Bruce Berkowitz’s latest 13G indicates he and his firm own or control 24.2 million shares of Sears Holdings (SHLD).

Didn’t Fairholme Capital get the memo? Holding 22.8% of SHLD stock, still a struggling department store for all of Edward Lampert’s involvement, hardly seems like a sensible investment.

Yet SHLD accounts for slightly more than 10% of Fairholme Capital’s $9.7 billion in holdings reported at the end of December. Only AIG (AIG) and Bank of America (BAC) have greater weightings. All three have been accumulated over several years: AIG and BAC since 2010 and SHLD since 2007. In all three situations, you’re talking about deeply ingrained investment hypotheses that Fairholme isn’t planning to abandon anytime soon.

I can see the attraction of both AIG and BAC — but SHLD? Lampert took two struggling retailers and put them together in 2004 with lackluster results. He’s made more management moves than Daniel Snyder. And after putting in a year as CEO, Lampert still doesn’t seem to be the answer. Berkowitz is a bright enough guy. He has to see that Lampert was and always will be over his head when it comes to retail.

What does Berkowitz see in SHLD stock that the rest of us don’t? Let’s see if we can find out.

SHLD Real Estate

Fairholme’s August 2012 case study of SHLD is easily understood. He believes the embedded value of Sears’ 250 million square feet of retail space in mall-based and freestanding locations across North America is significantly greater than its current enterprise value.

SHLD has more leasable retail square footage than either Simon Property Group (SPG), General Growth Properties (GGP) and Kimco Realty (KIM), three of the country’s largest shopping center owners. The trio’s average enterprise value is $40.2 billion, almost five times the value of SHLD stock. Fairholme has placed a major bet that the true enterprise value of SHLD is closer to that $40 billion than the current $8.5 billion.

And he’s not the only one.

In September 2013, Baker Street Capital Management, which owns 8.5% of SHLD, presented a case study of its own, suggesting “Sears is an extremely asymmetric, timely and high margin of safety investment.”

Baker Street believes Sears’ break-up valuation is between $85 and $158 per share, providing investors with a whole lot of upside and not much downside. Furthermore, it believes that SHLD could deliver assets (Lands’ End, Sears Canada, Sears Home Services) worth almost $44 per share to shareholders in short order without affecting its core business or its real estate.

However, as Chad Brand points out in this Dec. 4 blog, Baker Street seems to have put an awfully optimistic spin on the value of SHLD real estate. Case in point: In September, Baker Street estimated that Sears Canada’s (SEARF) Toronto Eaton Centre lease was worth $590 million. But in late October, Sears Canada announced it was terminating leases in five stores including the flagship in downtown Toronto for $400 million — substantially less than Baker Street’s projections.

Apply the same “realistic” valuation on all of SHLD’s properties and you get far less upside.

Long-Term Picture

Speculation exists that Eddie Lampert wants to get his hands on all the shares of SHLD that Fairholme doesn’t already own. To do that, he’ll continue to buy SHLD stock whenever its value is cheap (i.e., when it’s $40 as opposed to $60 like it was shortly after Baker Street’s optimistic valuation) and available. Bruce Berkowitz obviously sees the passing of time as Sears’ friend and not its enemy or he’d be pressing Lampert to speed up this process.

Sure, it’s a mess operationally. But as long as SHLD can keep the lights on at its top 350 locations that it owns as well as the top 50 that it leases over time, it should be able to generate real estate divestitures in excess of the $7.3 billion Baker Street currently estimates on those properties. The longer SHLD waits, the better off it might be.

Bottom Line

Nordstrom (JWN) has approximately 25.5 million square feet of space, both owned and leased — just one-tenth SHLD’s massive holdings. It’s clear that if Sears continues to operate retail stores it will be in a much smaller package. To do that, it needs time to evaluate which properties are better sold and which can continue operating.

Stores like the Eaton Centre lease are no-brainers to sell because Sears is no longer (not that it ever was) a downtown shopping destination. It’s a place for people living in smaller towns who don’t have a lot of options when it comes to shopping.

How many of these exist? I would think quite a few.

Recently I wrote that Warren Buffett’s legacy should be evaluated only after the entirety of Berkshire Hathaway (BRK.B) is sold off in a controlled sale, maximizing shareholder value. A process that would likely take years. Edward Lampert’s legacy, like Buffett’s, likely will follow the same course.

Until SHLD deals out its excess real estate, it’s hard to know whether Berkowitz’s bet pays off. Seven years in, he’s still biding his time. But if the sales pay off as he expects — which is plausible, if not necessarily guaranteed — the resulting bump in SHLD stock will make him look like a very smart man in retrospect.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.