by Will Ashworth | November 30, 2012 9:30 am
If you want to know where Sears Holdings (NASDAQ:SHLD) is heading, watch Bruce Berkowitz and his Fairholme (MUTF:FAIRX) fund. Although Berkowitz has had a rough ride the last few years, his losing bets now appear to be paying off: Fairholme is up 28.5% year-to-date through Nov. 28, more than double the large-cap value category. One of those bets is Sears Holdings, which represents 10% of the fund’s total assets.
In a recent Q&A with Fortune‘s Scott Cendrowski, Berkowitz comes awfully close to admitting that Sears is worth more dead than alive. So, let’s look at why the long-time money manager feels the way he does about Eddie Lampert’s ongoing battle to extract shareholder value from America’s worst department store. I’ll also throw in a curve ball or two about its valuation.
Any conversation about the true intrinsic value of SHLD stock begins with real estate. Between Sears and Kmart, the company has 241 million square feet of retail space, 37% of it owned and the rest in long-term, below-market leases. Berkowitz values its real estate at $160 per share, or $17 billion.
Let’s put that in some perspective.
Target (NYSE:TGT) paid $1.83 billion in January 2011 for 189 leases for Zellers stores in Canada. Most of those leases had 15 to 25 years on them with rental rates of $5 a square foot. Rio Can (PINK:RIOCF), a large Canadian REIT that owns many of the malls where those stores are located, took back 81 leases that Target didn’t want. Rio Can figures it can get $10 a square foot from the new tenants.
Sears conceivably has two options regarding its real estate: It can repurpose its properties into some sort of multi-use redevelopment by subletting the space or selling the leases as the Hudson’s Bay Company has done. Target paid approximately $121 per square foot for its leases, so using that number, Sears could fetch as much as $18.3 billion for its 151.4 million square feet in leases.
Hudson’s Bay sold an Alberta location in 2012 for $10.7 million, or $258 per square foot. If we use that figure for the remaining 89.6 million in square feet it owns, Sears would reap another $23.1 billion, for a potential asset sale of $41.4 billion.
Simon Property Group (NYSE:SPG) has 245 million square feet of retail space (almost an identical amount), and its market cap is $46.5 billion, 10 times Sears’ current valuation.
Clearly, it would take years to bring the above scenario to fruition, so it’s safe to say $41.4 billion isn’t what Sears would actually extract from its real estate. Especially when you consider that the longer it takes for Sears to enter the death spiral, the greater the decay in the value of those leases.
In addition, Target was buying massive market share in one transaction, hence the premium. If Sears sold off its real estate in dribs and drabs, that would likely put a huge drag on the price it gets for each location.
Now, back to Berkowitz’s thesis about Sears. In his opinion, everyone is missing the liquidation value of its inventory. It ended the third quarter with $9.6 billion in inventories and $3.9 billion in merchandise payables. Berkowitz puts the liquidation value of its inventory around $6.4 billion. Subtract the payables, and Sears would net $2.5 billion, or 53% of its current market cap.
I’d personally chop a billion dollars off that to $1.5 billion because you hardly ever get what you think you will in a liquidation scenario. The real point Berkowitz is trying to make is that as Sears closes stores, it will get $10 per square foot ($100,000 per store) from the inventory alone. This means it can take its time in shrinking itself. After all, the Kmart-Sears merger is now seven years old. What’s another seven years?
Many see Lampert using Sears as the next Berkshire Hathaway (NYSE:BRK.B), taking the proceeds of assets sales and reinvesting them elsewhere until Sears, the retailer, ceases to exist. It might take awhile, but Berkowitz is willing to patiently wait because deep down he knows Sears is worth far more dead than alive.
Eventually, Lampert will put the retailer out of its misery. When he does, you have to think it will all add up to more than the current $43 per share. How much more? That’s the many-million-dollar question.
As of this writing, Will Ashworth didn’t own any securities mentioned here.
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