By  on January 30, 2008

Add Dillard's Inc. to the list of retailers coming under fire from activist shareholders.

Barington Capital Group and Clinton Group Inc. revealed Tuesday they own more than 5.3 percent of Dillard's shares, and sent a letter to the retailer's board outlining recommendations for operational and strategic improvements.

The move by the two New York-based hedge funds follows similar ones involving retailers such as Saks Inc., Target Corp. and Sears Holdings Corp. It's a pattern that shows how hedge funds and private equity firms need to invest their money, but with cheap debt dried up because of the subprime mortgage crisis, funds are unable to mount big leveraged buyouts and instead have to take smaller stakes in firms by directly buying shares and other assets.

Not that the vultures aren't circling the retail sector. As famed investor Carl Icahn said earlier this month, "You retail companies are in major stock trouble and that's what I like.

"If you look at the godd--n cash flow, they're doing great," he added of retail companies. "The one question I ask is, 'Why aren't you buying back your stock?' Now is the time to look at these things."

Dillard's declined comment, as did representatives for Barington Capital and Clinton Group.

But a source familiar with the situation said one option could be for the shareholder group to seek board representation. The source said the two investors are simply looking to find ways for Dillard's to improve its operations and thus raise its share price.

Another possible way to boost the underperforming retailer's stock price is a possible separation of its real estate holdings into a separate entity, similar to what retailers such as Sears and Carrefour are doing to better monetize the asset.

Meanwhile, shares of Dillard's remain at the low end of their 52-week range. At the bell Tuesday, Dillard's shares rose 3.8 percent to close at $19.78 in trading on the New York Stock Exchange. Their 52-week high is $40.56 and the low is $14.46.

The letter from Barington and Clinton said, "Given the company's poor share price performance over the past six months, we are convinced that Dillard's is an undervalued asset with tremendous opportunity for improvement....[and as] you know, Barington has attempted to reach out to you and William T. Dillard 2nd, the company's chairman and chief executive officer, several times over the past six months to discuss measures to improve shareholder value....Unfortunately, it appears to us that you have not only ignored our letters but have also done little to improve the company on your own initiative, as Dillard's financial results have gone from bad to worse since our initial communication in June 2007."The letter also said that as significant shareholders, the two investment firms are "committed to taking all actions necessary to enhance shareholder value."

The letter also points to the retailer's operating losses of $24.5 million and $6.5 million for the second and third quarters ended Aug. 4, 2007 and Nov. 3, 2007, respectively.

"Unfortunately, the past few quarters are but a continuation of Dillard's history of chronic underperformance," the letter said. "As we have noted in prior correspondence, on average, Dillard's same-store sales growth rate has lagged its peer group by nearly 400 basis points per annum over the past five years. Furthermore, Dillard's has not posted an increase in annual same-store sales since 1999."

This is not the first time Barington Capital has tangoed with Dillard's. In June 2007, the investment firm sent a letter to the department store requesting a meeting to discuss improving profitability and stock valuation, after being unable to reach Dillard's ceo by telephone. In a research note at the time, Credit Suisse analyst Michael Exstein criticized the chain as a "wasting asset," citing its low cash flow and high capital expenditures in the past decade of $5.2 billion.

But there are major limitations to how much change any activist investor, no matter how vocal, can effect at the retailer. The Dillard family has about a 13 percent economic ownership in the company, but controls a substantial voting power. While family members own some of the nearly 72 million Class A common stock outstanding, they own over 99 percent of the 4 million Class B shares, according to Securities and Exchange Commission filings. One source noted that while each share of the two classes of stock is entitled to one vote, the difference is that Class A stockholders can vote for up to four directors, while Class B shareholders can vote for up to eight. That key difference allows the Dillard family to control the operations of the retailer via the directors they put on the board.

Financial sources have said in the past that while the retailer has been an acquisition target, the Dillard family isn't willing to sell.

Other recent activist investor activity include Iceland's Baugur Group, which is interested in expanding its holdings in Saks into full ownership of the luxury retailer, and William Ackman's Pershing Square Capital Management, which took a 9.6 percent stake in discounter Target Corp. in July. The speculation on Wall Street is that Ackman might try to push Target to boost shareholder value via a sale of its credit card portfolio. Target said last month it expects to complete a review of the operation during the first calendar quarter of this year. Ackman, who also was instrumental in derailing Sears Holdings' chairman Edward Lampert's attempt to take full control of Sears Canada last year, in October purchased a 3.5 percent stake, or 5 million shares, in Sears Holdings through Pershing.And while most retailers rarely discuss their investors in public, not all are as reticent. On Monday, off-pricer Syms Corp. said in a statement that it was sending a letter to shareholders updating its transition from trading on the Big Board to the over-the-counter Pink Sheets. It also used the opportunity to criticize one investor — Barington — for filing a lawsuit that seeks to compel Syms to relist its shares on the New York Stock Exchange.

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