March 13, 2008
Target Looking to Sell Half of Credit Card Biz
It might seem odd timing that Target would attempt to sell half of its credit card business while the country is in the middle of a credit crunch, but that is exactly what the retail chain has said it is attempting to do.
According to a report by Bloomberg, Target is in the process of selling part of its $8.3 billion portfolio while seeking to create a “long-term” relationship with the company that acquires the loans.
The retailer has been looking at a possible sale of the credit card unit since activist investor William Ackman began pushing the company to take steps to unlock the value of the chain’s stock.
Whether a deal at this time makes sense, analysts agree, depends on what Target gets for the business.
Carol Levenson, director of research at Gimme Credit, wrote in a report, “Would you call this a Solomon-like solution? Target seems to have come up with a plan for its credit card business that doesn’t contradict management’s longstanding contention that it was integral to the retailing operations but that might placate activist shareholders.”
“Without knowing anything more about the use of proceeds, we don’t see this as a credit positive,” she added.
Gwenn Bezard, an analyst at Aite Group, told The Associated Press that she sees the logic in Target’s move.
“It’s driven by the economy. It’s driven by the fact that you have more and more concerns over the fate of the receivables portfolio,” she said. “Target over the past few years has been very aggressive in growing the portfolio.”
Discussion Questions: What is your reaction to Target’s plan to sell half of its credit card portfolio considering it resisted making such a move for such a long time? Will other retailers follow suit?
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This appears to be just a smart management decision. Companies and retailers in particular should concentrate and focus on their core business. Making money elsewhere just takes management time and focus. Freeing up $8 billion will allow them to build many new stores. Retail is not like other businesses, it is always changing. Therefore, companies need to be on top of their game to say competitive.
Credit card lending is a great way to boost retail profits. If the retailer can borrow at 7% and lend at 29%, the 3% expense ratio and 4% loss ratio still leave plenty of room for profit. And promotions aimed at the store’s card holders generally work much better than promotions aimed at the general public. But Target, like some other publicly-held companies, works to please its shareholders. And William Ackman isn’t the only shareholder who wants Target to generate cash by selling its receivables.
I’d suggest you look no further than Bill Ackman for the culprit or guiding light behind this decision. This is usually the first thing an activist shareholder insists on if he’s a hedge fund manager, mainly because it’s the quickest way to provide a relatively large spike in shareholder value.
Take a look at present day Sears to see where this way of thinking eventually leads. They did the same thing a few years ago, just a few months after their then CEO had (at least for employee/media consumption) been touting the credit division as the only significant revenue producer the company had left. Chances are middling to good it was for much the same reason too.
It would appear that large scale professional investors who buy large stakes in companies just so they can realize a short term profit by introducing massive cost cutting procedures and forcing the sale of assets do neither the company or the general economy any good over any significant term. Looks like in fact, that they themselves are the ONLY ones that benefit.
Considering the liquidity crisis in the financial & banking system, the timing is NOT ideal for getting top dollar. But since the liquidity crunch is beginning to back up into retail, maybe the timing IS ideal–as long as Target can do the deal quickly with a buyer who won’t look too closely.
Which may be problematic. Card companies are panicking over record defaults–unlike mortgages or car loans, card debt is unsecured. The crisis has already spread up the FICO chain into so-called ‘prime’ risk ranges, meaning the predictive models for credit line decisions aren’t working as well in this economy.
Store cards historically attract a lower credit-quality applicant, and Target’s recent aggressive portfolio expansion suggests that their customers, particularly new accounts, may be riskier than average. Target’s buyer/partner would have to have plentiful funds and a voracious appetite for added risk–rare qualities in today’s troubled times.
The timing seems off, given the market conditions. Perhaps management sees risks that aren’t yet apparent or built into the market.
Another possibility is that the portfolio is showing signs of stress and Target is trying to unload it before the damage shows. I read an article that said they were rapidly expanding their portfolio this past year, which is contrary to what everyone else is doing. Their management said they have a good handle on credit risk, but then that’s what Wall Street said about mortgages.
Back in the days of the tech bubble Lucent and other companies (remember Carly Fiorina?) engaged heavily in what was called vendor financing, loaning money to the tech companies to buy the equipment. Sales got pumped up, and after Carly left, all the receivables got written down. So are Target’s (not so great lately) sales being purchased by lowering credit standards?
Time will tell.
With the credit market in the US having the difficulties it is having, it does seem to make great economic sense to get out of the credit business, especially if this is not the core business of a corporation.
Target seems to have found a partner that will allow it to continue to build its relationships with the future credit card customers, while minimizing its risk. At the same time, they will get a huge influx of cash, that can be used to upgrade stores, open new stores, and in short grow their retail business, which is their core competency. This should only be seen as a smart move.
My reaction is that the pressure of Bill Ackman of Pershing Square Capital, which owns 9.6% of Target’s stock, prevailed.
Resistance to key stockholder’s pressure lasts only so long as a company can be judged to be financially prudent. And today half a credit portfolio sale by Target is better than nothing. Last September, Target announced that it would put out bids for its receivables. Since then the credit environment has tanked and Target’s credit card portfolio has been deteriorating. Thus, Target is trying to get a deal done that will make Wall Street happy. If other retailers feel a similar pinch, they would follow.
Selling half of their credit card portfolio is just another technique of Retail 101. Most large retailers have sold their credit portfolios to generate funds to use for expansion, reduction of debt or share buybacks.
In today’s difficult retail economy, Target sees an opportunity to create significant liquidity with this transaction. Obviously, the Target portfolio must be quite strong to attract quality interest prior to a potential “credit card crises.” As the store already sold almost 10% of their portfolio, in a stronger economic environment, they have a good idea of the value and would not sacrifice significant profits unless they were comfortable with the price.
One must assume that Target management is making a sound decision based on opportunity rather than a hasty move based on dire need.