Target Corporation: Ackman versus the Board

Harvard Business School Case # 109010

Case Software # XLS-652

Copyright © 2010 President and Fellows of Harvard College. No part of this product may be
reproduced, stored in a retrieval system or transmitted in any form or by any means—electronic,
mechanical, photocopying, recording or otherwise—without the permission of Harvard Business
School.
 Ackman's demands Why Target should keep credit cards?
2008 Real estate sales lease back The use of credit cards enabled Taget to better capture information on
2009 Two board seats Target's typical customer had higher income and better credit histories
Credit cards Though its account receivables is 13 times higher than walmart its cas
Increasing stock buyback program

Credit card sales revenue grew by 25% annually from 2001 to 2008 co

What are credit card expenses?

Walmart had 24% of its revenue from international business

Target Director Steinhafel estimated Target could almost double its 2008 size without

4.908 1.98 Acquistion cost lower than share price?

What is the problem with target?

In March 2009 its annualised debt hit 14.2% ($100 million), up from just over 8% one year ealier
The number of cardholders, who were behind on their payments, an early indicator of default had begun to decline
 Why it should sell off credit card business?
er capture information on customer buying behaviour Credit card not core business
and better credit histories than those of its competitors
igher than walmart its cash ratios and operating cashflow ratios are better

ually from 2001 to 2008 compared to 10% growth rate in retail sales Does this prove their revenues increased in actual number
Or their customers have shifted to credit cards?

tional business
uble its 2008 size without expanding outside of US
Why did target agree for stock buy back
than share price?

gun to decline
creased in actual number?
o credit cards?
Exhibit 1 Target Corporation Financial Summary—Continuing Operations (dollar amounts in millions, except ratios and per share data)

2008a 2007
Financial Results (in millions): 0.022986 0.062079
Sales 62884.00 61471.00
Credit card revenues 2,064 1,896

Growth in credit card revenues 8.86% 17.62%

Credit Card revenues/Sales 3.28% 3.08%

Total revenues 0.0651706169 64,948 63,367

Cost of sales 44,157 42,929
68% 68%
Selling, general, and administrative expenses 12,954 12,670
Credit card expenses 1,609 837

Earnings from continuing operations before

Income taxes 4,402 4,625
Earnings from continuing operations $2,214 $2,849

Per Share:
Basic earnings per share $2.87 $3.37
Diluted earnings per share $2.86 $3.33
Cash dividends declared $0.62 $0.540

Financial Ratios:
Revenues per square foot b,c $301 $318
Comparable-store sales growth (2.9%) 3.0%
Gross margin rate (% of sales) 29.8% 30.2%
SG&A rate (% of sales) 20.4% 20.4%
EBIT margin (% of revenues) 6.5% 7.1%

Other:
Common shares outstanding (in millions) 752.7 818.7
Cash flow provided by operations (in millions) $4,430 $4,125
Retail square feet (in thousands) 222,588 207,945
Square footage growth 7.0% 8.3%
Total number of stores: 1,682 1,591
General merchandise 1,443 1,381
SuperTarget 239 210
Total number of distribution centers 34 32

Source: Adapted from Target Corporation's 10-Ks 2008 and 2009.

a
Fiscal year: Target's fiscal year ends on the Saturday nearest January 31. Fiscal year 2008 ended January 31, 2009.
b
Thirteen-month average retail square feet.
c
In 2006, revenues per square foot were calculated with 52 weeks of revenues (the 53rd week of revenues was excluded) because management believes that these numbers provide a more useful analytical comparison to
principles, 2006 revenues per square foot were $322.
 2006 2005 2004 2003 2002 2001 2000 1999
0.128864 0.122346 0.116155 0.120732 0.120146 0.106578 0.120399
57878.00 51271.00 45682.00 40928.00 36519.00 32602.00 29462.00 26296.00
1,612 1,349 1,157 1,097 891 419 278 233

19.50% 16.59% 5.47% 23.12% 112.65% 50.72% 19.31% In 2001 Target launched Visa credit cards
2.79% 2.63% 2.53% 2.68% 2.44% 1.29% 0.94% 0.89%

59,490 52,610 46,839 42,025 37,410 33,021 29,740 26,529

40,366 35,788 32,226 29,057 25,498 23,030 20,870 18,576
68% 68% 69% 69% 68% 70% 70% 70%
11,852 10,324 9,016 7,989 7,505 6,612 6,025 5,424
707 776 737 722 629 313 185 155

