SHLDQ - Sears Holdings Corp

[Guest wellmont]

Yep wm, I own the same. Underlying notes trading at $0.75 though. Liquidity + lack of tender + ch 11 liquidation risk discount on ssrap of 20% exists which to me is far to high.

 

Underlying notes + cds are a truer credit risk price metric imo.

 

EDIT: at $0.58, you must mean the old SBCKO / SBCKP notes... those are in a similar boat as SSRAP (but with longer duration, and no Ch 11 liquidation / no tender risk that SSRAP has... but even worse liquidity and longer duration).  Can you trade those notes with any broker?

 

I think the underlying SRAC '27, '28, and '32 notes that are larger size and trade dealer to dealer are the best .  Those are trading $0.72-0.75 now - the others are basically untradable and carry a massive discount due to that (I think).  I think they (OTC dealer traded notes) go to par soon, or SHLD will tender.

yeah these are the old sbcko exchange traded notes. they are marked daily in my schwab accounts and they can be traded. but it's a pain and the quotes are low ball. good to hear similar debt is marked higher. I have owned these since late 2008 when they were bought around 35% yield on cost. each and every year since I bought them, various people have predicted that SHLD will file bk, and these will be toast. some predicted they would bk the SRAC sub. so that's bout 7 years now, going on 8 years running. they continue to pay like clockwork. and the insider buying at shld suggests to me that this will continue indefinitely. as will the predictions of impending doom for shld, and these "oddball" notes.

[fareastwarriors]

 

Berkowitz's Fairholme Increases Sears Stake, Signals Active Role

 

http://www.bloomberg.com/news/articles/2015-12-30/berkowitz-s-fairholme-increases-sears-stake-signals-active-role

[adesigar]

Happy New Year From Bruce Berkowitz: Buffett Affirms Seritage, Buy When Others Sell

 

 

http://www.gurufocus.com/news/380720/happy-new-year-from-bruce-berkowitz-buffett-affirms-seritage-buy-when-others-sell

[ap1234]

Am I the only one who misses all the activity in the SHLD thread??

 

On a serious note, it was interesting to see Berkowitz’s comments in his annual latter. He has talked about his $150 NAV appraisal in the past. However, this is the first time I have seen him break out the value of the real estate. He thinks it’s worth $15.8 billion. He also laid out a breakdown of the properties by grade (A, B, C and D).

 

Peridotcapital, I know you have expressed concerns in the past about aggressive real estate valuations (i.e. Baker Street’s analysis). What do you think about Berkowitz’s real estate valuation?

 

I think Baker Street’s analysis pegged the real estate at $7-10 billion. Berkowitz’s $16 billion value is after the $3 billion sale (i.e. the real estate would have been even more valuable when Baker Street did their analysis).

 

I think the bear arguments about the brands/retailing operations being worthless as well as the large cash burn are well laid out.

 

Does anyone have any thoughts on Bruce's real estate appraisal/what he is missing? At $16 billion, you can take an awful lot of haircuts and get a margin of safety. 

 

[Picasso]

Berkowitz seems out of his mind.  REIT's like Simon own a bunch of in-line space, not just anchor space.  There's no way the rest of the real estate is worth $16 billion.  It's hard not to lose respect for a guy who can't be objective with these things.

[valueyoda]

Baker Street's NAV was too optimistic at the time, since Sears Auto's, Brands, Lands' End etc were overvalued and they double counted certain items. Berkowitz is really out of his mind if he truly believes that the NAV is still at $140 after selling off a lot of prime real estate to Seritage, spinning out Lands' End and several years of retail cash burn. Sears Holdings is staying afloat due to the high cost of shorting and Berkowitz/Lampert buying up the float. If Berkowitz at a certain point is forced to sell off his position due to redemptions, the stock could crater since the marginal buyer is gone.

[peridotcapital]

Am I the only one who misses all the activity in the SHLD thread??

 

On a serious note, it was interesting to see Berkowitz’s comments in his annual latter. He has talked about his $150 NAV appraisal in the past. However, this is the first time I have seen him break out the value of the real estate. He thinks it’s worth $15.8 billion. He also laid out a breakdown of the properties by grade (A, B, C and D).

 

Peridotcapital, I know you have expressed concerns in the past about aggressive real estate valuations (i.e. Baker Street’s analysis). What do you think about Berkowitz’s real estate valuation?

