SHLD anyone?

[JEast]

For all the talk about using the option market, I would mention that the option market makers aren't stupid.  With the skewed price of the puts, I would suspect that they are priced right.  Meaning that SHLD will probably go lower.  Anyway, just a cautionary note.

 

Cheers

Jeast

[value-is-what-you-get]

Seems like a majority of K-Marts I've seen around the country are in crappy locations and are poorly maintained run-down buildings. I don't think it would be as easy to sell a lot of these locations as some people think. Real Estate is only worth what people will pay for it. I do think that K-Mart is an awful business that should be shut down and liquidated though.

 

A few Kmart's that I know of are in shopping centers that are half empty so in factoring in the real estate value I'd maybe chop off 30% or so for bad locations and the length of time to sell. 

 

I was actually in a Kmart this past weekend, it's one of the only places you can buy ginormous clothes (3x and up for a relative) and the store is quite sad.  A lot of inventory that looks like it hasn't moved in years, the place just has this mishmash feel.  One minute you're next to washing machines, then suddenly you're in the middle of a toy section, and a few steps later you're looking at $1000 TVs which are next to piles of cheap Christmas candy.

 

I second that observation - went into Sears and they have good stock but the overall impression is "tired" - the sales staff give the impression that they are doing their best "under the circumstances".  There's no pinning a number on all this of course but I really have to scratch my head wondering what is the end game here for Lampert et al.  If it's to use retail cash flows to buy back all the shares and then sell the real estate, wouldn't you want the real estate to be wearing it's Sunday best?  Many of the Sears here in Canada are anchor stores and when they slide, to a certain extent the whole property/mall slides a bit too.  I have two daughters who will drive 40 minutes to another mall with better stores, and the one here seems pretty good to me!  My big nagging question is why would someone buy up all this retail when they clearly don't care that much about retail?

[zarley]

My big nagging question is why would someone buy up all this retail when they clearly don't care that much about retail?

 

Instead of focusing on why Sears isn't a great retailer, think about how Lampert got control of KMart and Sears and then think about maximizing the return on a collection of assets which were acquired for pennies on the dollar and which are now allocated to generic big-box retail but might be better allocated in different ways.  Would you continue to spend liberally on stores that are destined to lose money year after year, or would you work on transitioning away from those stores while minimizing costs?  And, if you know you need to reallocate stores to other uses or just sell them outright, how would you manage that in the face of the macro environment of the last 3 years?

 

Yes, the story was better 3-4 years ago when the retail operation turned out $1 billion in cash flow and the real estate values trumped most everything else, but the capital allocation from SHLD has been, IMO, appropriate.  Yes, SHLD would be much better off if the retail execution was better and the retail operation was incredibly profitable.  But, at the right price the retail doesn't need to be Target quality to make a decent return.

[FCharlie]

Seems like a majority of K-Marts I've seen around the country are in crappy locations and are poorly maintained run-down buildings. I don't think it would be as easy to sell a lot of these locations as some people think. Real Estate is only worth what people will pay for it. I do think that K-Mart is an awful business that should be shut down and liquidated though.

 

Kmart's historical operating income:

 

2007: $401 million

2008: $172 million

2009: $190 million

2010: $353 million

 

Not sure why you'd shut and liquidate something that produces operating cash flow year after year.  It's not a beautiful place, and the shoppers aren't exactly the most beautiful people, but they have cash and they spend it. You could argue that Sears is the laggard here, but then I think Sears is being held back because of housing starts at 600K. Housing starts need to rise 150% just to return to "normal". 

 

The pension is the biggest problem here, but the pension is frozen to new employees and eventually will run off. Interest rates being held at 0% are an issue. Lampert thinks every 1% rise in rates = $500 million change in pension liabilities. I think a lot can change w/ Sears over time. Seems like it's priced for near total failure here.

[dcollon]

Combining two threads here quickly, but maybe this helps the 4th quarter.  It's also a great thing to see.

