No-Moat Kohl’s Should Accept Franchise Group’s Offer

In the latest twist in an ongoing saga, Kohl’s (KSS) has entered an exclusive three-week negotiating period with Franchise Group to give it time to finalize an offer to buy Kohl’s for $60 per share. Franchise Group is a collection of retail concepts, including The Vitamin Shoppe and Pet Supplies Plus, that are mainly franchised, so operating a nationwide department store company with nearly $20 billion in annual sales would be a change in strategy and a huge step-up. Moreover, Franchise Group’s market capitalization is only $1.5 billion, a fraction of the $8 billion or so it will cost to buy Kohl’s. According to the company and media reports, Franchise Group intends to contribute $1 billion through borrowing and work with Oak Street Real Estate Capital to finance the rest of the purchase price with Kohl’s real estate. While we have reservations whether it can do this, especially as the market value of the real estate is unproven, the announcement of an exclusive negotiation suggests some confidence by the parties involved that it can.

If a financed offer does come, we think Kohl’s should accept it as it is above our fair value estimate of $58. Since reports first surfaced of potential buyers, we have recommended that Kohl’s accepts offers above our fair value estimate, partly because we view it as a no-moat company in an industry (United States department stores) that has been declining for the past 15 years and may continue to do so. Indeed, over the next decade, we forecast Kohl’s operating margins will decline from nearly 9% in 2021 to about 5%, so waiting for a higher offer may be risky. Even so, $60 per-share offer must be seen as a disappointment given that Kohl’s rejected offers that were reportedly higher than this just a few months ago. Unfortunately, media reports suggest potential bidders dropped out of the process after Kohl’s subpar first-quarter results, so its board may believe that Franchise Group’s offer is the best option.