It seems as though it is taking forever, but there seems little doubt that Sears Holdings Corp (NASDAQ:SHLD) will go bankrupt at some point, save the possibility of a White Knight “rescuing” it.
It is difficult to remain in business when Sears needs to cut expenses and does so by closing stores, when those stores are also a primary source of revenue. The upside is that fewer stores also means less inventory to keep in stock, which means less money spent on that inventory, which means cash flow will improve.
Now, with Sears effectively outsourcing the sale of its Kenmore appliances to Amazon.com, Inc. (NASDAQ:AMZN), margins will be reduced further, because online sales at Amazon tend to carry lower margins. Sure, it means stores can carry less inventory, and shoppers can poke around the stores to kick the tires on appliances and then order them from Amazon, but it still means less profit for Sears.
Then again, Kenmore sales have been declining themselves for years. According to the Chicago Tribune, “During the 12-month period ended in March, Sears accounted 21.8 percent of major appliance sales in the U.S., down from 30.1 percent four years ago. The Kenmore brand’s major appliance market share fell from 16.7 percent to 10.3 percent during the same four-year period.”
Ouch.
A lot of analysts point to Sears’ sizable real estate holdings as being some kind of long-term protection against bankruptcy. The problem is that mall and strip mall retail properties are also struggling. One look at the decline in the results of mall REITs should bring that point home.
Okay, so that’s the bear case and we’ve heard quite a lot about it. Is there any upside scenario here? I wrote about one possible scenario — Amazon buying out SHLD stock in its entirety.
Another scenario lies in the CEO, Eddie Lampert. He has a controlling position — about 55%– in both debt and equity, and it seems strange that he would continue to throw money at the chain out of his own ESL Investments fund if he really thought he would have SHLD stock have to file for bankruptcy.
Why would he have done all these deals — which included buying Kmart out of bankruptcy and then using it to merge into Sears — just to hand it all over to a bankruptcy judge?
That’s when I realized — what if I’m not seeing the entire picture of Sears stock? Then I found this SEC filing that shows everything that Sears actually owns. Wait a second. KCD IP, LLC is Kenmore, Craftsman and DieHard. There’s an insurance subsidiary. There’s a re-insurance subsidiary. There’s a Canada subsidiary. There’s a consumer credit operation. Wally Labs is a social media platform.
Now things make a little more sense. What if Lampert is throwing money at Sears to reposition it, rather than stave off bankruptcy, into more of a conglomerate? Something more like the old version of Tyco? Lampert has tons of cash available in his fund.
Suppose he’s waiting for the overpriced market to revert to the mean? It has to happen. When it does, is it possible that other businesses that fit into whatever vision he has for this conglomerate suddenly become cheap enough that he acquires them? What if he plows them into Sears Holdings?
In order to believe that Sears stock is going to zero, you have to assume that Lampert is literally throwing good money after bad. Is that really what someone of his experience would do?
I think not. There is no logic to throwing good money after bad no matter how rich a person may be. Lampert can deal with double-digit same-store sales declines and closing stores because of one very important concept:
Equilibrium.
Sooner or later, Sears’ operations will reach equilibrium. There will be just the right number of stores. It allows him to effectively trim back the brick-and-mortar operation to a place where it holds its own while waiting for the market to revert to the mean.
In the meantime, cutting costs will facilitate this transition. Adjusted SG&A was cut by $325 million in the last quarter, which is a trim of almost a quarter. Adjusted gross margins are improved by 190bps. The result was a $132 million improvement in adjusted EBITDA loss, and Sears even said it hit positive adjusted EBITDA in July.
I think Lampert is on to something here and you may want to think about it.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
