SHLDQ - Sears Holdings Corp

[heth247]

It seems odd to me that Sears is better off from a financial standpoint selling KCD products wholesale to Ace Hardware or Costco than to SHOS (I'm assuming they don't sell to unaffiliated third parties at cost as well). KCD gets a royalty on everything, so that subsidiary doesn't care where the sale takes place. But from SHLD's perspective, it seemed like SHOS could grow independently and be a retailer for KCD products long-term, which would offset the decline in KCD sales coming from the ever-shrinking Sears/Kmart store base. But SHLD stands to make more selling in their own stores or Ace/Costco vs selling to SHOS at cost and having the dealer/franchisee commission come back to SHOS, not SHLD. Now you could say that KCD is part of SHLD, and they are getting paid, so what's the difference... but in the SHLD world where every subsidiary competes with each other that seems like a strange justification. Or maybe I'm just missing something more obvious. Not that this is hugely important anyway...

 

It frees up more RE from Sears?

[jeffmori7]

It seems odd to me that Sears is better off from a financial standpoint selling KCD products wholesale to Ace Hardware or Costco than to SHOS (I'm assuming they don't sell to unaffiliated third parties at cost as well). KCD gets a royalty on everything, so that subsidiary doesn't care where the sale takes place. But from SHLD's perspective, it seemed like SHOS could grow independently and be a retailer for KCD products long-term, which would offset the decline in KCD sales coming from the ever-shrinking Sears/Kmart store base. But SHLD stands to make more selling in their own stores or Ace/Costco vs selling to SHOS at cost and having the dealer/franchisee commission come back to SHOS, not SHLD. Now you could say that KCD is part of SHLD, and they are getting paid, so what's the difference... but in the SHLD world where every subsidiary competes with each other that seems like a strange justification. Or maybe I'm just missing something more obvious. Not that this is hugely important anyway...

 

It frees up more RE from Sears?

 

Yep, for me they win as long as while they are shrinking their physical footprints by closing/reducing Sears/Kmart, SHOS keep opening some stores in the same area to become the principal KCD channel in this area, being a win-win for both SHLD and SHOS.

[Luke 532]

 

Yep, for me they win as long as while they are shrinking their physical footprints by closing/reducing Sears/Kmart, SHOS keep opening some stores in the same area to become the principal KCD channel in this area, being a win-win for both SHLD and SHOS.

 

And it preserves much of the value of the brands.  It is a counter-point to the argument "closing stores will kill brand value."

[peridotcapital]

 

Yep, for me they win as long as while they are shrinking their physical footprints by closing/reducing Sears/Kmart, SHOS keep opening some stores in the same area to become the principal KCD channel in this area, being a win-win for both SHLD and SHOS.

 

And it preserves much of the value of the brands.  It is a counter-point to the argument "closing stores will kill brand value."

 

Good points. Just take the royalty and have that be where the value lies. Since I'm skeptical of SHLD's ability to make money as a retailer, I guess I should want them to break-even on the product side (better than they're doing now) and make a little money on the IP side. I just found it unfortunate, I guess, that if a Sears Hometown store sells a Kenmore appliance, SHLD makes no profit on that actual sale. But if they can sell services and warranties on the item as well... that really becomes even less important...

[wisdom]

In the long run it should make SHLD asset lite and to an extent this has been hurting their margins. They are effectively selling KCD products at cost whereas they were marked up in the past.

 

In the end you have KCD sell directly to SHOS and you get the royalties without the stores or inventory - royalty business with minimal capital invested.

[ERICOPOLY]

What's the argument for spinning off a REIT?

 

Paying income tax at today's high rates can't be that compelling for Eddie.  The corporate tax rate is not only lower, but will probably go lower still.  Plus, don't they have a lot of losses at SHLD that can offset real estate rental income?  One might think they would use up those losses before spinning off a REIT?  At that point you might want a REIT structure to avoid the double taxation (corporate and dividend).

 

 

 

 

[finetrader]

It seems odd to me that Sears is better off from a financial standpoint selling KCD products wholesale to Ace Hardware or Costco than to SHOS (I'm assuming they don't sell to unaffiliated third parties at cost as well). KCD gets a royalty on everything, so that subsidiary doesn't care where the sale takes place. But from SHLD's perspective, it seemed like SHOS could grow independently and be a retailer for KCD products long-term, which would offset the decline in KCD sales coming from the ever-shrinking Sears/Kmart store base. But SHLD stands to make more selling in their own stores or Ace/Costco vs selling to SHOS at cost and having the dealer/franchisee commission come back to SHOS, not SHLD. Now you could say that KCD is part of SHLD, and they are getting paid, so what's the difference... but in the SHLD world where every subsidiary competes with each other that seems like a strange justification. Or maybe I'm just missing something more obvious. Not that this is hugely important anyway...

