Roughly four months ago, Kohl's CEO Michelle Gass insisted the retailer's stores were crucial assets and that the brick-and-mortar sites shouldn't be sold.

“I mean, they generate a lot of cash. ... There are other ways for us to find capital in a more economic way than having to leverage our real estate at this time,” Gass told Wall Street analysts during the department-store chain's fiscal fourth-quarter earnings call in March.

But times have apparently changed. On June 6, Kohl's and Franchise Group jointly announced they would be engaging in exclusive negotiations for the retailer to be acquired, for roughly $8 billion by the Delaware, Ohio-based holding company. And the prospective buyer Franchise Group — owner of The Vitamin Shoppe, Pet Supplies Plus, and Badcock Home Furniture & More — said it is looking to sell Kohl's real estate to finance the acquisition at a price of $60 per share, an expected sale-leaseback deal, with Kohl's leasing back its stores.

Both parties agreed to a three-week time window for their talks, a period that ended Monday. But neither Kohl's nor Franchise Group offered an update on where the negotiations stood at the end of the day, and neither company immediately responded to emails seeking a comment.

Franchise Group was considered by some to be a dark horse bidder for Kohl's, a surprise in a field of big players that had been expected to make offers, such as Simon Property Group and Brookfield Asset Management. Some critics don't see Franchise Group as a good fit, not an owner that can bring any benefits to Kohl's. The chain has been struggling following criticism by activist shareholder groups long before it reported weak first-quarter results that caught Wall Street off guard earlier this year. Inflation has also raised concerns about retail sales going forward.

Kohl's, based in Menomonee Falls, Wisconsin, is a national chain with roughly 1,150 stores, with most of them in strip shopping centers or standalone properties rather than in malls. As of January, the retailer owned 410 locations, leased 517 and had ground leased an additional 238 sites, according to Brandon Svec, national director of U.S. retail analytics for CoStar Group. He estimated the chain has 28.9 million square feet of owned selling space.

Even if the negotiation window is extended, there's no guarantee the Kohl's sale will close. Several published reports have said Franchise Group is seeking to lower its initial offer, to $50 in cash for each share from $60, because Kohl's stock price has dropped. It was trading at about $38 on Monday.

"First and foremost, I am highly doubtful that this deal closes at $60 per share given what we’ve seen happen to the stock market since the initial offer was made and growing concerns of a pullback in consumer spending," Svec said in an email. "The $60 per share offer would represent a 66% premium over today’s price, which would be a phenomenal deal for current shareholders. I am assuming it drops closer to $50, which would be a great deal for Franchise Group."

Kohl's poor showing in the first quarter and its lowering its outlook for the rest of the year, plus Wall Street's wide swings, have not created an ideal environment for the company.

It's all put Kohl's under pressure and possibly in a quandary, according to Neil Saunders, managing director at analytics firm GlobalData, and other retail analysts.

A deal with Franchise Group "will not transform the Kohl’s business," he said in a note. "It doesn’t add much additional expertise, skills, or advantages to the group. And it puts Kohl’s in a far weaker financial position. Kohl’s management likely knows all of this. However, it is currently holding a very weak hand which makes it more difficult, although not impossible, to reject the offer."

Franchise Group has kept a low profile over the years as it snapped up retailers for its portfolio, and it doesn't have any experience with the competitive sector — apparel — that's Kohl's bailiwick, according to Saunders and others. It owns Buddy’s Home Furnishings, Sylvan Learning and American Freight in addition to Vitamin Shoppe, Pet Supplies Plus and Badcock. The company operates over 3,000 locations, mostly in the United States, that are either company-run or operated under franchising and dealer agreements.

With the potential Kohl's sale-leaseback, Franchise Group appears to be repeating the game plan it recently used for its $580 million purchase last year of Badcock, the furniture retailer based in Mulberry, Florida.