 

I think Baker Street’s analysis pegged the real estate at $7-10 billion. Berkowitz’s $16 billion value is after the $3 billion sale (i.e. the real estate would have been even more valuable when Baker Street did their analysis).

 

I think the bear arguments about the brands/retailing operations being worthless as well as the large cash burn are well laid out.

 

Does anyone have any thoughts on Bruce's real estate appraisal/what he is missing? At $16 billion, you can take an awful lot of haircuts and get a margin of safety.

 

I do miss the active thread, but hopefully its demise signals that the longs wised up and finally bailed at much higher prices. Berkowitz is all-in on Sears and he will never admit he was wrong, even though it will likely cost him dearly in terms of his long-term track record. If you look at his average cost on SHLD since he first bought it in 2005 it is almost unimaginable.

 

As for his assessment of the real estate value, his errors are obvious to anyone who has done any work on SHLD. The Seritage properties were sold for $75 per square foot. My work indicates that they were slightly better than average, compared to all of SHLD's properties, but I am willing to go with Bruce's assertion that they are roughly an "average" sample.

 

The problem is that he is saying the rest of SHLD's real estate is worth $93 per square foot. That might not seem too crazy (compared with the Seritage deal), until you realize that 75% of the remaining SHLD square footage is leased and of that portion about 70% is Kmart stores (not more valuable mall space). It is certainly true that the leased stores have value, but Bruce is saying that they are worth more than owned stores. In order for his numbers to work, you have to think a leased Kmart is worth more than an owned Sears on a price per foot basis. Anyone who knows anything about SHLD's stores knows this cannot possibly be true.

 

Here's is the math to show this point:

 

Remaining 400 owned stores (at SRG prices, per Bruce's assumption)= $3.23B of value

 

This means the remaining 1,200 leased stores (900+ Kmarts) have to be worth $12.5B. That comes to ~$98 per foot. You simply can't justify it.

 

And the chart Bruce provides showing enterprise value per square foot all other REITS is irrelevant. Of course SHLD and SRG are trading at lower values than all of those other REIT peers. By far they generate the lowest rents!

 

You simply cannot argue that those stores are worth multiples more because they can be redeveloped. Doing so ignores the fact that it takes money to redevelop the stores! You can't just kick out Sears and Kmart and have another tenant come in the next day and raise the rent by 5x.

 

In my opinion, the SRG deal gives us a great comp for the owned stores. It was done with the help of an independent appraisal and it is a deal that was actually consummated. If you are super optimistic and say the leased stores are worth half (per sf) of the owned stores, then you get a value for the remaining SHLD real estate of $8 billion. Toss in the debt and the pension and the cash burn and it isn't compelling.

 

And that doesn't even address the fact that Bruce is double counting by including both the real estate values and values for KCD and Home Services in his numbers. To realize the real estate value you have to kick out Sears and Kmart. After that happens, you really think KCD and Home Services together are worth $5 billion? Not so much.

[Guest wellmont]

in your critique of the bb analysis aren't you assuming that SRG real estate is only worth $75 per sq ft? what if it's worth far more than that?  isn't bb basing his assessment of shld real estate on what he thinks srg real estate is worth, and not what it sold for ($75psf)? buffett is not buying srg because he thinks the real estate is worth $75psf. sorry if I am missing something in your analysis.

[valueyoda]

The free cash flow burn over the liquidation period should be subtracted first. Secondly, he should lower the value of Sears Autocenter, the Brands and homeservices accordingly with the decline in Sears's size. Thirdly, the K-mart real estate has a much lower value per sqft compared to Sears Locations. In addition, I am not sure whether Lampert is able to separate the remaining real estate (aside from the ones in the bankrutpcy remote entity) from the retail operations according the credit agreements. Lampert should give more disclosure with regard to the assets in guarantor/non-guarantor parts, especially with regard to the insurance company. I find it very hard to get a NAV above $15.

[tede02]

What baffles me is Bruce makes it sound like the long-term plan continues to be turning around the retail operation.  From his annual letter:

 

“The company must now accelerate its return to profitability in order to rebuild confidence with customers, creditors, vendors, employees, and other investors.”

 

Any casual observer can recognize that the existing retail operation is dead/obsolete.  Regardless of the true value of all the company's assets, I haven't heard Lampert or Berkowitz discuss a coherent long-term strategy. 