 

http://www.lancastereaglegazette.com/article/20111221/NEWS01/112210303/Donors-pay-off-Kmart-layaway-accounts?odyssey=tab|topnews|text|Frontpage

 

http://abcnews.go.com/Health/Wellness/complete-strangers-touched-altruistic-layaway-angels/story?id=15199745#.TvIls_Le58E

 

[tooskinneejs]

Welcome textual.

 

"He is not looking to bankrupt SHLD and make it go into the history books as his Waterloo. He actually intends to make this a transformation."

 

A transformation to what?  What is the end game?  What will this company look like and be in 5 or 10 years?  Thanks.

[prevalou]

Does someone have an idea about Orchard value? I suppose shld quotes nos ex Orchard.

[prevalou]

Annoter question: what happens if There are big redemptions on ESL, due to poor performance for instance. I suppose investors in the fund are locked, but for how long ? In case of redemptions, would Lampert be forced to sell a portion of his sears shares ?

[stahleyp]

how do you know which options are just for sears common vs the reorg?

[frankhkii]

 

"Too many stores are losing money, yet they stay open, even though it would seem the company could make a lot of money if the lagging stores were closed."

 

Outstanding lease obligations.  Maybe they believe its better to cover part of your lease costs rather than none of it.

 

I disagree with your perspective towards keeping stores open just to cover part of the lease costs.  It makes more sense that Eddie is holding the real estate/leases because of its underlying value.  Some of these stores have flat rents for the next 40 years @$2-4psf which leaves a lot of room for profitability...

 

As an anchor tenant, Sears and Kmart have a lot of leverage with the landlords.  Landlords make their money by leasing off of the Anchor tenants.  I.E. Anchor tenant (Sears/Kmart) pays approx $3-5psf while the small shop space pays approx $15-30psf+.  The small shop space is where the landlord generates their profit.  If the Anchor tenant is "letting their store go" by not reinvesting in it, it hurts the attractiveness of the small shop space and the rate that can be charged.  If the anchor tenant goes dark (closes completely) the small space is virtually un-leasable.  In fact, most small shops have language in their lease that allows them to cancel their lease if the Anchor tenant goes dark. 

 

For these reasons, I believe that Sears would be able to shrewdly negotiate its way out of leases on most unprofitable stores if they wanted too..

[tooskinneejs]

"Some of these stores have flat rents for the next 40 years @$2-4psf which leaves a lot of room for profitability..."

 

With such low occupancy costs, one should reasonably expect the company to be gushing operating income, right?  Instead, operating margins were 1% for fiscal 2010 and -3% for the 39 weeks ended October 29, 2011.  So despite (supposedly) having very favorable occupancy costs, the company can't even generate decent income from operations?  Is that a sign of a good business?  And what is long term direction of the company's retail profitability when you have six years of continually declining sales and major under-investment in store maintenance?

 

"It makes more sense that Eddie is holding the real estate/leases because of its underlying value."

 

I heard this five years ago.  Everyone was hyped on Lampert 'unlocking' some kind of secret value in the real estate/leases.  Nothing has happened since and I still haven't heard anything that indicates what might happen and when.

 

"I believe that Sears would be able to shrewdly negotiate its way out of leases on most unprofitable stores if they wanted to."

 

Why wouldn't they want to get rid of their most unprofitable stores?  And if they do want to get rid of them and can do so easily, why haven't they?

[ERICOPOLY]

For all the talk about using the option market, I would mention that the option market makers aren't stupid.  With the skewed price of the puts, I would suspect that they are priced right.  Meaning that SHLD will probably go lower.  Anyway, just a cautionary note.

 

Cheers

Jeast

 

options market makers reflect what's going on with the underlying, and in this case some weird technicals (supply and demand). I don't believe they have any more predictive power over where stocks go in the short term than anybody else does.

