up the combined value of Target's components to about $60 a share. Without those tax savings, low $40s, was a more likely valuation. Since management didn't want to break apart the company this way, that was probably the operative metric.

Ackman was more to the point with his observation that Target should sell its credit card receivables as they were written. Most lenders, Target included, are "suckers" for credit card debt. Therefore, Target should sell their such receivables to "greater fools" such as Citigroup or JP Morgan Chase. (The latter two sentences are our observations, not necessarily Ackman's.)

Yes, it's true that Pershing has the larger portion of its holdings in call options, otherwise known as derivatives. That's not a good thing. But so does management, with the important difference that  Pershing had to pay  for its options, while management got theirs free. So management ought to have interests aligned with Pershing's. In the early 1980s, Gulf Oil executives laughed all the way to the bank even as they protested the takeover bid of smaller Mesa Petroleum (which ultimately led to a takeover by Chevron).

We supported Ackman, after some deliberation. Management does have a team of highly capable operating executives. But it appears to us that these same people lack the strategic vision of Ackman's team, which is the reverse; all strategy, less operating skill. But in today's environment, the key issues are strategic, not tactical, which is why we now support Ackman.

Long Target