Sears Holdings Corp (NASDAQ:SHLD) hasn’t been easy to own at any point over the past eight years. But in a month and a half, owning Sears stock will become an outright exercise in raw nerve.
July 10 is the first day the struggling retailer could declare bankruptcy without undoing the mid-2015 sale of several dozen to stores to a specially-formed REIT called Seritage Growth Properties (NYSE:SRG). That was a honey of a deal for the real estate investment trust that — oh yeah — also happens to be run and largely owned via a hedge fund by the same Eddie Lampert who currently owns a big chunk of SHLD stock and is also serving as Sears’ CEO.
Conflict of interest? You bet.
That’s not to say Sears will be submitting its Chapter 11 paperwork to a bankruptcy court at 8 a.m. on July 10. Lampert almost seems to have convinced himself he can still salvage the imploding company, and will certainly be emboldened by Tuesday morning’s news that the maturity date of some $500 million worth of debt coming due in July has been pushed back to the beginning of 2018.
It is to say, however, that from any point beyond July 10, Sears stock holders shouldn’t act too surprised if they see the “B” word in a headline.
The Letter of the Law
The date in question is established in section 548 of the Federal Bankruptcy Code, which explains (emphasis mine):
“The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition… if such transfer or obligation was either made with actual intent to hinder, delay, or defraud present or future creditors, or was made for less than reasonably equivalent value, and (1) while the debtor was insolvent or rendered insolvent as a result of the transaction, or (2) left the debtor with an unreasonably small capital, or (3) the debtor intended to incur or believed it would incur debts that would be beyond the debtor’s ability to pay such debts when they matured.”
The transfer of those 235 store locations to Seritage happened on July 7, 2015. The first business day that would fall two years after that mark is Monday, July 10, of this year.
Intent — as is the case with much of the law — will be the sticky wicket. The $2.7 billion deal with Seritage could still only be done if someone was able to prove the whole plan was to shift valuable assets off of Sears’ books to prevent them from being claimed by creditors in the event of a bankruptcy filing. That’s usually tough to do.
In this particular case, Lampert didn’t do himself any favors by exercising a controlling interest in the buyer and the seller. Past July 10, the law shouldn’t (theoretically) matter anymore.
The End of the End
If you think Sears is going to be able to hang on much past that point, think again.
The company did just buy itself some time and flexibility. SHLD was going to have to come up with $500 million it didn’t have to pay back the principal on debt coming due in July. Now payment is due in January. Sears has also annuitized $515 million worth of its pension liability, ultimately lowering its cash costs incurred by paying those 50,000-plus retirees.
That won’t be enough. Sears lost $607 million last quarter, and it wasn’t an unusual quarter.
The latest chapter in the saga: What little goodwill Sears may have been able to support with its vendors was weakened last week when the company chose to follow through on threats made just a few days earlier. It filed a lawsuit against one of its tool suppliers that alleges a breach of contract.
The vendor, One World Technologies, is arguably in the wrong in that it didn’t want to honor its initial agreement. In light of Sears’ recent financial difficulties, the supplier sought to reduce its risk should the retailer go under. As they say, though, a deal is a deal. Should the worst-case scenario materialize, One World could fight for its share of the company’s assets in a bankruptcy court.
But the suit itself has much bigger damaging consequences than just one soured relationship with a vendor. Other suppliers of Sears merchandise have to be aware that the retailer just turned a partner into an adversary. Not looking to be the next target in a lawsuit, those other vendors may only be willing to work with Sears on very restricted terms going forward.
Count it as another mortal blow.
Bottom Line for Sears Stock
July 10 is the proverbial opening of the window for the retailer, but don’t be surprised if an actual Chapter 11 filing doesn’t materialize right away (assuming one materializes at all).
Remember: Lampert may have driven the company into the ground, but he’s not stupid. He has to know he has to sell the idea that his intent was to give the company a good shot at surviving as long as it could while he was trying to get traction with a turnaround effort. A July 10 filing would be a little too obvious.
Nevertheless, SHLD has fewer and fewer assets to sell to supply much-needed cash — if only to continue burning it. It’s difficult to imagine any other outcome for the once-iconic retailer.
In the event of a bankruptcy, Sears stock will effectively be worthless. Liabilities of $13.2 billion far exceed assets of $9.3 billion, and that’s assuming the company would be able to sell its assets at their fair price in a bankruptcy liquidation. Bondholders are first in line before SHLD shareholders, and there’s arguably not even enough to pay debtholders back.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.