Target's credit card crunch
Posted
Mar 14 2008, 10:33 AM
by
Anthony Mirhaydari
Rating:
Target, everyone’s favorite cheap-chic retailer, has a big ticking time bomb on its balance sheet. After rapidly expanding its in-store credit card program over the past year, taking on questionable risks, the company is now desperately trying to offload the decaying $8.6 billion portfolio. According to news out today, J.P. Morgan has stepped up and is interested in acquiring roughly 50% of the Target Red card and Target Visa accounts.
No doubt this was spurred by activist investor William Ackman, who back in December snatched up a 10% share in the company through his Pershing Square hedge fund. Ackman pushed management hard to sell the cards business, but they replied that “market conditions” were delaying the decision. Well, unless I missed something, the “market conditions” have been getting a heck of a lot worse since then. So why sell now? With the big banks hoarding cash, margins being called, and blood on the Street, the terms couldn’t have gotten any sweeter.
Unfortunately, details aren’t forthcoming as the company’s press release describing the deal was rather vague. Portales Partners analyst William Ryan noted “the company created more confusion than it provided detailed information.” Everyone is still trying to figure out what’s going on and determine whether this is good news or not.
Given Target’s “attitude of invincibility” and rapid credit growth at a time of tightening standards and rising defaults elsewhere, the sale should be considered a step in the right direction. Target’s credit balances have been growing at an accelerating rate, up nearly 30% last year. In comparison, outstanding loans at J.P. Morgan grew 3% last year while Capital One actually scaled back 2.8%.
William pointed out in a research note this week that Target’s credit portfolio was expanding so quickly, while declining in quality, that it posed a bigger threat to profitability than management was letting on. Target even let its bad-loan reserve fall to 6.6% of the portfolio in the last quarter, down from 7.7% in the prior year. This is counterintuitive and a sign of aggressive accounting given the rising pressures on the American consumer.
A straight purchase seems to be the most probable scenario, in which the buyer would pay par value for the 50% share. William isn’t looking for any kind of premium due to the difficult conditions in the credit markets, the weakness of the portfolio, and the fact that many of the potential buyers “are mired in their own financial/credit related turmoil.”
Previously, company management indicated they would use the proceeds to pay down debt. At the end of the day, this means Target will sell away roughly $550 million of its annual income for a $213 million reduction in interest expense. You don’t need a Ph.D in finance to know that isn’t a great deal.
From my vantage, it looks like sale is being motivated by a fear. Target’s management got in over their heads and extending credit recklessly to juice their quarterly retail sales numbers. Now they’re desperately trying to jettison the junk as Ackman breathes down their necks. Regrettable, since the cards business was so profitable for so long.
Colin Barr at Daily Briefings thinks otherwise and smiles upon the deal. He quotes the company's press release where it says J.P. Morgan's "broad experience is expected to result in strategic and financial benefits to Target over time.” Maybe the match is made in heaven, but when was the last time someone found true love with a bomb strapped to their chest?
(Disclosure: I don't own any shares of the companies mentioned in this post.)