 

Here is how I understand the pricing:

 

1)  I write a $45 strike put for $14 --the option market maker buys it from me

2)  He is hedged with a put now, so the option market maker buys the stock and lends it out to shorts, collecting huge cash flow from shorts. 

3)  He can also write a covered call

 

So the reason why the call is cheaper than the put is that the market maker makes up the excess value by lending his long position in the stock to the shorts.

 

Oh, and anytime somebody wants to buy the put for more than what he paid me, (the wide bid/ask spread), he can just unwind it all for a tidy profit.

 

This has absolutely nothing to do with the opinion of the market maker on the stock's long term or short term price movement.  He doesn't need to care about that -- he's just market-neutral, making money regardless.

 

 

 

 

[ERICOPOLY]

I heard this five years ago.  Everyone was hyped on Lampert 'unlocking' some kind of secret value in the real estate/leases.  Nothing has happened since and I still haven't heard anything that indicates what might happen and when.

 

I agree.  I have absolutely no clue as to why people think SHLD is going sky high.  There are probably some better vehicles to bet on a real estate bounce.  The only other value driver here seems to be the cash flow from the stores.

 

And what does he do with it?  Buys more SHLD shares.  No, he's not diversifying into better streams of cash flow, he's just effectively dividending it out.

 

So what do you get left with if the cash flow keeps on dwindling? 

 

So basically the only play here seems to be KMart getting up and kicking everyone's butt in retailing.  But it ain't gonna happen unless he invests heavily in the stores, instead of dividending it all out.

 

So I don't understand where the upside is unless you reinvest in the stores instead of returning it all to shareholders.

 

[txlaw]

I heard this five years ago.  Everyone was hyped on Lampert 'unlocking' some kind of secret value in the real estate/leases.  Nothing has happened since and I still haven't heard anything that indicates what might happen and when.

 

I agree.  I have absolutely no clue as to why people think SHLD is going sky high.  There are probably some better vehicles to bet on a real estate bounce.  The only other value driver here seems to be the cash flow from the stores.

 

And what does he do with it?  Buys more SHLD shares.  No, he's not diversifying into better streams of cash flow, he's just effectively dividending it out.

 

So what do you get left with if the cash flow keeps on dwindling? 

 

So basically the only play here seems to be KMart getting up and kicking everyone's butt in retailing.  But it ain't gonna happen unless he invests heavily in the stores, instead of dividending it all out.

 

So I don't understand where the upside is unless you reinvest in the stores instead of returning it all to shareholders.

 

Okay, well, I know I'm not going to make any headway on convincing you that this is not a mere return of capital.  But assuming that runoff value is well above market price, it makes sense to cash out existing shareholders who want liquidity, though I would prefer Lampert be less opaque about his plans prior to doing so. 

 

Regarding real estate value, of course, Lampert has been unable to monetize the real estate as of yet.  We just survived the worst financial crisis since right before the Great Depression.  The US is over-retailed, and the stronger retailers have to figure out where and when to best allocate capital in an environment that is unsure, to say the least.  Online retailers such as Amazon are starting to beat down on traditional retailers, squeezing margins and making it even less likely for the retailers to invest without really thinking things through.

 

So instead of taking over US leases from SHLD, people like Target go to places where the long term economic trajectory is more clearly upward like Canada (see Zellers deal).  Lampert has to bide his time and try to maximize the value of the existing store base, while things get sorted out in the US.  Whether his strategy is correct will be known in a couple of years. 

 

I tend to think that Sears in its current incarnation is hopeless.  Sears should only exist in the hometown format, being the alternative to Lowe's and Home Depot. 

 

Kmart shouldn't exist at all, to be frank.  They suck.  They should all be turned into Walmarts, Targets, or Costcos.

 

The brands should be distributed more broadly, and Lampert has begun to do that.

 

Patience, I guess.

[ERICOPOLY]

Okay, well, I know I'm not going to make any headway on convincing you that this is not a mere return of capital. 

