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Target's Credit-Card Sale: Bad Timing?

The big-box retailer's credit-card biz has been a profit machine, but a deterioration in credit quality could greatly weaken a sale price

by Robert Berner

As recently as last November, Target (TGT) steadfastly said it had no intention of selling its $7 billion credit-card portfolio, one of the last ones held by a retailer. That changed late on Sept. 12, when the trendy discounter disclosed it would explore letting it go. The trouble is, Target is a little late to put out the for-sale sign.

Target's portfolio, which consists largely of its Target Visa receivables, has shown some of the most serious deterioration in credit quality of any major card company over the last year and a half. That will weaken the price Target can command, particularly as worries about a consumer-led recession grow. At the same time, the turmoil in the overall credit market sparked by the subprime mortgage meltdown will dampen what potential buyers are willing to pay. "Target may have gotten a higher price just six months ago," says Nathon Powell, a credit analyst at the Center for Financial Research and Analysis (CFRA).

What changed Target's mind was the entrance of activist investor William Ackman. In July, his hedge fund Pershing Square Capital Management disclosed it had taken a 9.6% stake in the Minneapolis-based discounter and that it would prod management to boost shareholder value. Though Ackman hasn't given specifics, speculation has centered on his wanting Target to sell its card business. "They are responding to shareholder pressure," says William Ryan, an analyst at Portales Partners. Target didn't return a call seeking comment.

Underlying Signs of Weakness

There is precedent for such a sale. Sears (SHLD), Macy's (M), and Kohl's (KSS) all sold their card businesses at strong premiums between 2003 and 2006. Target and Nordstrom (JWN) are the last major retailers to underwrite their own card portfolios—others such as Wal-Mart Stores (WMT) contract with banks, who manage the cards and hold the risk.

Target's portfolio has been a profit machine. For Target's fiscal quarter ending Aug. 4, operating profits from credit rose 34% over the same quarter a year ago. Credit accounted for just more than a third of Target's overall 11% increase in operating profits for the quarter.

But underlying those profits are signs of weakness that could make potential buyers wary, says Powell. Since February, 2006, when bad credit-card debt bottomed for most major issuers, Target's troubled accounts have risen at a pace faster than the industry average. Accounts 60 days past due plus those that have been charged off have risen from 7.07% of receivables in February that year to 9.35% this July, the CFRA's Powell says.

"Not the Best Time" to Sell

Of the 16 largest credit-card issuers, only Bank of America (BAC) posted a larger percentage-point gain during that period, from 5.81% to 9.04%. The fact that a growing number of economists are concerned that consumers could lead the nation into recession next year weakens a potential price even further, Powell says.

Then there are the overall debt-market problems themselves, which hurt any buyer's ability to get favorable financing. The turmoil in the subprime mortgage industry has reached beyond companies such as Countrywide Financial's (CFC) ability to issue short-term debt. Major buyout firms such as Kohlberg Kravis Roberts are now having to make concessions to finance deals. A buyer of Target's portfolio would face the same constraint. "It's not the best time for Target to consider selling," says Portales' Ryan. "It's not the top of the market anymore."

Of course, Target may not have any intention of selling. Ryan wonders if Target is simply going through the motions to placate Ackman. Then again, Target could be concerned about the outlook of its credit-card customers and believe it's best to try to get out now—even if not at a peak price. Target's credit division faces no pressure on profits yet—Target has reserved conservatively for bad accounts. Still, if consumers continue to head south, Target's credit profits will eventually follow.

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