SHLDQ - Sears Holdings Corp

[peridotcapital]

Eric,

 

I think you know what the story is for SHLD is not a simple one where there is 1/2 businesses that could be cut off to revitalize everything.  SHLD is a FRANKENSTEIN's Monster created by Eddie Lampert. And it is like you said a few months ago similar to an oil company that has oil in the ground but has to spend $$ to go get it. I originally likened Sears to a Rent Controlled apartment where once you got the tenant out, the money could be made. But I've changed my thesis since then.

 

While I agree with Peridot for the most part, I disagree with him on the upside for SHLD - I think it's much higher ( I think his upside does not assume a nicely profitable retail side of things).  I think he is right on regarding the downside for SHLD due to asset protection. I also agree with both him and Eric that it's going to take time to get stores subleased/leased.

 

Looking at the numbers over and over, I'm starting to realize that Sears (the retail side) will be meaningfully profitable given the right average store size.  Add to that the cashflows from the rental income from the subleased section of the store, as well as the reduced cash drain from the pension fund as rates rise SHLD should  be able to earn a reasonable ROI on its entire asset base.  If SHLD can earn a 10% ROA (I know it seems outlandish now) you will make multiples on your money.  This I think is the real bull case. Now to be fair, SHLD is a small position for me right now as I only 1000 shares of SHLD, whereas earlier in the summer I owned appx 10x that amount -- I'm not sure what is holding me back. (Maybe I'm not convinced, maybe I'm greedy and want it to go lower, I'm not sure. Perhaps I'm not convinced of the certainty of the bull case). 

 

As an aside. I am a loyal Amazon Prime customer. We spend at least $5k a year on amazon on random stuff (we have 2 young kids) - Diapers, toys, games, books, etc. We buy everything there. The price is right and the service is great.

 

Over the past few months, I've been trying out SYW Max (to study SHLD).  It's actually quite good -- the websites themselves are not great -- but their fulfillment seems to be pretty good. Shipping is free and they've been able to get everything to me within 2 days as promised using only UPS Ground delivery (this is a good sign). I expect that they've been spending all their CAPEX here. They seem to give you free SYW points all the time and additionally promise additional bonus points with purchases via special email offers.  The SYW points that you earn expire quickly though -- anyone know how the accounting for this works? thanks

 

By the way I don't think ESL is going to make SHLD into his permanent Investment Vehicle -- who knows 5-10 years down the line, but that is not at all part of my thesis.

 

I agree that if he can get the retail side nicely profitable then the upside is quite larger than what I expect in a base case. I'm curious why you think that is a reasonably attainable goal. Do you think you would see material gross margin expansion on a smaller store format? You will most certainly get G&A deleveraging as revenue declines, so that won't be much help. What kind of EBITDA margins on the retail side are you expecting?

 

The way I see it, SHLD leases about 60% of their retail space today and pays gross rent of ~$800M (~$6/sf). Let's assume subleasing goes very well over the next 3-5 years and they can generate that same $800M in sublease income (at $20/sf that would equate to 40M sf rented, or ~20% of their total store space). That would mean they effectively own all of their stores (from a cost perspective). Without any net rent expense, and assuming nothing else changes materially, their retail operations EBITDA would go from a few hundred million negative to a few hundred million positive. So maybe 2% EBITDA margins. To me that's not a big catalyst for SHLD equity.

 

Now, if you are right and they can really make great progress figuring out integrated retail, and can get to, say, 5% EBITDA margins (still below their peers), then it is a different story. I am assuming you see more of that type of scenario... maybe they can generate $1B of operating cash flow on, say, $20 billion of retail revenue...

 

[ERICOPOLY]

BAC seems like T-Ball.  The value is just sitting there on a T, easy to see.  I have a feeling of the where, and the when.

 

SHLD seems more like Luke Skywalker wearing that helmet thing that shields his vision and trying to use the force to swing at the moving ball shooting lasers at him.

 

Nobody is telling me what the price is that they would sell it for.  Is that because nobody really knows?

[thepupil]

BAC seems like T-Ball.  The value is just sitting there on a T, easy to see.  I have a feeling of the where, and the when.

SHLD seems more like Luke Skywalker wearing that helmet thing that shields his vision and trying to use the force to swing at the moving ball shooting lasers at him.

Nobody is telling me what the price is that they would sell it for.  Is that because nobody really knows?

