Capital Markets

What’s Target Really Up To?

Its plan to review credit-card alternatives may reflect interest in a securitization, rather than an outright sale of the business.
Roy HarrisSeptember 13, 2007

Target Corp.’s description of a plan to “review ownership alternatives” for its $7 billion of credit-card receivables seems more likely to result in a securitization than the sale of the assets to a bank, as other retailers have done.

The Minneapolis-based retailer said on Wednesday that it had engaged Goldman Sachs to advise it in a study of credit-card assets that will run through the end of December. The work “will be focused on the economics of possible alternatives and will include, but not be limited to, an examination of possible differences in growth rates and credit risk exposure between the current direct ownership model and other possible ownership structures, the cost of debt and equity capital to fund our receivables, and current and future liquidity considerations.”

Target’s credit-card review was widely interpreted as a response to pressure from activist William Ackman, of Pershing Square Capital, for Target to find ways to boost its stock price. Short-term, the Target plan did just that, as Bloomberg News reported that shares rose $1.92, or 3 percent, to $64.64 by mid-afternoon on Thursday. The news service identified Ackman as controlling 9.6 percent of Target, the nation’s largest discounter after Wal-Mart.

Many observers also saw Target as suggesting that it might be considering a sell-off of its entire credit-card business, as Sears and Macy’s have done before it. (Each selected Citigroup as the purchaser.) Elements of the Target announcement, however, point to such a dramatic approach being less likely for Target than either a securitization or a one-time sale of receivables that allows it to retain the credit-card business itself. Target’s release referred several times to selling “receivables,” rather than the credit-care business unit. A sale of receivables is often the first step in a securitization, giving the seller an upfront infusion of cash while transferring rights to future payments to investors in the form of asset-backed commercial paper or other securities. Under that scenario, Target would continue to own its credit-card business and also likely would continue to collect and service the receivables.

If Target is indeed considering a securitization, the cautious, exploratory approach it is taking in doing so could be a further indication of the decline in investor appetite for asset-backed commercial paper. A year ago the disposal of Target’s receivables, while a large issuance requiring due diligence, would have posed little problem. The volatile market today, however, could offer a test of investors’ willingness to digest such an offering.

Target spokesman John Hulbert told that the company’s plan to study alternatives did not reflect the current volatile credit-market situation or other outside factors. Asked whether securitization was an option being considered, he said that “there are many possible structures in which we would no longer have the receivables on our balance sheet. We want to make sure that whatever is done with those receivables is consistent with our brand.”

In the announcement, much of the description of the review came from CFO Doug Scovanner, who also expanded on the release in a brief recorded message that Target made available. In that message, Scovanner said that Target is “committed to maintaining the core operations of Target Financial Services and its team, including all aspects of the interaction between our team members and our guests” — as the company calls its customers.

Scovanner also emphasized that Target’s credit-card business, run through its own Target National Bank industrial loan corporation, is “unique to the retail industry.” Target’s main finance products are its Target Visa Card and Target Credit Card, both of which are known as REDcards, and its millions of account holders make it among the nation’s 10 largest credit-card issuers. Target reported its second quarter ended Aug. 4 that $163 million in operating income came from the business, up 34 percent over the prior year’s contribution.

“Given our objective to create substantial shareholder value over time, we plan to approach the capital markets to determine whether Target or a financial institution is better suited to own our receivables,” Scovanner said. Unlike other retail credit-card portfolios, Target’s “include strong double-digit growth, a consistently high yield and unprecedented integration with our retail operations,” according to the CFO. “Regardless of whether or not our review results in a receivables sale, we intend to maintain our core financial services operation” and to build the Target financial team

A second part of Target’s Wednesday announcement involved a company plan to review the role of debt in its capital structure and “the pace of current and possible future share repurchase activity.” Currently, Target has $3.5 billion left to go on an $8-billion repurchase authorization, which it expects to complete “by the end of 2010 or sooner,” according to spokesman Hulbert. (While he did not expand on what changes might be considered in the capital-structure review, he added that “nothing in the review of alternatives represents an about-face” for Target.)

In Scovanner’s remarks, the CFO further said that he remains “firmly committed to maintaining Target’s strong investment-grade credit ratings,” and that “specifically we will not consider taking any deliberate actions that would jeopardize our current short-term debt ratings.” Target also expects “to preserve our long-term debt ratings within the ‘A’ category,” he added, noting that long-term debt currently is rated A1 with Moody’s and A-plus in the Standard & Poor’s and Fitch systems.

On Thursday, however, S&P said it may lower it’s A-plus rating based on the possibility of a Target credit-card portfolio sale and a potential speed-up of share-repurchase plans, Bloomberg reported. Any downgrade would probably be limited to one level, S&P said, reflecting Target’s commitment to keeping an A rating.

In a report for Gimme Credit, analyst Carol Levenson weighed in on the Target announcement as “a perfect example of how shareholder activism can hurt shareholders as well as bondholders, especially when messing with an already well-run company.” Target’s review of alternatives for its credit operations and its capital structure, “obviously bowing to pressure (implied or exerted) from Pershing Square Capital,” comes “right at the start of an already iffy holiday shopping season.” If Target’s actions don’t lift the stock price, Levenson wrote, the company’s “devotion to high ratings could come under pressure.”

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