Shares of Kohl's (NYSE: KSS) jumped by more than 8% on Monday as the company faces pressure to split from its online business or face a sale. A letter from an activist investor urged the management team to make a move while slamming the leadership as having failed to create value.
What plan was proposed for Kohl's?
Engine Capital, which owns around 1% of the retailer, reportedly valued Kohl's digital business alone at around $12.4bn, provided it achieved revenues of $6.2bn. As such, the activist investor was keen to pressure Kohl's into deciding to split or allow itself to be sold.
Engine reasoned that a "simpler, more defined corporate structure" would be more appealing to the public market.
The hedge fund appeared to have a candidate buyer all lined up, with a letter to Kohl's reportedly indicating that private equity firms would be happy to snap up the company for a minimum of $75 per share. This amounts to 5.5x forward EBITDA.
Hedge fund Engine Capital made the suggestion as a means of boosting the retailer's share price. The letter explained:
"Given leadership's failure to create value through operational excellence and strategic initiatives over long periods of time, it is time for the Board to accept the fact that the public market is not appreciating Kohl's in its current form.
"Even the most patient long-term shareholders cannot be expected to endure the punishing underperformance and perpetual value disconnect seen at Kohl's. This is why we are urging the Board to publicly commit to conducting a full review of strategic alternatives."
The numbers
While Kohl's has more than 1,100 brick-and-mortar stores in 49 states, the company also runs the Kohls.com website and the Kohl's App.
In the retailer's most recent results, it reported a 6% year-on-year increase in third-quarter digital sales, amounting to a 33% increase on a two-year basis. Digital sales made up 29% of total sales during the three-month period.
This helped to drive overall net sales up by 19% compared to the same period the year before, though only slightly above the levels achieved in 2019. These most recent results were well-received by analysts, generally beating their expectations.
Such was the good mood, CEO Michelle Gass, raised full-year guidance and announced plans to accelerate share repurchase activity.
However, Engine pointed out that Kohl's share price has failed to compete on a par with its competition.
It noted that, since Gass had become head honcho of the retailer in May 2018, Kohl's shareholder returns had declined in price by 10.5%, while the average competitor saw theirs increase by 8.5%.
The letter added that it was "stunning" that the company had managed to underperform the S&P500 by 305% in the last decade, even as it generated $11.8bn of free cash flow and shelled out $6.9bn on share purchases during the ten-year period.
What does this mean for Kohl's?
The letter itself doesn't necessarily mean a great deal for the company's direction. Engine Capital only owns around 1% of the retailer, so the letter is more of a call to arms than an all-out declaration of war.
Even so, the points raised in the letter should be concerning for the retailer's leadership. The leadership has a carefully crafted strategy that does not tally with Engine Capital's ideas.
The company has been positioning itself to appeal to consumers seeking active and casual lifestyle clothing and accessories. What's more, Kohl's has been focusing on delivering an omnichannel presence, where customers order products online and pick them up at stores. Clearly, this does not lend itself well to splitting the business in two.
While the letter might not have been music to the ears of Kohl's leadership, investors have clearly had their interest piqued. The retailer's share price increased by more than 8% following the news, indicating some level of appeal.
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