SHLDQ - Sears Holdings Corp

[ni-co]

For Lands End, it seems as if Eddie is adding debt to SpinCo and then spitting a dividend to HoldCo.  That is not a good sign for future spin-offs.  It could mean (a) the legal advisors required it in order to prevent any gripes from the debt holders or (2) he needs liquidity at HoldCo very badly.  Otherwise, he could have spun LE first, added the debt after spin and then paid cash from LE directly to LE shareholders.  That would have removed HoldCo's claim against the cash.

Or (3) Neither of the above. It's simply a question of capital allocation. Why should a spin-off be debt free, if the business generates FCF?

 

This is a great case study for young investors like myself.

Yes, for me too.

[constructive]

The problem with the spin-off situation is as follows: (1) The market will probably only give value to positive EBITDA spin-offs and (2) SHLD is already struggling with negative EBITDA and negative operating income.  So for every good business that is spun-out, the losses from the bad business are magnified. 

 

Yes, there is definitely a limit to how much can be spun off from SHLD without severe consequences for the remaining business, and I think it is under $20 per share. People have estimated the value of spinning off LE, SAC, SC, KCD, etc but I don't think anyone has quantified how much cash SHLD would burn per year if they spun all the good parts of the business off.

 

For Lands End, it seems as if Eddie is adding debt to SpinCo and then spitting a dividend to HoldCo.  That is not a good sign for future spin-offs.  It could mean (a) the legal advisors required it in order to prevent any gripes from the debt holders or (2) he needs liquidity at HoldCo very badly.  Otherwise, he could have spun LE first, added the debt after spin and then paid cash from LE directly to LE shareholders.  That would have removed HoldCo's claim against the cash.

 

SHLD does need liquidity, if only to replace the cash generation being lost from LE. Anyways, for Lampert believers $500M in his hands is as good as $500M in your hands.

[BTShine]

He could want the $500 million inside of SHLD because he wants to repurchase stock, or reduce debt, since he may believe the HoldCo is a good investment at this point.  Maybe he thinks they can raise prices a small amount (1-2%; an extra ~$500 million of margin) and reduce advertising expense from $1.6 billion to the approx $1 Billion we see at JCP and Macys (an extra ~$500 million).  And maybe he thinks they can do this while giving out less than my estimate of $800 million in SYWR Points annually (maybe $300 million less there).  And maybe he thinks that closing 50 or 100 stores will reduce losses by $200 to $400 million a year. 

 

That list I created is a lot of "Ifs and Maybes."  But, those are the levers EL might believe he can pull to produce value for shareholders.  After reading the SHLD press releases and blogs closely, I do believe he is going to try to create value through those ways.  I'm not of the belief he will produce the full ~$1.5 billion a year that I laid out above, but I'd think he could get $750 million or $1 Billion.  Which unfortunately just brings us back to around break even for cash flow.

[gg]

Ultimately, its SHLD's value that Lampert is trying to maximize. By spinning off LE, he already received a $500 million acquisition price (the dividend to SHLD) with potential upside if the LE shares go up in the future. But that $500 million dividend will have been paid out, and if LE eventually fails, SHLD will still have made at least the $500 million for SHLD on day 1 of the spin-off transaction.

 

I do believe that Lampert is a good steward of shareholder capital, and ultimately is not going to screw the minority shareholders long term, but it doesn't mean he plans on paying out the available cash in the short term. Having ample liquidity at the HoldCo is currently much more important to him than paying out shorter term dividends to SHLD shareholders (who will be the LE shareholders on day 1). So, I think that's why he is doing debt and dividend pre-spin.

[merkhet]

Nope you cant use 8 million shares in your calculation. Fairholme already held over 20 million shares, 15 million for the mutual funds and I believe 5 million shares held in other assets it manages for high net worth individuals etc. The site for that I think is https://clients.fairholme.net/ 

 

What I was trying to point out (and I wasn't very clear) is he added about 3.5 Million shares but non a single share in his mutual funds. All of the addition was done in the private accounts/hedge fund. Id have been more impressed if he had increased SHLD in his mutual fund holdings which would mean selling AIG or BAC.

 

You're right that it's probably not as high as 8 million, but it's also probably not as low as 3.5 million.