 

So KCD make an about 4% royalty on all KCD products that SHOS is selling. Now, SHOS has 1200 stores and about 2.5B$ in annual sales

 

KCD also make a 4% royalty on all KCD's product that Sears and Kmart stores are selling. And SHLD has about 35B$ sales. Their might be some double counting here, but that is why I think Eddie is trying to make all these efforts to make SHLD profitable.

 

What would you prefer, a royalty on a 2,5B$ business or a 35B$ business?

 

So in trying to turn around the retail business, SHLD is burning more and more cash so they have to either take on more debt or selling valuable RE.

 

A SHLD's shareholder has to trust Eddie's judgment here that he will either pull the plug in time before all those operating losses messed his balance sheet too much or that he succeed on restructuring the retail business.

 

I think the former is more likely to happen.

 

[Myth465]

I think the chances of EL succeddeding as a retailer are slim to known.

Ask any of your friends or people in your community do they shop at sears, use SYW, or use the sears website...

This is similar to circuit city, or black berry, or any number of brands / retailers. They are losing mind share, and its showing up in market share and SSS numbers.

 

Also you are forgetting that the goods are consigned to SHOS. This is arguably the worst way to sell merchandise. You still own it, but it sits in someone elses warehouse. Its on your books but not in your possession. To be doing consignment for 0% Gross Margin, or 4% Gross Margin depending on how you look at it. Doesnt make sense, and allows you to get screwed easily...

 

If I ran the royalty side of KCD I would want this deal.

If I was in charge or inventory, accounting, customer service / backoffice I would hate this deal.

If I ran Sears I would probably hate this deal.

 

Everyone has slightly different motives here.

[krazeenyc]

I think the chances of EL succeddeding as a retailer are slim to known.

Ask any of your friends or people in your community do they shop at sears, use SYW, or use the sears website...

This is similar to circuit city, or black berry, or any number of brands / retailers. They are losing mind share, and its showing up in market share and SSS numbers.

 

Also you are forgetting that the goods are consigned to SHOS. This is arguably the worst way to sell merchandise. You still own it, but it sits in someone elses warehouse. Its on your books but not in your possession. To be doing consignment for 0% Gross Margin, or 4% Gross Margin depending on how you look at it. Doesnt make sense, and allows you to get screwed easily...

 

If I ran the royalty side of KCD I would want this deal.

If I was in charge or inventory, accounting, customer service / backoffice I would hate this deal.

If I ran Sears I would probably hate this deal.

 

Everyone has slightly different motives here.

 

the goods are consigned to SHOS from SHLD -- are you sure you have that right?

 

I know that SHOS consigns the goods to their individual franchise owners... but do not think that SHLD consigns the goods to SHOS. 

[adesigar]

What's the argument for spinning off a REIT?

 

Paying income tax at today's high rates can't be that compelling for Eddie.  The corporate tax rate is not only lower, but will probably go lower still.  Plus, don't they have a lot of losses at SHLD that can offset real estate rental income?  One might think they would use up those losses before spinning off a REIT?  At that point you might want a REIT structure to avoid the double taxation (corporate and dividend).

 

Sorry it was a rumor/speculation of SHLD+REIT and I didn't read the posting fully before I put the link on the board. What was interesting to me was the stock price reaction to a job posting.

 

I was really hoping Short sellers would be out in force today and cause a nice drop in price and then this rumor comes along ARGH.

[Myth465]

@ krazeenyc - Not sure, basing it on prior posts in this thread which indicate the goods are sold on consignment. I personally havent checked the relationship between SHOS and SHLD, but its been posted a few times here that those are the terms. Hopefully you are right, because its a crappy way to sell goods.

 

Well folks, I'm now long SHOS, in addition to my existing position in Sears Canada. At this rate, I'll be a SHLD bull in no time :)

 

Interesting tidbit I saw while reading up on SHOS. In 2012, 56% of their revenue came from KCD products. That comes to $1.37 billion of KCD retail sales through SHOS's 1,200+ stores. SHLD consigns this merchandise to SHOS stores, and then the dealer gets a cut when the products are sold. How likely is it that SHLD makes a 10% margin on their wholesale KCD sales to SHOS? In that case KCD's profit from SHOS alone could be ~$100M. Just an interesting data point that may be useful when trying to peg a value for KCD... especially in a scenario where SHLD's retail store base is a fraction of what it is today...

