Wednesday, May 27, 2009

Ackman Vs. Target

05/27/09 - 12:07 AM EDT


The much-anticipated annual meeting of retailer Target(TGT Quote) is Thursday and large shareholder Bill Ackman of Pershing Square has been in a long-running battle for the past several weeks to win five seats on the board.

Ackman has spent $10 million to $15 million of his own money on his campaign thus far. Although he's won over the support of two influential proxy advisory firms -- RiskMetrics and Proxy Governance -- he faces a daunting task in winning Thursday's vote. In its latest issue, Barron's magazine proclaimed that Ackman's campaign was "off-target," stating that "Ackman's initiative could be one of the worst-conceived efforts in recent years by an activist investor."

On Tuesday, Ackman pledged to retain his stake in Target for at least five years if he's elected to the company's board. He said his personal stake in Target is now worth more than $55 million.
Here's my view on the campaign.

A Review of the Fight

Ackman's Pershing Square has been a shareholder in Target for more than two years. In 2007, he opened Pershing Square IV, which was a fund solely dedicated to investing in Target. Pershing's funds own 3% of the stock outright with options to purchase at least another 2%, many of which are already in-the-money.

From very early on in his stock ownership of Target, Ackman has been an outspoken critic of the company. His calls for the company to unlock value in its real estate holdings date back to at least 2007.

Earlier this year, Ackman apologized to investors in Pershing Square IV after his option bets on Target had gone against him resulting in a drop in fund performance of 89.5% as of the end of January. Target management has used Ackman's option holdings to imply that he's more a short-termist than other investors and that his proposed changes are riskier.

Ackman's plan for Target consists of four parts: (1) unlock up to $40 billion in real estate value by placing the land under the stores in a real estate investment trust structure and then leasing back the land from the REIT; (2) sell the entire credit card operation; (3) improve the quality of the board of directors; (4) close the performance gap over time with Target's No. 1 competitor Wal-Mart Stores(WMT Quote).

Proxy Governance has supported Ackman's activist efforts and his full slate of nominees for Target's board. RiskMetrics, the more influential of the two proxy advisory firms, has recommended two of Ackman's five nominees (Ackman himself and Jim Donald, the ex-CEO of Starbucks(SBUX Quote)). Glass Lewis, another proxy advisory firm, has rejected Ackman's nominees and supports Target's full slate.

In the weeks leading up to Thursday's vote, Ackman has taken to the airwaves to make his case. He's an exceptional communicator. He's clear, thoughtful and forceful in making his case. I don't think there's a better activist investor currently practicing today when it comes to communication skills.

Target, for its part, also has been pushing its rebuttal to Ackman's criticisms, taking 10 minutes at the beginning of its most recent earnings call to cast doubt on the Pershing plan.

What's Worked With Ackman's Campaign

1. Target's performance has clearly lagged Wal-Mart's recently, and that's relevant. Barron's includes figures in its article that show Target's total three-, five- and 10-year returns vs. Wal-Mart, Costco(COST Quote), and the S&P 500. The results are through April 30, and cite Morningstar. The reported returns imply that Target's returns have been pretty good on a five and 10-year basis, even though they've lagged their peers in the last three years.

I was incredulous after reading this and so I went to Morningstar to revisit these numbers. What I found on its site tells a different story than the Barron's numbers. On the currently reported numbers (through May 22), Target's year-to-date, one-, three-, five- and 10-year returns all clearly lag their industry and the S&P, although the five and 10-year are roughly comparable with Wal-Mart).

2. This Target board is out of touch, like many corporate boards. There are many compelling points Ackman makes about how out of touch the Target board has become. Its directors currently own only 0.27% of the total Target shares outstanding. Many directors only hold shares given to them through options or equity grants. They've consistently relaxed the director tenure limits to allow directors like former Telstra CEO Sol Trujillo to serve up to 20 years on the same board.

