SHLDQ - Sears Holdings Corp

[moneyball]

When your returns are substantially higher than your cost of capital, isn't cash-flow reinvestment opportunity a good thing? Shouldn't we be happy that there is a need to reinvest? Why would we want a dividend when our money can compound?

 

Litigation related to fraudulent conveyance would be strange as the money raised by the transaction was used to pay down debt (credit facility due 2016 then renegociated and a big chunk of 2018 bonds). Who would sue Seritage then?

 

As for the quality, it can be debated: the new rates paid by the tenants are great... But should it matter that much when a business is worth the sum of its future cash-flows? And Seritage is indeed growing at a nice clip for a REIT.

 

(I'm not sure WPG ROIs are comparable to those of SRG although the story is certainly worth a study)

 

Cash-flow reinvestment is a good thing. The real issue is since they are a REIT they will have to pay out 90% of income as dividend. (Of course this is not the same as cash flow, of course so the company can build up their balance sheet and fund through operations). The issue with this is that at some point you have to rely on capital markets and SRG has a big pipeline so they will need external funding. In my opinion, worst case scenario is that SHLD would go into bankruptcy in near future and default on Master Lease. SRG would then lose a substantial source of NOI and then would have to find equity of debt in some manner. This would be a funding problem. The severity of this scenario drops with every completed development and every SNO lease, but doesn't mean it isn't there. (Just to be clear I don't care about the dividend. I look at REITs from a value perspective not a yield perspective).

 

On litigation on grounds of fraudulent conveyance: I include it as a risk because if SHLD does go bankrupt in near future I can see Pension Benefit Guaranty Corporation making a claim in order to protect their interests. While this action might not be merited, and I do think SHLD did a lot to mitigate this (independent appraisals, JV with SPG, GGP and MAC that established a mkt price for assets), if a suit is filed I can see investors panic due to uncertainity. Once again, though this might not be a likely scenario, I would not discount the potential risk.

 

In terms of quality: Let's be honest there are some great assets in this portfolio. 48 wholly owned assets have sales greater than $400/SF. The JV assets should be the same quality. That gets us to 81 out of 266 assets. 38 malls have sales between $300-$400. 16 malls less than $200. So sixteen are real duds. So you can get a rough estimation of what the quality is. For the standalone and K-mart assets, you are without a doubt going to have a lower quality portfolio than class-A mall reits. Some of these sites (St. Paul standalone, Santa Monica standalone) have paths to value creation through extensive redevelopment, however, that is a harder path to FCF generation.

 

Lastly, new rents. I agree with Peridot that SRG is taking best projects first. Rent growth now is great, but don't project too much. Some of the malls won't get those rents, it is unclear how many auto-center sites will remain great growth opportunities, and K-mart assets are harder to create value.

 

Despite my seeming negativity, I am long. Just after Buffett got in I started to see some euphoric projections on the internet and want to add my 2 cents so people don't get burned (or at least can have a sounding board).

 

[peridotcapital]

When your returns are substantially higher than your cost of capital, isn't cash-flow reinvestment opportunity a good thing? Shouldn't we be happy that there is a need to reinvest? Why would we want a dividend when our money can compound?

 

Litigation related to fraudulent conveyance would be strange as the money raised by the transaction was used to pay down debt (credit facility due 2016 then renegociated and a big chunk of 2018 bonds). Who would sue Seritage then?

 

As for the quality, it can be debated: the new rates paid by the tenants are great... But should it matter that much when a business is worth the sum of its future cash-flows? And Seritage is indeed growing at a nice clip for a REIT.

 

(I'm not sure WPG ROIs are comparable to those of SRG although the story is certainly worth a study)

 

Cash-flow reinvestment is a good thing. The real issue is since they are a REIT they will have to pay out 90% of income as dividend. (Of course this is not the same as cash flow, of course so the company can build up their balance sheet and fund through operations). The issue with this is that at some point you have to rely on capital markets and SRG has a big pipeline so they will need external funding. In my opinion, worst case scenario is that SHLD would go into bankruptcy in near future and default on Master Lease. SRG would then lose a substantial source of NOI and then would have to find equity of debt in some manner. This would be a funding problem. The severity of this scenario drops with every completed development and every SNO lease, but doesn't mean it isn't there. (Just to be clear I don't care about the dividend. I look at REITs from a value perspective not a yield perspective).