[alertmeipp]

Just like buyers always want lower price to buy, short sellers would want to see higher price to sell short.

Unless they see there will be more shoes to drop, shorting additional shares not may not be the smartest move.

 

For those that think the restriction lift will cause big drop today, did you actually short any today to take advantage of that?

[krazeenyc]

@ krazeenyc - Not sure, basing it on prior posts in this thread which indicate the goods are sold on consignment. I personally havent checked the relationship between SHOS and SHLD, but its been posted a few times here that those are the terms. Hopefully you are right, because its a crappy way to sell goods.

 

Well folks, I'm now long SHOS, in addition to my existing position in Sears Canada. At this rate, I'll be a SHLD bull in no time :)

 

Interesting tidbit I saw while reading up on SHOS. In 2012, 56% of their revenue came from KCD products. That comes to $1.37 billion of KCD retail sales through SHOS's 1,200+ stores. SHLD consigns this merchandise to SHOS stores, and then the dealer gets a cut when the products are sold. How likely is it that SHLD makes a 10% margin on their wholesale KCD sales to SHOS? In that case KCD's profit from SHOS alone could be ~$100M. Just an interesting data point that may be useful when trying to peg a value for KCD... especially in a scenario where SHLD's retail store base is a fraction of what it is today...

 

I'm pretty sure SHLD sells to SHOS and SHOS consigns to the franchise owners.

[alertmeipp]

I think the chances of EL succeddeding as a retailer are slim to known.

Ask any of your friends or people in your community do they shop at sears, use SYW, or use the sears website...

This is similar to circuit city, or black berry, or any number of brands / retailers. They are losing mind share, and its showing up in market share and SSS numbers.

 

Also you are forgetting that the goods are consigned to SHOS. This is arguably the worst way to sell merchandise. You still own it, but it sits in someone elses warehouse. Its on your books but not in your possession. To be doing consignment for 0% Gross Margin, or 4% Gross Margin depending on how you look at it. Doesnt make sense, and allows you to get screwed easily...

 

If I ran the royalty side of KCD I would want this deal.

If I was in charge or inventory, accounting, customer service / backoffice I would hate this deal.

If I ran Sears I would probably hate this deal.

 

Everyone has slightly different motives here.

 

They have like 35 billions of sales, so there are definitely lots of shoppers that still go there. The problem, as mentioned by others and EL himself, is how to translate those sales into profit.

 

Store closing, investing on technologies, etc... all try to increase the margin.

 

If they can improve 3% on their margin, that's 1billions swing. EL is not trying to grow the business, he is trying to improve margin by shrinking it (hopefully intelligently).

 

 

[peridotcapital]

@ krazeenyc - Not sure, basing it on prior posts in this thread which indicate the goods are sold on consignment. I personally havent checked the relationship between SHOS and SHLD, but its been posted a few times here that those are the terms. Hopefully you are right, because its a crappy way to sell goods.

 

Well folks, I'm now long SHOS, in addition to my existing position in Sears Canada. At this rate, I'll be a SHLD bull in no time :)

 

Interesting tidbit I saw while reading up on SHOS. In 2012, 56% of their revenue came from KCD products. That comes to $1.37 billion of KCD retail sales through SHOS's 1,200+ stores. SHLD consigns this merchandise to SHOS stores, and then the dealer gets a cut when the products are sold. How likely is it that SHLD makes a 10% margin on their wholesale KCD sales to SHOS? In that case KCD's profit from SHOS alone could be ~$100M. Just an interesting data point that may be useful when trying to peg a value for KCD... especially in a scenario where SHLD's retail store base is a fraction of what it is today...

 

I'm pretty sure SHLD sells to SHOS and SHOS consigns to the franchise owners.

 

You are right. I see that my incorrect use of the symbols above misled about that. SHLD is only one of many suppliers to SHOS. SHOS supplies all of the dealers/franchisees on a consignment basis. My original thought was that SHLD built in some margin on the sale to SHOS, rather than selling at cost. That would allow them to take on the distributor role for SHOS and have another avenue to make some money...

[BTShine]

I think it's most likely SYW will try to do this with their 3rd party vendors on Sears.com before joining up with GAP, but that's just my assumption.

 

The Sears real estate is located in the mall though -- so you would want to leverage that uniquenesss.  It would be a shame if the other stores at that very mall could not participate.

 

They all want their online customers to pick up the item in the store, or to return the item to their store, so their salesperson can tackle them, tie them down, and make them buy more things.

 

One of the problems with online shopping is losing that personal customer contact.  That might lead to less sales, and therefore less pressure on rents at the mall.  Suppose you are a mall REIT executive -- you would want to perhaps help SHLD get this done as it drives up the value of your owned properties.

