Hedge fund takes aim at Target

NEW YORK (CNNMoney.com) -- Pershing Square Capital Management, a hedge fund headed by activist investor William Ackman, disclosed a sizeable stake in retailer Target Corp. in a Securities and Exchange Commission regulatory filing on Monday.

According to the SEC filing, the fund has acquired a 9.6 percent holding in Target, or about 82 million shares, of the No. 2 discount chain after Wal-Mart (Charts, Fortune 500).

Target currently has a total of 851.5 million shares outstanding.

Pershing Square Capital said it believes Target offers "significant growth opportunities and the strongest operating management in the retail industry."

"[Target's] common stock is undervalued and [we] intend to discuss with management ways in which this undervaluation can be corrected," the firm said in the filing.

Separately, Ackman stated in the filing that the investment group would donate about one-third of the profits from the Target investment to charitable foundations including the Pershing Square Foundation.

Target (Charts, Fortune 500) shares were trading lower Monday on the New York Stock Exchange.

"I think the stock's trading lower because there was nothing substantial that was revealed in the Pershing filing other than the firm thinking that the stock is undervalued," said Mark Husson, analyst with HSBC Global Research.

'Frankly, I was surprised that's Pershing's opinion about Target," Husson said. "I don't see how you can make this company perform significantly better."

So far this year, Target's stock is up 23 percent versus a 6.4 percent gain in Wal-Mart shares. Target stock trades at 12.8 times analysts' earnings estimates for this fiscal year versus 9.3 times for Wal-Mart.

Target's profits are expected to grow 14.7 percent, higher than the industry average, and better than the 12.3 percent annual growth for Wal-Mart over the same period.

"Part of the reason that Target's valuations are where they are is because Wal-Mart is so cheap," Husson said.

Could Ackman push for Target to sell its credit card business?

"Target's credit card operations contribute 10 to 12 percent to its total earnings and its been heavily promoting the card and deals tied to the card in its stores," said Husson, adding that short-term benefit of selling the division would be to free up cash that the retailer can then invest elsewhere in its business.

"But at the same time, Target would then have to let a credit card operator run the card business and I'm not sure how that would improve its valuations," Husson said.

In the past, Ackman, has pressured firms such as No. 1 fast-food chain McDonald's (Charts, Fortune 500) to restructure its operations and spin-off a percentage of its restaurant business. He also aggressively pushed Wendy's (Charts) to spinoff its Tim Hortons chain.

Pershing Share Capital's interest in the retail chain is likely to fuel speculation that Target could be the next big buyout target.

Over the past two years, the U.S. retail industry, burdened by too many stores and slowing sales and profit growth, has seen a frenzy of M&A activity as well as billion-dollar leveraged buyouts by cash-rich private equity firms and hedge funds.

In the first quarter, U.S. M&A activity across industries including retailing accounted for 41 percent of worldwide volume in the period, amounting to just over $1 trillion.

And industry experts say anyone is a target.

Target certainly is an attractive prospect. The company recently reported a 3.3 percent gain in June sales at its stores open at least a year, which is a closely-watched measure of retail activity known as same-store sales.

Despite operating in the same discount space as Wal-Mart, which is struggling to grow its sales amid a housing slowdown and gas price inflation, Target has consistently continued to outperform its rival in terms of same-store sales growth.

"Target throws up decent cash, it has decent sales and profit growth. So it would be an attractive target for a leveraged buyout," Husson said. "But given the strength of its management team, it would be difficult to envision a hostile takeover of this company."