Activist Spotlight: What’s behind the campaign to force changes at Kohl’s

Percentage Ownership: 9.48%

Average Cost: $43.73

Activist Commentary: Macellum is not an activist investor but is willing to take activist measures when they believe change is necessary. They have significant experience with consumer retail companies, and that experience is evident in their detailed letter to the board. While Macellum prefers to work constructively with a company, it has had past success at The Children’s Place, Christopher & Banks, Citi Trends, Bed Bath and Beyond and Big Lots, receiving board representation through settlements. In this situation, Macellum has teamed up with Legion Partners, Ancora Advisors and 4010 Capital (collectively, the “Group”). The Group’s 9.48% ownership is comprised of Macellum (5.53%), Ancora (2.59%), Legion (1.34%) and 4010 Capital (.02%).

The group sent a very detailed letter and analysis to the company highlighting its case for change at Kohl’s and nominating nine directors for election to the board. The group’s letter starts by glaringly pointing out Kohl’s extreme underperformance to the market and its peers over the long term. The group believes this is because the board failed to develop and oversee a strategic plan in response to a rapidly-changing retail environment, and they back this statement up with many detailed problems they identify at the company such as stagnant revenue and declining margins. The group notes the company’s sales are basically the same as 2011 with compounded same store sales declining since then by 0.6% while the industry grew at 17%. This is particularly troubling in light of the many competitive store closures and bankruptcies in the industry over that time resulting in $12 billion of sales that could have accrued to Kohl’s.  The group believes that the reasons for stagnant sales include a repetitive and over-assorted collection, disappointing new brand launches and private label failures, losing market share in the home category, confusing promotional gimmicks, and confusing loyalty programs.

The company’s operating margins have also been a problem, declining from 11.5% in 2011 to 6.1% in 2019. The group details reasons for the company’s declining gross margins including several factors including low inventory turnover, leading to large markdowns, unproductive product and pricing mixes, failures to offset higher shopping expenses, inefficient sourcing agreements and failures in its private label products and poor e-commerce. The group also points to a bloated S,G&A as a culprit – an increase of more than $450 million in SG&A from 2014 to 2019 while sales were flat. Macellum blames this on a lack of cost/benefit analysis and cost discipline – for example, the activist alleges the company keeps a full-time flight crew and two private jets.

This lack of discipline extends to capital allocation where the group believes that the board has not demonstrated sufficient discipline in overseeing a prudent capital spending program. In addition to these operational issues, which could take some time to remedy, the group makes a capital allocation suggestion that could create more immediate shareholder value. They state that the company has $7-8 billion in value trapped in non-core, non-earning real estate assets and at least $3 billion of that could be unlocked through sale-leaseback transactions in 60 to 90 days. Moreover, if the company uses the proceeds to buy back shares, this could result in little to no annual cash flow impact depending on when and at what level the company reinstates the dividend.

While the group identifies many serious issues with the company, these issues are not problems as much as a symptom of the larger problem that the group also identifies – a culture at the company that lacks cost discipline by management and a board that does not prioritize efficiency and cost cutting or that will hold management accountable. This is a culture that allows for multiple private jets and where executives could receive 100% of their target bonus on a decrease in sales and net income. It is clear that the problem starts at the board as the company has been led by several different management teams but the board has largely remained the same. The group also does not have hope for the future of the company under this board and management team as it points out that the company’s 2020 investor presentation looks “hauntingly familiar” to its 2014 plan that it grossly failed to achieve.

The group is nominating a majority of nine directors to the board, but just because they are asking for a majority does not mean they will insist on it. In Macellum’s 13D at Bed, Bath and Beyond they initially nominated 15 directors (later reduced to 10) and settled for 4. And in their 13D at Big Lots, they also nominated a nine-person majority but settled for two. Both of those investments were with a similar investor group as Kohl’s and in both Macellum has shown that they do not need a majority of seats to create value. Based on the company’s horrid performance and operations and Macellum’s history in consumer retail, we would expect the company to genuinely engage with them. While Macellum is reasonable and would likely settle for less than a majority, they also would not hesitate to bring a full-fledged proxy fight if necessary and could very well receive a majority of seats in a shareholder vote.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.