 

As Luke pointed out a few posts ago, November 2012, the filings indicated 16,934,080 shares. The only Fairholme Fund Increase has been about 400,000 to the Allocation Fund. As far as I can tell, the Fairholme Fund hasn't had any increase in allocation since then.

 

That leaves the differential at around 7 million+ shares -- though it's unclear how much of it went into the Fairholme Partnership and how much went into HNW client accounts.

 

Also, towards your point about the Fairholme & Allocation funds -- it's all about incentive. Fairholme Fund is a $9 billion fund, so I'm not sure adding $100 million of Sears (3.5 million shares) does very much for the fund -- remember it's not like they can buy a $1 billion chunk of Sears since there's only an effective float of about $700 million (not counting the 3.5 million shares Berkowitz just bought). Additionally, if I'm choosing between increasing my 15% weighting in the Allocation Fund versus my X% weighting in my hedge fund, I'm probably going to allocate it to the hedge fund since that's where I'm going to make the most money...

[Luke 532]

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[moody202]

Also, the liabilities don't matter if you think they can spin out those companies without any of the liabilities attached...

Yes, they can spin Lands End, Auto Centers, etc without the liabilities, but then you are left with a weaker SHLD (they are spinning out the divisions with profits because that's the only way they can load them up with debt post-spin). As a result, core SHLD is smaller, less profitable, and has the same liabilities attached to it. Therefore that equity is worth less. So you get shares in the new independent businesses, but you will also take a hit on the value of your core SHLD position. You have to factor in both sides of the equation.

 

This was in relation to a question about how some analyst has a $20 price target on SHLD.  SHLD could spin off assets worth more than the price target of the analysts. So explain how what you said about the core SHLD position supports the analysts. If the spinoffs are worth more than $20. The core position can go to 0. It cant go negative can it?

 

The fact that the core can go to zero is why I think it is short-sighted when people say you can just "ignore" the liabilities. They assume Eddie spins off all the good stuff debt-free and leaves the bad stuff behind with all of the existing debt, which they say puts the equity holders in a better position relative to the bond holders. I don't see how equity holders don't take a hit (due to the liabilities) in that scenario (ignoring for a moment that he is currently doing the exact opposite by spinning off the stuff that doesn't fit).

 

If you buy SHLD at $35/share today and 5 years from now wind up with $75/share of "good" spin-offs, the value of your original SHLD equity investment could very well be zero (especially if there is still $4B of debt attached to the legacy "bad" assets). In that case you have $75 of valuable assets, but you didn't double your money. You took a $35 loss on the original shares you bought, have a $75 gain on the spin-offs you received, for a net value of $40 per share (for which you paid $35).

 

I just made up these numbers as an example, but the fact that the real estate alone might be worth double the current stock price doesn't really tell you much about the investment merits of SHLD stock at $35 today as long as you ignore the liabilities and the core operations.

 

I'm not saying I agree with a $20 target price, but if you assign a negative value to the retail business and think Baker Street's valuation assumptions are too high on the other stuff (this is essentially Gary Balter's view), that is how you would arrive at a target price like that.

 

At the end of Q3 the pension was $2.4 billion. I estimate that at the end of Q4 the debt will be $3.9, net inventories will be $4.4, and cash will be $1.8 pro-forma of the LE dividend. The pension will most likely be lower given the market's rise. These 4 items roughly all cancel each other out.

 

Now for the market cap of $3.9 billion you get all the assets. $1.8 for KCD, $300 million for LE, $500 million for the warranty business, and you are left with $1.3 billion for the real estate, home services, and whatever else I left out.

 

Also, off the top of my head I think that for every 100 bps of interest rate rise the pension decreases by $674 million. That means that if rates move up by say 300 bps, it will be nearly wiped out. This should drive significant extra value. Now one major liability I didn't include is store severance/closing costs. But let's just say that balances out with the decrease in pension.

 

PS: I didn't account for SCC, since these are all consolidated. I'll pull those numbers up later though.

[/quote

 

Your math is good but it assumes all these actions happen immediately. How do you account for ongoing operational losses?

[ERICOPOLY]

How do you account for ongoing operational losses?

 

It accounted for as  "gravy", or "a bonus".  Something you get "for free".

