SHLDQ - Sears Holdings Corp

[ni-co]

70% implied volatility on a 5-year warrant.  Anyone seen this before on a 5-year warrant?  I was thinking this should be closer to 30-40%.

 

I realize there's a lot of buying pressure given the low liquidity on the warrants for the shorts, but is anyone able to get a short borrow on SHLDW?  I am curious if investors will be able to buy SHLD and short SHLDW as that spread narrows.

 

Have you ever seen a 5 year warrant on such a volatile stock? Try a volatility calculator.

 

SHLD's average daily volatility over the last 5 years: 62%

SHLD's average monthly volatility over the last 5 years: 73%

 

At the beginning of the rights offering people completely miscalculated the price of the warrant (based on Black/Scholes) – now it's "fairly" valued. But I agree, I prefer the common now.

[Picasso]

I think a lot gets lost in a Black Scholes model trying to figure out where the warrants should be valued.  I would say most of the time I see long dated warrants have a much lower implied volatility than the short dated options.  GM is a good example where there's almost no implied volatility on the long dated warrants but the options trade in the 20-30% area.

 

Because as it stands now if you want to value the warrants along the 2017 options and say it deserves a fair value in the 70% implied volatility area the math starts to get weird.  You are effectively long the stock at $50 in 2019.  That sounds great in theory but Sears is losing about a billion dollars a year and even if you bring that down to $500 million that is about $2.5 billion that needs to be added to the enterprise value of the company by 2019.  So you're looking at warrants that would now be in the money, bringing the share count to about 130 million for a $6.5 billion dollar market cap plus debt of say $4 billion plus another $2.5 billion that needs to offset those losses.  I realize the idea is Sears should start turning profitable before then but I think it is a conservative scenario to think they might need to fund another $2.5 billion.

 

And yet the bonds which are just ahead of the equity also mature in 2019 are trading around $85 and pay $8 a year.  That means if we are still discussing Sears in 2019 you would have about $45 invested net of your coupon payments on $625 million of bonds that sit directly in front of all the equity holders.  If those $625 million of bonds are that impaired, equity holders have much bigger problems in 2019.

 

So on one hand the market is saying Sears equity is practically worth zero (if you follow where the bonds trade) and on the other hands the equity is worth a ton if you're willing to own SHLD at $50 knowing you have around $6.5 billion sitting in front of you and all those valuable Sears assets. 

 

I think it is more probable that the bonds are undervalued since most traditional bond investors will ignore this debt offering.  The warrants seem too expensive when you can just go buy the common around $33 today instead of paying $20 to own it at $28.41 to juice up your leverage.  It would be a different story if SHLD was still trading in the $40's when they first announced the REIT plans.

[ni-co]

I agree. I think a lot is wrong with Black/Scholes and similar models. I also agree that there's not much sense in owning a 28/2019 warrant at 20 while you're able to own the common at 33 – regardless of how volatile a stock is. Just wanted to point this out. I don't use the Black/Scholes model as a valuation tool with very volatile stocks. But it's a useful sentiment indicator.

[Luke 532]

I wanted to start a thread for those bullish on SHLD.  The purpose of this thread is to discuss which strategy might be best moving forward: (a) long common stock, (b) long warrants, © synthetic long, (d) other.

 

(a) Long Common Stock

trading at $33

(b) Long Warrants

trading at $20, expiring December 2019, strike $28.41, strike price adjusts down and shares per warrant adjust up for various spinoffs, offerings, etc.

© Synthetic Long

simultaneously buying a call and selling a put at the same strike and same expiration date

examples:

$33.50-strike 1/3/2015 expiration (1 month): credit of $0.60

$33-strike 3/20/2015 expiration (3.5 months): credit of $1.75

$33-strike 6/19/2015 expiration (6.5 months): credit of $2.38

Some initial thoughts...

 

Stock vs Warrants

-More capital at risk with the stock.

-For same capital one can control more shares with the warrants.