 

Nice metaphor Eric! I for one have no idea what SHLD is worth. All I know is:

 

- I get paid 10% in lend fees (which offsets over half my theta decay on the puts that protect my full position, profits from flipping calls during the runup paid for most of the puts, thanks COBAF! so in my illogical mental accounting i have no downside).

- I get spinoffs and possible rights offerings whose intrinsic value may be higher than the put strike adjustment to return my capital

- I get short squeeze optionality, turnaround optionality, some other billionaire just bought 20% of the company optionality, Eddie rolls his holdings into SHLD and buys an operating business to offset the depleting operating losses and utilize tax asset optionality, just paid off the pension by selling a few trophy malls optionality, all kind of optionality.

 

For me I don't need to know what it's worth. I know Baker Street hazarded  what is probably an overly optimistic and promotional guess, but he could be right too.

 

I just like the return profile for the next 5 years for my position which i consider to be 0 - very positive %. I own more linear and straightforward returning things where its easy to see how I get paid.

 

This just isn't that type of thing in my opinion. 

[Luke 532]

Nobody is telling me what the price is that they would sell it for.  Is that because nobody really knows?

 

Yes.

 

My job is to quantify the downside and the upside oftentimes takes care of itself.  And is it such a bad thing to not have a ceiling on the stock price of a company you own?

[ERICOPOLY]

Yeah, thanks.  I like that metaphor too. 

 

 

Han Solo: [laughs] Hokey religions and ancient weapons are no match for a good blaster at your side, kid.

Skywalker: You don't believe in the Force, do you?

Solo: Kid, I've flown from one side of this galaxy to the other. I've seen a lot of strange stuff, but I've never seen anything to make me believe there's one all-powerful Force controlling everything. There's no mystical energy field that controls my destiny. [Kenobi smiles] Anyway, it's all a lot of simple tricks and nonsense.

Kenobi: [gets up and takes a blast helmet] I suggest you try it again, Luke. Only this time, let go your conscious self and act on instinct. [puts the helmet on Luke, which covers his eyes]

Skywalker: But with the blast shield down, I can't even see! How am I supposed to fight?

Kenobi: Your eyes can deceive you. Don't trust them. [remote shoots Luke] Stretch out with your feelings! [Watches Luke succeed in blocking the lasers] You see? You can do it.

Solo: I call it luck.

Kenobi: In my experience, there is no such thing as luck.

 

 

[Guest hellsten]

Nobody is telling me what the price is that they would sell it for.  Is that because nobody really knows?

 

bmichaud's gave a price estimate and a suggestion for when to sell:

As far as when to sell etc....buy now, sell half when it reaches $100, then play with the house's money until the full Seritage REIT potential is realized

 

Peter Cundill also recommended selling 50% after 100% gains. I would sell 50% at ~$80.

 

Sears and Eric's focus on "where" reminds me of this paper I read recently:

The paper presented a brief overview of the origins of value investing and discussed the

problem of cognitive biases in investment decision making. Psychologists suggest that when

decision makers find themselves with limited capacity to deal with complex data and high

degrees of uncertainty (as in making investment decisions) they resort to the use of heuristics

as a simplifying tool. However, intuitive heuristics are prone to cognitive bias errors. One

way to minimize the chances of being subject to cognitive biases is to specify the decision

making process (or rule) in advance and stick to it with strict emotional discipline. In light of

that, we developed a heuristic for making value investing decisions

 

http://www.valueinvestingletter.com/pdfs/Eben%20and%20Siddiquee%20-%20Overcoming%20Cognitive%20Biases.pdf

 

With Sears I'm trying to follow Mohnish Pabrai's advice:

"Do not invest in anything that does not look like a 2-3x in 2-3 years."

 

At $40 I believe Sears could be a 2-3x in 2-3 years. I also get to invest with one of the best investors in the world, who ironically seems to be replicating the mistakes Warren and Berkshire Hathaway made, even though he studied Warren's career in detail. Try replacing "Warren Buffett" with "Eddie Lampert" here http://www.iwarrenbuffettquotes.com/warren-buffett-investment-in-berkshire-hathaway-nysebrk-a/:

 

Eddie Lampert’s partnership owned a majority stake in Sears (SHLD) by 2005. Considering only its retail operations, this investment was a failure – the company consistently produced net losses; Eddie eventually had to liquidate the company, as he could not find a single buyer. However, Sears could be seen as a strategic investment, as Lampert used the company’s working capital to make one of his first investments in insurance companies.

 

When Lampert purchased Sears, it had an accounting net worth of $x million. He later realized that its intrinsic business value was considerably less, because its real estate assets were unable to earn returns that were in proportion to their accounting value.