 

On litigation on grounds of fraudulent conveyance: I include it as a risk because if SHLD does go bankrupt in near future I can see Pension Benefit Guaranty Corporation making a claim in order to protect their interests. While this action might not be merited, and I do think SHLD did a lot to mitigate this (independent appraisals, JV with SPG, GGP and MAC that established a mkt price for assets), if a suit is filed I can see investors panic due to uncertainity. Once again, though this might not be a likely scenario, I would not discount the potential risk.

 

In terms of quality: Let's be honest there are some great assets in this portfolio. 48 wholly owned assets have sales greater than $400/SF. The JV assets should be the same quality. That gets us to 81 out of 266 assets. 38 malls have sales between $300-$400. 16 malls less than $200. So sixteen are real duds. So you can get a rough estimation of what the quality is. For the standalone and K-mart assets, you are without a doubt going to have a lower quality portfolio than class-A mall reits. Some of these sites (St. Paul standalone, Santa Monica standalone) have paths to value creation through extensive redevelopment, however, that is a harder path to FCF generation.

 

Lastly, new rents. I agree with Peridot that SRG is taking best projects first. Rent growth now is great, but don't project too much. Some of the malls won't get those rents, it is unclear how many auto-center sites will remain great growth opportunities, and K-mart assets are harder to create value.

 

Despite my seeming negativity, I am long. Just after Buffett got in I started to see some euphoric projections on the internet and want to add my 2 cents so people don't get burned (or at least can have a sounding board).

 

Well said. While I am not long, I don't think SRG is going to see negative returns going forward or anything like that. It just doesn't clear my hurdle rate when I run my own numbers.

 

But between Buffett and Lampert and Berkowitz, the float on this stock is very low. It could certainly get to extreme levels based on that (in either direction depending on the market environment). That could make for interesting opportunities along the way, both long and/or short.

 

I agree that FFO growth will be solid, but when you estimate fully developed value on the 42M sf of space, make an assumption about the amount they can redevelop every year, and discount that value back at an appropriate discount rate for such a long period of time, it's not a clear outperformer (at least when I run my own numbers). I think it will do fine, but a home run that easily beats the S&P... I'm not so sure at recent prices (assuming one is planning to buy and hold for 20 years while they slowly get Sears to vacate 36M sf). I suggest doing that exercise though... it's interesting as SRG is a very unique situation.

[Orchard]

In terms of quality: Let's be honest there are some great assets in this portfolio. 48 wholly owned assets have sales greater than $400/SF. The JV assets should be the same quality. That gets us to 81 out of 266 assets. 38 malls have sales between $300-$400. 16 malls less than $200. So sixteen are real duds. So you can get a rough estimation of what the quality is. For the standalone and K-mart assets, you are without a doubt going to have a lower quality portfolio than class-A mall reits. Some of these sites (St. Paul standalone, Santa Monica standalone) have paths to value creation through extensive redevelopment, however, that is a harder path to FCF generation.

Great post Moneyball. Would you be able to disclose your sales/SF source?

[moneyball]

Yeah no worries Orchard it's from JP Morgan's cmbs annex for the portfolio. I can dm you later or post when I get to my computer tomorrow.

[moneyball]

Here is the CMBS annex

SRG_JPM_Deal_Annex.pdf

[BTShine]

What's the likelihood this man is brought on to wind down the company?

 

http://www.reuters.com/article/idUSASC08IGY

[randallchsu]

Question: In the SRG JPM Deal Annex pdf, Annex A: Collateral Schedule listed each mall's land acres and total square footage, so SRG owns mall space in square footage and surrounding land in acres?

[moneyball]

I would believe the land they own quoted in acres has the at grade square footage of the properties included.

[nkp007]

Even though the operations of the business are doing terribly, is there option value in Lampert changing his mind under pressure from Berkowitz?

 

Too late?

 

Whatever happens should happen within the next two years, I'm guessing.

 

 

[merkhet]

Even though the operations of the business are doing terribly, is there option value in Lampert changing his mind under pressure from Berkowitz?

 

Too late?

 

Whatever happens should happen within the next two years, I'm guessing.

 

I had literally the same thought... in 2013... but who knows.

[Sehayes1982]

Emotionally, when ones arbitrary targeted timeframe  is missed, it feels like it will never conclude, that it will continue in perpetuity. But realistically, you are closer to completion (despite being wrong). Two years from now seems more probable than two years ago :)

[fareastwarriors]

Sears Taps Bill Gates’s Fortune in Latest Borrowing

 

Eddie Lampert’s hedge fund and Cascade Investment among backers of $500 million in financing

 

http://www.wsj.com/articles/sears-taps-bill-gatess-fortune-in-latest-borrowing-1460141163

[OracleofCarolina]

Maybe Berkowitz is having an effect, SHLD announce they will close about 70 stores by the summer today.

