Dillard's, Inc. (NYSE: DDS) may soon be facing a board and management shake-up after a several large activist investors took their campaign for change a step further yesterday. Barington Capital and the Clinton Group revealed in a Schedule 13D/A filing with the SEC that they are now on the verge of launching a proxy battle to install their own candidates to the company's board of directors. The two activist hedge funds requested a list of shareholders and other documents that typically point to a proxy contest. Unfortunately, the company's poison pill gives the Dillard's family majority control (8 of 12 board seats), but many believe that the two funds will seek to put a minority slate of directors on the board to increase pressure. So, does this represent a catalyst that could make Dillard's a buy here?
Barington Capital originally contacted the company at the end of January, insisting that the vast vlaue potential of the company was not being realied. In their opinion, if the company were more effectively managed it would be worth substantially more than its current stock price. Furthrmore, the company's sizable asset base provides the company with a number of untapped options to create additional value for stockholders. More specifically, the activist hedge fund sees the following opportunities for improvement (in their own words):
1. Dillard's $7.5 billion revenue base offers significant margin leverage capable of producing sizable cash flow gains from any future operating improvements. The Company’s geographic concentration, especially in high-growth areas of the Southeast and Southwest United States, offers unique regional opportunities for its 331-store portfolio. Furthermore, the Dillard’s brand name is well-regarded in the department store sector and the Company has received above average scores in the area of customer loyalty according to a recently released survey by Brand Keys.Clearly, Dillard’s has the scale and brand recognition to be a successful retailer.
2. As Dillard’s trailing twelve month operating free cash flow margin is 2.4% versus 7.7% for its department store peer group, we believe that stockholders can realize enormous upside if margins can be improved to the levels achieved by the Company’s peers. We see a number of opportunities to immediately reduce the Company’s cost base, including by improving sourcing, rationalizing SG&A expenses and lowering capital expenditures. We also believe that there are a host of initiatives in inventory management and merchandising that can drive customer traffic and enhance margins. Among other things, we believe that Dillard’s needs to tighten its current assortment of offerings and vendors and consider a more regular promotional cadence, as its stores, in our opinion, are over-inventoried. In addition, we believe that Dillard’s needs to embark upon an aggressive re-merchandising effort that features new vendors (including exclusive offerings) and updated private label and in-house collections to differentiate its value proposition for customers. Furthermore, it is our belief that the Company needs to enhance its brand marketing by adding more image and lifestyle campaigns that communicate a revitalized message to the marketplace. We are convinced that each of these initiatives would add excitement and newness to the Dillard’s shopping experience and attract customers to its stores.
3. Dillard’s owns approximately 75% of its store portfolio, comprised of approximately 42 million square feet of retail real estate. Currently, the Company’s shares trade at only 0.5x its tangible book value of approximately $32.50 per share. This represents a significant discount to the Company’s peer group, which trades at an average tangible book value multiple of approximately 2.0x. We also believe that Dillard’s tangible book value is understated, since the current market value of the Company’s owned real estate far exceeds its depreciated book value. In fact, in a November 26, 2007 research report, Deutsche Bank estimated Dillard’s net asset value before taxes to be $59 per share. Deutsche Bank also notes that “actions taken to unlock the Company’s real estate value would be positive for the shares, as the NAV [net asset value] for Dillard’s [is] greater than the value based solely on operating fundamentals.” It is our belief that there are a number of measures that the Company can take to enhance the value of its real estate portfolio, including converting certain properties to higher and better use, closing underperforming stores and engaging in sale/leaseback transactions.
These are all classic activist arguments that really do have merit and should be considered by the board. Unfortunately, Barington was shunned by Dillard's and is now being forced to take more dramatic actions in order to unlock value. In the meantime, their investment (and that of other investors) is quickly deteriorating as the company repored slower same store sales, subpar operating performance, and a falling stock price. Many analysts estimate that Barington Capital and the Clinton Group could have around 12% support from institutions, which bodes well for their odds in getting at least one board seat. Combined, these factors make DDS a stock worth watching!
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