-Implied volatility seems pretty high on warrants, although it's difficult to tell as five-year warrants are uncommon.

-Break-even on stock is ~$33.  Break-even on warrants is ~$48.

-Delta on stock is 1.00 (obviously) and ~0.80 on warrants (although that might not be very accurate given it's a newly issued security).

-The handling of future rights offerings is likely fairly simple for those owning stock.  However, there is uncertainty as to how the warrants will be treated (although some transactions would cause the strike price to adjust downward and shares per warrant to adjust upward, both of which are good for the warrant holder).

 

Stock vs Synthetic Long

-Might be easier to capture option credit premium than it is to loan out shares (get the option premium up front and might not be able to always loan out all of your shares).

-Delta on both stock and synthetic long is 1.00.

-Break-even on stock is $33 and slightly below $33 for the synthetic long by whatever credit amount is received.  This assumes the stock is not being loaned out and collecting income.

-The handling of future rights offerings is, again, likely simple with the common stock.  But options can get crazy as spreads widen and the rights eventually are eliminated from the underlying value calculation of the option.

 

Warrants vs Synthetic Long

-Receive option premium credit with synthetic long, but you don't with warrants.

-Delta on synthetic long is 1.00 and ~0.80 on warrants.

-Break-even on warrants is ~$48 and less than $33 on the synthetic long by whatever credit amount is received.

-Uncertainty as to whether or not warrants can be loaned out to shorts (or if people can even initiate a new short position in warrants). EDIT (12/8/2014): Warrants can be lent out and shorted.

-Execution risk of rolling synthetic long from month-to-month, quarter-to-quarter, or whatever method is used to stay in the synthetic long position.  Execution risk due to the potentially wide bid/ask spread of the option contracts when trying to roll.

-Liquidity (or lack thereof) of both warrants and options is unpredictable.

-The handling of future rights offerings… see above for thoughts on how warrants and a synthetic long would be impacted.

 

Please chime-in with your thoughts.  I'm still weighing the pros and cons of each strategy.  Thanks!

 

EDITS:

EDIT (12/8/2014): Warrants can be lent out and shorted.

[Luke 532]

New thread...

SHLD - Stock vs. Warrants vs. Synthetic Long

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/shld-stock-vs-warrants-vs-synthetic-long/

[namo]

FYI: my SHLDW warrants have been lent out. I'm with Interactive Brokers; I saw that just yesterday. So shorting should be possible.

If I recall correctly, the fee was around 8%.

 

I'm in observation mode for now - I own both warrants and stock -, but I suspect I'll sell the warrants first. They seem more expensive to me right now, plus stock is tax-favoured over warrants here (in France).

[Luke 532]

FYI: my SHLDW warrants have been lent out. I'm with Interactive Brokers; I saw that just yesterday. So shorting should be possible.

If I recall correctly, the fee was around 8%.

 

I'm in observation mode for now - I own both warrants and stock -, but I suspect I'll sell the warrants first. They seem more expensive to me right now, plus stock is tax-favoured over warrants here (in France).

 

Thank you, namo.  I've edited the original post.

[compoundinglife]

A couple of quick thoughts on common vs warrants. No thoughts on synthenic position ATM.

 

At an approximation of todays prices assuming a $100 of captial you could buy 3 common  vs 5 warrants. 

 

Here is what you have at expiration given the following prices:

 

Stock Price                        $50    $80

$100 today Common        $150    240

$100 today Warrants        $110    260

 

If Sears is $80 at expiration you are only earning 8% more while taking on much more risk. Assuming you were looking at putting the same amount of $$ in one or other.

 

On a notional basis:

 

3 common    cost 100      150    240 

3 warrants    cost  60        66      156

 

So at 50, you make 10% on the warrants. At 80 you make 160%. On the common you make 50% at 50

140% at 80. By adding a time contraint to your investment you have not gotten compensated any reasonable incremental return given these two prices at expiration.