 

Yeah, I've made my views on that pretty clear I suppose.  Where is Bronco?

 

I guess a lot of shareholders who bought high are happy at least that they can capture a tax loss at the same time that they get their laundered dividend.  One of these days the government is going to get smart and tax this stuff the same as dividends.

[Guest Hester]

Kmart's historical operating income:

 

2007: $401 million

2008: $172 million

2009: $190 million

2010: $353 million

 

Not sure why you'd shut and liquidate something that produces operating cash flow year after year.  It's not a beautiful place, and the shoppers aren't exactly the most beautiful people, but they have cash and they spend it. You could argue that Sears is the laggard here, but then I think Sears is being held back because of housing starts at 600K. Housing starts need to rise 150% just to return to "normal". 

 

What's KMART's likely ROIC then? Something tells me it's less than what Lampert could compound at.

[FCharlie]

Kmart's historical operating income:

 

2007: $401 million

2008: $172 million

2009: $190 million

2010: $353 million

 

Not sure why you'd shut and liquidate something that produces operating cash flow year after year.  It's not a beautiful place, and the shoppers aren't exactly the most beautiful people, but they have cash and they spend it. You could argue that Sears is the laggard here, but then I think Sears is being held back because of housing starts at 600K. Housing starts need to rise 150% just to return to "normal". 

 

What's KMART's likely ROIC then? Something tells me it's less than what Lampert could compound at.

 

 

I'm sure Lampert could compound at a better rate. Just because he's not doing it now doesn't mean he's not going to do it later. Here's a quote from this years letter to shareholders:

 

"As we have done since we took control of Kmart in 2003, we will continue to evaluate alternative uses of the company’s cash flow and capital resources to generate long-term value for all shareholders.  Each year brings with it different circumstances, and we expect to have a variety of opportunities to invest our cash in the years to come.  "

 

[ageofsocrates]

retailing is a tough business..margins are low. He should had sold off non core assets and invest into businesses (passive equity investments) where returns would have been higher...

[prevalou]

A lot of people seem to disagree with Lampert strategy and his implication with sears.  It reminds me Berkowitz and St Joe with a larger scale. This could be a motive for redemptions In the future, even if he bought the shares at 5$ 7 years ago. The problem: will investors In Esl continue to follow Lampert if the street always disagree with him and if he has a bad year ( like Berkowitz).

Then the risk is a forced sears sale by Lampert himself.

[stahleyp]

ESL has a 5 year lock up. That'll help a ton with redemptions.

[prevalou]

Sears top at 160+ was in 2006/2007, five years ago...

[stahleyp]

Sears top at 160+ was in 2006/2007, five years ago...

 

Yeah, but I doubt that everyone in the fund just renewed their 5 year period at that time. I'm also thinking that most of the people who have been with him for a really long time and they're not jumping just few the past few years. To most of the world, Buffett looked like an old man who didn't know much from 1995-2000 or so. Also, if people are willing to lock up money for 5 years, I'd imagine they know the value of long term investing (hopefully!).

[prevalou]

Do you know if it is five years lockup and then five more years lockup or if it is five years lockup and then you are free to sell when you want?

[stahleyp]

Do you know if it is five years lockup and then five more years lockup or if it is five years lockup and then you are free to sell when you want?

 

Hmmm...very good question. I assumed (maybe wrongly) that it was a 5 year lock up and then they had to lock it up again. You know what they say about assuming, though! :P

[dcollon]

I think it's important to remember that a significant amount of the money in the partnership is Mr. Lampert's.  In addition, much of the rest is long time clients (Dell, etc...) and most of it is family money, which is much more sticky that fund of fund or institutional money. 

 

I have been told that they aren't completely closed, but my guess would be that if Mr. Lampert wanted to raise more capital he probably could.  A run on the fund isn't out of the question, but I would think it's a lower probability. 

 

And most lockups don't roll, however some do if you contribute new capital at a later date.