 

(I'm still long SHLD btw, it's just that I recognize the parts that lose money may not be bonus)

[Kraven]

T?/E

[gg]

This is the way I think about it;

 

SHLD's equity value = Unencumbered Assets + max[0,Other Assets - Debt - Operating Losses (from now until major real estate divestments/sales occur)]

 

Unencumbered assets, like Lands Ends and much of the real estate, can be distributed to equity holders, so those should be treated differently than assets that are already tied to specific bond issuances. Inventory, on the other hand, can not be distributed (or liquidated and then distributed) without violating the debt covenants. The same occurs with some of the brands, like Kenmore, whose brand names are also tied to specific debt securities.

 

Theoretically, if SHLD sold all of its real estate that is unencumbered in the next five years, they could pass on that cash directly to SHLD equity holders without violating debt agreements. (same is not true for the assets that will have to stay put, like Kenmore and inventory). However, the value of those can never go below zero, and so the Maximum function is helpful because that negative value should not affect the distributions that equity holders could still get from the sale of the unencumbered assets.

 

I'm not saying it will happen this way, but from a financial modeling perspective, I think that's how the value needs to be thought about...

[heth247]

I do believe that Lampert is a good steward of shareholder capital, and ultimately is not going to screw the minority shareholders long term, but it doesn't mean he plans on paying out the available cash in the short term. Having ample liquidity at the HoldCo is currently much more important to him than paying out shorter term dividends to SHLD shareholders (who will be the LE shareholders on day 1). So, I think that's why he is doing debt and dividend pre-spin.

 

If Eddie is going to be a "Outsider" CEO, he should never pay out a dividend even if he can, regardless of short-term or long-term. He should use it to earn a much better return than his shareholders and let his shareholders ride with him.

 

[Luke 532]

I do believe that Lampert is a good steward of shareholder capital, and ultimately is not going to screw the minority shareholders long term, but it doesn't mean he plans on paying out the available cash in the short term. Having ample liquidity at the HoldCo is currently much more important to him than paying out shorter term dividends to SHLD shareholders (who will be the LE shareholders on day 1). So, I think that's why he is doing debt and dividend pre-spin.

 

If Eddie is going to be a "Outsider" CEO, he should never pay out a dividend even if he can, regardless of short-term or long-term. He should use it to earn a much better return than his shareholders and let his shareholders ride with him.

 

I couldn't agree more.

[CorpRaider]

Maybe he's waiting for the shares to return to prices above $100 per share so he can do some more buybacks?  heh.

[peridotcapital]

This is the way I think about it;

 

SHLD's equity value = Unencumbered Assets + max[0,Other Assets - Debt - Operating Losses (from now until major real estate divestments/sales occur)]

 

Unencumbered assets, like Lands Ends and much of the real estate, can be distributed to equity holders, so those should be treated differently than assets that are already tied to specific bond issuances. Inventory, on the other hand, can not be distributed (or liquidated and then distributed) without violating the debt covenants. The same occurs with some of the brands, like Kenmore, whose brand names are also tied to specific debt securities.

 

Theoretically, if SHLD sold all of its real estate that is unencumbered in the next five years, they could pass on that cash directly to SHLD equity holders without violating debt agreements. (same is not true for the assets that will have to stay put, like Kenmore and inventory). However, the value of those can never go below zero, and so the Maximum function is helpful because that negative value should not affect the distributions that equity holders could still get from the sale of the unencumbered assets.

 

I'm not saying it will happen this way, but from a financial modeling perspective, I think that's how the value needs to be thought about...

 

Would you be concerned at all that a portion of the value created from the unencumbered spin offs would be distributed back to the holding company, where it could be flushed down the toilet? For instance, SHLD collects $500M from LE, which reduces the value of the spun off shares by an equal amount. That money then is comingled within SHLD and is used to pay for other things associated with the encumbered assets (pension contributions, debt service, capex, etc). In that sense, is it not possible for the full value of the unencumbered assets to not be realized by the equity holders? Even if the value of the encumbered assets cannot fall below zero, is it not possible for those assets, left operating, to dilute the value of the unencumbered ones (assuming that spin-off dividends back to SHLD continue in the future)?