 

Borrowing to buy the common if you are able to do so safely seems like a better way to leverage. Volatility priced in to the warrant is just too high to make it attractive for a long position. 

[Picasso]

A couple of quick thoughts on common vs warrants. No thoughts on synthenic position ATM.

 

At an approximation of todays prices assuming a $100 of captial you could buy 3 common  vs 5 warrants. 

 

Here is what you have at expiration given the following prices:

 

Stock Price                        $50    $80

$100 today Common        $150    240

$100 today Warrants        $110    260

 

If Sears is $80 at expiration you are only earning 8% more while taking on much more risk. Assuming you were looking at putting the same amount of $$ in one or other.

 

On a notional basis:

 

3 common    cost 100      150    240 

3 warrants    cost  60        66      156

 

So at 50, you make 10% on the warrants. At 80 you make 160%. On the common you make 50% at 50

140% at 80. By adding a time contraint to your investment you have not gotten compensated any reasonable incremental return given these two prices at expiration.

 

Borrowing to buy the common if you are able to do so safely seems like a better way to leverage. Volatility priced in to the warrant is just too high to make it attractive for a long position.

 

Now add in the possibility that SHLD trades at $25 in 2019 and you have a worthless warrant.  The stock would still be worth about $75 in your scenario.

[compoundinglife]

Now add in the possibility that SHLD trades at $25 in 2019 and you have a worthless warrant.  The stock would still be worth about $75 in your scenario.

 

Yup, I didn't outright say that but that is what I meant with the amount of risk you are taking on in the warrant position.

 

 

[Luke 532]

What will be interesting is the adjustments on the warrants.  In theory, the strike price could get adjusted down significantly while simultaneously the shares per warrants could increase (example, at expiration a $20 strike and 1.5 shares/warrant would drastically change the dynamics of this discussion).  If my understanding is correct from what the SEC filings disclose, these adjustments would not require additional money to be invested by the holder of the warrants. 

 

Common stockholders, in the event of any financial engineering, would likely be asked to invest more money which could increase the total capital at risk for an investor.  Contrast that with the set initial investment in the warrants for potentially similar benefit from future rights offerings.

 

Just something to think about as I'm trying to play devil's advocate and dig a bit deeper than what lies on the surface.

[compoundinglife]

What will be interesting is the adjustments on the warrants.  In theory, the strike price could get adjusted down significantly while simultaneously the shares per warrants could increase (example, at expiration a $20 strike and 1.5 shares/warrant would drastically change the dynamics of this discussion).  If my understanding is correct from what the SEC filings disclose, these adjustments would not require additional money to be invested by the holder of the warrants. 

 

Common stockholders, in the event of any financial engineering, would likely be asked to invest more money which could increase the total capital at risk for an investor.  Contrast that with the set initial investment in the warrants for potentially similar benefit from future rights offerings.

 

Just something to think about as I'm trying to play devil's advocate and dig a bit deeper than what lies on the surface.

 

That is a fair point but it depends on what your core thesis is. For example if you feel that SYW/Sears retail will eventually be a home run then the warrants will give you that expsoure based on what we know today. If you think monetization of the real estate will be the home run then its could be a different story. While you will be compensated as a warrant holder for the departure of assets in the spinoff/splitoff you will have likely lost a good chunk of the RE exposure and hence increased the ratio SYW exposure. So if you hold the warrants and the rights offering happens you will likely have to pony up cash on your own to buy the REIT shares post rights offering (assuming you want the RE). At least that is what I am guessing. I guess another option might be to exercise the warrant and participate in the REIT offering. If you can do so given the record dates.

 

This is speculation on my part of what might happen so take it with a grain of salt.

[dowfin1]

Regarding warrant adjustment for any rights offering, I suspect the adjustment will depend on the FMV of the rights determined by a 10 day trading average.  So if, like the notes/warrants RO, the market undervalues the REIT offering, the warrants will fail to adjust enough for the lost value.   

