As we have indicated before, we believe that Sears Holdings (SHLD) is a misunderstood story. There are many moving parts but we believe Sears Holdings’ intrinsic value lies in its real estate assets. It also has other valuable assets such as Kenmore, Craftsman and Diehard. Being a traditional department store has become a tough business during the last decade but, according to management, Sears is transitioning its historic focus on running a brick and mortar department store into a business that provides and delivers value by serving its members in the manner most convenient for them: whether in store, at home or through digital devices.
The value of its real estate allows Eddie Lampert, the controlling shareholder and CEO, the time and money to effect the changes. What Lampert is doing is the right thing to do, considering the possible outcomes – if it works, it’ll be a multi-bagger; if the transformation does not work out as expected, we believe the real estate values are high enough that we would not lose money in our investment at current prices after netting out all liabilities. If real estate was the only play from Lampert’s viewpoint, it seems that he would have liquidated the company a long time ago.
Caveat Emptor: With Sears announcing the REIT plans for part of their real estate holdings, which could be effected by the end of this year, those who bought Sears on the basis of that if the retail operations do not pan out, the value is covered by its real estate - that kind of reasoning will be less valid than before.
So, after the REIT transaction, you will be betting more on Sears' retail transformation, ostensibly called as 'SHOPYOURWAY'. If it doesn't work out, Lampert will be called 'LOSTYOURWAY', and so will be the investors who are still holding the stock.
The various bonds and debentures in Sears will also have less coverage than before. Lampert was smart enough to structure the debt in such a manner that if parts of Sears were spun off directly or through rights offerings, fraudulent conveyance laws wouldn't come into play.
Some of the debt like the one at Sears, Roebuck and Acceptance Corp. (SRAC) are guaranteed by Sears Holdings, but the assets of Lands' End, Sears Hometown and Sears Canada have flown the coop. On some of these transactions, Sears did receive the cash, and that may mitigate the argument of fraudulent conveyance laws. Unfortunately, the level at which cash is being consumed is unacceptable and if the transformation does not happen soon enough or is not sufficiently successful, it may make staying invested in Sears a highly risky investment, despite its vast real estate holdings.
There is one unusual quirk in the latest bond issuance with a coupon of 8%, maturing in 2019. It looks junior to the SRAC bonds but it gives the warrant holder the right to use this 8% bonds at 100 cents on a dollar to buy Sears Holdings stock at $28.41 per share. No wonder it is trading at 96 cents on a dollar versus 60 cents on a dollar for the SRAC bonds.
From Francis Chou (Trades, Portfolio)’s Chou Funds 2014 Annual Report.