 

Here is the lesson Buffett took away from the entire episode: should you ever find yourself in a chronically-leaking boat, “energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.

 

It seems Eddie is trying to change vessels, but so far it has taken too long and Wall Street's patience is at an end. I trust Eddie and hope what he said in 2006 is part of his strategy:

He points to three role models that together may say more about where he's going than any retail initiative he might float: Bob Rubin, who claims that the best decision-makers keep their options open until the last reasonable moment; Bill Belichick, the coach of the New England Patriots football team, who befuddles and outwits his opponents by constantly adjusting the game plan; and Warren Buffett, who turned from investor to business builder by acquiring operations at good prices and rearranging the cash flow, in many cases to invest elsewhere. "The entrance strategy is actually more important than the exit strategy," Lampert says.

 

Wall Street is asking "Are we there yet?". I'm betting Eddie will act fast, if needed:

 

Are we there yet?

[Kraven]

An interesting article.

 

Why Lampert May Have the Last Laugh

http://www.institutionalinvestorsalpha.com/Article/3288390/Why-Lampert-May-Have-the-Last-Laugh.html

[Guest hellsten]

Simon Property Group Announces Plan To Spin Off Its Strip Center Business And Smaller Enclosed Malls:

http://seekingalpha.com/news-article/8450641-simon-property-group-announces-plan-to-spin-off-its-strip-center-business-and-smaller-enclosed-malls

 

SpinCo's mission will be to own stable, quality strip centers and malls that effectively serve the communities in which they are located. SpinCo is expected to initially own or have an interest in 54 strip centers and 44 malls (each of the malls generating annual net operating income ("NOI") of approximately $10 million or less).  SpinCo's initial year NOI is estimated to be in excess of $400 million and its initial year funds from operations ("FFO") is estimated to be approximately $300 million which is approximately $0.80 per share. SpinCo will operate one of the largest, most diversified portfolios of strip centers and malls in the U.S., having 53 million total square feet in 23 states. Occupancy of SpinCo's strip centers and malls is 94.2% and 90.4%, respectively, as of September 30, 2013, and substantial recent investment has been made in SpinCo's assets.

…

Creates a Retail Real Estate Company Poised for Growth. With one of the largest, most diversified portfolios of strip centers and malls in the United States, SpinCo's significant scale and flexible balance sheet will provide a unique ability to act as a leading acquirer of these assets.

 

[bmichaud]

Simon Property Group Announces Plan To Spin Off Its Strip Center Business And Smaller Enclosed Malls:

http://seekingalpha.com/news-article/8450641-simon-property-group-announces-plan-to-spin-off-its-strip-center-business-and-smaller-enclosed-malls

 

SpinCo's mission will be to own stable, quality strip centers and malls that effectively serve the communities in which they are located. SpinCo is expected to initially own or have an interest in 54 strip centers and 44 malls (each of the malls generating annual net operating income ("NOI") of approximately $10 million or less).  SpinCo's initial year NOI is estimated to be in excess of $400 million and its initial year funds from operations ("FFO") is estimated to be approximately $300 million which is approximately $0.80 per share. SpinCo will operate one of the largest, most diversified portfolios of strip centers and malls in the U.S., having 53 million total square feet in 23 states. Occupancy of SpinCo's strip centers and malls is 94.2% and 90.4%, respectively, as of September 30, 2013, and substantial recent investment has been made in SpinCo's assets.

…

Creates a Retail Real Estate Company Poised for Growth. With one of the largest, most diversified portfolios of strip centers and malls in the United States, SpinCo's significant scale and flexible balance sheet will provide a unique ability to act as a leading acquirer of these assets.

 

 

NOI/SF ~$8 after adjusting for occupancy. I wonder how NOI/SF compares generally for high quality mall RE versus strip malls...

[peridotcapital]

Simon Property Group Announces Plan To Spin Off Its Strip Center Business And Smaller Enclosed Malls:

http://seekingalpha.com/news-article/8450641-simon-property-group-announces-plan-to-spin-off-its-strip-center-business-and-smaller-enclosed-malls

 

SpinCo's mission will be to own stable, quality strip centers and malls that effectively serve the communities in which they are located. SpinCo is expected to initially own or have an interest in 54 strip centers and 44 malls (each of the malls generating annual net operating income ("NOI") of approximately $10 million or less).  SpinCo's initial year NOI is estimated to be in excess of $400 million and its initial year funds from operations ("FFO") is estimated to be approximately $300 million which is approximately $0.80 per share. SpinCo will operate one of the largest, most diversified portfolios of strip centers and malls in the U.S., having 53 million total square feet in 23 states. Occupancy of SpinCo's strip centers and malls is 94.2% and 90.4%, respectively, as of September 30, 2013, and substantial recent investment has been made in SpinCo's assets.