The proposed Kohl's sale-leaseback strategy set off alarms with some retail analysts, who warn that selling Kohl's-owned real estate — the tack that Gass once said was anathema — will saddle the company with debt. While such a sale would provide the necessary financing for the transaction, in its wake Kohl's would now be obligated to start paying rent for potentially hundreds of its stores and have lease obligations for them. Too much debt has led to the demise of a number of retailers, most notably Toys R Us, providing what some claim is a cautionary tale.

Kohl's has been under intense scrutiny. Gass' management team has been under siege for more than a year by several activist groups — including Sycamore Partners and Macellum Advisors — who complained about the company's performance. They called for Kohl's to monetize and unlock the value of its real estate holdings and explore a sale of the company. Kohl's finally obliged by engaging in negotiations with Franchise Group.

In a statement, Franchise Group said it intends to contribute $1 billion in capital to the transaction, funded through increases in its existing secured debt facilities. "A majority of the financing for the transaction is anticipated to be provided on the basis of the real estate assets of Kohl’s," Franchise Group said in its June 6 statement.

That proposed deal structure has sparked criticism.

"The biggest downside ... is that other than the $1 billion of capital Franchise Group will put into the transaction, most of the funding will be financed off the back of Kohl’s real estate," Saunders said. "Franchise Group has made it clear that it will not be liable for this debt. This potentially encumbers Kohl’s with a huge debt pile that it will need to service. In our view, this is completely unnecessary and will only serve to weaken the firm and restrict investments that are needed to revitalize the business. Takeovers of other retail businesses that have followed this model have never ended well for the party being taken over."

Franchise Group said it expects its free cash flow and earnings “would significantly increase” after acquiring Kohl’s.

The holding company "has flown a bit under the radar from an analytical standpoint," according to David Silverman, a senior director at Fitch Ratings, as a company with "a bit of a private-equity style portfolio of various retail businesses — somewhat connected, somewhat disparate to be frank.”

He went on to describe Franchise Group as "almost like a retail-focused private equity fund that happens to be publicly traded,” adding that “a purchase of Kohl’s would be game-changing in terms of size and scale and scope” for the company.

Sale-leasebacks are part of Franchise Group's repertoire. The firm, led by president and CEO Brian Kahn, acquired the Badcock furniture chain in November last year for roughly $580 million. The next month, Franchise Group said it would repay $400 million of debt with the proceeds from the sale of Badcock's consumer-credit accounts receivable portfolio. Then it turned to Badcock's real estate.

It put Badcock's owned stores, headquarters and distribution centers on the block. In March it completed the sale-leaseback of 35 Badcock stores for $94 million to National Retail Properties, saying it would use the cash proceeds to repay part of the remaining $175 million of its acquisition financing for the chain. Then on June 21, just last week, Badcock closed a sale-leaseback deal for three Badcock distribution centers, which Chicago's Oak Street Real Estate Capital, a division of Blue Owl Capital, purchased for about $150 million.

Franchise Group has also been talking to Oak Tree about it acquiring Kohl's real estate for that sale-leaseback deal, according to CNBC.

“Oak Street has proven to be a trustworthy partner throughout our sale leaseback process,” Kahn said in his statement on the recent Badcock warehouse sale closing. "We are pleased to close the sale of the Badcock distribution centers and retire the balance of our [Badcock] acquisition term loan with the cash proceeds.”

Sale-leaseback deals aren't unusual in retail, and Oak Street has been involved in a number of them. In January 2020, Bed Bath & Beyond, the home-goods chain based in Union, New Jersey, sold roughly half its real estate portfolio, including its headquarters, to Oak Street in a sale-leaseback deal valued at $250 million. The transaction was spearheaded by the retailer's then-new CEO, Mark Tritton.

And in 2020, Oak Street struck a deal to purchase four distribution centers owned by discounter Big Lots for $725 million, and then leased them back to the retailer.

Oak Street didn't immediately respond to an email seeking a comment.

The scenario that Franchise Group appears to be planning for Kohl's, burdening the retailer with a lot of debt, has been the downfall of a number of retailers, whose liquidity options are then limited, and can sometimes lead the way to bankruptcy filings, according to Silverman.

