Kohl’s Corporation announced on 6 June that its board of directors has entered into exclusive three-week negotiations with the holding company of market-leading and emerging brands, Franchise Group, Inc., in relation to its proposal to acquire the company for US$60 per share.
GlobalData’s analyst Neil Saunders, however does not believe that – on the surface – Franchise Group is a perfect fit for Kohl’s.
He explains: “For one, as the name suggests, Franchise Group is mostly about businesses than can be franchised. While their plans for Kohl’s are not clear, franchising a department store is much more difficult than franchising a single category business such as vitamins, pet products, or furniture. In our view, the complex Kohl’s business is not best suited to a franchising model.”
Saunders also points out that while Franchise Group has retail experience, Kohl’s will represent its biggest and most prominent deal. He says this means there will be a lot of work to be done to put Kohl’s on the right track and he is not not entirely convinced that Franchise Group has the expertise to make all the required changes.
However, the biggest stumbling block as far as Saunders is concerned is that other than the $1bn of capital Franchise Group will put into the transaction, most of the funding will be financed off the back of Kohl’s real estate. Franchise Group has made it clear that it will not be liable for this debt.
He says: “This potentially encumbers Kohl’s with a huge debt pile that it will need to service. In our view, this is completely unnecessary and will only serve to weaken the firm and restrict investments that are needed to revitalise the business. Takeovers of other retail businesses that have followed this model have never ended well for the party being taken over.”
Saunders states that because of all these factors he sees very little commercial merit in a deal with Franchise Group: “It will not transform the Kohl’s business. It doesn’t add much additional expertise, skills, or advantages to the group, and it puts Kohl’s in a far weaker financial position.”
In saying this, he highlights that Kohl’s management likely knows all of this.
He explains: “However, it is currently holding a very weak hand which makes it more difficult, although not impossible, to reject the offer.”
The transaction remains subject to approvals of the boards of directors of both companies.
The official negotiations statement says: “There can be no assurances that any agreement will be reached or that a transaction will be agreed or completed on the terms set forth above or otherwise.”
It adds: “Kohl’s board of directors remain focused on selecting the path that maximises value for all Kohl’s shareholders.
However, it also states the purpose of the exclusive three-week period is to allow Franchise Group and its financing partners to finalise due diligence and financing arrangements and for the parties to complete the negotiation of binding documentation.
Saunders does provide some positives for Kohl’s striking a deal with Franchise Group.
He says: “The positives mainly revolve around the fact that Franchise Group is already involved in retail and has experience from running various brands such as The Vitamin Shoppe and Pet Supplies Plus. This is a more attractive fit than a financial firm that focuses mainly on financials with scant regard to retail operations.”
The issue for Kohl’s, according to Saunders, is that its weak set of quarterly results has left the company in a vulnerable position and this has made it more inevitable that a sale will need to be, at least, thoroughly explored.
It is for this reason, he says Kohl’s management has elected to go through the discussions process with Franchise Group despite the fact there are both positive and negatives surrounding any potential deal that emerges.
Last month Kohl’s was underlining its commitment to bricks and mortar with plans to open about 100 new, smaller format stores over the next four years in a move it said represented a sales opportunity of more than $500m.