Consumer

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Shelly Banjo is a Bloomberg Gadfly columnist covering retail and consumer goods. She previously was a reporter at Quartz and the Wall Street Journal.

Department Store Blues
Source: Bloomberg

Kohl's might put itself up for sale, but that doesn't mean anyone will step up to buy it.

In a move designed to fend off activists, the flailing department store chain is considering taking itself private or breaking off parts of its business, according to the Wall Street Journal. But encouraging a private equity buyer to pay a premium above its market value of $9.5 billion -- and take over its $5.1 billion in debt -- may be impossible.

At first glance, the retailer looks relatively inexpensive: The stock has fallen roughly 40 percent from its record high last April. Kohl's shares are trading at just 5.2 times current Ebitda, according to data compiled by Bloomberg.

At a 40 percent premium to its closing price Friday, Kohl’s would be valued at $17.5 billion, or 6.6 times its current Ebitda, a touch below the 6.7 multiple that Sycamore Partners paid for smaller regional department store chain Belk in a deal that closed last month. That’s a far cry from the 10.2 multiple Hudson’s Bay paid for Saks and the 9.3 multiple Ares and Canada Pension Plan Investment Board paid for Neiman Marcus in 2013, partly because Kohl’s isn’t a luxury department store.

Assuming a private-equity consortium (likely comprised of one or two firms and their investors) is able to cobble together 20 percent of the transaction value, or some $3.5 billion in equity, that still leaves almost $14 billion to be funded with debt. Banks may have little appetite for such a deal, remembering that wary investors balked at Belk’s buyout debt, forcing underwriting banks to offer it at a discount of 89 cents on the dollar.

Kohl’s purposefully built its low-price department stores away from malls, to lure shoppers looking to get everything from shoes to home goods under one roof. The problem is, its diminished brands and commoditized products no longer make it an attractive enough destination. The company benefited from an over-eager expansion program for the better part of a decade, but demand has slowed. Now it's struggling to grow top-line sales enough to justify its nearly 1,200 locations.

Bloated Retail
Kohl's has opened too many stores over the past decade.
Source: Bloomberg

 

Retail Cannibalization
Kohl's store-opening spree has hurt sales.
Source: Bloomberg Intelligence

New efforts to boost its e-commerce operations and launch off-price retail stores probably won't pay off quickly enough. And all signs point to more pain for department stores as shoppers increasingly shift to Amazon and other online retailers to shop for clothing and electronics.  

Kohl's sales are still holding up slightly better than those of its rivals. Its sales and earnings per square foot are still above the industry average. And it's still profitable and generates plenty of cash.

Executives have unsuccessfully tried to juice the stock price through massive share buybacks. They probably figure they'll be able to sell out now at a decent price, before shares tank further or they attract the scrutiny of activist investors that could make their lives even harder. On average, analysts expect about a 5 percent rise in Kohl's shares over the next year, and any takeover premium would create immediate value for shareholders. 

But there's little upside here for would-be private equity buyers. First off, Kohl’s isn’t as much of a real estate play as Hudson’s Bay or Macy’s, whose Manhattan flagship alone is estimated to be worth $4 billion. By contrast, all of Kohl’s real estate -- it owns 400 stores and carries on-balance-sheet leases on about 500 -- is worth nearly $4 billion, according to estimates by Bloomberg Intelligence analyst Noel Hebert.

And while a PE firm would be able to slash costs, close poor-performing locations, and right-size the retailer to make it attractive enough to sell, a smaller Kohl's wouldn't yield the kind of profits that would make a deal worthwhile.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Gillian Tan in New York at gtan129@bloomberg.net
Shelly Banjo in New York at sbanjo@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net