[Kraven]

I recently read a glowing endorsement of Sears and was discussing it with a couple of good friends.  The write up was from a subscription only publication and I won't name it here.  I wrote an email to them discussing the misunderstanding of Sears' corporate structure and everyone's favorite Sears topic, the guarantor/non-guarantor structure (as well and the use of bankruptcy remote vehicles).  One friend thought that it would be interesting for the board and thought I should put it up here.  So here it is adapted to remove references to the publication and few other things.

 

_________________________

 

He clearly writes a good story about Sears.  Who knows, maybe he will be right.  Maybe all the things Lampert says about what he's trying to do are just smoke and mirrors and this is really a behind the scenes liquidation.

 

Reading through it it reminded me of some of the things that bothered me when he wrote this up last year.  He clearly does not understand what it means to be a guarantor/non-guarantor and what bankruptcy-remote entities are and what they are used for.  Drives me crazy.  He says several times that what he is saying are "facts", but he is incorrect.

 

He asserts that the magic of what Lampert is doing is that he has shoved some of these crown jewels into bankruptcy remote entities (that are also non-guarantors) and thus creditors cannot legally touch them!  Wow it's like magic!  It's like you can hear the ShamWow! and Slap Chop informercial guy raving about it.  He would apparently have us believe that by dumping assets into a bankruptcy remote entity that it means creditors of Sears can't touch them. 

 

That is not what a bankruptcy remote entity is.  He's looking at it from the wrong direction.  It's not that creditors from above (parent level or otherwise) can't touch things, it's that someone from the other end (i.e. an investor in securities or obligations of the bankruptcy remote entity) can have some confidence that if they make that investment that the issuer (the bankruptcy remote entity) will not go bankrupt.  It doesn't mean they can't or won't.  In fact they have, it's just that it's like the term says - it's "remote".  It's set up to limit the various things that would cause an entity to be bankrupt.  That's it.  It has nothing to do with creditors of Sears not being able to touch assets.

 

So that leads me to one of my favorite (or least favorite depending on how you look at it) things - the guarantor/non-guarantor structure.  So many people are confused by this it's ridiculous.  In some ways it's similar at a 10,000 foot level to the bankruptcy remote discussion.  By having some entities guarantee debt, and others not, it doesn't mean the non guarantors are off scot free, it simply means that it's less likely that they will be implicated.

 

So Sears has various subsidiaries each of which owns various assets.  Sears issues debt. Since Sears is a holding company creditors require that some of the "meat" (i.e. subsidiaries) guarantee the debt.  Nothing says it has to be that way, it's just what is negotiated from investors, needs for certain ratings, etc.  So some guarantee the debt which means they are on the hook directly.  If Sears doesn't pay, the guarantors must pay. 

 

Here's where people miss the point.  Say Sears can't pay and the guarantors can't pay, does that mean everyone goes home with a loss?  Of course not.  It means that now creditors start picking over Sears' assets.  What does it own?  Well, among other things it owns it's subsidiaries.  The equity in them more specifically.  So, yes, technically creditors of Sears cannot directly touch the assets of a subsidiary so long as those assets were legally transferred to them.  But creditors don't need to get at those assets.  They simply go after the equity Sears owns and then they own and/or control those subs and at that point can reach the assets.

 

That's not to say that Sears is going under.  I have no idea.  It just means that Lampert isn't able to stick crown jewels away in a locked box never to be seen again.

 

 

 

[ni-co]

Thanks for posting this, I'm guilty as charged (meaning me, one year ago).

 

I think people are confusing – that is to say what I confused – the guarantor/non-guarantor question with the more interesting question which part of SHLD could be spun-off without violating the terms of outstanding SHLD debt issuances.

[Kraven]

Thanks for posting this, I'm guilty as charged (meaning me, one year ago).

 

I think people are confusing – that is to say what I confused – the guarantor/non-guarantor question with the more interesting question which part of SHLD could be spun-off without violating the terms of outstanding SHLD debt issuances.