4,497 3,860 3,031 2,603 2,227 1,776 1,562 1,336

$2,787 $2,408 $1,885 $1,619 $1,376 $1,101 $962 $818

$3.23 $2.73 $2.09 $1.78 $1.52 $1.22 $1.06 $0.93

$3.21 $2.71 $2.07 $1.76 $1.51 $1.21 $1.06 $0.88
$0.460 $0.380 $0.310 $0.270 $0.240 $0.225 $0.215 $0.200

$316 $307 $294 $287 $281 $277 $276 $269

4.8% 5.6% 5.3% 4.4% 2.2% 4.1% 3.4% 6.7%
30.3% 30.2% 29.5% 29.0% 30.2% 29.4% 29.2% 29.4%
20.3% 19.9% 19.6% 19.4% 20.5% 20.3% 20.5% 20.6%
7.4$ 7.5% 7.2% 7.0% 7.5% 6.8% 6.7% 6.8%

859.8 874.1 890.6 911.8 909.8 905.2 897.8 911.7

$4,862 $4,451 $3,808 $3,188 $2,703
 192,064 178,260 165,015 152,563 140,294 125,359 113,060 103,369
7.7% 8.0% 8.2% 8.8% 11.9% 10.9% 9.4% 8.9%
1,488 1,397 1,308 1,225 1,147 1,053 977 912
1,311 1,239 1,172 1,107 1,053 991 947 896
177 158 136 118 94 62 30 16
29 26 25 22 16 14 12 11

useful analytical comparison to other years. Using our revenues for the 53-week year under generally accepted accounting
 1251 481
160%
Exhibit 2 Wal-Mart Financial Summary (dollar amounts in millions, except ratios and per share data)

2008a 2007 2006 2005 2004 2003 2002 2001 2000 1999

Operating Results
Net sales $401,244 $374,526 $344,992 $308,945 $281,488 $252,792 $226,479 $201,166 $178,028 $153,345
Net sales increase 7.2% 8.6% 11.7% 9.8% 11.4% 11.6% 12.6% 13.0% 16.1% 18.7%
Comparable store sales increase in the U.S. 3.5% 2% 2% 3% 3% 4% 5% 6% 5% 8%
Cost of sales $306,158 $286,515 $264,152 $237,649 4216.832 $195,922 $175,769 $156,807 $138,438 $119,526
Operating, selling, general, and administrative
expenses 76,651 70,288 64,001 55,739 50,178 43,877 39,178 34,275 29,942 25,182
Interest expense, net 1,900 1,798 1,529 1,178 980 825 930 1,183 1,194 837
Effective tax rate 34.2% 34.2% 33.6% 33.1% 34.2% 34.4% 34.9% 36.4% 36.6% 37.4%
Income from continuing operations $13,254 $12,884 $12,178 $11,408 410,482 $9,096 $7,940 $6,718 $6,446 $5,582
Net income 13,400 12,731 11,284 11,231 10,267 9,054 7,955 6,592 6,235 5,324
Per share of common stock:
Income from continuing operations, diluted $3.35 $3.16 $2.92 $2.72 $2.46 $2.08 $1.79 $1.50 $1.44 $1.25
Net income, diluted 3.39 3.13 2.71 2.68 2.41 2.07 1.79 1.47 1.39 1.19
Dividends 0.95 0.88 0.67 0.60 0.52 0.36 0.3 0.28 0.24 0.2

Financial Position
Current assets of continuing operations $48,754 $47,585 $46,982 $43,752 $37,913 $33,548 $28,867 $25,915 $24,796 $22,982
Inventories 34,511 35,180 33,685 31,91 29,419 26,263 24,098 21,793 20,710 18,961
Property, equipment and capital lease assets, net 95,653 97,017 88,440 77,865 66,549 57,592 50,053 44,172 39,439 34,570
Total assets of continuing operations 163,234 163,514 151,587 136,230 117,139 102,455 90,229 79,301 74,316 67,290
Current liabilities of continuing operations 55,307 58,454 52,148 48,954 42,609 37,308 31,752 26,309 28,096 25,058
Long-term debt 31,349 29,799 27,222 26,429 20,087 17,088 16,545 15,632 12,453 13,650
Long-term obligations under capital leases 3,200 3,603 3,513 3,667 3,073 2,888 2,903 2,956 3,054 2,852
Shareholders' equity 65,285 64,608 61,573 53,171 49,396 43,623 39,461 35,192 31,407 25,878