[Spekulatius]

If you like Sears Real estate, just buy SRG like WEB did. This isn't really that hard.

 

[BTShine]

in your critique of the bb analysis aren't you assuming that SRG real estate is only worth $75 per sq ft? what if it's worth far more than that?  isn't bb basing his assessment of shld real estate on what he thinks srg real estate is worth, and not what it sold for ($75psf)? buffett is not buying srg because he thinks the real estate is worth $75psf. sorry if I am missing something in your analysis.

 

Yes, my thoughts are that Buffett clearly thinks $75 a sqft for SRG is undervalued.  And/or he is keen on their redevelopment opportunities.  Either way, if Buffett's correct the current price of SRG is a great price for buying (aka undervalued).

[peridotcapital]

in your critique of the bb analysis aren't you assuming that SRG real estate is only worth $75 per sq ft? what if it's worth far more than that?  isn't bb basing his assessment of shld real estate on what he thinks srg real estate is worth, and not what it sold for ($75psf)? buffett is not buying srg because he thinks the real estate is worth $75psf. sorry if I am missing something in your analysis.

$75 psf is what the space is worth with Sears as a tenant. The SRG deal was not done at some crazy below-market discount. It was based on the low rent Sears is paying. Is it worth more after kick out Sears, subdivide and renovate the space, and re-lease it to another tenant? Of course. But realizing that value requires a huge capital investment. If you listen to what GGP/MAC/SPG have said about the returns they expect from redeveloping the Sears boxes, you might be surprised at how low the ROI is going to be on those projects. They have guided to high single digit returns, maybe 10% in the best case.

 

So, let's say a 100K SF box with Sears as the tenant is worth $7.5M, but post-redevelopment it is worth 3x that amount. You can't just say "the box is really worth $22.5M even though it sold for $7.5M." The reason is that in order to get $22.5M of value from it, you have to spend ~$13.75M to redevelop it. Berkowitz is valuing it at $22.5M today and ignoring the capital investment required to realize that value.

[ni-co]

I still have my calls. But I'm very glad to have switched for common to leaps a while ago… 

[adesigar]

Am I the only one who misses all the activity in the SHLD thread??

 

On a serious note, it was interesting to see Berkowitz’s comments in his annual latter. He has talked about his $150 NAV appraisal in the past. However, this is the first time I have seen him break out the value of the real estate. He thinks it’s worth $15.8 billion. He also laid out a breakdown of the properties by grade (A, B, C and D).

 

Peridotcapital, I know you have expressed concerns in the past about aggressive real estate valuations (i.e. Baker Street’s analysis). What do you think about Berkowitz’s real estate valuation?

 

I think Baker Street’s analysis pegged the real estate at $7-10 billion. Berkowitz’s $16 billion value is after the $3 billion sale (i.e. the real estate would have been even more valuable when Baker Street did their analysis).

 

I think the bear arguments about the brands/retailing operations being worthless as well as the large cash burn are well laid out.

 

Does anyone have any thoughts on Bruce's real estate appraisal/what he is missing? At $16 billion, you can take an awful lot of haircuts and get a margin of safety.

 

I do miss the active thread, but hopefully its demise signals that the longs wised up and finally bailed at much higher prices. Berkowitz is all-in on Sears and he will never admit he was wrong, even though it will likely cost him dearly in terms of his long-term track record. If you look at his average cost on SHLD since he first bought it in 2005 it is almost unimaginable.

 

As for his assessment of the real estate value, his errors are obvious to anyone who has done any work on SHLD. The Seritage properties were sold for $75 per square foot. My work indicates that they were slightly better than average, compared to all of SHLD's properties, but I am willing to go with Bruce's assertion that they are roughly an "average" sample.

 

The problem is that he is saying the rest of SHLD's real estate is worth $93 per square foot. That might not seem too crazy (compared with the Seritage deal), until you realize that 75% of the remaining SHLD square footage is leased and of that portion about 70% is Kmart stores (not more valuable mall space). It is certainly true that the leased stores have value, but Bruce is saying that they are worth more than owned stores. In order for his numbers to work, you have to think a leased Kmart is worth more than an owned Sears on a price per foot basis. Anyone who knows anything about SHLD's stores knows this cannot possibly be true.

