Target Corporation (NYSE: TGT) may not seem like a bright spot in today’s market after shares were cut in half in 2008, but at least one activist investor is confident that value can be extracted from the retailer. William Ackman’s Pershing Square owns nearly 10% of the retailer and even created a separate fund to make a leveraged bet on a sharp turnaround.

Ackman’s theory relies on the fact that, unlike many other retailers, Target owns the land under its stores. Currently, this land is not valued at all in the retailer’s market capitalization. The activist investor believes that the true value of this land could be $40 billion or more given the location and tenant (Target). The problem is: How can we unlock that value?

Ackman proposed that Target spin-off its land into a real estate investment trust (REIT) that would then lease the land back to Target. Since the entity would be publicly traded on its own, it would have to come to its true value while Target would retain its value. Meanwhile, since the REIT would have Target as its tenant on its land with its buildings as collateral – a very safe bet.

The problem now is that Target seems hesitant to go through with the plan. Despite the fact that all major concerns were addressed, the retailer still believes that its credit rating and stock price may be adversely affected by the transaction. However, Ackman and Target are still likely in talks to smooth things over while investors wait for further comments from the company.

In the meantime, Pershing Square is hurting from Target’s demise. Pershing Square IV, which invests exclusively in the retailer with 2x leverage, lost 68% last year after Target’s stock slid 31% on the year. This adds to the fund’s losses of 43% in 2007 to make for a less-than-spectacular track-record. Investors are now questioning whether the plan will work.

However, Ackman is no stranger to being ahead of the game and remains confident. His short investment in bond insurers like MBIA took years to materialize and resulted in similar losses ahead of their big pay days. Target may turn out to be a similar story...