Officials in the Badger State have the same concern. In March, U.S. Sen. Tammy Baldwin, a Democrat from Wisconsin, wrote a letter to Kohl's board pleading for it to reject any offer that would include increasing its debt level. She expressed fear that a Kohl's sale could end up like that of Green Bay, Wisconsin-based Shopko, which filed for bankruptcy and was liquidated in 2019 several years after being purchased by Sun Capital Partners for $1.1 billion.

“I ask that you carefully consider each proposal’s long-term strategy and reject any offers that propose a sale-leaseback, increase the risk of bankruptcy, or imperil the jobs and retirement security of thousands of Wisconsin workers,” Baldwin wrote.

Part of the saga of the storied Sears chain, which came out of bankruptcy and is now owned by its former CEO and chairman, billionaire investor Edward Lampert, is Seritage Growth Properties, a real estate firm that has converted one-time Sears stores to other uses or sold them to malls, said Edward Dittmer, senior vice president at DBRS Morningstar, in an interview. And after JCPenney's bankruptcy filing in 2020 its new owners, Simon and Brookfield, have sold some of its real estate, some stores, and distribution centers, according to Dittmer.

The JCPenney stores remaining in operation have been performing above expectations, David Simon, CEO of Simon Property, has told Wall Street analysts on several earnings calls.

Though Kohl's had a bad first quarter, with same-store sales dropping 5.2%, Gass has been creative in her efforts during the past few years to evolve the chain and boost its foot traffic and revenue. She struck a deal for shoppers to be able to drop off their Amazon returns at Kohl's stores. Kohl's has been opening so-called shop-in-shop sites for beauty retailer Sephora at its stores, bringing in new and younger customers to the department stores. And Kohl's is piloting opening up small-format stores.

Not everyone thinks the proposed Franchise Group acquisition is a bad idea. Right after the negotiations were announced, Morningstar equity analyst David Swartz issued a note saying that Kohl's should accept the "underwhelming" $60-a-share offer. At the time, he estimated Kohl's fair value at $58.

"We have recommended that Kohl's accepts offers above our fair value estimate, partly because we view it as a no-moat company in an industry (U.S. department stores) that has been declining for the past 15 years and may continue to do so," Swartz wrote on June 7.

Svec sees an upside in the proposed Franchise Group deal, as well.

"By tapping the value of the real estate and borrowing the rest, Franchise Group can buy Kohl’s (which is substantially larger) with a minimal capital investment," he said. "Thus, if they find a way to get a deal done, both current shareholders and Franchise Group benefit. The issue is that by tapping the real estate to finance the deal, Kohl’s emerges from the buyout with a weaker balance sheet, higher rent expenses, and less flexibility to invest in the business in the future. Leveraged buyouts tend to work out well for everyone involved in the transaction (current shareholders, bankers, and acquiring firm), but are typically a net negative for other stakeholders, including current employees and landlords."

With that in mind, Swartz has also written that "Kohl's large fleet of big-box stores is unnecessary in an increasingly fragmented market."

The chain's stores average 70,000 square feet, while rivals like Old Navy are less than 20,000 square feet and T.J. Maxx and Ross Stores average less than 30,000 square feet, according to Swartz. Yet over the past five years Ross Stores average more than $400 in sales a square foot of selling space compared with Kohl's $219, he said.

That prompted DBRS Morningtar Vice President Steven Jellinek in a May 31 report to write that whether or not a Kohl's sale comes to fruition, he believes the chain may do some downsizing and "selectively exit under-performing stores as its leases approach expiration."

Franchise Group could revive Kohl's, according to Dittmer.

“It’s a big bite for [Franchise Group] to take on," he said. "But if they’re committed to fixing it, it could very well work out. The Kohl’s brand isn’t a bad brand but they’ve obviously fallen on hard times at a time when apparel sales have done pretty well.”

Saunders doesn't think Franchise Group is up to the challenge.

"The second issue is that while Franchise Group has retail experience, Kohl’s will represent its biggest and most prominent deal," he said. "There is a lot of work to be done to put Kohl’s on the right track and we are not entirely convinced that Franchise Group has the expertise to make all the required changes."