[CorpRaider]

http://www.bloomberg.com/news/articles/2016-04-21/sears-plans-to-close-almost-80-stores-in-bid-for-profitability

[Eye4Valu]

They just need to close the rest of them down now!

[CorpRaider]

http://www.usatoday.com/story/money/business/2016/04/21/sears-close-78-more-kmart-and-sears-stores/83357662/

[PLynchJr]

New lows reached yet again.    :o

[Marve2013]

Hi Everyone,

 

Question - what is the risk in owning SHLD, but not SRG? 

 

I know that both RBS and Fairholme own substantial stakes in both. 

 

So is there the possibility that real estate will be sold to SRG at sub-optimal prices continually?  I know on the last transaction (establishing SRG) an independent appraisal was done.  But it would be far better to also hold an open bid process for subsequent real estate transactions.

 

Maybe that's why Mr. Buffett was interested to invested in SRG?  Buy in cheap and wait for the transfer of assets. 

 

Thank you for your thoughts.

 

 

[CorpRaider]

Chief risk to me as merely a casual follower is that creditors, including the PBGC, end up owning all of the assets in SHLD which are left after the conclusion of the failed conversion to a Costco/Amazon model.

[benhacker]

Question - what is the risk in owning SHLD, but not SRG? 

 

I would say that one is burning many hundreds of millions of $ per quarter in losses, while one is not.  Thus, I think the risk profiles of each is tremendously disparate.

 

I think trying to determine risks of an asset given the ownership of an asset is probably incorrect approach.  You identify risks by reading the financial statements.  In the case of SHLD and SRG, the underlying assets may have some similarity, but I think the financial performance of the business, and thus risk / reward is night and day.

[adesigar]

Question - what is the risk in owning SHLD, but not SRG? 

 

The risk and the reward with owning SHLD is Eddie Lampert. Lampert wants to be known as a great businessman. He is using SHLD as his instrument to get to that end. His father passed away at 47 so he worries that he might die young like his father and not have time to achieve his goals. I think this causes him to take more risk with SHLD than he needs to. If you read the annual letters you see comparisons to Uber/Tesla/Amazon/Apple etc. That's because he is spending money on trying a bunch of different things, its like a retail version of google ventures. You also read Berkowitz saying the Cash Burn is Voluntary which seems like a silly comment but its not. He talking about the cash spend on SHLD ventures. Francis Chou in his annual report says

 

"The transformation from the bricks-and-mortar business to their member-centric Shop Your Way (www.shopyourway.com) is happening; whether it is going to be successful or not is another story. These types of ventures should be classified as "venture capitals" and in spite of all the positive spins written about the transformation, it is still a hit or miss affair"

 

SHLD has done a decent job moving to the internet. In online sales it is 5th in the US between Staples and Netflix 1) Amazon, 2) Apple, 3)Walmart, 4)Staples, 5)SHLD, 6)Netflix. It has not done so well with other ideas eg (It bought a tech startup called Delver.com which is integrated into SYW but was supposed to be a social network based search engine).

 

The big question is will the cash burn be stopped or will the quest to be know as a great businessman consume SHLD?

 

 

 

 

 

[Marve2013]

Thank you for your thoughts. 

 

I was thinking along that same line, meaning if the Shop Your Way transformation doesn't work out as expected ... and Eddie still persists (as he sure seems like one determined person!).  Eddie decides to continue divesting other assets to keep funding the transformation and ends up selling more and more of the retail estate.  Perhaps at not so great prices, but at least good enough to keep the transformation going for another leg.  So if he continually sells real estate from SHLD to SRG, there is a chance that all the upside value of the real estate will be captured in SRG instead of SHLD.

 

I do think he's a fair person and he knows he has a fiduciary duty to SHLD shareholders, especially when there are some (like me) who hold shares in SHLD but not SRG.

 

Anyway, thanks so much :)

[adesigar]

Anyone attending the SHLD Annual Meeting tomorrow?

[ScottHall]

New lows reached yet again.    :o

 

Haha, big shocker. Surprised the ballgame hasn't been called on this one yet.

[scorpioncapital]

Not sure why a CEO stubbornly sticks to a lousy - perhaps dying business year after year. Is there a reason Lampert persists? It reminds me of an investor with a huge loss on a stock trying to recoup their losses. The adage that you don't have to make it back the same way you lost it could apply here as well. SRG is a step in the right direction.