Financial Ratios:
Current ratio 0.9 0.8 0.9 0.9 0.9 0.9 0.9 1.0 0.9 0.9
Return on assets 8.4% 8.4% 8.8% 9.3% 9.8% 9.7% 9.6% 9.0% 9.3% 10.1%
Return on shareholders' equity 21.2% 21.1% 22.0% 22.9% 23.15 22.4% 21.8% 20.7% 23.0% 24.55
Other Year-End Data

Wal-Mart U.S. Segment

Discount stores in the United States 891 971 1,075 1,209 1,353 1,478 1,568 1,647 1,736 1,801
Supercenters in the United States 2,612 2,447 2,256 1,980 1,713 1,471 1,258 1,066 888 721
Neighborhood Markets in the United States 153 132 112 100 85 64 49 31 19 7
International Segment
Units outside the United States 3,615 3,121 2,757 2,181 1,480 1,249 1,173 1,-5- 055 902
Sam's Club Segment
Sam's Clubs in the United States 602 591 579 567 551 538 525 500 475 463

Source: Adapted from Wal-Mart Stores, Inc., forms 10-K 2008 and 2009.

a
Fiscal year: Wal-Mart's fiscal year ends January 31. For the purposes of this case study fiscal year 2008 ended January 31, 2009.
Exhibit 4 Stock Market Information for Target and Wal-Mart (January 30, 2009)

Target Wal-Mart
Stock price $31.20 $47.12
Price-earnings multiple 10.87 14.02
Price-to-book-equity multiple 1.72 2.83
Estimated cost of equitya 10.01% 8.27%

Source: Adapted from data from http://www.ustreas.gov/offices/domestic-finance/debt-

management/interest-rate/, accessed June 2009.

a
Cost of equity calculated as 10-year U.S. treasury (2.87%) plus company's beta (0.9 for Wal-Mart and
1.19 for Target) x market premium (6%).
Exhibit 5 Target Corp Sales by Product Categories

2008 2007 2006 2005

Consumables and commodities 37% 34% 32% 30%
Electronics, entertainment, sporting goods and toys 22 22 23 23
Apparel and accessories 20 22 22 22
Home furnishings and decor 21 22 23 25
Total 100% 100% 100% 100%

Source: Adapted from Target Corporation's 10-Ks 2008 and 2009.

2008 2007
Grocery 49% 47% 50% of Walmart's busines
Entertainment 13 14 In 2009 Target operated 14
Hardlines 12 12 Target was opening 100 ne
Apparel 11 12
Health & Wellness 10 9
Home 5 6
Total 100% 100%
50% of Walmart's business is groceries. So is it appropriate to compare with Walmart?
In 2009 Target operated 1443 Target stores and 239 SuperTarget stores which included a full grocery offerings
Target was opening 100 new stores per year and increasing its emphasis on grocery and other consumable items
Exhibit 6 Wal-Mart U.S. Segment Sales by Product Category a

2008 2007
Grocery 49% 47%
Entertainment 13 14
Hardlines 12 12
Apparel 11 12
Health & Wellness 10 9
Home 5 6
Total 100% 100%

Source: Wal-Mart Stores Inc. 10-K 2009.

a
Wal-Mart U.S. consisted of Wal-Mart Supercenters, Wal-Mart discount stores,
and Wal-Mart Neighborhood Markets stores. Wal-Mart U.S. did not include Wal-
Mart's International segment or the U.S. operations of its Sam's Club segment.
Exhibit 7 Financial Ratios—Target and Wal-Mart

Target Wal-Mart
2006 2007 2008 2006 2007 2008
DECOMPOSING PROFITABILITY: DUPONT
ALTERNATIVE
NOPAT/Sales 5.4% 5.2% 4.3% 3.6% 3.8% 3.7%
x Sales/Net Assets 2.65 2.55 2.17 4.04 4.03 3.88
= Operating ROA 14.2% 13.3% 9.3% 14.7% 15.2% 14.3%
Spread 9.3% 8.3% 5.4% 10.7% 10.6% 10.6%
x Net Financial Leverage 0.58 0.59 0.96 0.61 0.51 0.61
= Financial Leverage Gain 5.4% 4.9% 5.2% 6.5% 5.4% 6.4%
ROE (Operating ROA + Spread *
Net Financial Leverage) 19.60% 18.2% 14.5% 21.2% 20.7% 20.7%

EVALUATING OPERATING MANAGEMENT

Key Growth Rates:

Annual Sales Growth 13.1% 6.5% 2.5% 10.4% 8.5% 7.2%
Annual Net Income Growth 15.7% 2.2% -22.3% 0.5% 12.8% 5.3%

Key Profitability Ratios:

Sales / Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100%
Cost of Sales / Sales 66.2% 66.1% 68.0% 74.8% 74.7% 74.4%
Gross Margin 33.8% 33.9% 32.0% 25.2% 25.3% 25.6%
SG&A / Sales 22.7% 22.9% 22.4% 18.5% 18.7% 19.0%
Other Operating Expense / Sales 2.6% 2.6% 2.8% 1.6% 1.7% 1.7%
Investment Income / Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Other Income, net of Other Expense / Sales 0.2% 0.2% 0.0% 0.9% 1.1% 0.8%
Minority Interest/ Sales 0.0% 0.0% 0.0% 0.1% 0.1% 0.1%
EBIT Margin 8.6% 8.5% 6.8% 5.9% 5.9% 5.6%
Net Interest Expense (Income) / Sales 1.1% 1.2% 1.4% 0.6% 0.6% 0.6%
Pre-Tax Income Margin 7.6% 7.3% 5.4% 5.4% 5.3% 5.1%
Taxes / Sales 2.9% 2.8% 2.0% 1.8% 1.8% 1.8%
Unusual Gains, Net of Unusual Losses (after tax) / Sales 0.0% 0.0% 0.0% -0.3% 0.0% 0.0%
 Net Income Margin 4.7% 4.5% 3.4% 3.3% 3.4% 3.3%

EBITDA Margin 11.2% 11.1% 9.6% 7.5% 7.6% 7.3%

NOPAT Margin 5.4% 5.2% 4.3% 3.6% 3.8% 3.7%
Recurring NOPAT Margin 5.3% 5.1% 4.2% 3.3% 3.1% 3.1%

EVALUATING INVESTMENT MANAGEMENT

Working Capital Management:

Operating Working Capital / Sales 6.6% 6.5% 10.2% -0.8% -1.1% -1.3%
Operating Working Capital Turnover 15.17 15.31 9.78 -124.99 -88.20 -77.83
Accounts Receivable Turnover 9.56 9.38 7.51 129.97 132.17 110.10
Inventory Turnover 6.75 6.70 6.51 8.04 8.32 8.51
Accounts Payable Turnover 6.29 6.37 6.57 10.20 9.98 9.86
Days' Receivables 38.20 38.92 48.62 2.81 2.76 3.32
Days' Inventory 54.08 54.49 56.04 45.42 43.86 42.89
Days' Payables 58.07 57.28 55.56 35.80 36.58 37.02

Long-Term Asset Management:

Net Long-Term Assets Turnover 3.21 3.06 2.79 3.92 3.85 3.69
Net Long-Term Assets / Sales 31.1% 32.7% 35.9% 25.5% 26.0% 27.1%
PP&E Turnover 3.12 2.96 2.70 4.36 4.24 4.15
Depreciation & Amortization / Sales 2.5% 2.6% 2.8% 1.6% 1.7% 1.7%

EVALUATING FINANCIAL MANAGEMENT

Short-Term Liquidity:
Current Ratio 1.5 1.32 1.60 0.90 0.90 0.81
Quick Ratio 0.82 0.68 0.94 0.19 0.20 0.16
Cash Ratio 0.17 0.07 0.21 0.13 0.14 0.10
Operating Cash Flow Ratio 0.55 0.41 0.42 0.44 0.42 0.42

Debt and Long-Term Solvency:

Liabilities-to-Equity 1.46 1.39 1.91 1.57 1.42 1.50
Debt-to-Equity 0.69 0.64 1.12 0.73 0.63 0.69
Net-Debt-to-Equity 0.58 0.59 0.96 0.61 0.51 0.61
 Debt-to-Capital 0.41 0.39 0.53 0.42 0.39 0.41
Net-Debt-to-Net Capital 0.37 0.37 0.49 0.38 0.34 0.38
Interest Coverage Ratio:
Interest Coverage 7.96 7.19 4.96 9.86 9.72 10.04

Payout Ratio:
Dividend Payout Ratio 13.6% 15.5% 21.0% 24.8% 28.2% 28.0%

Sustainable Growth Rate: 16.9% 15.4% 11.4% 16.0% 14.9% 14.9%

Source: Casewriter, based on data from Target Corp. 10-Ks and Wal-Mart Stores, Inc. 10-Ks.
 0.039 0.05 0.049

Higher for target Target sold more upscale goods while walmart had higher reliance on groceries

Higher for target

Depreciation expense higher for target 0.026 0.026 0.028 0.016 0.017 0.017

Days receivable too high 13.59431 times higher

Net debt is higher for Walmart but interest coverage ratio is low