Why the Franchise Group wants to buy Kohl’s and what might happen next

Shoppers enter a Kohl’s store in Peoria, Illinois.

Daniel Acker | Bloomberg | Getty Images

A little-known conglomerate of companies, including The Vitamin Shoppe, Pet Supplies Plus and a furniture chain called Buddy’s, is suddenly the talk of the retail industry.

The Franchise Group, a publicly traded company with a market capitalization of about $1.6 billion, has entered into exclusive sale negotiations with Kohl’s. He proposed an offer of $60 per share to acquire the retailer at a valuation of approximately $8 billion. Franchise Group and Kohl’s are in a three-week window during which the two companies can enter into any due diligence and final financing arrangements.

Questions have since arisen about what all this will mean for Kohl’s, should a deal go through: What will happen to Sephora’s beauty stores inside Kohl’s or the retailer’s comeback partnership with Amazon? Will Kohl’s CEO Michelle Gass remain 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, Kohl’s lowered its financial forecast for the full fiscal year as more Americans cut back on discretionary spending. Meanwhile, investors are grappling with the Federal Reserve’s rate hikes and the potential for a recession in the short term.

The deal is still ongoing, so these questions don’t have firm answers at this point. Instead, analysts and experts point to the Franchise Group’s track record and its recent acquisitions for a better sense of what Kohl’s future may hold.

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

What the Franchise Group wants

“What the Franchise Group does is look for good businesses and strong, well-known brands with a good following of consumers,” said Michael Baker, senior research analyst at DA Davidson.

“And then they have a different strategy on how to capitalize or monetize those acquisitions,” he added. “Sometimes it’s turning them from flagship stores to franchise stores.”

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

Under chairman and CEO Brian Kahn, who has a background in private equity, the Franchise Group won Sears’ outlet business; Vitamin Shoppe; American Freight, which sells furniture, mattresses and appliances; Pet Supplies Plus; Wild Learning; and Badcock, a home improvement chain serving low-income families.

A Vitamin Shoppe store in New York.

Scott Mlyn | CNBC

Franchise Group is primarily in the business of owning franchises. But the consensus is that Kahn is unlikely to employ the same strategy at Kohl’s, which has more than 1,100 brick-and-mortar stores in 49 states.

“The strategy there would be to work with the current management team to execute [Kohl’s] better, or replace management if necessary,” Baker said. “They did that with some of their assets. … Kahn has a track record of doing good business.”

Baker used the latest acquisition of Badcock by the Franchise Group, a deal valued at about $580 million, as an example. Since then, the company has entered into two separate sales agreements, one for Badcock’s retail stores and one for its distribution centers, corporate headquarters and additional real estate, totaling around $265 million. Rob Burnette remains in his role as president and CEO of Badcock.

On an earnings call in early May, Kahn of the Franchise Group told analysts β€” without directly naming Kohl’s β€” what he looks for in any transaction.

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

“We have a lot of conviction in the brands we operate now,” Kahn said on the conference call.

He added that all of the Franchise Group’s previous acquisitions generate a lot of cash to support the company’s dividends and allow for more M&A activity, and any deals he considers in the future will also have to fit that mold.

a real estate game

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

The Franchise Group likely views its $60-a-share offer as theft, particularly if the company can finance most of the transaction through real estate.

Franchise Group said in a press release earlier this week that it plans to contribute about $1 billion in equity to the Kohl transaction, which is expected to be financed through debt rather than equity. Apollo is in talks to potentially be the Franchise Group’s term loan provider, according to a person familiar with the matter. Apollo declined to comment.

Meanwhile, most of this business is expected to be financed through real estate. CNBC previously reported that the Franchise Group is working with Oak Street Real Estate Capital on a so-called sell-lease transaction. Oak Street declined to comment.

If it played out this way, the Franchise Group would receive an influx of capital from Oak Street and would no longer have Kohl’s real estate on its balance sheet. Instead, it would have rent payments and lease obligations.

As of January 29, Kohl’s owned 410 locations, leased another 517 and operated land leases in 238 of its stores. All the properties he owned were valued at just over $8 billion at the time, an annual filing shows.

“If the Franchise Group gets the $7 billion or $8 billion in real estate, they’re only paying about $1 billion for the assets. So it’s very cheap,” said Susan Anderson, senior research analyst at B. .Riley Securities. “And I think [Kahn] wouldn’t do the deal unless he already has the sale lined up and the deals already in place.”

‘A manual in place’

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

“This is completely unnecessary and will only serve to weaken the company and constrain the investments needed to revitalize the business,” said Neil Saunders, managing director of GlobalData Retail. “Acquisitions of other retail businesses that followed this model never ended well for the party being acquired.”

Certainly, some sale-lease transactions, and particularly those on a much smaller scale, were seen as successful.

In 2020, Big Lots reached an agreement with Oak Street to raise $725 million by selling four company-owned distribution centers and leasing them back. This gave the large retailer additional liquidity during the start of the Covid-19 pandemic.

Also in 2020, Bed Bath & Beyond completed a sell-lease transaction with Oak Street, in which it sold approximately 2.1 million square feet of commercial real estate and raised $250 million in revenue. Bed Bath CEO Mark Tritton lauded the deal at the time as a move to raise capital to reinvest in the business.

The Franchise Group may have its eye on Kohl’s as a way to create more back-end efficiencies among all its other businesses, according to Vincent Caintic, an analyst at Stephens. Bringing together resources like fulfillment centers and shipping providers could be a smart move, he said.

“They have furniture stores, a rental store of their own and a lot of them deal in consumer goods,” Caintic said. “Maybe they can get some additional price power by becoming a bigger player.”

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

All Franchise Group retailers combined had revenue of $3.3 billion in calendar year 2021. Kohl’s total revenue exceeded $19.4 billion in the 12-month period ending Jan. 29.

β€œThe Franchise Group has a history of buying companies, leveraging them and releasing capital very quickly to pay off this debt,” said Caintic. “They have a primer in place.”

But, he added, the companies the Franchise bought before chasing Kohl’s were much smaller – “And these were made when it was very cheap to get debt.”

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