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Ackman Aims at Target's Land

Nicholas Yulico

A campaign to unlock value at Target(TGT Quote) is Bill Ackman's boldest move yet. And if history is any guide, the hedge fund manager is quietly employing his large network of investment banker and real estate contacts to help get backing for what will be his most difficult crusade ever.

Ackman, the head of Pershing Square Capital Management, has gained a reputation for innovative and audacious ideas to promote improvements at Wendy's(WEN Quote) and McDonald's(MCD Quote) that resulted in millions of dollars of value for shareholders.

In July, Ackman surprised Wall Street by zeroing in on Target, disclosing a 9.6% stake in the discount retailer because he felt the stock was undervalued. The fund manager said he wants to find ways to improve value at Target but didn't provide details of his intentions.

Several industry sources say that Ackman, as with his prior campaigns, is looking to generate more value from Target's real estate assets.

Getting Wall Street on board with that idea likely will be much more challenging than with his past efforts. There's not to complain about at Target, considering the health of the company and the belief that it's one of the most respected, best-run retailers in the U.S.

But it's little known that Ackman has ties to Wall Street heavy hitters who in the past have backed his proposals and helped his quests gain credence.

Blackstone Group (BX Quote) served as an influential adviser on the Wendy's and McDonald's campaigns by preparing reports backing Ackman's ideas that were shared with other institutional investors, sources say. Recently, Ackman acknowledged that he hired the investment bank Lazard to help him search for a better buyout deal for Ceridian(CEN Quote), a human resources firm that Ackman is now waging a proxy war against.

"Bill has been fairly aggressive about making sure that he stays in the mix with guys like Lazard, Blackstone and some of the guys in corporate strategy to get credibility for his ideas," says a veteran real estate investor who has worked on deals with Ackman in the past.

"He used some of the big firms to lend some credence to what would otherwise be considered harebrained ideas," the investor says. "Although his track record shows these are not harebrained ideas anymore."

At heart, Ackman is a real estate tycoon, ever since his days as a young late-20-something investor at the Manhattan-based real estate investment shop Gotham Partners, so it only makes sense that the majority of his activist targets center on the ability to unlock value from untapped real estate assets.

That's the case with Target, which owns some 85% of its stores. Ackman pushed for both Wendy's and McDonald's to sell off company-owned stores.

But one M&A advisory executive says that Target's case is more challenging because there may not be natural buyers for Target's stores. With Wendy's and McDonald's, for example, other franchisers served as logical investors. In Target's case, buyers might be more difficult to identify, the executive says.

Nonetheless, Ackman could be eyeing a sale-leaseback transaction for Target, industry experts say. In such a deal, an asset-heavy company sells properties, creates cash and takes on lease obligations for future rents.

"A lot of companies, especially retail companies, have embraced the concept of sale leaseback," says Edward LaPuma, a managing director with W.P. Carey(WPC Quote), a major provider of sale-leaseback financing.

One of the largest retail sale-leasebacks came when Kohlberg Kravis Roberts teamed up with Vornado Realty Trust(VNO Quote) and other partners to purchase Toys-R-Us in 2005. Since Target owns so much of its real estate, it would probably be a good candidate for a sale-leaseback situation, LaPuma says.

Despite this seemingly obvious real estate angle, the fact that Target is so widely respected as a retailer makes Ackman's campaign puzzling to industry veterans.

"I think it is an unusual example, because you usually focus on companies that are performing below their peer group from an operation standpoint or are inefficient in their use of capital. Target does not appear to meet either of those two criteria," says Randy Lampert, managing director of Morgan Joseph, who has written a study on shareholder activism.

Lampert says it wouldn't surprise him if, as in the past, Ackman enlisted a financial adviser on the Target proposal, "especially given the lack of apparent reason for the campaign."

The relationship between investment banks (and other advisers) and activist hedge fund managers is one that doesn't get much publicity. The most famous publicized case of an adviser teaming up with an activist fund manager came in 2005, when billionaire Carl Icahn enlisted Lazard in his campaign to maximize value at Time Warner(TWX Quote).

The remainder of these deals typically fly under the radar.

Ackman's relationship with Blackstone emerged with his investment in Wendy's in 2005. In an SEC filing, Ackman said he retained Blackstone as his financial adviser to evaluate his proposal for the fast-food chain. Wendy's eventually adopted a piece of Ackman's plan by spinning off its Tim Hortons(THI Quote) doughnut chain.

Ackman's relationship with Blackstone continued with the McDonald's campaign, sources familiar with the matter say. One such person speculates that Ackman paid Blackstone several million dollars to essentially create the report on McDonald's that was shared with other large institutional shareholders. A.J. Agarwal, a senior managing director at Blackstone, was a key point man on the McDonald's and Wendy's campaigns, sources say.

"Bill didn't need [Blackstone] to come to his own conclusion," says the industry source. But it provides weight for Blackstone "to do the report and say he's right," the person adds.

Blackstone and Ackman declined to comment for this article.

The fact that Ackman is even pressuring Target would have seemed much stranger back in 2003, when he dissolved his first hedge fund, Gotham Partners, because of unprofitable private-equity bets and a swarm of investor redemption demands. New York Gov. Eliot Spitzer, at the time attorney general, also had investigated Gotham about trading and research practices surrounding its investment in Pre-Paid Legal Services(PPD Quote).

After Gotham unwound in 2003, Ackman's comeback trail began with his first major investment idea for his new hedge fund, Pershing Square Capital Management. He purchased stock in Sears Roebuck and Kmart in 2004 before hedge fund guru Ed Lampert later merged the companies into Sears Holdings(SHLD Quote).

Ackman's research into the real estate value at both retailers propelled the respected real estate minds at Vornado Realty Trust to purchase a 4.3% stake in Sears in 2004, says an industry veteran familiar with matter.

"Bill was heavily involved in getting Vornado involved with Sears," the industry veteran says. Vornado also later invested in McDonald's after Ackman's ideas became public.

Whether Ackman ultimately succeeds with Target could depend on whether any of his previous contacts at Lazard, Blackstone or Vornado become involved. For now, this all remains a mystery.

One rival hedge fund manager remains skeptical about how Ackman could possibly convince Target's management that change is needed.

"Yet he always surprises me," he says, "So who knows."