Most corporate governance experts would tell you that a director no longer has "fresh eyes" to look at a company's issues and challenges after eight years on the same board. A two-decade term limit is outrageous. It's also ridiculous to hear that Target's nominating committee refused to meet with Ackman or his nominees about joining the Target board last year but paid themselves fees for sitting on this committee, even though that committee didn't meet once formally during the year. I can't recall seeing that in a recent large company proxy.

Target's board deserves a revamp. Its practices suggest a cozy group of insiders seeking to protect their job security as directors, rather than doing the right thing for shareholders. Things likely will change significantly in future boardroom battles, as last week the Securities and Exchange Commission threw its support behind "proxy access," which would make it much less expensive to mount campaigns and give shareholders a real choice in who they want to represent them on the board instead of only choosing from the incumbent slate. If Target's board doesn't change Thursday, it most certainly will next year.

3. This is a legitimate campaign -- not a distraction. As the Barron's article stated over the weekend, there is no shortage of management apologists who come out of the woodwork when there is a dissident proxy fight. Most of the time these commentators who support the status quo usually complain that the company isn't the worst of the bunch and therefore an activist campaign is a waste of time and a distraction.

That approach has allowed mediocre boards to persist in this country for decades. As the points I've mentioned verify, this campaign certainly has merit. What's more, Ackman has paid his way to put it on. He has real "skin in the game" -- unlike most, if not all, of these kinds of critics. The fact is that if more mediocre boards had been "distracted" by legitimate activist campaigns over the past two years it's likely we'd have a much stronger capital markets system today than the one which absolved itself of any risk management responsibility.

4. Ackman's made a great case. I tip my hat to Ackman, including his spirited attack of the Barron's article, for being a very precise and skilled communicator. I think he's made about as strong a case as an activist can make at this time against Target.

What Hasn't Worked

1. Target's poor performance relative to Wal-Mart hasn't been compelling enough. It's hard to win an activist campaign arguing what Target should have done in the last few years. Shareholders are human. They take short-cuts, they summarize, they look for sound-bite logic for understanding a campaign, and then they base their voting decisions on this incomplete information. Some shareholders rely heavily on what the major proxy advisory firms say when deciding how to vote. Although Ackman's made some salient points on how Target has lagged Wal-Mart, he will not gain as much shareholder support as he could have if the gap had been much more compelling.

2. The REIT component of Pershing's plan doesn't match today's environment. A large part of Ackman's plan includes increasing shareholder value through creating a new Real Estate Investment Trust. It matters not that Target uses Richard Sokolov, the president of Simon Property Group (SPG Quote) (who competes against General Growth Properties, of which Ackman is a large owner), to discredit Pershing's plan. The optics of the plan don't match the current environment we're operating in even if the substance of the plan is on the mark. It will be difficult to convince many investors to take a leap of faith on a sudden creation of $40 billion in value from moving a few shells around. At the moment, skepticism reigns.

3. Jim Donald's communication skills haven't matched Ackman's. As RiskMetrics' recommendation confirms, there appears to be the most support for Donald as a second pick for the Target board after Ackman.

During a recent joint CNBC appearance, Donald, who also helped build Wal-Mart's grocery business before leaving for Starbucks, failed to match Ackman's oratory skills. When someone questioned Donald about what changes as a director he'd like to see Target make, he deferred, saying that he needed some time to study things in more depth. It was modest and diplomatic but not in keeping with a bloody-nosed proxy fight.

What's more, it played to what Target has tried to press -- that there's nothing that significant to fix at the company. It would be ideal if all shareholders took the time to review all candidates' utterances prior to forming their selections, but unfortunately sound bites matter, and that one hurt.

When all is said and done Thursday, I expect that Ackman will win two seats on the Target board, along the lines as RiskMetrics suggests. In the long run, it should greatly help Target's other shareholders and prove the naysayers wrong. Ackman hasn't run a perfect campaign, but it's been very effective, and he will consider it a success with this kind of outcome. It also will give him the chance to further press his views at the board level. It's likely that Thursday's showdown will be a preview of many more activist contests to come next year, once the new SEC proxy access rule goes into effect. Sleepy boards should get ready for more distractions.

At the time of publication, Jackson had no positions in the companies mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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