…

Creates a Retail Real Estate Company Poised for Growth. With one of the largest, most diversified portfolios of strip centers and malls in the United States, SpinCo's significant scale and flexible balance sheet will provide a unique ability to act as a leading acquirer of these assets.

 

 

NOI/SF ~$8 after adjusting for occupancy. I wonder how NOI/SF compares generally for high quality mall RE versus strip malls...

 

This spin-off will be a great comp for Seritage, as most of Seritage's properties are not actually inside the malls themselves. FFO of $6 per gross square foot (on 18M total sf) would be ~$100M. So you are looking at a value of roughly $1.5B, if you think it's a good comp.

[ERICOPOLY]

Nobody is telling me what the price is that they would sell it for.  Is that because nobody really knows?

 

bmichaud's gave a price estimate and a suggestion for when to sell:

 

Yes, thanks bmichaud.

 

 

Sears and Eric's focus on "where" reminds me of this paper I read recently:

The paper presented a brief overview of the origins of value investing and discussed the

problem of cognitive biases in investment decision making. Psychologists suggest that when

decision makers find themselves with limited capacity to deal with complex data and high

degrees of uncertainty (as in making investment decisions) they resort to the use of heuristics

as a simplifying tool. However, intuitive heuristics are prone to cognitive bias errors. One

way to minimize the chances of being subject to cognitive biases is to specify the decision

making process (or rule) in advance and stick to it with strict emotional discipline. In light of

that, we developed a heuristic for making value investing decisions

 

You can't invest if you don't know the price you are waiting for.  I take it that's what they are saying and it's my "where".

[bmichaud]

Simon Property Group Announces Plan To Spin Off Its Strip Center Business And Smaller Enclosed Malls:

http://seekingalpha.com/news-article/8450641-simon-property-group-announces-plan-to-spin-off-its-strip-center-business-and-smaller-enclosed-malls

 

SpinCo's mission will be to own stable, quality strip centers and malls that effectively serve the communities in which they are located. SpinCo is expected to initially own or have an interest in 54 strip centers and 44 malls (each of the malls generating annual net operating income ("NOI") of approximately $10 million or less).  SpinCo's initial year NOI is estimated to be in excess of $400 million and its initial year funds from operations ("FFO") is estimated to be approximately $300 million which is approximately $0.80 per share. SpinCo will operate one of the largest, most diversified portfolios of strip centers and malls in the U.S., having 53 million total square feet in 23 states. Occupancy of SpinCo's strip centers and malls is 94.2% and 90.4%, respectively, as of September 30, 2013, and substantial recent investment has been made in SpinCo's assets.

…

Creates a Retail Real Estate Company Poised for Growth. With one of the largest, most diversified portfolios of strip centers and malls in the United States, SpinCo's significant scale and flexible balance sheet will provide a unique ability to act as a leading acquirer of these assets.

 

 

NOI/SF ~$8 after adjusting for occupancy. I wonder how NOI/SF compares generally for high quality mall RE versus strip malls...

 

This spin-off will be a great comp for Seritage, as most of Seritage's properties are not actually inside the malls themselves. FFO of $6 per gross square foot (on 18M total sf) would be ~$100M. So you are looking at a value of roughly $1.5B, if you think it's a good comp.

 

Chad,

 

What is stopping Lampert from dumping the top 350 owned and 50 leased properties (as outlined by Baker) into Seritage? If Lampert were to simply split SHLD into its three logical parts - Retail, Brands/Ancillary services (auto/warranty/Lands End), Seritage - and begin charging the Retail segment market rates, he could instantly turn Seritage into a real live REIT, would he not? 

 

So perhaps the SPG SpinCo is comparable to the existing Seritage, but the potential Seritage as outlined above may be more along the lines of NOI/SF of $20 to $30 on average across the real estate portfolio.

 

Curious what your thoughts are!

 

Thanks.

[thepupil]

 

This spin-off will be a great comp for Seritage, as most of Seritage's properties are not actually inside the malls themselves. FFO of $6 per gross square foot (on 18M total sf) would be ~$100M. So you are looking at a value of roughly $1.5B, if you think it's a good comp.

