By defeating activist shareholders, Kohl’s Corp. (NYSE: KSS) 9.54 percent has entered into discussions to be sold for roughly $8 billion. However, the department store company may face fresh difficulties if it is acquired by its prospective bidder.

According to FRG 4.78 percent, the company that owns The Vitamin Shoppe, Pet Supplies Plus, and other stores has begun an exclusive three-week negotiating phase to purchase Kohl’s Corp. for $60 per share. In addition to Franchise Group’s one-billion-dollar investment, Kohl’s real estate will be used to fund the majority of the deal’s financing needs.

Whether or if the two sides can come to an agreement is unknown.

Franchise Group has a market valuation of roughly $1.5 billion, making it a smaller company than Kohl’s Corps. Toys “R” Us Inc., Shopko Corp., and Mervyn’s LLC all filed for bankruptcy as a result of the transaction structure proposed by Franchise Group, which involves selling real estate and taking on more debt.

When reached, Franchise Group refused to make any comments. When we contacted Kohl’s for further information, they didn’t get back to us.

As a Wisconsin senator, Tammy Baldwin is opposed to the deal, which includes a large business located in her state. This transaction “could do all of those things,” she said. “I continue to urge Kohl’s to reject any offer that dramatically increases debt, sells off assets, raises shareholder payouts at the expense of reinvestment, or increases the likelihood of a bankruptcy—and I fear that this transaction could do all of those things,” she said.

More than 1,100 Kohl’s shops may be found mostly in shopping malls. With 410 sites, 517 properties, and 238 ground leases as of the beginning of the year, it held ground leases on an additional 238 locations.

Investors are drawn to real estate sales and leasebacks because they provide a steady flow of revenue. As a result, retailers’ profit margins are slashed as a result of leases and rent payments. Having a decrease in sales might have a negative impact on earnings.

Analyst Neil Saunders of GlobalData Plc, the managing director of the research company, stated that selling real estate would put Kohl’s Corp. at risk of increasing rent and property prices. It might also lead to Kohl’s credit rating being downgraded, resulting in higher borrowing costs. Kohl’s would have less money to spend on growing its company in the face of rising competition if it took on more debt.

“Kohl’s will be in a poorer position if they use the real estate to pay the purchase,” Mr. Saunders said.

When activist investor Macellum Capital Management LLC offered a sale-leaseback of real estate as part of its proxy war with Kohl’s earlier this year, the store fought against it.

Sale leasebacks, the company said at the time, were an inefficient form of financing that would have a detrimental effect on profit margins by causing Kohl’s to incur ever-increasing rent costs.

To be sure, sale-leasebacks may work, especially if they are done on a smaller scale.

Some of Hudson’s Bay Company’s real estate is held in joint ventures with mall owners, including Saks Fifth Avenue and a network of Canadian department shops. Since then, Hudson’s Bay has been sold to a private equity firm. A letter from Saks CEO Marc Metrick informed suppliers of the company’s recent excellent sales increase.

One-off transactions like selling its men’s shop in San Francisco’s Union Square have been the company’s response to demands from an activist investor to spin off its real estate assets. As of January, the company owned 427 of its 725 sites, although it leased the property on 104 of them.

Several distribution locations were sold and leased back by Big Lots Inc. in 2020, generating $725 million in revenue. A senior analyst at Telsey Advisory Group, Joe Feldman, stated that selling a warehouse “won’t encumber the corporation in the same way as selling a portfolio of shops.” “There’s a history of this not working when it’s done on a larger scale.”

Brian Kahn, CEO of Franchise Group, is a former private equity investor. After founding Vintage Capital Management and its predecessor in 1998, he has been in charge of the company’s investments ever since. Vintage has a 28 percent stake in the outstanding shares of Franchise Group as of the end of the first quarter.

Shares of Kohl’s rose 9.5 percent to $45.59 on Tuesday after the Wall Street Journal first reported on the discussions. Over the last year, the stock’s price has dropped by more than 20%. Franchise Group’s stock price rose by 4.8% to $38.77.

An activist investor tried to change up to 10 directors at Kohl’s in May, but the company’s shareholders rejected this and voted to keep the current board in place. People familiar with the incident say Kohl’s informed investors that it was serious about considering bids and that altering the board may have scuppered the negotiations.

People familiar with Kohl’s acquisition strategy said that the business previously said it felt it had a value of at least $70 per share. The business reported a decrease in quarterly sales and lowered its sales and profit forecasts for the year because of the weakening retail climate.

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