 

But anyways, just a brainstorm.

 

Absolutely!  The highest and best use of the real estate is related to the mall.  I don't know exactly how that would be organized.  I mean, in some ways this concept is already taking place.  We've seen Forever 21 take part of the space that Sears used to use.  So, whether its retail floor space, or backroom storage space, etc, etc., etc. it's all the same idea.  Mall space is very valuable, and Sears controls a lot of it.

 

 

[merkhet]

For those that don't think Sears is spending a fortune on Shop Your Way points, please see the attached image.  I wonder how much Sprint is paying them for this.  My sense is that Sprint is shouldering part of the burden, but Sears is also likely shouldering part of the burden to get members more engaged.

[adesigar]

For those that don't think Sears is spending a fortune on Shop Your Way points, please see the attached image.  I wonder how much Sprint is paying them for this.  My sense is that Sprint is shouldering part of the burden, but Sears is also likely shouldering part of the burden to get members more engaged.

 

Well Sears provided us info on how much they are spending

 

We believe that we are making progress in this transformation, as we are seeing continued increases in our SYW member engagement metrics with 69% of our sales in the nine-week period ended January 4, 2014 derived from members as compared to 58% last year. We are intentionally transitioning business models in a thoughtful manner and are making the investments which we believe will demonstrate the value of SYW to our members. Throughout this transition, we have continued with traditional promotional programs and marketing expenditures while investing in our member-centric model, which has impacted our margin and expenses. For the nine-week period ended January 4, 2014 we spent $69 million more on SYW points expense compared to the same period last year.

 

So $69 million more for increase in sales to SYW from 58% to 69%. That would mean approx $400 Million for those 9 weeks. Since those 9 weeks are the most promotional with tons of free points imagine they are half the cost of points for the year. That would still mean approximately $800 Million is SYW points expenses for the year. A fortune sounds about right.

[krazeenyc]

For those that don't think Sears is spending a fortune on Shop Your Way points, please see the attached image.  I wonder how much Sprint is paying them for this.  My sense is that Sprint is shouldering part of the burden, but Sears is also likely shouldering part of the burden to get members more engaged.

 

It's interesting I'm not too sure what Sprint is paying here. It could be that Sears is getting a commission (like Best Buy/Walmart/etc.) for signing someone up for mobile service at Sprint.

[merkhet]

For those that don't think Sears is spending a fortune on Shop Your Way points, please see the attached image.  I wonder how much Sprint is paying them for this.  My sense is that Sprint is shouldering part of the burden, but Sears is also likely shouldering part of the burden to get members more engaged.

 

Well Sears provided us info on how much they are spending

 

We believe that we are making progress in this transformation, as we are seeing continued increases in our SYW member engagement metrics with 69% of our sales in the nine-week period ended January 4, 2014 derived from members as compared to 58% last year. We are intentionally transitioning business models in a thoughtful manner and are making the investments which we believe will demonstrate the value of SYW to our members. Throughout this transition, we have continued with traditional promotional programs and marketing expenditures while investing in our member-centric model, which has impacted our margin and expenses. For the nine-week period ended January 4, 2014 we spent $69 million more on SYW points expense compared to the same period last year.

 

So $69 million more for increase in sales to SYW from 58% to 69%. That would mean approx $400 Million for those 9 weeks. Since those 9 weeks are the most promotional with tons of free points imagine they are half the cost of points for the year. That would still mean approximately $800 Million is SYW points expenses for the year. A fortune sounds about right.

 

I did a similar calculation for Q3.

 

"Sears revealed that 70% of their sales in Q3 2013 came from SYW members, which was up from around 50% of their sales Q3 2012.  This meant that SYW sales went from $4.43 billion to $5.79 billion on a year-over-year basis.  The change in gross margin year-over-year that was attributable to SYW Points came in at $75 million.  The incremental SYW sales cost them north of 5.5% in incremental margin!"

[constructive]

They have like 35 billions of sales, so there are definitely lots of shoppers that still go there. The problem, as mentioned by others and EL himself, is how to translate those sales into profit.

 

Store closing, investing on technologies, etc... all try to increase the margin.

 

If they can improve 3% on their margin, that's 1billions swing. EL is not trying to grow the business, he is trying to improve margin by shrinking it (hopefully intelligently).

 

The more likely outcome for declining retail is a death spiral. Margins continue to decline since they can't reduce distribution centers, overhead costs, bloated corporate management who are fellow HBS alumni, etc. as aggressively as store count.

