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What Kohl’s Means to The Franchise Group

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The Franchise Group believes having a diversified portfolio has served it well — and has been aggressive in its growth strategy.

Two years ago, TFG — the parent company of The Vitamin Shoppe — bought FFO Home, a regional retailer of furniture, appliances and mattresses, and proceeded to rebrand it to American Freight. Three years ago, The Vitamin Shoppe was acquired. Franchise Group’s other businesses include Pet Supplies Plus, Badcock Home Furniture & More, Buddy’s Home Furnishings and the Sylvan Learning Centers.

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Now the Virginia Beach, Va.-based, publicly held retailer is pursuing an acquisition of Kohl’s Corp. Considering Kohl’s is a department store without any franchising, a deal would certainly bring TFG’s portfolio to a new level of diversification. On a combined basis, TFG operates more than 3,000 store locations mostly in the U.S., and predominately franchised or under dealer agreements, though there are also company-run stores.

Late Monday, Kohl’s and TFG said they entered into a three-week exclusive negotiation period to enable TFG to acquire Kohl’s Corp. for $60 per share in cash, valuing Kohl’s at close to $8 billion.

It’s like David taking on Goliath, considering The Franchise Group’s annual volume of $3.26 billion, and Kohl’s at $19.4 billion. Yet, there have been cases where smaller retail companies purchased larger ones. Le Tote filed for bankruptcy subsequent to purchasing Lord & Taylor.

There’s also a question of financing — whether a deal with TFG would leave Kohl’s stuck servicing a big debt load. Remember what happened with the Neiman Marcus Group — it was saddled with some $300 million to $400 million in annual interest payments to service debt stemming from its acquisition. That, along with the pandemic, ultimately drove the luxury retailer into bankruptcy.

If the Kohl’s-Franchise Group talks lead to a definitive agreement, TFG intends to contribute approximately $1 billion of capital to the transaction, all of which is expected to be funded through a corresponding increase in the size of its secured debt facilities. The Wall Street Journal has reported that Oak Street Real Estate Capital is reportedly working with Franchise Group on the financing.

Activist shareholders, in particular Macellum Advisors, have valued Kohl’s real estate at about $8 billion. Macellum has pressured Kohl’s to sell some of its real estate and lease it back, to raise shareholder value, but Kohl’s rejected that idea.

In a conference call earlier this year, TFG’s president and chief executive officer Brian R. Kahn responded to a question regarding the potential acquisition of Kohl’s.

“I can’t tell you what we’re going to do in the future. But I can tell you, I think a lot about our philosophy when it comes to M&A and things that we look at from time to time,” Kahn said. “So first, we’ve got a lot of conviction in the brands that we operate now. And so we very strongly believe that these brands that we operate will give us significant organic growth over time and also generate enough free cash flow to support a healthy and growing dividend and also additional free cash flow that we can reinvest both internally and externally in M&A. And we don’t have any interest in putting that at risk for any transaction…we’re not going to mortgage the farm to do any one transaction.…We look at everything that’s available. And some things make sense, some things don’t make sense.

“Any transaction of size certainly would need to be significantly accretive to FRG earnings per share and cash flow per share. And I think you can also imagine, as wonderful as our lenders are, we do have capacity constraints regarding capital and large transactions would certainly have to be just over-the-top positive for FRG. In my personal opinion to tie us up, money doesn’t grow on trees,” he said.

“Management for us is always the key. I think you heard me talk about management a little bit ago of the businesses we have. We have really investable management teams at Franchise Group…whether we do very small transactions or very large transactions, management is always going to be a key to what we’re looking for.”

TFG indicated in its Monday statement that it remains committed to conservative financial policies, including target leverage levels, and maximizing free cash flow generation. “If a transaction is completed, it is anticipated that the free cash flow, adjusted EBITDA and non-GAAP EPS of Franchise Group would significantly increase,” the company indicated. “The significant increase in free cash flow generation is expected to further Franchise Group’s objective of increasing dividends and other capital return to shareholders, while also enabling Franchise Group to accelerate continued organic and inorganic investments.”

Both Kohl’s and TFG made it clear that a transaction is not assured. Other parties, including private equity firm Sycamore Partners, have made offers to buy Kohl’s.

“I don’t think Kohl’s and The Franchise Group is a good fit. The Franchise Group doesn’t know anything about the fashion business, even the banks are going to question it,” said Walter Loeb, the veteran retail analyst.

“The fit would be better with Sycamore,” observed Craig Johnson, president of Customer Growth Partners. “They have experience acquiring a bunch of troubled brands, such as Talbots, and also they bought Belk, which is still a good department store. Sycamore has experience in retail and specifically department store retail. We think they have a better chance of creating value out of the acquisition.”

“The three-week exclusive will come rapidly to an end and I wouldn’t be surprised if Sycamore or a third party comes back with another offer,” Johnson suggested. “If you are a Kohl’s shareholder you want to get as much as you can for your shares.”

“It’s a head scratcher,” added Allan Ellinger, founder and senior managing partner of MMG Advisors. “This is a franchise operator. What does it know about department stores, and how would they finance a deal? I don’t understand what their strategy is. This would be a really big gulp for them. If you are going to change your strategy and diverge from your core competencies, make it a smaller gulp.”

Retail analysts agree that Kohl’s has needed fixing for some time and has been doing a lot to elevate its game, such as bringing in Sephora as well as a host of national brands focused on active and casual offerings. But the changes need time to kick in and so far, Kohl’s has not been showing signs of improvement. Instead, the Menomonee Falls, Wisc.-based retailer has been underperforming its peers in the retail industry. And some shareholders have been getting impatient.

“Kohl’s has not had the bounce back seen at other department stores,” Johnson said. “Macy’s and Nordstrom have done a better job of matching capacity with demand,” through significant numbers of store closings.

“My suspicion is the acquiring party, whether it’s The Franchise Group, Sycamore or some other firm would take a hard look at bringing the number of Kohl’s stores down,” from the current fleet of about 1,100. “But you don’t want to cut too deeply. One advantage Kohl’s has are its locations. They’re closer to where people live and work,” Johnson said.

“I would say a deal isn’t absolutely necessary but something has to be done to improve the performance at Kohl’s.”