Under Pressure, Target is Likely to Quit Card Line

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No matter who wins the proxy battle at Target Corp. this month, the retailer's days in the credit card business appear to be numbered.

William Ackman, the activist shareholder campaigning to get himself and four others elected to the Target board at the May 28 annual meeting, has long pressed the company to sell its $8.77 billion portfolio of cobranded and private-label cards. A year ago, Target compromised by selling a minority stake in the portfolio to JPMorgan Chase & Co. But now the retailer says it is interested in selling the remainder once market conditions improve.

Target's portfolio is by far the largest of the few remaining that are run by retailers. The company has long insisted that an in-house card operation was integral to its core business, though in 2007 it began exploring alternatives to direct ownership. The recession has been particularly hard on store card portfolios, and the credit quality of Target's has declined dramatically in the year since it sold the stake.

Ackman, the founder and manager of Pershing Square Capital Management LP, says he recognizes that a sale is a tall order in the current environment. To help the retailer manage its portfolio through the recession — and eventually unload it — Ackman recruited the veteran card executive Richard Vague to join Pershing's slate of board nominees.

"This is a guy who's built, founded and sold two major credit card operations, and the businesses he ran did a lot of partnering transactions," Ackman said in an interview Friday. "Richard's going to be helpful, number one, in helping the company manage through a recession. … Two, he's going to help them negotiate a transaction to exit. And three, even after the company exits … the company's still going to be very much involved with the business. … Having someone on the board with that expertise is essential."

Vague co-founded both First USA, the credit card monoline that the former Bank One Corp. bought in 1997, and Juniper Financial Corp., a monoline specializing in cobranded cards, which Barclays PLC bought in 2004. He remained at Barclays as chief executive of the U.S. card unit until 2007. (Bank One is now part of JPMorgan Chase).

Ackman cited that resume to explain why he approached Vague a few months ago and asked him to run against incumbent Target director Richard Kovacevich, the chairman and former CEO of Wells Fargo & Co.

Kovacevich "doesn't run the credit card business at Wells Fargo. He knows something about credit cards, but Richard Vague is just by far superior in terms of his expertise," Ackman said. "Richard Kovacevich is a great bank chairman, just great, and if this were a bank it would be great to have him. But this is a credit card issuer, a retail credit card issuer."

Wells referred an interview request to Target, which would not make Kovacevich available.

A Target spokesman said: "Mr. Kovacevich has led one of the country's largest retail banking chains and one of the largest credit card and debit card issuers in the U.S. He has a wealth of experience relevant to Target."

Vague, in an interview last week, said he would need to get on the board and learn more about Target's portfolio before formulating a strategy.

But "you would hope that there's a way to convey to a third party the credit risk and also free up capital, and yet at the same time retain significant control over the customer relationships," he said. "In my credit card career we were always on the other side, we were always providing partnership services to a large retailer or airline. … We always found that the partners that remained, even when they had conveyed the portfolio or some aspects of the risk … to a bank, it was only if they remained very actively involved in the management and marketing of that portfolio that the program really ended up being as vibrant as you wanted it to be."

The annualized chargeoff rate of the Target portfolio hit 14.23% in March — up 135 basis points from February and 611 basis points from a year earlier. In a regulatory filing Thursday, Target said its credit card results for April were "in line with prior guidance, including writeoffs of approximately $300 million and continued improvement in early-stage delinquencies, resulting in no increase to the allowance for doubtful accounts at quarter-end."

Ackman said Target's credit problems show the hazards of mixing lending with commerce.

"There are conflicts of interest when a retailer owns a credit card business because a retailer wants to grow same-store sales, and one way to do that is by lowering your underwriting standards and extending more credit to your customers," he said. "Now, obviously, there are risks associated with that. So separating the retailer from the underwriting decision, we think, is a good idea."

Even if Ackman loses the proxy fight, Target appears to be listening to his advice when it comes to credit cards. The Minneapolis company has started telling investors that it intends to unload the rest of its card business once conditions improve. And according to analysts, it has already picked its preferred buyer: JPMorgan Chase.

Bill Dreher Jr., a Deutsche Bank AG analyst who met with Target executives on April 8, wrote in a subsequent note to clients, "In order to really satisfy investors, Target would need to complete a second transaction that removed ALL of the assets from their financial statement and transferred all of the underwriting and risk management responsibilities to the buyer. The company sees JPMorgan as an optimal purchaser given the development of their relationship over the last year."

Dreher — who urged investors in his note to vote against Pershing's nominees — also wrote: "Management is also realistic about the type of transaction that can be done in this environment and is committed to making sure the timing of such a transaction is appropriate. We could envision such a deal being completed sometime within the next year."

A Target spokesman said by e-mail: "We have a great relationship with JPMorgan Chase. As previously stated, we are interested in selling the balance of our credit card business, given the right macroeconomic environment and the right economic proposition."

A JPMorgan Chase spokeswoman said that she could not comment "for proprietary reasons."

But selling a store card portfolio became almost impossible in the past year, as both General Electric Co. and Citigroup Inc. have discovered.

GE, which put up its private-label portfolio for sale in December 2007, stopped its search for a buyer last September, citing poor conditions for a sale. This year Citi put its private-label card business into Citi Holdings, a repository for noncore assets the company is seeking to sell or wind down, but also has yet to find a buyer.

"This becomes very theoretical when there are no buyers and the few buyers that there are are bottom-fishing," said John Grund, a partner at First Annapolis Consulting Inc., who specializes in retail credit card programs, including partnerships.

"Maybe we're out of the eye of the storm," he said, "but there's a bunch of winds behind the storm that have yet to clear. … The realities of the marketplace are such that you could cut a really bad deal."

Cards veterans said Vague's retail-card focus could serve Target well if he is elected.

"If I were Ackman and I put Vague on the board, I would unleash him to be creative and to make the company more dynamic and maybe to make the portfolio more profitable and salable two years from now, as opposed to right now," said Duncan MacDonald, a former general counsel of Citigroup Inc.'s Europe and North America card businesses. "If Target had its choice, on its own, simply looking for somebody out there in the marketplace, they'd probably consider a guy like Vague. The fact that he's tied to Pershing maybe complicates it, but Vague brings something to the table."

(MacDonald also called Kovacevich "one of the best. If they lose him that's pretty important. … For somebody to suggest that he's an amateur in this realm is silly.")

Leigh Allen, a consultant at Global Consumer Finance Advisory LLC, agreed that Vague is "one of the most dedicated credit card professionals out there."

But for Target shareholders, Allen said, "their fellow investors are either going to be for Pershing or not. People aren't voting for the individual, they're voting for the cause."

Ackman, a Target shareholder since 2007, has also lobbied the company to spin off some of its real estate holdings.

Today Pershing Square plans to hold a meeting in New York for Target shareholders to discuss the hedge fund's plans for the company and introduce its slate of board nominees, which also includes specialists in retailing, real estate and corporate governance.

Ackman stressed that he wants his nominees to improve the leadership and expertise at Target rather than push a specific agenda.

"This is not a platform to do a credit card deal or to do a real estate transaction," he said. "If I wanted to do that, I would have found five directors who were committed to a specific course of action, and I would have told shareholders that 'If you vote for us, we're going to do X, Y and Z.' This is really just about making sure that the best people are on the board."

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