Why Franchise Group wants to buy Kohl’s and what can happen next

Shoppers walk into a Kohl’s store in Peoria, Illinois.

Daniel Acker | Bloomberg | Getty pictures

A little-known conglomerate of companies including The Vitamin Shoppe, Pet Supplies Plus and a home furnishing chain called Buddy’s are suddenly talking about retail.

Franchise Group, a listed company with a market value of around $ 1.6 billion, has entered into exclusive sales agreements with Kohl’s. It offered a bid of $ 60 per share to buy the trader at a value of around $ 8 billion. Franchise Group and Kohl’s are in a three-week window where the two companies can confirm any due diligence and final financing arrangements.

Questions have since swirled about what all this will mean for Kohl’s, should an agreement go through: What will happen to the Sephora beauty shop in Kohl’s, or the retailer’s return partnership with Amazon? Will Kohl’s CEO Michelle Gass continue in the company? Are store closures inevitable?

Also, why should the Franchise Group want to own Kohl’s in the first place, since dealers including Kohl’s face stock challenges and inflation? Just a few weeks ago, Kohl’s cut its financial forecast for the entire fiscal year as more Americans retire on discretionary spending. Meanwhile, investors are arguing with interest rate hikes from the Federal Reserve and the potential for a short-term recession.

The agreement is still changing, so these questions do not have definite answers on this point. Instead, analysts and experts point to Franchise Group’s track record and its recent acquisitions for a better sense of what Kohl’s future may bring.

Spokesmen for Franchise Group, Sephora and Amazon did not immediately respond to requests for comment on this story. Kohl’s declined to comment.

What the Franchise Group wants

“What the Franchise Group is doing is looking for good companies and well-known, strong brand names with a good consumer following,” said Michael Baker, senior analyst at DA Davidson.

“And then they have a different strategy for how to capitalize or make money on these acquisitions,” he added. “Sometimes it’s turning them from business-owned stores to franchise stores.”

The franchise group was founded in 2019 through a $ 138 million merger between Liberty Tax Service and Buddy’s, according to the company’s website.

Under President and CEO Brian Kahn, who has a private equity background, the Franchise Group continued to acquire Sears’ outlet business; Vitamin Shoppe; American Freight, which sells furniture, mattresses and appliances; Pet Supplies Plus; Sylvan Learning; and Badcock, a home furnishing chain that caters to lower-income households.

A Vitamin Shoppe store in New York.

Scott Mlyn | CNBC

Franchise Group mostly owns franchisees. But the consensus is that Kahn is unlikely to use the same strategy at Kohl’s, which has more than 1,100 brick-and-mortar stores in 49 states.

“The strategy there would be to work with the current management team to drive [Kohl’s] better, or replace management if necessary, “Baker said.” They’ve done it with some of their assets. … Kahn has a track record for making great deals. “

Baker used the Franchise Group’s recent acquisition of Badcock, a deal valued at around $ 580 million, as an example. The company has since entered into two different sales agreements, one for Badcock’s retail stores and another for the distribution centers, the company’s headquarters and additional properties, for a total of approximately $ 265 million. Rob Burnette remains in the role of President and CEO of Badcock.

In an earnings interview in early May, Franchise Groups Kahn analysts told – without naming Kohls directly – what he looks for in any transaction.

“Leadership for us is always the key,” he said. “Whether we make very small transactions or very large transactions.”

“We have a lot of conviction in the brands that we operate now,” Kahn also said during the conversation.

He added that all of Franchise Group’s previous acquisitions generate ample cash to support the company’s dividends and to allow further M&A activity, and any agreements it considers in the future will also have to fit this form.

A real estate game

Earlier this year, Kohl’s considered a $ 64 share offer from Starboard-backed Acacia Research to be too low. At the end of May, the trader’s shares traded as low as $ 34.64, and have not been as high as $ 64.38 since the end of January. Kohl’s shares closed at $ 45.76 on Wednesday.

Franchise Group probably sees the $ 60 per share offer as something of a theft, especially if the company can finance most of the transaction through real estate.

Franchise Group said in a press release earlier this week that they plan to contribute around $ 1 billion in capital to Kohl’s transaction, all of which are expected to be financed through debt instead of equity. Apollo is set to be the Franchise Group’s provider of term loans, according to a person familiar with the matter. An Apollo spokesman did not immediately respond to CNBC’s request for comment.

In the meantime, most of this agreement is expected to be financed through real estate. CNBC has previously reported that Franchise Group is working with Oak Street Real Estate Capital on a so-called sale-leaseback transaction. Oak Street declined to comment.

If it plays out this way, the Franchise Group will receive an inflow of capital from Oak Street, and it will no longer have Kohl’s property on the balance sheet. Instead, it would have rent payments and lease obligations.

As of January 29, Kohl’s owned 410 locations, leased another 517 and operated ground lease agreements at 238 of its stores. All of the property owned was valued at just over $ 8 billion at the time, an annual filing shows.

“If Franchise Group can get $ 7 or $ 8 billion out of the property, they’ll only pay around $ 1 billion for the assets. So it’s pretty cheap,” said Susan Anderson, a senior analyst at B. Riley Securities. “And I’m thinking [Kahn] would not make the deal unless he already has the sale in place and deals are already in place. “

“A playbook in place”

But some retail experts prefer cold water on the plan, saying such a significant real estate sale could end up putting Kohl’s in a much weaker financial position.

“This is completely unnecessary and will only serve to weaken the company and limit the investments needed to revitalize the business,” said Neil Saunders, CEO of GlobalData Retail. “Takeovers of other retail companies that have followed this model have never ended well for the party that was taken over.”

Some sale-leaseback transactions, and especially those on a much smaller scale, have reportedly been considered successful.

In 2020, Big Lots entered into an agreement with Oak Street to raise $ 725 million from selling and leasing four company-owned distribution centers. It gave the big box retailer extra liquidity during almost the beginning of the Covid-19 pandemic.

Also in 2020, Bed Bath & Beyond completed a sale-leaseback transaction with Oak Street, where they sold about 2.1 million square feet of commercial property and received $ 250 million in revenue. Bed Bath’s CEO Mark Tritton at the time described the deal as a move to raise capital to reinvest in the business.

The franchise group can look at Kohls as a way to create more backend efficiency, among all other businesses, according to Vincent Caintic, an analyst at Stephens. Putting together resources such as fulfillment centers and shipping providers can be a smart move, he said.

“They have furniture stores, a rent-to-own store, and a lot of them are consumer goods,” Caintic said. “Maybe they can get a little extra price power by becoming a bigger player.”

At the same time, he said, this would be the Franchise Group’s largest acquisition to date, which could come with a steeper learning curve.

All Franchise Group dealers had a combined revenue of $ 3.3 billion in the calendar year 2021. Kohl’s total revenue exceeded $ 19.4 billion in the 12-month period ended January 29.

“The franchise group has a history of buying businesses, lifting them up, and then releasing capital very quickly to pay down debt,” Caintic said. “They have a playbook in place.”

But, he added, the companies Franchise bought before the persecuted Kohls were much smaller – “And they were made when it was very cheap to get debt.”