 

Yes, exactly.  There is this view that there is something magical going on.  There isn't.  Sears has an asset/borrowing base concept.  It can spin off or rid itself of assets so long as there is sufficient coverage.  Standard stuff.  In some sense, at a high level, they could spin off just about anything, but not everything.  It's like saying you can have anything you want, but not everything you want.  There is also this view that there is a secretive reinsurer hanging out there in the wings squirreling away prime assets.  They certainly keep disclosure on it to a minimum, but it's just another subsidiary like anything else.  Parent goes under, equity in the sub is up for grabs.

[wisdom]

This is why you have subsidiaries borrow without the holdco guaranteeing the debt. This way only the subsidiary boprrowing is impacted if things do not work out.

 

[Kraven]

This is why you have subsidiaries borrow without the holdco guaranteeing the debt. This way only the subsidiary boprrowing is impacted if things do not work out.

 

This isn't true to the extent that the holdco relies on dividends from the sub and/or is required to keep a certain level of assets.  Sub goes under and now parent loses whatever funds it gets from it plus that asset value is gone.

[adesigar]

I recently read a glowing endorsement of Sears and was discussing it with a couple of good friends.  The write up was from a subscription only publication and I won't name it here.  I wrote an email to them discussing the misunderstanding of Sears' corporate structure and everyone's favorite Sears topic, the guarantor/non-guarantor structure (as well and the use of bankruptcy remote vehicles).  One friend thought that it would be interesting for the board and thought I should put it up here.  So here it is adapted to remove references to the publication and few other things.

 

_________________________

 

He clearly writes a good story about Sears.  Who knows, maybe he will be right.  Maybe all the things Lampert says about what he's trying to do are just smoke and mirrors and this is really a behind the scenes liquidation.

 

Reading through it it reminded me of some of the things that bothered me when he wrote this up last year.  He clearly does not understand what it means to be a guarantor/non-guarantor and what bankruptcy-remote entities are and what they are used for.  Drives me crazy.  He says several times that what he is saying are "facts", but he is incorrect.

 

He asserts that the magic of what Lampert is doing is that he has shoved some of these crown jewels into bankruptcy remote entities (that are also non-guarantors) and thus creditors cannot legally touch them!  Wow it's like magic!  It's like you can hear the ShamWow! and Slap Chop informercial guy raving about it.  He would apparently have us believe that by dumping assets into a bankruptcy remote entity that it means creditors of Sears can't touch them. 

 

That is not what a bankruptcy remote entity is.  He's looking at it from the wrong direction.  It's not that creditors from above (parent level or otherwise) can't touch things, it's that someone from the other end (i.e. an investor in securities or obligations of the bankruptcy remote entity) can have some confidence that if they make that investment that the issuer (the bankruptcy remote entity) will not go bankrupt.  It doesn't mean they can't or won't.  In fact they have, it's just that it's like the term says - it's "remote".  It's set up to limit the various things that would cause an entity to be bankrupt.  That's it.  It has nothing to do with creditors of Sears not being able to touch assets.

 

So that leads me to one of my favorite (or least favorite depending on how you look at it) things - the guarantor/non-guarantor structure.  So many people are confused by this it's ridiculous.  In some ways it's similar at a 10,000 foot level to the bankruptcy remote discussion.  By having some entities guarantee debt, and others not, it doesn't mean the non guarantors are off scot free, it simply means that it's less likely that they will be implicated.

 

So Sears has various subsidiaries each of which owns various assets.  Sears issues debt. Since Sears is a holding company creditors require that some of the "meat" (i.e. subsidiaries) guarantee the debt.  Nothing says it has to be that way, it's just what is negotiated from investors, needs for certain ratings, etc.  So some guarantee the debt which means they are on the hook directly.  If Sears doesn't pay, the guarantors must pay. 