[gg]

This is the way I think about it;

 

SHLD's equity value = Unencumbered Assets + max[0,Other Assets - Debt - Operating Losses (from now until major real estate divestments/sales occur)]

 

Unencumbered assets, like Lands Ends and much of the real estate, can be distributed to equity holders, so those should be treated differently than assets that are already tied to specific bond issuances. Inventory, on the other hand, can not be distributed (or liquidated and then distributed) without violating the debt covenants. The same occurs with some of the brands, like Kenmore, whose brand names are also tied to specific debt securities.

 

Theoretically, if SHLD sold all of its real estate that is unencumbered in the next five years, they could pass on that cash directly to SHLD equity holders without violating debt agreements. (same is not true for the assets that will have to stay put, like Kenmore and inventory). However, the value of those can never go below zero, and so the Maximum function is helpful because that negative value should not affect the distributions that equity holders could still get from the sale of the unencumbered assets.

 

I'm not saying it will happen this way, but from a financial modeling perspective, I think that's how the value needs to be thought about...

 

Would you be concerned at all that a portion of the value created from the unencumbered spin offs would be distributed back to the holding company, where it could be flushed down the toilet? For instance, SHLD collects $500M from LE, which reduces the value of the spun off shares by an equal amount. That money then is comingled within SHLD and is used to pay for other things associated with the encumbered assets (pension contributions, debt service, capex, etc). In that sense, is it not possible for the full value of the unencumbered assets to not be realized by the equity holders? Even if the value of the encumbered assets cannot fall below zero, is it not possible for those assets, left operating, to dilute the value of the unencumbered ones (assuming that spin-off dividends back to SHLD continue in the future)?

 

I agree with your comment, and I would definitely be concerned. (So much so that I still have not pulled the trigger on buying SHLD...) If properties are slowly sold one at a time, and then cash taken up to the HoldCo, just to subsidize a money-losing retail operation, than it will for sure end badly.

 

If, alternatively, though, SHLD got a handful of these unencumbered properties that are in class A malls into a subsidiary, and spun that off, and it was then acquired by a GGP or SPG, then that would be a huge win and a scenario in which the bad retail business will not be able to bring down the high value available from the real estate. I do strongly believe that for Lampert, this is his ultimate insurance policy. (I really do think that any day he can wake up, decide that retail is not salvable, and make this happen in a matter of months.) Everything is a worthwhile experiment for Lampert right now though because righting the ship in any meaningful way will have a much larger positive impact on the share price than liquidation. But if all else fails, I think he will carve out the unencumbered class A properties, and sell them to the major class A REITs who have high equity valuations, access to overly-cheap debt, and few better prospects for growth than purchases of SHLD anchor spots in their malls (as GGP's CEO stated on the call).

[Luke 532]

"S" - for short interest, or should it be "$" for the nice risk/reward on far OTM calls.  :)

 

Disappointing as only 200,000 more shares sold short between 1/15 and 1/31.

 

Short (as of 1/31/2014): 15.3M

Lampert/Berkowitz/Tisch: 79.5M (76M + 3.47M added by Berkowitz as reported 2/10/14)

Outstanding: 106M

Float: 26.5M

Horizon/Chou/OldWest/BakerSt/Force = ~3.9M

 

Short interest as % of float: 57.7% (assuming zero shares are long-term oriented of those held by Horizon Kinetics, Baker Street, Old West, Chou, and Force Capital)

Short interest as % of float: 60.5% (assuming 30% of shares... 15.3/25.3)

Short interest as % of float: 62.4% (assuming 50% of shares...15.3/24.5)

Short interest as % of float: 67.7% (assuming 100% of shares... 15.3/22.6)

http://www.nasdaq.com/symbol/shld/short-interest

[bmichaud]

Lampert stated in his 2012 letter that the ~300 stores closed since 2006 generated $100MM of the $3.2B domestic EBITDA generated in 2006. The Baker report cites 400 "Top" stores - say these 400 generated 50% of 2006 EBITDA, or $4MM per store.

 

SHLD projects approximately -$400MM of domestic adjusted EBITDA in 2013. Say the "top 400" generated $2MM per store, or $800MM of EBITDA - that implies the 1,636 "bottom" stores (Baker total stores of 2,036 - 400 "top" stores) generated -$1.2B of EBITDA in 2013, or -$733K per store.