 

1.5B for a fully leased up diversified (in terms of tenants) Seritage, so Seritage in its current state is obviously worth far less. But, of course,  Seritage doesn't appear to  include the trophy mall locations and it is a great comp for seeing the potential value of Seritage.

[peridotcapital]

Simon Property Group Announces Plan To Spin Off Its Strip Center Business And Smaller Enclosed Malls:

http://seekingalpha.com/news-article/8450641-simon-property-group-announces-plan-to-spin-off-its-strip-center-business-and-smaller-enclosed-malls

 

SpinCo's mission will be to own stable, quality strip centers and malls that effectively serve the communities in which they are located. SpinCo is expected to initially own or have an interest in 54 strip centers and 44 malls (each of the malls generating annual net operating income ("NOI") of approximately $10 million or less).  SpinCo's initial year NOI is estimated to be in excess of $400 million and its initial year funds from operations ("FFO") is estimated to be approximately $300 million which is approximately $0.80 per share. SpinCo will operate one of the largest, most diversified portfolios of strip centers and malls in the U.S., having 53 million total square feet in 23 states. Occupancy of SpinCo's strip centers and malls is 94.2% and 90.4%, respectively, as of September 30, 2013, and substantial recent investment has been made in SpinCo's assets.

…

Creates a Retail Real Estate Company Poised for Growth. With one of the largest, most diversified portfolios of strip centers and malls in the United States, SpinCo's significant scale and flexible balance sheet will provide a unique ability to act as a leading acquirer of these assets.

 

 

NOI/SF ~$8 after adjusting for occupancy. I wonder how NOI/SF compares generally for high quality mall RE versus strip malls...

 

This spin-off will be a great comp for Seritage, as most of Seritage's properties are not actually inside the malls themselves. FFO of $6 per gross square foot (on 18M total sf) would be ~$100M. So you are looking at a value of roughly $1.5B, if you think it's a good comp.

 

Chad,

 

What is stopping Lampert from dumping the top 350 owned and 50 leased properties (as outlined by Baker) into Seritage? If Lampert were to simply split SHLD into its three logical parts - Retail, Brands/Ancillary services (auto/warranty/Lands End), Seritage - and begin charging the Retail segment market rates, he could instantly turn Seritage into a real live REIT, would he not? 

 

So perhaps the SPG SpinCo is comparable to the existing Seritage, but the potential Seritage as outlined above may be more along the lines of NOI/SF of $20 to $30 on average across the real estate portfolio.

 

Curious what your thoughts are!

 

Thanks.

 

Yes, I was speaking about the potential value of Seritage (at 94% occupancy) assuming its current configuration. What is stopping Lampert from literally spitting the company into clearly independent landlord and retail businesses? Nothing, but I don't see the advantage to doing so unless he is truly winding down the entire Sears U.S. and Kmart brands, and therefore does not care if his existing store base makes any money/survives. If he keeps Sears/Kmart stores open, why charge them market rents? That simply transfers capital from the retail side to the real estate side, with no change to the total value of the two businesses. And I doubt the retail could break-even in that scenario, even if the pension is fully funded by then.

 

It seems that most bulls believe Lampert will have a smaller store footprint in 5 years (in the 1,000-1,500 store range, vs 2,000 today), rather than wind it down completely as leases expire (and rent out every owned store it gets interest in from another tenant). In that case charging market rents just bankrupts the retail stores he would need to effectively pursue the integrated retail strategy he seems so keen on right now. Now, if Sears/Kmart go away completely over time, then yes, you can start getting $20-$30/sf rents and the real estate is worth far more and easy to value. Then it becomes a question of how long the retail side stays operational, and how much money it earns/loses until that time.

 

Another point to consider is that we don't know how many of Baker Street's "top 400" properties are either already included in Seritage's 200 or the 125 leased locations backing the MBS owned by Sears Re. It is conceivable to me that nearly half could be ( including most/all of the top 50 leased properties). In that case, the pool from which he could add to Seritage could be smaller than we might think. SHLD only owns about ~700 properties in total (~500 Sears and ~200 Kmarts) and I would bet most of the Kmarts aren't worth all that much.

[bmichaud]

If he keeps Sears/Kmart stores open, why charge them market rents? That simply transfers capital from the retail side to the real estate side, with no change to the total value of the two businesses.

 

Hypothetically:

 

$100 Seritage FV + -$50 Retail FV = $50 SHLD FV.