[Mephistopheles]

For those that don't think Sears is spending a fortune on Shop Your Way points, please see the attached image.  I wonder how much Sprint is paying them for this.  My sense is that Sprint is shouldering part of the burden, but Sears is also likely shouldering part of the burden to get members more engaged.

 

Well Sears provided us info on how much they are spending

 

We believe that we are making progress in this transformation, as we are seeing continued increases in our SYW member engagement metrics with 69% of our sales in the nine-week period ended January 4, 2014 derived from members as compared to 58% last year. We are intentionally transitioning business models in a thoughtful manner and are making the investments which we believe will demonstrate the value of SYW to our members. Throughout this transition, we have continued with traditional promotional programs and marketing expenditures while investing in our member-centric model, which has impacted our margin and expenses. For the nine-week period ended January 4, 2014 we spent $69 million more on SYW points expense compared to the same period last year.

 

So $69 million more for increase in sales to SYW from 58% to 69%. That would mean approx $400 Million for those 9 weeks. Since those 9 weeks are the most promotional with tons of free points imagine they are half the cost of points for the year. That would still mean approximately $800 Million is SYW points expenses for the year. A fortune sounds about right.

 

That's a good way to estimate it. $800 million is lot. It comes down to roughly $7.50/share.

 

Let's assume that the IV of a liquidation/spinoff scenario is $80/share, which is conservative based on many of the estimates that are out there. So if we assume that $7.50 is money we will never see again, that value goes down to $72.50 in the first year, $65 in the second year, and $57.50 in the third year.

 

By year 3 I would expect either a) SWY starts adding, rather than destroying value, or the more likely b) Lampert stops burning $800 million a year. So if it is worth $57.50 in 3 years, at the current price of $37 that is a 16% return annualized.

 

I think there is a lot of MOS built into this. It assumes $800 million/year wasted for 3 years. It assumes liquidation value to not increase in 3 years from a pretty conservative $80. And it doesn't account for any positive developments such as: a real estate sale to a REIT, a REIT spinoff, better than expected leasing/subleasing.

 

It's important to remember that the SWY spending can be pulled, and that won't effect the value of the brands or the real estate. It's not like it's a necessary form of maintenance capex. And the pension should be paid off in some time, and after that, if SWY is killed then the company should be cash flow positive.

 

My $.02, but I think SHLD is a good buy at this price.

[Vish_ram]

Just curious. Has anyone come across a struggling retailer that has managed to create shareholder value by shrinking and selling real estate? I think most of them (like montgomery ward, circuit city etc) went the bankruptcy route.

 

The WSJ article on Circuit city is interesting.

http://blogs.wsj.com/bankruptcy/2012/10/25/lessons-from-the-death-of-circuit-city/

 

If SHLD pulled it off, it'll probably be the first one to do it.

 

Even more interesting was the comment by a user that applies to sears as well

 

84OG wrote :

Well, by the 2000s, they did not have the best prices…or the best service…or the nicest stores….or the latest and greatest merchandise…or the widest assortment….or the most selection….maybe that is why customers stopped coming, there was no value proposition attached to their “stuff”….it was just stuff.

 

 

 

 

[hyten1]

alexander?

 

Just curious. Has anyone come across a struggling retailer that has managed to create shareholder value by shrinking and selling real estate? I think most of them (like montgomery ward, circuit city etc) went the bankruptcy route.

 

The WSJ article on Circuit city is interesting.

http://blogs.wsj.com/bankruptcy/2012/10/25/lessons-from-the-death-of-circuit-city/

 

If SHLD pulled it off, it'll probably be the first one to do it.

 

Even more interesting was the comment by a user that applies to sears as well

 

84OG wrote :

Well, by the 2000s, they did not have the best prices…or the best service…or the nicest stores….or the latest and greatest merchandise…or the widest assortment….or the most selection….maybe that is why customers stopped coming, there was no value proposition attached to their “stuff”….it was just stuff.

[valuecfa]

Just curious. Has anyone come across a struggling retailer that has managed to create shareholder value by shrinking and selling real estate? I think most of them (like montgomery ward, circuit city etc) went the bankruptcy route.

 

The WSJ article on Circuit city is interesting.

http://blogs.wsj.com/bankruptcy/2012/10/25/lessons-from-the-death-of-circuit-city/

 

If SHLD pulled it off, it'll probably be the first one to do it.

 

Even more interesting was the comment by a user that applies to sears as well

 

84OG wrote :

Well, by the 2000s, they did not have the best prices…or the best service…or the nicest stores….or the latest and greatest merchandise…or the widest assortment….or the most selection….maybe that is why customers stopped coming, there was no value proposition attached to their “stuff”….it was just stuff.

 

Dillard's