Bill Ackman’s Target War Highlights Cultural Changes, Past Mistakes

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Pershing Square hedge fund manager Bill Ackman is holding a Town Hall meeting today to convince investors that Target’s board needs to be replaced. His attempted shakeup highlights a shift in activist investor culture as well as a questionable moneymaking strategy.

The Backstory
Ackman launched a board shakeup fight after Target refused a real estate proposal that would convert 20% of Target’s land–the retailer owns most of its stores outright–into an inflation-protected security called a TIP REIT.

The Fight
Ackman said the real estate deal would make Target more money. Target claims that the proposal would burden the company with $1.4 billion in annual lease expenses for 75 years, a number which would increase at the rate of inflation. Now, Ackman is hitting the streets, touting his nominees for a new Target board three weeks before the company’s annual shareholder meeting.

Ackman’s nominees include:

Himself
Jim Donald, former Starbucks CEO
Michael Ashner, Chairman/CEO, Winthrop Realty Trust
Ronald Gilson, law professor
Richard Vague, former Chairman/CEO, First USA
(from DealBook)

Mr. Ackman has maintained that this slate will bolster the board’s expertise in retail, credit cards and real estate issues. In the filing, Mr. Ackman insisted that the nominees are ”entirely independent” and have ”no preconceived agenda other than to maximize shareholder value.”

Ackman’s Stake
Ackman’s Pershing Square IV fund, which invests only in Target stock, owns 26.8 million shares (3.3%) of Target. He holds another 4.5% in options, according to an excellent article by Fortune’s Jennifer Reingold.

Ackman’s fund hit a low in February, when it was down 93%. Reingold writes that he let some investors close their investments, waived fees for others, and issued a public apology. He put $25 million of his own money into the Target fund.

Ackman’s Pershing SIV fund usually moves at twice the move of Target because Ackman uses derivative contracts that give his fund two-times leverage, according to the Street Insider.

Target’s Response
Target is reacting by pouring $11 million into the proxy fight. From Fortune:

Far from treating Ackman like a mere irritant, (Target) is spending some $11 million to promote its own candidates — money, Steinhafel notes, that would be better spent improving its business. “This is a very challenging economic environment,” he says, “and it’s unfortunate that we are having to invest our time in [fighting] a proxy contest.”

A Change in Corporate Takeover Culture?

Reingold comments
on the meaning of the proxy fight:

The stakes are high, and not only because Target is one of the largest companies ever to be involved in a proxy fight. Regardless of who wins the vote at the annual meeting on May 28, Ackman’s move against a widely respected company with no record of poor governance represents a new front in the world of shareholder activism, and one that any company should pay attention to.

Although directors of companies with worse records — Citigroup, anyone? — have been reelected, the fight at Target suggests that the days of the “trust me” boardroom are waning, and that costly struggles for control may become commonplace.

Meanwhile, Seeking Alpha’s TraderMark posted a quote that sums up Ackman’s motivations:

“Bottom line, PSIV has been one of the greatest disappointments of my career to date,” Mr. Ackman said in the letter. “That said, we continue to believe that we will ultimately be successful in our investment in Target.”

Bad Idea
Ackman has a reputation as a sharp investor, but I wonder about his strategy. Mervyn’s, a former Target subsidiary, experienced a similar shakeup in 2004. Target sold Mervyn’s to PE firms Sun Capital and Cerebrus, as well as real estate investor Lubert-Adler Management. The San Diego Union-Tribune explains what happened next:

The new owners changed the structure of the company, dividing it into separate real estate and retail businesses. In essence, the Mervyns real estate arm charged retailer Mervyns huge rents for its department store space.

“It didn’t make any logical business sense,” (one analyst) said. “The new owners saw it as a way to generate a lot of cash, but it was impossible for Mervyns to build a viable, long-term business facing those staggering rents.”

Mervyn’s ended up going the way of the dodo–after suing Cerebrus and Sun Capital for increasing rent to leverage the buyout.

It’s hard to imagine Target, a much stronger business than Mervyn’s, facing a similar fate. Still, if I held TGT shares, I’d steer clear of Ackman.