 

Here's is the math to show this point:

 

Remaining 400 owned stores (at SRG prices, per Bruce's assumption)= $3.23B of value

 

This means the remaining 1,200 leased stores (900+ Kmarts) have to be worth $12.5B. That comes to ~$98 per foot. You simply can't justify it.

 

And the chart Bruce provides showing enterprise value per square foot all other REITS is irrelevant. Of course SHLD and SRG are trading at lower values than all of those other REIT peers. By far they generate the lowest rents!

 

You simply cannot argue that those stores are worth multiples more because they can be redeveloped. Doing so ignores the fact that it takes money to redevelop the stores! You can't just kick out Sears and Kmart and have another tenant come in the next day and raise the rent by 5x.

 

In my opinion, the SRG deal gives us a great comp for the owned stores. It was done with the help of an independent appraisal and it is a deal that was actually consummated. If you are super optimistic and say the leased stores are worth half (per sf) of the owned stores, then you get a value for the remaining SHLD real estate of $8 billion. Toss in the debt and the pension and the cash burn and it isn't compelling.

 

And that doesn't even address the fact that Bruce is double counting by including both the real estate values and values for KCD and Home Services in his numbers. To realize the real estate value you have to kick out Sears and Kmart. After that happens, you really think KCD and Home Services together are worth $5 billion? Not so much.

 

I don't miss the activity on the SHLD thread. Its the same stuff over and over and over. No one will do the research and study but everyone has an opinion on what the company is worth. They pull random numbers out of thin air. Its worth $0-$15 for the Bears and worth $150-$350 for the bulls.

 

The Bears believe Lampert is dumb/incompetent and Berkowitz is clueless on how to value SHLD. They've repeatedly been wrong on the value of the assets.

The Bulls(some not all) believe there is going to be magical short squeeze or they are going to get all the Non guarantor assets and the bondholders will be stuck with the retail operation.

 

The only one who has spend any time and money valuing individual properties is Berkowitz. Anyone elses calculation of the real estate (bull or bear) is a load of crap. And forgive me if I don't believe that he or the people he has hired don't know how to value real estate (cost of redeveloping, or in-line vs anchor space, etc).

 

Look at this article on seeking alpha using generalized numbers like Peridotcapital does.

http://seekingalpha.com/article/3835566-sears-holdings-much-real-estate-california

says the total value of stores is between $134 and $388 million.

even though the Sears ownership of their stake in South Coast Plaza could be worth as much as his total valuation.

 

or this bullish one

http://seekingalpha.com/article/3836596-sears-holdings-lifetime-investment-opportunity

which in my opinion says a whole lot of nothing. He points to the Non Guarantors 32 Billion in Assets and 4 Billion is liabilities and completely ignores the 28 Billion in Shareholder Equity where in this case the shareholders are the Guarantor companies. Just above the balance sheet in the report it says " The Company has accounted for investments in subsidiaries under the equity method."

And completely ignores the next line ("Certain investments primarily held by non-guarantor subsidiaries are recorded by the issuers at historical cost and are recorded at fair value by the holder.")which is where some assets are hidden but they are actually on the Guarantor side.

 

Finally to answer valueyodas question "whether Lampert is able to separate the remaining real estate (aside from the ones in the bankrutpcy remote entity) from the retail operations according the credit agreements"

 

Q3 presentation slide 17 - Financial Capacity

After giving effect to the Seritage transaction, SHC owns 421 stores, including 125 that are part of the REMIC transaction.  There are no restrictions on real estate financing in the Company’s credit agreement

 

Note 3 at bottom of page -  Includes [125] stores in the REMIC.  No credit agreement limits exist on real estate financing or non-remic properties.

 

[valueyoda]

It is hardly possible to put a value on SHLD (my $15 target was just based on realistic estimates that I used, but it could be much lower if the liquidation process doesn't ramp up or higher if the RE value is significantly higher than expected).

 

I find it funny that most investors including Berkowitz look at SHLD from a NAV perspective without taking into account the cumulative cash burn until the end of the liquidation process. SHLD is not a REIT, but still a large organization that is difficult to dismantle within a reasonable time span. The recent purchases by Berkowitz would indicate that a ramp up in store closures is in the works, as it would silly to add that much to his position without knowing when the turnaround would occur. However, Lampert still seems interested in a retail transformation of Sears. Historically, we have assumed that Lampert closed down stores that were producing negative EBITDA and that the EBITDA profile of the remaining stores would improve. However, due to internet competition, underinvestment and better brick-and-mortar competition, the competitive position of the remaining better stores have moved into the negative EBITDA quadrant. There is no evidence that a smaller Sears would be free cash flow positive, as operating leverage keeps weighing it down. Nor is there evidence that Shop your Way is gaining any traction.

