Could This Big Box Retailer Be Private Equity's Next Target?

Target (NYSE: TGT) is once again the subject of takeover rumors. Negative sentiment and both company- and macro-specific factors have pushed the discount retailer's stock over 35% year to date. According to analysts at D.A. Davidson, this means that the stock has fallen to such a low price that a leveraged buyout of the company could prove very profitable.

This latest report gives further credence to the idea that Target is a viable "target" of private equity, despite its massive size compared to the mid-cap and small-cap companies private equity firms typically acquire.

Nevertheless, I wouldn't buy Target solely as a takeover play. Rather, a buy-and-hold strategy may be the best approach. Why? Takeover rumors could continue to come and go, but over an extended time frame, this stock could experience strong gains, if and when investor sentiment shifts back to positive.

Target is a logical private equity target

Make no mistake: if private equity took Target private, it would be a record-setting deal for the industry. Target's market cap currently stands at around $40 billion. Combined with net debt and lease liabilities, the company's enterprise value comes out to $56.3 billion.

A private equity buyer, or most likely a consortium of buyers, would also have to offer a takeover premium to secure the deal. Add it all together, and the acquisition price would likely exceed $60 billion. That's more than what's currently set to become the largest private equity deal of all time, the pending $55 billion acquisition of Electronic Arts (NASDAQ: EA) by a consortium of private equity firms and large investors.

Image source: Getty Images.

Still, given the billions in dry powder, or uninvested cash, many major private equity firms are sitting on, it's not outside the realm of possibility that they could join forces to purchase Target in a leveraged buyout transaction. Add in how other old-school retailers, like Nordstrom, have gone private in recent years, and the prospect of a takeover appears much less like wishful thinking on the part of speculators.

Again, though, buying Target on takeover potential is likely not a surefire strategy to profit. Predicting a takeover is more a game of luck than a game of skill. Instead of speculating that this company could be acquired at a 20% or more premium in the near term, it's likely best to view this stock as a long-term play.

The long-term view

The aforementioned D.A. Davidson analyst report gives Target's stock a $108-per-share price target. This amount, around 23.6% above the current stock price on October 14, represents the amount the sell-side research firm believes the company could fetch in a private equity takeover.

Yet while it may seem tempting to "bottom-fish" in Target shares, buying after the big sell-off, only to quickly profit once the private equity bid comes in, there are more ways this trade could blow up rather than lift off. In the next few months, the stock could remain subject to negative volatility.

Next month, Target will release its next quarterly earnings. The same combination of disappointment with fiscal results and negative sentiment surrounding issues like poor customer service and public relations missteps could send the stock to even lower prices. In turn, private equity could arrive, but offer a far less impressive bid.

Moreover, while a private equity takeout is possible, is it probable? Existing shareholders and management may prefer to see Target go it alone in a turnaround, enabling all investors to benefit from the potential rebound -- mainly because said rebound could send the stock to levels well above D.A. Davidson's price target.

Should you buy Target today?

Over the next few years, macro issues like tariffs and inflation could normalize. Past controversy will retreat into the rearview mirror. Target's management could make serious headway restoring its reputation among investors and the general public alike.

These efforts could have only a modest impact on earnings, yet result in significant price appreciation. Right now, the stock trades at a forward price-to-earnings (forward P/E) ratio of just 11. In recent years, shares have often traded at an earnings multiple in the mid- to high-teens.

Better yet, it's not as if you'll be sitting on zero return waiting for better times to take shape. Target, a Dividend King with over 50 years of consecutive annual dividend growth, is a "get paid while you wait" type opportunity with its current 5.33% forward dividend yield. Takeover rumors may have placed Target back on your radar, but the patient approach may be the better course of action here.

Thomas Niel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.