 

Now separate them into two publicly traded entites. Since RetailCo cannot trade at -$50, SHLD shareholders now own one stock worth $100 and another worth $0. So like with the Orchard SpinCo, RetailCo goes BK, but that negative value no longer drags down the Seritage FV (In my hypothetical example, I assume Seritage is worth half of its true value in order to account for the time it would take to re-lease RetailCo's properties post BK).

 

Barring a lawsuit, I struggle to see why he would not do something like this. Plus, a separate Seritage would be able to raise redevelopment capital far easier than while under the SHLD umbrella.

[peridotcapital]

If he keeps Sears/Kmart stores open, why charge them market rents? That simply transfers capital from the retail side to the real estate side, with no change to the total value of the two businesses.

 

Hypothetically:

 

$100 Seritage FV + -$50 Retail FV = $50 SHLD FV.

 

Now separate them into two publicly traded entites. Since RetailCo cannot trade at -$50, SHLD shareholders now own one stock worth $100 and another worth $0. So like with the Orchard SpinCo, RetailCo goes BK, but that negative value no longer drags down the Seritage FV (In my hypothetical example, I assume Seritage is worth half of its true value in order to account for the time it would take to re-lease RetailCo's properties post BK).

 

Barring a lawsuit, I struggle to see why he would not do something like this. Plus, a separate Seritage would be able to raise redevelopment capital far easier than while under the SHLD umbrella.

 

I agree, IF Eddie wants out of the retail business entirely. It would make the stores unfeasible and make it easy to BK them. Seems unlikely though, right? Why be spending so much money on SYW and integrated retail if that scenario was the end goal? Plus, he would have to spin off/sell warranties, home services, KCD, etc beforehand (the value of those businesses would plummet if the retail side disappeared, even with SHOS still operating). So while I do think being out of the retail business makes sense, nothing he seems to do or spend money on jives with that goal right now.

[wisdom]

I look at it differently -

 

SHLD is not a trade for me. I know approximately SHLD is worth a lot more than today's price. I cannot give you an exact amount as it depends on several outcomes that we have no control over. The only individual who has some control is ESL. Thus, it is very important to judge his character, how will he treat his fellow investors in SHLD (buyout SHLD from under them), how smart he is and does he know what he is doing.

 

I would argue - for character - all you can look at is history, the way he has behaved. In addition, I like someone who isn't promotional and keeps things close to his chest rather than disclose his plans and push up the share price. That does not help a long term investor like me who is buying and who wants SHLD buyback more shares.

 

He has not done anything in the past for me to think he will take advantage of me being a minority holder. As long as I partner with him my gains will be similar to his.

 

Again based on history - I would argue he is better at what he is attempting than most people in this world. He is where he is because of that. He understands finance and retail better than most. I would argue that all you need to do is look at other retailers. Most retailers will not even admit that there is huge change happening in the industry and that North America has too much retail. I only know one CEO in retail who has admitted to that.

 

I need someone who can admit to themselves what is happening in the real world even if it impacts their major business running my company rather than someone who keeps fighting to retain the old ways. Denial will kill most businesses and most CEOs have no incentive to admit that they are in a declining business or one that is rapidly transforming.

 

Most CEOs like JC Penny will bet the company in one direction or that other as they are supremely confident that they have figured it all out and they know what worked in the past. I do not believe this to be smart. I would rather have a CEO who realizes his limitations and tries several things on a small scale. If some projects succeed he can choose to proceed with them otherwise wind them down. I would rather partner with that CEO.

 

I would not compare ESL with Buffett but if you are truthful - how many here could have predicted in 1967 what BRK would look like today. So let us not kid ourselves. I do not believe even ESL knows what SHLD will look like in 10-20 years.

[wisdom]

I want to partner with a CEO/owner who will do what makes sense rather than publicly spell out a masterplan and then be held to it by Mr Market. That is suicide in a transforming industry.

 

Human nature is to look for certainty even though there is no certainity in life. This is why there is an opportunity for mispricing. Everyone in the world does not have to believe SHLD is an opportunity or else the opportunity to buy an investment at a low price would not exist.

 

Mr market hates uncertainty, lacks patience and a CEO who does not sound confident. Mr Market would rather partner with Ron Johnson (when he laid out his plans) as he sounded confident.

[bmichaud]

If he keeps Sears/Kmart stores open, why charge them market rents? That simply transfers capital from the retail side to the real estate side, with no change to the total value of the two businesses.

