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Could Kohl's Corporation Be An LBO Target?

 February 21, 2013 10:06 AM

(By Mani) The proposed $24.4 billion leveraged buyout of Dell, Inc. (NASDAQ: DELL) and $23 billion acquisition of H. J. Heinz Company (NYSE: HNZ) by Berkshire Hathaway and 3G Capital have caused some investors to wonder about other large transactions that would be attractive to private equity sponsors that are hungry for yield.

If the proposed Dell deal takes off, it would be the largest leveraged buyout (LBO) since the 2008 financial crisis and could set the stage for mega deals.

According to a Bloomberg data, there have been 22 global consumer-related transactions greater than $10 billion from 2006 through year-to-date 2013. Of the 22, two, or less than 10 percent of the transactions, were in the retailing industry (Alliance Boots, Albertsons).

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If we are entering a period where the appetite for mega deals grows, then Kohl's Corporation (NYSE: KSS) could be a target company thanks to an attractive EV/EBITDA valuation, strong free cash flow, margins that may be close to being reset.

The department store chain's public debt could travel with the LBO—lessening the need to raise new capital coupled with 35 percent owned real estate position, and several strategies that may be easier to implement in a private setting. The attractive part is that insiders control only 2.3 percent of the common stock making a hostile transaction less likely.

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"We estimate a consortium of private equity sponsors could acquire the company for about $18.6 billion (including fees) or a 30% equity premium. Our assumptions include a 25% equity contribution (~$4.6 billion) and a sale-leaseback transaction for owned properties," BMO Capital Markets analyst Wayne Hood wrote in a note to clients.

While the proposed transaction at 6.8 times trailing 12-month EV/EBITDA would represent a premium to Macy's (NYSE:M) 5.7 times and 5.6 times for Dillard's, Inc. (NYSE:DDS), it would be at a discount to the mean of retailing transaction values of 9.5 times that was realized from 2004-2012.

"We estimate the transaction could potentially give equity sponsors a 23.6% IRR at a 6.5x exit multiple or 25.6% IRR at a 7.0x estimate multiple," Hood noted.

The private equity investors could be attracted towards the real estate assets of the company, which owned 36 percent, or 403, of its stores at the end of fiscal 2011. The company potentially could unlock $4 billion in value or 37 percent of the company's market capitalization were it to enter into a sale-leaseback transaction on these locations.

Meanwhile, Kohl's generates strong free cash flow as new store expansion has slowed. The company is generating close to $2 billion in annual operating cash flow and $1.2 billion in free cash flow after $800 million in capital expenditures and has a cash flow yield of 11.2 percent compared with the group average of 7-8 percent.

"We estimate the company will end FY12 with $1.3B in cash on the balance sheet," the analyst added.

For the third quarter ended Oct.27, Kohl's net income grew to $215 million from $211 million in the same quarter prior year. Earnings per share advanced to 91 cents from 80 cents last year. Net sales climbed to $4.49 billion from $4.38 billion. Comparable store sales for the quarter increased 1.1 percent.

As of Oct.27, the company had cash and cash equivalents of $550 million and long-term debt of $2.49 billion.

Menomonee Falls, Wisconsin-based Kohl's operated 1,146 stores in 49 states at the end of the quarter, compared to 1,127 stores last year. During the year, the company opened 21 new stores, including 1 relocated store, closed 1 store and completed 50 remodels.

The company is expected to report fourth-quarter and full-year2012 results on Feb.28. Wall Street expects earnings of $1.63 a share for the quarter and $4.14 a share for the full year. Quarterly revenues are projected at $6.23 billion, and full-year revenues are estimated at $19.20 billion, according to analysts polled by Thomson Reuters.

Both quarterly and full-year earnings are expected to decline about 10 percent and 4 percent, respectively from last year. Sales are anticipated to increase 3.5 percent and 2.1 percent, respectively.

The fiscal 2013 will be a year where management must demonstrate it can restore sales and profit growth or investors/activist will likely call for a change in leadership that could include a going-private transaction.

Kohl's shares, which have been trading between $41.35 and $55.25 during the past 52-weeks, trades 11.3 times its 2013 consensus earnings estimate, in line with Macy's, but lower than Dillard's 13.6 times. They have declined 11 percent in the past two years and gained only 3 percent in the past five years.

Out of 22 analysts covering the stock, 8 of them rate it as a "strong buy" or "buy," while 12 analysts recommend a "hold." Two analysts have a "sell" rating on the stock.



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