Franchise Group (FRG) is one in all my largest positions, naturally I really feel obligated to put up one thing on the headline grabbing information that FRG is the obvious winner of the public sale for struggling retailer Kohl’s (KSS). Kohl’s can be a transformative acquisition, FRG is at the moment a $2.7B enterprise worth firm and press stories have them paying $8B for KSS ($60/share). FRG is at the moment guiding to $450MM in 2022 EBITDA, TIKR has the consensus KSS estimate at $2.1B. The mixture of FRG being smaller than the goal, little recognized exterior of sure worth/event-driven circles and fears of credit score markets tightening appear to have the market doubting this deal will get finished (KSS final traded for $45.75). However I think about CEO Brian Kahn, FRG entered my portfolio as a particular state of affairs when it was then known as Liberty Tax, which went a couple of sophisticated merger and tender provide transaction that appeared novel and fascinating from an outsider perspective. Right here is FRG’s most current investor presentation for what the corporate seems like at present, lots has modified, together with FRG promoting the unique Liberty Tax to a SPAC (sponsored by NexPoint). My thesis within the final two years has principally revolved round “in Kahn we belief”, given the information leaks round credit score suppliers being lined up, it seems this deal is getting finished. I’ve added some KSS as a small speculative merger arbitrage place alongside FRG.
Taking a number of steps again, in April, information broke from Reuters that FRG was becoming a member of the bidding for struggling retailer Kohl’s (KSS), I used to be a bit shocked however not fully, Kahn is a artistic deal maker and certain seems at many acquisition alternatives that do not match Franchise Group’s said technique of “proudly owning and working franchised and franchisable companies”. My guess is the “franchise” half is extra aspirational than fact, it’s a generic title and technique, they only search for enticing offers. Kohl’s actually would not appear to suit the franchise mould, exhausting to think about somebody working a division retailer as a franchise, however the deal does resemble different current FRG acquisitions because the non-core property could possibly be used to finance the transaction.
Final November, FRG entered right into a transaction to purchase southeastern furnishings retailer W.S. Babcock for $580MM. Subsequently, FRG went on to promote Babcock’s credit score accounts receivables to B Riley (RILY) for $400MM, the retail actual property for $94MM, and the distribution facilities and company headquarters to Oak Road Actual Property Capital for $173.5MM. Greater than paying for the acquisition with asset gross sales and nonetheless anticipating to obtain $60MM in proforma LTM EBITDA. The same transaction appears to be in retailer for Kohl’s, the division retailer chain owns their company headquarters, virtually all of their distribution and e-fulfillment facilities, and personal 410 of their retail shops outright and one other 238 of them owned however on floor leases.
Reviews have FRG re-teaming up with Oak Road Actual Property Capital (a part of Blue Owl’s platform) to supply $6B in financing primarily based on the company headquarters and distribution services actual property (may additionally embody the retail actual property, so my 6% cap quantity beneath may be too low), and $2B (fuzzy, In search of Alpha quantity) from Apollo in non-recourse Kohl’s degree time period mortgage financing, with FRG kicking within the extra $1B by way of an upsized time period mortgage. Apollo is not the best lender, however since they are a direct lender and are not counting on syndicating the mortgage instantly like a big regulated financial institution, the financing appears safer within the present unsure surroundings. It’s an fascinating construction, FRG is utilizing no fairness, financing all of it with debt and can absolutely personal a levered fairness stub KSS.
Placing collectively a fast again of the envelope proforma, I provide you with the beneath:
As at all times, most likely a number of errors above, be at liberty to level them out, and clearly, that is all excluding the capitalized leases which is actual leverage even whether it is non-recourse, however even for those who did an EBITDAR valuation, the proforma firm can be extraordinarily low cost. However I believe it exhibits the creativity of Kahn and FRG, they’re making a diversified collection of levered bets by way of non-recourse sale leaseback financing.
- Whereas not a “wager the corporate” deal, it’s fairly shut and definitely dangerous. The market would not like extremely leveraged corporations, FRG will probably commerce cheaply for some time as they convey down the debt and finally additional diversify away from Kohl’s with future offers. Kohl’s is actually a weak enterprise, it’s within the center floor of not likely having an id, I can not consider something you could purchase at Kohl’s that you simply could not get elsewhere. There’s numerous debt right here, issues might go horribly fallacious.
- There’s some political strain to reject the deal, notably in Kohl’s dwelling state of Wisconsin, probably if FRG acquires KSS, long run it is a sluggish movement liquidation. FRG usually companions with B Riley, the 2 are intertwined some, B Riley has a retail liquidation enterprise and sometimes invests in these distressed retailers. Promoting to FRG most likely cements Kohl’s as a declining enterprise and which may face political backlash.
- FRG is closely into dwelling furnishings (beforehand talked about Babcock, in addition they personal American Freight which sells clearance home equipment and Buddy’s, a rent-to-own retailer), primarily based on the current Goal stock debacle, folks aren’t shopping for dwelling furnishings anymore now that covid is generally within the rear view mirror. Cynically, FRG may be doing this deal to distract from points on the core enterprise. Nonetheless, Brian Kahn has sounded sober via the pandemic concerning stock, provide chain, going ahead expectations, he hasn’t sounded shocked by the slowdown and up to now hasn’t needed to drastically change steering.
- Macellum Capital Administration has been participating in an activist marketing campaign towards Kohl’s, they misplaced their proxy combat just lately, however have been placing important strain on the corporate to promote themselves. Kohl’s administration believed they had been value $70+, however with the current downturn and disappointing Q1 earnings, bids have are available in decrease, so it may be an opportunistic time for FRG to swoop in and be the white knight. FRG additionally runs a decentralized administration construction, so it could possibly be seen as a most popular purchaser for administration as they might preserve their jobs.
- FRG did just lately put a $500MM buyback in place (after it was reported they had been a KSS bidder), issues might get fairly wild in the event that they use the KSS money flows to buyback shares versus paydown debt given their Debt/EBITDA ratio would probably stay inside there goal vary instantly upon closing of the transaction.
- Brian Kahn has by no means been shy about shopping for shares within the open market (did lots throughout that preliminary Liberty Tax/Buddy’s transaction, signed huge boy letters with anybody that might promote him shares) and his personal fairness agency, Classic Capital, owns 25+% of the corporate.
Disclosure: I personal shares of FRG and KSS