 

Hypothetically:

 

$100 Seritage FV + -$50 Retail FV = $50 SHLD FV.

 

Now separate them into two publicly traded entites. Since RetailCo cannot trade at -$50, SHLD shareholders now own one stock worth $100 and another worth $0. So like with the Orchard SpinCo, RetailCo goes BK, but that negative value no longer drags down the Seritage FV (In my hypothetical example, I assume Seritage is worth half of its true value in order to account for the time it would take to re-lease RetailCo's properties post BK).

 

Barring a lawsuit, I struggle to see why he would not do something like this. Plus, a separate Seritage would be able to raise redevelopment capital far easier than while under the SHLD umbrella.

 

I agree, IF Eddie wants out of the retail business entirely. It would make the stores unfeasible and make it easy to BK them. Seems unlikely though, right? Why be spending so much money on SYW and integrated retail if that scenario was the end goal? Plus, he would have to spin off/sell warranties, home services, KCD, etc beforehand (the value of those businesses would plummet if the retail side disappeared, even with SHOS still operating). So while I do think being out of the retail business makes sense, nothing he seems to do or spend money on jives with that goal right now.

 

 

Re-thinking my previous two posts - originally I said split into three parts, then I used an example of BK'ing RetailCo while splitting off Seritage.

 

Incorporating your post....

 

1. Why not bundle all brands/auto/warranty together with retail (obviously Land's End will be spun) into CrapCo and try to keep it out of BK

2. Spin Seritage with the top 350 owned/50 leased, but charge $8/SF on average, more along the lines of the SPG spinCo in order to not BK CrapCo

3. 68MM SF leased at $8 NNN/SF with a 7% cap rate is $7.8B or $73 per SHLD share for a Seritage SpinCo initial FV

4. Any redevelopment cost for Seritage would be made up by market-rate rents on redeveloped property

 

Since Seritage isn't a cash contributor to SHLD, the Retail side would be left to itself in all of its current glory to fight off BK. SHLD shareholders then have stock in something worth at least $73, plus a stock that can at worst trade at $0 in the form of CrapCo.

 

 

All I am trying to do is figure out what Lampert could possibly be thinking here. He's not an idiot - he knows the time value of money is not on his side by keeping a money-losing retailer "cancer" attached to a hidden REIT. The market will never give SHLD equity credit for this hidden REIT under the current construct - nor should it, as there are zero tax benefits from keeping it in its current corporate form, and in the event of BK, a liquidation process would yield FAR less real estate value than a separately listed, tax-advantaged Seritage.

[peridotcapital]

SHLD is not a trade for me. I know approximately SHLD is worth a lot more than today's price. I cannot give you an exact amount as it depends on several outcomes that we have no control over.

 

I'm curious why you are so confident that SHLD is worth approximately "a lot more than today's price." The current enterprise value is $10 billion. Baker Street's real estate valuation at the mid-point was $1.5 billion below that (I am assuming they did not low ball their numbers and there is little evidence to suggest they did).

 

If SHLD equity is worth 50% more than the current price then the present value of the other assets has to be more than $4 billion. For a collection of assets that is currently collectively losing money, that conclusion strikes me as possible, but far from close to certain.

[Luke 532]

Mr market hates uncertainty, lacks patience and a CEO who does not sound confident. Mr Market would rather partner with Ron Johnson (when he laid out his plans) as he sounded confident.

 

wisdom, your comment reminded me of the following from The Little Book of Behavioral Investing by Montier.

 

"We want people to sound confident... Psychologists have repeatedly found that people prefer those who sound confident and are even willing to pay more for confident (but inaccurate) advisors" (page 44).

 

"As long as you were wrong but sounded extremely confident, even a poor track record was excused" (45).

[peridotcapital]

If he keeps Sears/Kmart stores open, why charge them market rents? That simply transfers capital from the retail side to the real estate side, with no change to the total value of the two businesses.

 

Hypothetically:

 

$100 Seritage FV + -$50 Retail FV = $50 SHLD FV.

 

Now separate them into two publicly traded entites. Since RetailCo cannot trade at -$50, SHLD shareholders now own one stock worth $100 and another worth $0. So like with the Orchard SpinCo, RetailCo goes BK, but that negative value no longer drags down the Seritage FV (In my hypothetical example, I assume Seritage is worth half of its true value in order to account for the time it would take to re-lease RetailCo's properties post BK).

 

Barring a lawsuit, I struggle to see why he would not do something like this. Plus, a separate Seritage would be able to raise redevelopment capital far easier than while under the SHLD umbrella.