 

If SHLD shutters 300 stores per annum, that's ~6 years of liquidating. Using very rough analysis, assume the EBITDA burn per liquidation store remains constant at -$733K over the next 6 years. Arguably unrealistic, but likely there are cost cutting/marketing/SYW levers that can be pulled to keep it relatively flat at -733/store:

 

- 300 stores open for 6 years: -$1.3B EBITDA burn

- 300 stores open for 5 years: -$1.1B

- 300 stores open for 4 years: -$.88B

- 300 stores open for 3 years: -$.66B

- 300 stores open for 2 years: -$.44B

- 300 stores open for 1 year: -$.22B

- Total EBITDA Burn: -$4.6B

 

Lampert cited $3.3MM per store of liquidation net cash proceeds in his 2012 letter: 1,636 stores x $3.3MM = $5.4B of liquidation net cash proceeds from net inventory release and real estate sales.

 

Net Liquidation Value: $800MM

 

Inventory net of payables as of 3Q13 was $5.4B, or $2.65MM per store. $2.65MM x 400 top stores = $1B of net inventory associated with the "Core Retail" operation (I did not adjust for Sears Canada, but below I will exclude SCC from the valuation to make up for it...). Net Working Capital, including cash, is then -$1.8B for "Core Retail".

 

So total valuation break down before "Core Real Estate":

 

Non-Core Retail Liquidation: +$.8B

Core Retail Net Working Capital: -$1.8B

Debt = -$4.6B

Pension = -$2.4B

Total Valuation Pre-Core RE: -$8B, or -$75 per share

 

Core Real Estate of 68MM SF valued at $150/SF = $95 per share

 

So if the Core RE is fully encumbered by all of the above, then SHLD equity is worth $20 per share - likely a decent worst-case downside target.

 

Given that it has been stated hundreds of times (exaggeration yes) by Lampert, Berkowitz et al that the Core RE is unencumbered and that the pension obligation will likely be lower than $2.4B over time due to interest rate normalization, the more realistic valuation break-down looks like:

 

Non-Core Retail Liquidation: +$.8B

Core Retail NWC: -$1.8B

Pension: -$1.2B

Core RE: $10.2B

Total Valuation: $8B, or $75 per share

 

Valuing the Core RE at its long-term potential of $250/SF brings the valuation up to $139 per share, much closer to Berkowitz's $150 target price.

[JSArbitrage]

Does the SHLD domestic 2013 EBITDA projection include Lands End EBITDA? Or is it ex-LE EBITDA?

[Eye4Valu]

I noticed that Paul Swinand at Morningstar had a price target of $10 on SHLD. The disparity between Bruce's estimate at +$150 and Morningstar's estimate at $10 is huge! Someone is very wrong. Can anyone on this board think of big mistakes that Bruce has made investing? In following him for a little while, I can't recall any beyond exiting positions such as Pfizer and Wellpoint too early. 

[blainehodder]

I noticed that Paul Swinand at Morningstar had a price target of $10 on SHLD. The disparity between Bruce's estimate at +$150 and Morningstar's estimate at $10 is huge! Someone is very wrong. Can anyone on this board think of big mistakes that Bruce has made investing? In following him for a little while, I can't recall any beyond exiting positions such as Pfizer and Wellpoint too early.

 

Buying SHLD.  At least at the historical price he paid.

[bmichaud]

Includes LE.

[Mephistopheles]

 

 

At the end of Q3 the pension was $2.4 billion. I estimate that at the end of Q4 the debt will be $3.9, net inventories will be $4.4, and cash will be $1.8 pro-forma of the LE dividend. The pension will most likely be lower given the market's rise. These 4 items roughly all cancel each other out.

 

Now for the market cap of $3.9 billion you get all the assets. $1.8 for KCD, $300 million for LE, $500 million for the warranty business, and you are left with $1.3 billion for the real estate, home services, and whatever else I left out.

 

Also, off the top of my head I think that for every 100 bps of interest rate rise the pension decreases by $674 million. That means that if rates move up by say 300 bps, it will be nearly wiped out. This should drive significant extra value. Now one major liability I didn't include is store severance/closing costs. But let's just say that balances out with the decrease in pension.