 

Here's where people miss the point.  Say Sears can't pay and the guarantors can't pay, does that mean everyone goes home with a loss?  Of course not.  It means that now creditors start picking over Sears' assets.  What does it own?  Well, among other things it owns it's subsidiaries.  The equity in them more specifically.  So, yes, technically creditors of Sears cannot directly touch the assets of a subsidiary so long as those assets were legally transferred to them.  But creditors don't need to get at those assets.  They simply go after the equity Sears owns and then they own and/or control those subs and at that point can reach the assets.

 

That's not to say that Sears is going under.  I have no idea.  It just means that Lampert isn't able to stick crown jewels away in a locked box never to be seen again.

 

Firstly I don't believe in a SHLD bankruptcy.

 

Seriously you've been saying this for a year and I still don't get it. Why do you say that if the subsidiary issued the bonds that the HOLDINGS company is responsible for it.

 

Maybe im wrong but a judge will only lift the corporate veil IF there was fraud or improper transfer of assets. My understanding is if Sears Roebuck or Kmart (the retailers) file for bankruptcy the creditors get the retailers assets. Unless there is fraud or improper transfer of assets they cant go after the Holdings company and so they cant go after the bankruptcy remote subsidiaries.

[CorpRaider]

Yeah I thought most of the debt is downstream and is in the form of a massive ABLOC with borrowing base audits, but there is some unsecured debt (and now ESL's secured) at holdco level that seems "structurally beast moded" if you will.

[wisdom]

Kraven, that would depend on the terms and conditions. I am assuming there is enough buffer.

 

Eg. ESL could be doing right offerings to be able to meet certain conditions and thus still be able to spin off real estate. There are ways around things if you have a large margin of safety. Which is what SHLD offers.

[oddballstocks]

 

Firstly I don't believe in a SHLD bankruptcy.

 

Seriously you've been saying this for a year and I still don't get it. Why do you say that if the subsidiary issued the bonds that the HOLDINGS company is responsible for it.

 

Maybe im wrong but a judge will only lift the corporate veil IF there was fraud or improper transfer of assets. My understanding is if Sears Roebuck or Kmart (the retailers) file for bankruptcy the creditors get the retailers assets. Unless there is fraud or improper transfer of assets they cant go after the Holdings company and so they cant go after the bankruptcy remote subsidiaries.

 

Maybe because he knows how this works?  And not just at the textbook level.  A post like that isn't written at a theoretical level, it's borne out of experience.

 

So why would the holding company be on the hook for subsidiary bonds?  It's the same as if a parent co-signs their child's car and then the kid stops paying.

 

Maybe the papers try to separate this stuff out, but if you read bankruptcy proceedings you know that the rules are ripped up many times.  If I was a billion dollar hedge fund that had invested in Sears Retail bonds why wouldn't I spend a few million on a lawyer to sue the holding company?  Maybe nothing comes of it, except that Holdings is locked up in litigation for 5-10 years.

 

I don't know you or your experience, maybe these structures are what you specialize in, I don't know.  But I do know Kraven, and I know his background, and I know he knows what he's talking about because he's lived it.

 

When these posts come up it feels like the following scenario.  You're having a backyard BBQ and the Fire Marshall from down the street comes.  He takes a look at the grill and says "It's likely to catch on fire" and your response is "nah, I know what I'm doing, I've grilled for five years on it." 

 

I have no position in Sears, Kraven doesn't either.  I've followed this thread closely because the situation appears enticing, but in talking to Kraven extensively and understanding the structures there are too many things that have me concerned to take a position.  Maybe I would have been better off in the ignorance is bliss crowd, not sure.  I'm still following, but it's a pass.

 

Last night I was thinking about this and in some regards Sears reminds me of the Penn Central Railroad.  Extremely complicated structure built on top of a very shaky company.  The company went under and dragged everything down with it.  Investors in the Penn Central bonds made a killing, but they purchased during the bankruptcy.  I don't believe equity holders before did well.  I'm not saying bankruptcy is going to happen here either.  What I'm saying is there is likely value buried deep in the capital structure somewhere, but I'm not sure how accessible it is.  I believe the Penn Central took a decade to work out.

