It’s been on the radar since November, but it became official today — Sears Holdings Corp (NASDAQ:SHLD) will be raising cash by spinning off some of its real estate into a REIT, hitting up current SHLD owners for the funding to make it happen.
The knee-jerk response to the announcement of the Sears REIT was an 8% pop from SHLD, although that gain was whittled down to only a 5% advance later on in the session. Still, given the 37% run-up from Sears stock since the end of January in anticipation of the formation of the REIT, it’s clear the market likes the idea.
Current owners of SHLD, however, might not like it as much once a key reality sinks in.
Introducing the New Sears REIT
Technically speaking, the REIT hasn’t materialized just yet. The legal structure is in place. It’s just waiting for funding, which will be generated via a rights offering made to current owners of SHLD. All told, the struggling retailer could raise up to $2.5 billion by selling 254 existing Sears and K-Mart units to what’s been named the Seritage Growth Properties.
These 254 stores won’t be closing … at least not yet. The retailer will simply lease the property from the Sears REIT.
More important, the creation of the REIT will put some much needed cash into Sears Holdings’ coffers.
Although Sears was sitting on $250 million in cash and had access to another $800 million via a credit facility as of the end of the fourth quarter, that’s not enough for the still-struggling company. Sears lost $159 million last quarter, and booked a loss of $1.68 billion for all of 2014. Although the company says it’s in a turnaround (a transformation that’s been underway for years, though that’s another story), even the most successful of turnaround scenarios wouldn’t get the company back in the black before it ran out of cash. As such, the creation of the Sears REIT as a means to raise funds is crucial to the company’s survival.
As is usually the case with hedge fund manager, acting CEO and majority SHLD shareholder Eddie Lampert, though, there’s more to the story.
Something for Sears Stock Owners to Mull
To be fair, the creation of the Sears REIT was and is likely the last bastion of hope the company has to keep itself alive while it works on its turnaround. It’s sold everything else of value to raise money, including last year’s spinoff of Lands’ End, Inc. (NASDAQ:LE) and the more recent sale of its stake in Sears Canada. With nothing else left to shed, its owned real estate was the only viable choice to raise money.
It doesn’t change this fact for those who are currently shareholders of SHLD, though: Eddie Lampert is trying to sell you what you already own.
For equity investors, every share of Sears stock represents proportional ownership in the company’s operation, assets and goodwill, minus its debt and other obligations. Those assets include the company’s real estate. By issuing current SHLD shareholders rights to buy some of that same real estate by investing in the new Sears REIT, Lampert has effectively made them pay for it twice.
The ethical argument is trumped by a much bigger concern current SHLD shareholders may want to think about, however. That is, how can a company that’s already losing money on a regular basis when it’s not making lease payments afford to start paying rent in the immediate future?
Answer: It probably can’t.
All of a sudden the already-high turnaround hurdle got considerably higher.
Bottom Line for SHLD
In his defense, Lampert — through his hedge fund and associated funds — is the company’s largest shareholder, holding nearly half of all Sears stock. He’s eating his own cooking, so to speak, and was likely telling the truth when he said we would fully subscribe to the Sears REIT rights offering.
But that doesn’t mean it’s the wise thing for the average retail investors on SHLD to do.
For all intents and purposes, the Seritage Growth Properties is a decided bet that the Sears retailing operation is going to turn things around.
The sale of Land’s End, Sears Canada and a few other divisions in recent years freed up cash and unlocked value, but they never created an obligation. The formation of a Sears REIT is the creation of an obligation (in the form of rent payments) for some of the company’s stores, and it also tacitly implies that REIT owners can expect regular distributions from their Seritage investment, driven by those rent payments. Unless the company starts making a lot of money though, and soon, someone in the mix is going to get the short end of the stick.
It all still hinges on whether or not Sears can make itself a relevant and viable retailer again, which is the one thing Lampert has yet to prove he knows how to do.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.