 

Next year, SHLD runs out of cash again. Question remains what assets they will sell to keep the fire burning? Perhaps, South Coast Plaza? I agree that South Coast Plaza is worth more than the article suggests, but it is also one of the few remaining RE crown jewels that SHLD can monetize.

 

Even though, SHLD has no credit agreement limitations with regard to non-REMIC properties financing, I think it will be hard to spin the remaining properties out of SRAC without the approval of the bondholders. I strongly agree with Peridot that the IRR for redevelopment of those properties is lower than the bulls suspect given their exclusion of redevelopment costs.

 

I actually think that Lampert is a genius, but that he has put himself in an arduous position with SHLD as he underestimated the decline in operating results post-merger. He has frequently said that he tries to make the most rational decision possible each day. In 2007, when SHLD was still strongly free cash flow positive, I can imagine that he thought the shares were undervalued at $170 per share and that there was no immediate need to monetize the real estate. However, once a retail business enters a death spiral and can't be turned around, it will eat away your margin of safety. It is comparable to a situation where Buffett would have used the capital and cash flows of Berkshire Hathaway in the beginning to repurchase shares instead of diversifying away from the core business. Sooner or later, the deterioration of the business would have caught up with him. That is also why Lampert's investment in Autonation and Autozone worked, because the economic moat remained intact and the free cash flow generating machine wasn't hampered.

 

As to Berkowitz, I have a feeling following him for many years that he has an inclination to think in terms of p/b or p/nav ratios without really having a clear road map how to close the discount (often times, markets normalize and these ratios converge again, but sometimes the business is of a lower quality), look at Bank of America, AIG, St. Joe, Sears etc. He already started buying Sears above a $100 and continues to buy until today. I agree that in 2008 he did a thorough analysis of the tax records of Sears properties, but there is no evidence that he has done an extensive property analysis recently of the remaining properties. In addition, it remains opaque for shareholders how much value remains in the leases, as it has been many years now since that argument was first used. Plus, the window of opportunity of selling the remaining properties may be closing fast given the state of the economy, given the fact that GGP/SPG have already committed to a lot of transactions and the fact that many other department stores including Macy's may be looking at monetization of their real estate.

 

I also don't understand why Sears hasn't written down the brands intangibles, as the brand value of these brands continues to erode with further revenues declines. In addition, Lampert has been hoping for years that the unfunded pension liability would erode because of future higher interest rates. If I am correct in that interest rates will stay low for a long period of time due to a liquidity trap, that would be a further nail in the coffin.

 

Both Lampert and Berkowitz can't exit the position if they want to, because it would collapse the stock without any marginal buyers.

[ap1234]

Thanks for your insights Peridot! I really enjoy hearing your perspective on this. You seem to have done a lot of work on SHLD and are level headed in your analysis.

 

As much I enjoy the endless debates about whether Bruce or Eddie is the “next Buffett” or have lost their mind, it’s refreshing to occasionally focus on the fundamentals!

 

I agree with several of your points. For example:

 

1. SHLD’s real estate isn’t as valuable as a landlord like Simon. Looking at metrics like EV/sqf is deceiving as it ignores the difference in rents.

 

2. There is a very real cost to repositioning if either Sears subdivides the space or walks away from the box. You can’t look at the incremental rent from a new tenant without adjusting for the costs associated with the repositioning.

 

Having followed Bruce for a long time (I have admired him ever since I read the 1992 OID interview on WFC), I would be very surprised if he didn’t understand these points above. While he can come across as superficial in his interviews/letters, I think that's more a reflection of trying to cater to a mass audience then suggesting anything about his due diligence. And he has a lot of experience investing in the shopping mall space including buying GGP debt/equity during the crisis. That said, there is no point having a theoretical debate about whether he has done his homework or not. Let’s stick to the facts.

 

The part that I’m not sure I agree with you on is as follows:

 

1. You argue that the SRG sale price was “fair” because it had an independent appraisal. I’m not sure hiring an independent appraiser makes the price either fair or a good comp.