 

PS: I didn't account for SCC, since these are all consolidated. I'll pull those numbers up later though.

 

Your math is good but it assumes all these actions happen immediately. How do you account for ongoing operational losses?

 

So I think for 2013 the operating cash flow ex-pension will be about -($300 to $400 million). I'm not sure how much Eddie spends on SYW, but I've heard assumptions up to $800 million on this forum. Now if we assume that he's going to continue to liquidate the entire company and spend every single dollar on SYW, then obviously the stock is worth nothing. I think a more likely scenario is that SYW won't go on forever without producing obvious results. At that point, there is a lot of fat to cut with that $800 million. Another possibility is that the $1.6 billion (2012) advertising budget continues to come down. It already came down from $2.0 billion in 2011. I believe Eddie has mentioned that he wants Sears to be membership points based, and allow for a reduction in advertising.

 

Let's say over the next 3 years they burn $1.5 billion in operating cash. If we add that to the $1.3 billion number I came up with for the real estate + home services, it's still cheap. I really don't think he would go on forever trying to make SYW work unless he's a complete idiot. I believe at some point, perhaps in the next 3 years it will either work, or he will give up.

 

As far the actions happening immediately, you're right. We are not getting the real estate or other assets handed to us today in cash. But the debt is also not immediate. So in that way I feel like it balances out.

 

As long as he keeps liquidating at this pace (I think 46 stores have closed YTD), and spinning off assets, I am happy.

[spin]

 

Non-Core Retail Liquidation: +$.8B

Core Retail NWC: -$1.8B

Pension: -$1.2B

Core RE: $10.2B

Total Valuation: $8B, or $75 per share

 

 

Where did the 4.2B in debt go again?  Are you spinning the Core Re and trying to leave the debt behind?

 

I'd test your model to accommodate the borrowing base test so as you liquidate your 1600 stores any revolver/ term loan impacts are accomidated.  Just eyeballing, in your model the borrowing base goes from something like 6.7B (not adjusted for SCC/LE) to about 1.3B not adjusted for SCC/LE.

 

"“Borrowing Base” means, at any time, an amount equal to

(a) 85% of the aggregate outstanding Eligible Credit Card Accounts Receivable at such time plus

(b) 85% of the Eligible Pharmacy Receivables at such time plus

© the lesser of (i) 70% of the Net Eligible Inventory at such time and

(ii) 80% of the Net Orderly Liquidation Value at such time, minus

(d) 100% of the then Availability Reserves.

The Agent may, in its Permitted Discretion after the expiration of the Reserve Notice Period, adjust

Availability Reserves and Inventory Reserves used in computing the Borrowing Base.

"

 

Spin

[OracleofCarolina]

I noticed that Paul Swinand at Morningstar had a price target of $10 on SHLD. The disparity between Bruce's estimate at +$150 and Morningstar's estimate at $10 is huge! Someone is very wrong. Can anyone on this board think of big mistakes that Bruce has made investing? In following him for a little while, I can't recall any beyond exiting positions such as Pfizer and Wellpoint too early.

 

I also noticed Morningstar had a "fair value" for BAC of $14

[ERICOPOLY]

The disparity between Bruce's estimate at +$150 and Morningstar's estimate at $10 is huge!

 

A few years ago (I think 4 years ago) Bruce said that Citigroup is worth $10.  That would be $100 per share (after the reverse 10x split), but it's been 4 years!  So how far off do you figure he was?  Remember it's been 4 years, so $100 4 years ago is $146 today (at 10% a year).  But is Citi worth $146 today, or more like half that?

 

Three years ago he bought BAC for about $15.  Compound that by 10% per year and you've got a $20 stock price.  So he paid pretty darn close to IV for BAC when he bought it.

 

The man makes mistakes.

 

Now, that said...

 

I believe he said the assets at SHLD are worth $150, not the stock!  Take Eddie's word for it -- they are not earning an acceptable return on their assets (actually, they earn a negative return).  So assets that return less than they "should" are going to be discounted in the stock price.  So Bruce knows that too, but he's only talking about the assets per share without mentioning what they should be valued at in the stock.