Why does the Franchise Group want to buy Kohl’s and what could happen next

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

Daniel Acker | Bloomberg | Getty Images

A little-known conglomerate including Vitamin Shoppe, Pet Supplies Plus, and a home furnishing chain called Buddy’s has suddenly become the talk of the retail industry.

The Franchise Group, a publicly traded company with a market capitalization of $1.6 billion, has entered into exclusive sale talks with Kohl’s. It proposed a $60-per-share offer to acquire the retailer at a valuation of nearly $8 billion. The Franchise Group and Kohl’s operate within a three-week window during which the two companies can finalize any due diligence and final financing arrangements.

Since then, questions have been swirling about what all of this will mean for Kohl’s, should the deal go through: What will happen to the beauty shop in Sephora’s stores within Kohl’s, or the retailer’s return partnership with Amazon? Will Michelle Gass, Kohl’s CEO, continue to work with the company? Are store closures inevitable?

Also, why would the Franchise Group want to own Kohl’s in the first place, as retailers including Kohl’s face inventory and inflation challenges? Just a few weeks ago, Coles lowered his financial forecast for the entire fiscal year as more Americans pulled back from discretionary spending. Meanwhile, investors are arguing with an interest rate hike by the Federal Reserve and the possibility of a recession in the near term.

The deal is still in flux, so these questions don’t have definitive answers at this point. Instead, analysts and experts are pointing to The Franchise Group’s past track record and recent acquisitions in order to better understand what Kohl’s future may hold.

Spokespeople for the Franchise Group, Sephora, and Amazon did not immediately respond to requests for comment for this story. Cole declined to comment.

What does the franchise group want?

“What the Franchise Group does is look for good business and strong known brand names with a good following of consumers,” said Michael Baker, Senior Research Analyst at DA Davidson.

“And so they have a different strategy on how to profit or how to monetize these acquisitions,” he added. “Sometimes they are converted from company-owned stores to franchise stores.”

The Franchise Group was founded in 2019 by the $138 million merger between Liberty Tax and Buddy’s, according to the company’s website.

Under the leadership of President and CEO Brian Kahn, who has a background in private equity, the Franchise Group has continued its operations in the Sears outlet. The Vitamin Shoppe American Frit Company that sells furniture, mattresses, and appliances; pet supplies plus; Learning by Sylvan and Badcock, a home furnishing chain that caters to low-income families.

The Vitamin Shoppe Store in New York.

Scott Millian | CNBC

The franchise group mostly operates franchisees. But the consensus is that Kahn likely won’t use the same strategy at Kohl’s, which has more than 1,100 brick and mortar stores in 49 states.

“The strategy will be there to work with the existing management team to operate [Kohl’s] Better, said Becker, or replace management if necessary. They did so with some of their origins. … he had a track record of doing good deals.”

Baker used the franchise group’s latest acquisition of Badcock, a deal valued at approximately $580 million, as an example. The company has since entered into two different sales agreements, one for the Badcock retailer and the other for distribution centers, corporate headquarters and additional real estate, netting approximately $265 million. Rob Burnett remains in position as President and CEO of Badcock.

On an earnings call in early May, Franchise Group’s Kahn told analysts — without naming Kohl’s directly — what to look for in a deal.

“Management for us is always key,” he said. “Whether we do very small transactions or very large transactions.”

“We have a lot of conviction about the brands we’re working with now,” Khan also said on the call.

He added that all of the Franchise Group’s previous acquisitions generate a lot of cash to support the company’s earnings and allow for more mergers and acquisitions, and any deals it sees in the future should also fit this template.

real estate play

Earlier this year, Kohl’s deemed a $64 share offer from Starboard-backed Acacia Research too low. In late May, the retailer’s stock traded as low as $34.64 and hasn’t reached $64.38 since late January. Kohl’s shares closed Wednesday at $45.76.

The Franchise Group would likely view its $60-a-share offer as somewhat of a steal, especially if the company could fund most transactions through real estate.

The Franchise Group said in a press release earlier this week that it plans to contribute about $1 billion of capital to the Kohl deal, all of which is expected to be funded through debt rather than equity. Apollo is designed to be the term loan provider for the Franchise Group, according to a person familiar with the matter. An Apollo spokesperson did not immediately respond to CNBC’s request for comment.

Meanwhile, the majority of this transaction is expected to be financed by real estate. CNBC previously reported that the Franchise Group is working with Oak Street Real Estate Capital on a so-called sale and leaseback transaction. Oak Street declined to comment.

If the order were executed in this way, the Franchise Group would receive a capital inflow from Oak Street, and would no longer have Kohl’s properties on its balance sheet. Instead, it will have lease payments and lease obligations.

As of January. 29, Kohl owns 410 locations, leased another 517 and operated land leases on 238 of its stores. All of the properties she owned were valued at just over $8 billion at the time, which the annual filing shows.

“If the franchise group can get $7 billion or $8 billion in real estate, they’re only paying about $1 billion in assets. So it’s pretty cheap,” said Susan Anderson, senior research analyst at B Riley Securities. . “I think [Kahn] He won’t do the deal unless he already has the sale deal and the agreements are already in place.”

‘Guide in place’

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

“This is completely unnecessary and will only dilute the company and restrict the investments needed to get the business going,” said Neil Saunders, managing director of GlobalData Retail. “Other retail acquisitions that have followed this model have never ended well for the acquired party.”

Certainly some sale and leaseback transactions, particularly those on a much smaller scale, have been viewed as successful.

In 2020, Big Lots reached an agreement with Oak Street to raise $725 million from the sale and leaseback of four company-owned distribution centers. It gave the big retailer extra liquidity during the imminent onslaught of the Covid-19 pandemic.

Also in 2020, Bed Bath & Beyond completed a sale and leaseback transaction with Oak Street, selling approximately 2.1 million square feet of commercial real estate and generating $250 million in revenue. Mark Tritton, Bed Bath CEO, described the deal at the time as a move to raise capital to reinvest in the business.

The Franchise Group may be looking to Kohl’s as a way to create more efficiencies on the backend, among all of its other businesses, according to Vincent Kainetic, an analyst at Stevens. He said pooling resources such as fulfillment centers and freight service providers could be a smart move.

“They have furniture stores, a rent-to-own store, and a lot of them deal with consumer goods,” Sentic said. “Maybe they can get additional pricing power by becoming bigger players.”

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

All of the retailers in the franchise group combined generated revenue of $3.3 billion in calendar year 2021. Kohl’s total revenue exceeded $19.4 billion in the 12-month period ending January 3. 29.

“The franchise group has a history of buying companies, upgrading them, and then freeing up capital very quickly to pay off that debt,” Caintic said. “They have a clue in place.”

But, he added, the companies the franchise bought out before Kohl went after her were much smaller — “and that was done when getting debt was very cheap.”

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