The Franchise Group believes that having a diverse 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 renamed it American Freight. Three years ago, The Vitamin Shoppe was acquired. Other Franchise Group businesses include Pet Supplies Plus, Badcock Home Furniture & More, Buddy’s Home Furnishings and Sylvan Learning Centers.
Now, the publicly owned retailer based in Virginia Beach, Va., is pursuing the acquisition of Kohl’s Corp. Considering that Kohl’s is a department store without any franchises, a deal would certainly take TFG’s portfolio to a new level of diversification. On a combined basis, TFG operates over 3,000 stores, primarily in the United States, and mostly franchised or under concessionary agreements, although there are also company-operated stores.
Late Monday, Kohl’s and TFG announced that it had entered into a three-week exclusive negotiation period for TFG to acquire Kohl’s Corp. for $60 per share in cash, valuing Kohl’s at nearly $8 billion.
It’s like David taking on Goliath, considering The Franchise Group’s $3.26 billion annual volume and Kohl’s $19.4 billion. Still, there have been instances where smaller retail companies have bought into larger ones. The Tote filed for bankruptcy following the purchase of Lord & Taylor.
There’s also a question of funding — whether a deal with TFG would leave Kohl stuck in servicing a big debt. Remember what happened with the Neiman Marcus Group – it was saddled with some $300-400 million in annual interest payments to service debt from its acquisition. That, added to the pandemic, ultimately drove the luxury retailer out of business.
If Kohl’s-Franchise Group talks result in a definitive agreement, TFG intends to contribute approximately $1 billion in capital to the transaction, which is expected to be fully funded by a corresponding increase in the size of its secured credit facilities. . The Wall Street Journal reported that Oak Street Real Estate Capital will work with Franchise Group on financing.
Activist shareholders, particularly Macellum Advisors, have valued Kohl’s real estate at around $8 billion. Macellum pressured Kohl’s to sell some of his real estate and lease it out, in order to increase shareholder value, but Kohl’s rejected the idea.
During a conference call earlier this year, TFG President and CEO Brian R. Kahn answered 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 that I think a lot about our M&A philosophy and the things that we look at from time to time,” Kahn said. “So first of all, we have a lot of belief in the brands that we operate now. And so we are confident that these brands that we operate will bring us significant organic growth over time and also generate enough free cash flow to support a healthy and growing dividend, as well as additional free cash flow that we can reinvest both internally and externally in mergers and acquisitions.. And we have no interest in jeopardizing that for any transaction. …we’re not going to mortgage the farm to do any transaction… We’re looking at everything that’s available and some things make sense, some don’t.
“Any size transaction should certainly be significantly accretive to FRG’s earnings per share and cash flow per share. And I think you can also imagine, wonderful as our lenders are, that we have capacity constraints on of capital and that large transactions should certainly be just positive for FRG. In my opinion, to bind us, money does not grow on trees,” he said.
“For us, management is always the key. I think you heard me talk earlier about the management of the companies we have. We have really investable management teams at Franchise Group…whether we are doing very small transactions or very large transactions, management will always be key to what we are looking for.
TFG said in its Monday statement that it remains committed to conservative financial policies, including target debt levels and maximizing free cash flow generation. “If a transaction closes, Franchise Group’s free cash flow, adjusted EBITDA and non-GAAP EPS are expected to increase significantly,” the company said. “The significant increase in free cash flow generation should support Franchise Group’s objective of increasing dividends and other capital returns to shareholders, while allowing Franchise Group to accelerate further organic and inorganic.”
Kohl’s and TFG have 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 are a good complement. The Franchise Group knows nothing about the fashion industry, even the banks will question it,” said veteran retail analyst Walter Loeb.
“The fit would be better with Sycamore,” observed Craig Johnson, president of Customer Growth Partners. “They have experience acquiring a bunch of struggling brands, like Talbots, and they’ve also bought Belk, which is still a good department store. Sycamore has experience in retail and especially in department stores, we believe they have a better chance of creating value from the acquisition.
“The three-week exclusivity will end quickly and I wouldn’t be surprised if Sycamore or a third party came back with another offer,” Johnson suggested. “If you’re a Kohl shareholder, you want to get the most for your shares.”
“It’s a headache,” added Allan Ellinger, founder and senior managing partner of MMG Advisors. “He’s a franchise operator. What does he know about department stores and how would they finance a transaction? I don’t understand what their strategy is. It would be a very big gulp for them. If you’re going to change your strategy and walk away of your basic skills, make a small bite out of it.
Retail analysts agree that Kohl’s has been in need of a fix for some time and has done a lot to up its game, such as the arrival of Sephora as well as a slew of deals-focused national brands. active and relaxed. But changes need time to kick in and so far Kohl’s hasn’t shown signs of improvement. Instead, the Menomonee Falls, Wis.-based retailer underperformed its retail industry peers. And some shareholders are getting impatient.
“Kohl’s hasn’t had the rebound seen in other department stores,” Johnson said. “Macy’s and Nordstrom have been better at matching capacity to demand,” thanks to a significant number of store closures.
“I suspect the acquirer, whether it’s The Franchise Group, Sycamore or another company, would consider reducing the number of Kohl stores,” from the current fleet of around 1,100. “But you don’t want to cut too deeply. One of the advantages of Kohl’s are its locations. They’re closer to where people live and work,” Johnson said.
“I would say a deal is not absolutely necessary, but something has to be done to improve Kohl’s performance.”