 

There are many ways to highlight that the properties were undervalued on a fundamental basis (rental lift on repositioning + the large development backlog). I don’t think it makes sense to value the properties assuming Sears is the tenant in perpetuity (as this isn't likely the case). And I've heard from both large and small landlords who are happy to spend money to remove Sears and reposition the box (even if you think the ROI sounds low). From a landlord's perspective, there are also secondary benefits to spending money and getting rid of Sears (it increases mall traffic and can result in a lower cap rate for the entire property).

 

You can also look at how “investors” reacted to Seritage REIT. While normally I wouldn't pay attention to the stock market reaction to a company, I think it's interesting to see how Seritage has traded since going public. In a difficult market for most companies (including REITs), it’s interesting that the stock has never traded even close to the subscription price of $29.58 (today’s stock price is 35% higher). This was not a spinoff - Bruce and Eddie had to put up fresh capital to own Seritage. If it was fully valued, it’s hard to see why Bruce/Eddie would put incremental new money in addition to their significant SHLD investments. Finally, Warren Buffett bought it in his PA (and presumably his average cost is above the $29.58 subscription price). Buffett has a pretty large universe of stocks to look at (especially in his PA) and I don’t think he has such a great affinity to the Sears brand that he wanted to pay a fair price for Seritage. 

 

2. The initial Seritage sale price partly reflects the fact that Seritage doesn’t own 100% of the economics of the real estate (i.e. they would have had to pay more if they wanted to own 100% of the land free and clear). For example, for most of the properties, Seritage has to pay a termination fee to Sears if they want to recapture the remaining 50% of the box. When you look at the value of SHLD's remaining real estate they still retain 100% of the economics.

 

3. You mentioned that the leases are worth substantially less than the owned stores. I think you suggested that at most the leases are worth 50% of the value of the owned stores. I'd be curious to know whether you have seen any historical data that highlights this?

 

Based upon disclosed transactions, I've seen many leases that seemed to sell at similar valuations to what a property would be worth if the retailer owned it. For example, Sears (and other retailers) have sold lots of leases in Canada and the US at extremely high valuations ($/sqf) which seems to suggest that it’s the quality of the property and not the fact that it’s owned/leased that determines value.

 

4. You mention that the Bruce’s implied valuation suggests the 900+ Kmarts have to be worth $12.5 billion or $98/sqf. I wonder if doing high level math (as opposed to doing property by property appraisals) like this can skew the numbers. A very small % of the properties represents the vast majority of the value. And there are a ton of properties that are likely worth sub $10/sqf. But that misses the point. The much more important figure is what the top 10-20% of the real estate is worth. So if you do high level math and potentially understate the value of the highest valued properties, it might make the lower valued properties look more expensive than they actually are.

 

Anyways, I would love to hear your thoughts on this. You seem to be very knowledgeable about Sears and always interested to see your perspective. 

 

[peridotcapital]

 

The part that I’m not sure I agree with you on is as follows:

 

1. You argue that the SRG sale price was “fair” because it had an independent appraisal. I’m not sure hiring an independent appraiser makes the price either fair or a good comp.

 

There are many ways to highlight that the properties were undervalued on a fundamental basis (rental lift on repositioning + the large development backlog). I don’t think it makes sense to value the properties assuming Sears is the tenant in perpetuity (as this isn't likely the case). And I've heard from both large and small landlords who are happy to spend money to remove Sears and reposition the box (even if you think the ROI sounds low). From a landlord's perspective, there are also secondary benefits to spending money and getting rid of Sears (it increases mall traffic and can result in a lower cap rate for the entire property).

 

You can also look at how “investors” reacted to Seritage REIT. While normally I wouldn't pay attention to the stock market reaction to a company, I think it's interesting to see how Seritage has traded since going public. In a difficult market for most companies (including REITs), it’s interesting that the stock has never traded even close to the subscription price of $29.58 (today’s stock price is 35% higher). This was not a spinoff - Bruce and Eddie had to put up fresh capital to own Seritage. If it was fully valued, it’s hard to see why Bruce/Eddie would put incremental new money in addition to their significant SHLD investments. Finally, Warren Buffett bought it in his PA (and presumably his average cost is above the $29.58 subscription price). Buffett has a pretty large universe of stocks to look at (especially in his PA) and I don’t think he has such a great affinity to the Sears brand that he wanted to pay a fair price for Seritage. 

