Financial engineering may have fallen into ill repute in Washington and much of the country, but let no one imagine that Wall Street has given up.

William Ackman, the activist investor and hedge-fund manager, proffered an idea on Wednesday that he claimed was worth billions. He wants Target Corporation, the large discount chain, to sell the land underneath its stores to a new unit set up for the purpose. Target, he proposes, would pay rent to the spinoff, with existing Target shareholders gaining stakes in the new real estate business.

The supposed benefit? Mr. Ackman foresees a big increase in the total value the stock market would attach to a sliced-up Target, as much as 74 percent by his reckoning. That would include a payday of several billion dollars for Mr. Ackman’s hedge fund, Pershing Square Capital Management, which owns nearly 10 percent of Target.

The potential cost? According to several analysts and Target itself, the complicated new setup would hurt Target’s credit rating and thereby raise its cost of borrowing, perhaps undermining the company’s ability to survive the economic downturn. And the company believes a sliced-and-diced Target would ultimately have less control over its stores, the lifeblood of the business.

The plan might lead to transitory gains in the short run, but in the long run, “the retailer would be on much shakier ground, so to speak,” wrote Carol Levenson, director of research for Gimme Credit, a bond research firm. In an e-mail message, she added that “with overleveraged retailers going under right and left, and inhospitable lending and commercial paper markets,” the timing of such a transaction could not be worse.

Maneuvers like the one Mr. Ackman suggested Wednesday are the latest variation on the Wall Street notion that the parts of a company may be worth more than the whole. Wall Street sees chopping such a company up as “unlocking value.” But in some recent cases, activist investors who pushed such deals through have been accused of wrecking the companies.

For example, Mervyn’s, the bankrupt department store chain, is suing its onetime private equity owners on grounds that they crippled the company by separating the chain’s valuable real estate from its retail operations.

Mr. Ackman has included features in his plan meant to avoid some of the worst problems of previous deals. In particular, he proposed that Target spin off only the land on which its stores sit, retaining long-term leases on the stores themselves.

But several analysts were left scratching their heads after he presented his proposal to investors in Manhattan on Wednesday. They could not figure out if he had come up with a truly novel idea or just some financial manipulation that would end badly.

Deborah Weinswig, a retail equity analyst with Citigroup, said Mr. Ackman’s presentation answered a fundamental concern that retailers always had when they contemplate a real estate spinoff: Will the company retain adequate control of its buildings? But, she added: “In this kind of environment, I don’t know if anyone wants to tamper with or wants to risk a credit-rating downgrade.”

Target, which operates 1,684 stores, owns the majority of its real estate and considers it a significant asset that strengthens its balance sheet and financing options in difficult economic times.

“For a retailer to have more control of their destiny in today’s environment is critical,” said Marshal Cohen, chief industry analyst for NPD Group. Mr. Ackman said his proposal was in the interest of all Target shareholders. Noting that Target owns the highest percentage of its real estate compared with other big-box retailers, he said the transaction would unlock the value of that real estate, which he said he thought had not been reflected in the company’s stock price.

In Mr. Ackman’s proposal, Target would retain control of the buildings through 75-year leases. He argued that the long leases offer “bondlike stability.”

“It’s a very creative and innovative way to do this,” said David Bassuk, managing director in the retail performance improvement practice of AlixPartners.

Indeed, industry experts in reorganization and in mergers and acquisitions said financial engineering was likely to happen even more now, given the gloomy economy.

“These conversations are going on in every single board room in every single C.E.O. suite in this country,” said Claire Gruppo, managing director of Gruppo, Levey & Company. “ People are scrambling to be as creative as possible, to look at ways that they can generate cash.”

“Believe me,” she added, “this is all anyone is thinking about.”

Target, along with an outside adviser, Goldman Sachs, has been listening to Mr. Ackman’s ideas since May, and has put several of them into effect, such as selling part of Target’s credit card business to JPMorgan Chase for $3.6 billion. The retailer said that it would evaluate Mr. Ackman’s proposal.

Continue reading…

By STEPHANIE ROSENBLOOM

Source: New York Times – U.S.A.