 

I agree, IF Eddie wants out of the retail business entirely. It would make the stores unfeasible and make it easy to BK them. Seems unlikely though, right? Why be spending so much money on SYW and integrated retail if that scenario was the end goal? Plus, he would have to spin off/sell warranties, home services, KCD, etc beforehand (the value of those businesses would plummet if the retail side disappeared, even with SHOS still operating). So while I do think being out of the retail business makes sense, nothing he seems to do or spend money on jives with that goal right now.

 

1. Why not bundle all brands/auto/warranty together with retail (obviously Land's End will be spun) into CrapCo and try to keep it out of BK

2. Spin Seritage with the top 350 owned/50 leased, but charge $8/SF on average, more along the lines of the SPG spinCo in order to not BK CrapCo

3. 68MM SF leased at $8 NNN/SF with a 7% cap rate is $7.8B or $73 per SHLD share for a Seritage SpinCo initial FV

4. Any redevelopment cost for Seritage would be made up by market-rate rents on redeveloped property

 

Since Seritage isn't a cash contributor to SHLD, the Retail side would be left to itself in all of its current glory to fight off BK. SHLD shareholders then have stock in something worth at least $73, plus a stock that can at worst trade at $0 in the form of CrapCo.

 

 

That scenario seems most likely given what we know now (but who knows, it could change in a matter of months). But you are ignoring the $5 billion of debt. That's $47 per share of debt that stands in front of the equity holders. It's not just 0 + 73 = $73 per share of value for SHLD equity. For every $1 billion of the debt that Seritage would likely take with it (assuming CrapCo wants to stay in business), that $73 per share of value would be reduced by ~$10/share. Now, over time Seritage could use FCF to delever, which would be accretive to the equity holders, but that would be even further into the future.

 

The leverage ratio is the problem with the equity, in my view. If that gets reduced somehow, the stock zooms higher. And that is why the retail losses bother me so much. I have been spending a ton of time on this name lately (as the volume of my posting here shows), and I very much want to find reasons to buy, but it's turning out to be more difficult than I hoped. But maybe I'm just too focused on the numbers and not giving Eddie enough credit for his 30-year track record. And unlike most on this forum, I actually think there is a big difference between being a great stock picker and being a great capital allocator as the CEO of an operating business. We know Eddie is great at the former, but he has no experience or track record of the latter. And the last 10 years do little to convince me otherwise.

[wisdom]

Assuming SHLD is a going concern -

 

Inventory                                    $8.9 B

total current liabilities                  $9.6 B

 

                                                      cash with the canadian 5 canadian leases being cancelled should be $1B. For simplicity lets assume net is $0.

 

SCC has cancelled about 10 leases in Canada over the last 2 years for $770 mil in cash. SCC has about 122 stores and has a mkt cap of $1.3B. 10% of the leased stores resulted in $770 mil in cash. These are not owned.

 

Let's assume that Canadian commercial real estate is vastly over-valued for some reason. Even then you can come up with numbers higher than the current propery and equipment value of $5.6B on the B/S. This alone would account for the market cap today. You just happen to have Land's end, SRAC, SCC, serotage, brands, etc in addition. I believe there is more value here than the market gives it credit for.

 

Again I am not that concerned about the long term obligations as I don't expect SHLD to be in bankruptcy anytime soon.

 

EDIT: SCC numbers as I was wrong on the store count.

[bmichaud]

You're right - Seritage could take on debt if it were spun out. Though since Current SHLD = CrapCo (b/c Seritage adds no value under the current construct), you might as well spin Seritage debt free for the benefit of shareholders. As far as debt service goes, debt holders are no worse off than pre-Seritage spin (collateral-wise, it appears Lampert has really made it difficult for creditors to access RE in a liquidation scenario...but maybe Kraven is right, and that doesn't matter in a cpt. 11 situation).

 

But yes: long-term debt net of working capital is ~$19 per share, which would bring Seritage down to $54 if spun with said debt load.

[JSArbitrage]

I think some of you are missing a larger piece of this analysis: the REIT would have SHLD as their ONLY tenant (for all practical purposes).  SHLD isn't profitable with (a) below market leases and (b) not paying leases at all (depending on the location.)  Spinning the RE into a REIT would require market leases across the board.  That's like throwing gasoline on this fire.

 

Let's also not pretend like the current valuation gives no credit to Seritage.  If you can read a 10K and do some back of the envelope calculations to gather a view of Seritage, then the market has already done so.