 

 

I would guess that the appraisal was done based on the master lease terms that the two companies had agreed to, so I would disagree that the appraisal has minimal value. If it was not based on this particular situation, why have one done at all? And why base the deal price on it? Accordingly, I believe the $75 per foot price was based on the fact that Sears will be paying $4 per foot for a while, but not forever (rent of $4/sf in perpetuity would garner a price far less than $75/sf, whereas an in-line rent from day one would garner far more, etc).

 

As for the market action of SRG, I actually think it supports my view. At $38 per share, SRG's E/V is roughly $3.2 billion. So the market is valuing SRG at roughly $80 per square foot.

 

As for why Buffett bought it, the thesis might very well be something other than "it's currently trading at 50% of NAV." For one thing, consider the margin of safety. You are buying real estate at a price based on Sears' $4/sf rent terms but you know that over time Sears will leave and rents will rise. Buying SRG today means you can pay a "fair price" on "trough cash flow." The margin of safety is pretty high. The only way you lose is if the space goes vacant in the future. I think SRG is much more a situation of "I'm paying a fair price today but there is minimal downside and a high probability that NAV grows over time" as opposed to a "50 cent dollar" scenario.

 

Here is another way of illustrating that point. We know that SRG is getting $19/sf on the leases they are signing for the redeveloped space. Take a look at other public retail REIT comps that have average rents of around $19/sf and figure out what you think a fair price for those properties is on an EV per sf basis. Then apply that multiple across the entire SRG portfolio. That is what SRG would be worth if we woke up tomorrow and every Sears store had been redeveloped and rented out. Take that number, make an assumption about the capex required for redevelopment and the time it will take, and discount the gross fair value back to present value today. I think you'll see that SRG is a not a "50 cent dollar" right now.

 

 

2. The initial Seritage sale price partly reflects the fact that Seritage doesn’t own 100% of the economics of the real estate (i.e. they would have had to pay more if they wanted to own 100% of the land free and clear). For example, for most of the properties, Seritage has to pay a termination fee to Sears if they want to recapture the remaining 50% of the box. When you look at the value of SHLD's remaining real estate they still retain 100% of the economics.

 

 

That is true. But since Sears is burning cash they cannot redevelop these stores themselves. When they run out of cash again (it won't take very long), they will likely have to sell more stores to a third party like SRG, and the same terms will apply.

 

 

3. You mentioned that the leases are worth substantially less than the owned stores. I think you suggested that at most the leases are worth 50% of the value of the owned stores. I'd be curious to know whether you have seen any historical data that highlights this?

 

Based upon disclosed transactions, I've seen many leases that seemed to sell at similar valuations to what a property would be worth if the retailer owned it. For example, Sears (and other retailers) have sold lots of leases in Canada and the US at extremely high valuations ($/sqf) which seems to suggest that it’s the quality of the property and not the fact that it’s owned/leased that determines value.

 

 

Yes, some of the best leases do command prices comparable to owned stores. Given how Kmart-centric the remaining leases are, the majority of them are actually worth zero. On a weighted average basis the owned stores are worth more because even the worst ones have some value. You will find many owned Kmart stores that are worth $1-3 million each. When you have so many leases worth zero, even certain crown jewels that might fetch $150-$200/sf can't make up the difference. The problem really comes down to the fact that most of the Kmarts are leased and most of the Sears are owned. As a result, there aren't enough high value leases to offset the crappy ones. 

 

 

4. You mention that the Bruce’s implied valuation suggests the 900+ Kmarts have to be worth $12.5 billion or $98/sqf. I wonder if doing high level math (as opposed to doing property by property appraisals) like this can skew the numbers. A very small % of the properties represents the vast majority of the value. And there are a ton of properties that are likely worth sub $10/sqf. But that misses the point. The much more important figure is what the top 10-20% of the real estate is worth. So if you do high level math and potentially understate the value of the highest valued properties, it might make the lower valued properties look more expensive than they actually are.

 

That's true, but I'm not basing my views on just high level math. I have done a lot of property by property analysis and so my averages are based on actual data. Baker Street did the same thing (individual property analysis followed by a summary that grouped the stores in buckets and assigned a dollar per foot value on each one). The only thing I thought was really good about their presentation was their real estate assessment. If you look at their values vs what the SRG properties fetched (both to SRG and the 3 JV's) you will see that their numbers were quite accurate.