[benhacker]

I think a lot gets lost in a Black Scholes model trying to figure out where the warrants should be valued.  I would say most of the time I see long dated warrants have a much lower implied volatility than the short dated options.  GM is a good example where there's almost no implied volatility on the long dated warrants but the options trade in the 20-30% area.

 

Because as it stands now if you want to value the warrants along the 2017 options and say it deserves a fair value in the 70% implied volatility area the math starts to get weird.  You are effectively long the stock at $50 in 2019.  That sounds great in theory but Sears is losing about a billion dollars a year and even if you bring that down to $500 million that is about $2.5 billion that needs to be added to the enterprise value of the company by 2019.  So you're looking at warrants that would now be in the money, bringing the share count to about 130 million for a $6.5 billion dollar market cap plus debt of say $4 billion plus another $2.5 billion that needs to offset those losses.  I realize the idea is Sears should start turning profitable before then but I think it is a conservative scenario to think they might need to fund another $2.5 billion.

 

And yet the bonds which are just ahead of the equity also mature in 2019 are trading around $85 and pay $8 a year.  That means if we are still discussing Sears in 2019 you would have about $45 invested net of your coupon payments on $625 million of bonds that sit directly in front of all the equity holders.  If those $625 million of bonds are that impaired, equity holders have much bigger problems in 2019.

 

So on one hand the market is saying Sears equity is practically worth zero (if you follow where the bonds trade) and on the other hands the equity is worth a ton if you're willing to own SHLD at $50 knowing you have around $6.5 billion sitting in front of you and all those valuable Sears assets. 

 

I think it is more probable that the bonds are undervalued since most traditional bond investors will ignore this debt offering.  The warrants seem too expensive when you can just go buy the common around $33 today instead of paying $20 to own it at $28.41 to juice up your leverage.  It would be a different story if SHLD was still trading in the $40's when they first announced the REIT plans.

 

+1 Picasso.  I think those long the stock have to either have very high expectations of outcomes, or have to assume that bonds / equity have similar downsides (both may be true).  This is a classic case where it is good to not be dogmatic about the part of the capital structure you invest in.  Similarly in 2008 / 2009 you could buy the bonds for >20% YTMs and there was a huge borrow fee for shorting the stock... all the "stock only" investors were wonder why, but if you were bond investor buy 25-35% of par bonds and shorting stock was a good idea even with the fees (at times).

 

Kraven,

 

I obviously didn't read the letter you were responding to, but I guess to me, the main thinking on the Guarantor / non-guarantor is two issues:

1) Non-guarantors represent assets that can more easily be spun off or otherwise sent to shareholders via rights offerings.

2) Seeing the non-guarantor / guarantor split can on some level give equity holders ideas as to the capital efficiency and/or level of attractiveness of the underlying business's economics (ie, "if we just winder down crap-Co, we will have good-Co's return profile at the end").  The way the SRAC debt is structured, it does of course have claims on the holding company assets effectively.

3) Agree that if someone was referring to bankruptcy remote in the way you mention, it would be comical (unless said asset was physically separated appropriate by spin off or a rights offering... and of course wasn't considered fraudulent conveyance).

 

Separately, an interesting note on this from Moody's rating the new notes, I didn't see it mentioned and I think it gets to the heart of some confusion (and adds to it!):

 

https://www.moodys.com/research/Moodys-revises-Sears-Holdings-rating-outlook-to-negative-affirms-Caa1--PR_312325

 

This should be very helpful to read for all who are confused by SHLD structure and would like to be moreso :)

 

Translating the link, it gives the following details:

 

Sears Holdings 6.675% secured notes rated Caa1

Sears Holdings 8% unsecured notes rated Caa3

Sears & Roebuck Acceptance notes rated Caa2

 

The statement around the 8% notes states that the rating is derived from the fact that the notes have no explicit guarantee / security, and thus do not have backing of the subsidiaries (back to Kraven's point, that means that if there is a general credit fight in Ch 11, they get in line for subsidiary equity, but not before SRAC obligations is my understanding).