[valueinvestor82]

Peridot, what qualifies your ability to analyze real estate asset values better than the throng of experts that Berkowitz hired? Pardon me if I trust an immensely successful long-term value investor like Bruce over your word that you looked at each property...

[Patmo]

Peridot, what qualifies your ability to analyze real estate asset values better than the throng of experts that Berkowitz hired? Pardon me if I trust an immensely successful long-term value investor like Bruce over your word that you looked at each property...

 

To play devil's advocate, what tells you these experts aren't just telling Berkowitz what he wants? They have lots of incentives to do so

[peridotcapital]

Peridot, what qualifies your ability to analyze real estate asset values better than the throng of experts that Berkowitz hired? Pardon me if I trust an immensely successful long-term value investor like Bruce over your word that you looked at each property...

 

You shouldn't blindly trust me. You should do your own work. I was asked my opinion so I provided it. What baffles me is that people still trust Bruce on this investment, even though if you look at his track record with it during the 11 years he has owned it, it's pathetic. Smart people make mistakes. Bruce made a mistake. No matter what happens, Bruce's CAGR on SHLD will never beat the S&P 500 over his holding period.

 

As for valuing real estate, it is not a hugely complicated process. You don't need to spend tens of thousands of dollars on "experts." Anyone who values assets for a living and is relatively good at it can do it well. And to assist you, there are dozens of public retail REITS to use as comps and to help you determine what the costs and returns are for developing retail square footage. Local governments conduct annual appraisals. You don't have to actually visit 1,600 stores. You focus on the best hundred and you take smaller diverse samples of the rest, etc. One of the things I did was analyze the REMIC stores. Made for an excellent sample.

 

I don't think it's a stretch to trust people who have been on the right side of SHLD (I have been long the bonds in recent years, which have trounced the equity on both an absolute basis and risk-adjusted basis) more than people who have been dead wrong on the equity. You might disagree, but it's not a crazy idea. That doesn't mean I'm smarter than Bruce, it just means he made a mistake. Everybody does. But it's certainly reasonable to admit that, perhaps, on Sears Holdings specifically, I and many others have done a better job analyzing the investment. Especially when he has made bad calls on real estate before (St Joe is an obvious one to point to).

 

I just find the argument that Eddie and Bruce are smart, and therefore SHLD must be a good investment, to be silly. Smart people make errors and the last 11 years have shown that they both made the same one on his particular stock. The fact that SHLD's operations has burned through more than $4.3 billion of cash over the last three years ($40 per SHLD share) and Bruce's NAV estimate has stayed pretty much the same ($150 or so) tells me all I need to know. His sum of the parts valuation doesn't make sense when the company continues to operate as a retail company and burn over $100M of cash per month. And when Eddie sells off 40% of the company's owned stores for well below Bruce's real estate valuation (and their value to SHLD equity holders is even less than what they were sold for because they remain open and in the red, that just drives home the point. How much more evidence do we need?

[BTShine]

Many of you have probably read this presentation by Seritage and I apologize for posting more Seritage info on the SHLD board.  That said, I found it interesting and clear.

 

http://ir.seritage.com/Cache/1001205931.PDF?O=PDF&T=&Y=&D=&FID=1001205931&iid=4584761

 

Hope everyone is enjoying their weekend. 

 

BTS

[jeffmori7]

Bad holiday again...store closures will restart: http://www.montrealgazette.com/business/after+challenging+holiday+sears+speed+store+closings/11707244/story.html

[opihiman2]

^^ Terrible #'s.  Pretty much a blood bath again for Sears.  At this point, buying long out puts and going short will probably be a better bet than buying the common for Berkowitz, et. al.  I mean, if you can't see the trend in the past several years, you're delusional.

 

And, I'm being sincere here, but has ANYONE ever heard of a retail turn-around story??  Because, I've been trying to think of one and I can't.  All I have seen in the past decade is retail carnage.  Anyone?

[Against the crowd]

I believe there has hardly been a retail turnaround story. Nothing that I can remember in last 10 years. I wonder when does Eddie Lampert throw in the towel and say enough is enough. i sold my position yesterday at 50% Hair cut after waiting for the turnaround.