 

Kraven, as this is your area of expertise, I would love to hear any thoughts or meanderings you have on this issue.

 

Thanks,

 

[Kraven]

Kraven,

 

I obviously didn't read the letter you were responding to, but I guess to me, the main thinking on the Guarantor / non-guarantor is two issues:

1) Non-guarantors represent assets that can more easily be spun off or otherwise sent to shareholders via rights offerings.

2) Seeing the non-guarantor / guarantor split can on some level give equity holders ideas as to the capital efficiency and/or level of attractiveness of the underlying business's economics (ie, "if we just winder down crap-Co, we will have good-Co's return profile at the end").  The way the SRAC debt is structured, it does of course have claims on the holding company assets effectively.

3) Agree that if someone was referring to bankruptcy remote in the way you mention, it would be comical (unless said asset was physically separated appropriate by spin off or a rights offering... and of course wasn't considered fraudulent conveyance).

 

Separately, an interesting note on this from Moody's rating the new notes, I didn't see it mentioned and I think it gets to the heart of some confusion (and adds to it!):

 

https://www.moodys.com/research/Moodys-revises-Sears-Holdings-rating-outlook-to-negative-affirms-Caa1--PR_312325

 

This should be very helpful to read for all who are confused by SHLD structure and would like to be moreso :)

 

Translating the link, it gives the following details:

 

Sears Holdings 6.675% secured notes rated Caa1

Sears Holdings 8% unsecured notes rated Caa3

Sears & Roebuck Acceptance notes rated Caa2

 

The statement around the 8% notes states that the rating is derived from the fact that the notes have no explicit guarantee / security, and thus do not have backing of the subsidiaries (back to Kraven's point, that means that if there is a general credit fight in Ch 11, they get in line for subsidiary equity, but not before SRAC obligations is my understanding).

 

Kraven, as this is your area of expertise, I would love to hear any thoughts or meanderings you have on this issue.

 

Thanks,

 

Ben, I don't have a ton of additional thoughts.  On the G/N-G issue I would agree with you that N-G's can more easily be spun off, etc., if only because they aren't contractually committed as a guarantor and getting them released is probably borderline impossible (realistically speaking).  From a reporting standpoint, I would agree as well that the split is helpful to getting a handle on underlying economics.

 

On the bankruptcy remote issue, that is true.  If assets were legally separated and assuming no fraudulent conveyance or similar issues then of course the asset is presumably out of reach.  But that has nothing to do with something being bankruptcy remote.  The problem is that people seem to have taken a view that these terms have some kind of plain meaning.  So "bankruptcy remote" means "remote from a Sears hold co bankruptcy".  "Guarantor/Non-Guarantor" means "only guarantors are tied into the Sears hold co structure and non-guarantors are completely free from it".  Obviously these terms don't mean that.

 

Finally, on the Moody's report, I quickly skimmed it.  All they are saying is that hold co debt since it doesn't have any sub guarantees is structurally subordinate to the sub debt and other obligations.  What that means is that even though a parent owns the equity in a sub, the sub's debts and obligations (absent some other contractual obligation with the parent, like a guarantee) will get paid first before there are any funds available to the parent.  So after those obligations are satisfied, there might not be anything left. 

 

[benhacker]

Finally, on the Moody's report, I quickly skimmed it.  All they are saying is that hold co debt since it doesn't have any sub guarantees is structurally subordinate to the sub debt and other obligations.  What that means is that even though a parent owns the equity in a sub, the sub's debts and obligations (absent some other contractual obligation with the parent, like a guarantee) will get paid first before there are any funds available to the parent.  So after those obligations are satisfied, there might not be anything left.

 

Thanks Kraven.  Bonds (SRAC vs. 8% notes) are not trading anywhere near (relatively speaking) the rating difference, it's inverted.

 

Always an interesting situation.

 

Ben