Jan

3

Here are a few more random comments on Sears and real estate:

1. It seems correct that the balance sheet carrying value of the some of the owned real estate is below its market value — if the pieces were sold in an orderly fashion. This statement is confirmed by the last 10K (page 24), in which they did a couple of sale & leaseback "S&LB" transactions. For example, they did a S&LB on a Sears Auto Center in October 2006 — and for accounting purposes, the excess of proceeds received over the carrying value of the associated property was deferred. [BUT, we] closed our operations at this location during the first quarter of 2010 and, as a result, recognized a gain of $35 million on this sale at that time. Note: they don't disclose what it cost to cancel the lease. And furthermore, given that they have a junk bond credit rating now, any S&LB's that they might enter into would have to be done at unattractive prices. That is, the cap rate for a Walmart S&LB might be 4% or 5%; my guess is that for Sears, it is now well into the high single digits…

More importantly, the problem with valuing Sears on the real estate portfolio is that they are the elephant in the room. When Alexander's went bankrupt, the stock actually rallied because they had a crown jewel in their 59th Street NYC story — and they could then reject the other leases. Because Sears has such a huge and geographically diverse portfolio, it's unclear to me how they could monetize it in a meaningful way except for S&LB (not an option right now). There is not enough commercial demand.

2. As I noted in my original post about Sears, Eddie's story was originally a real estate/asset play. That was 7 years ago. Generally speaking the retail real estate market is obviously quite soft, and there are few big footprint vendors who are expanding at the moment. This will eventually turn. A national tax on internet sales could help. So could a turn in the economy. But that's macro stuff.

3. It's notable that they sold $240 million of commercial paper to Eddie Lampert's Hedge Fund. (page 88) during 2010. In the latest 10Q, Eddie's commercial paper holdings declined to $220 million (page 18) and $100 million of the money was identified as Eddie's Personal money. This bears watching. Because as we know, during 2011, Sears drew down about $400 million in its bank lines.

I think the bullish case for Sears is that they find a new store format/model that works. This is what they've been trying to do with their throwing spaghetti against a wall. Once they do, the can continue to shrink the portfolio of existing underperforming stores. There is some historical precedent for this: For example, Melville Corp (aka Melvillle Shoe Co) was founded in 1922 had 7,282 stores at one point. They shed all of their retail chains … except for CVS (40%) … and today CVS is a successful drug store operator. Similarly Dayton Dry Goods Company (founded in 1902) had a series of successes and failures before they morphed into Dayton Hudson and now the successful Target Corporation. Most attempts to turn these companies around fail however, etc. Ames, Caldors, Montgomery Ward, Woolworth's. Even now-successfull Macy's went through bankruptcy.

So, if you want to give Sears the benefit of the doubt, I think what you need to see is a new store format that WORKS. They are not investing the required capX into their existing stores. And if they lose the confidence of their bankers and vendors, they implode. Lastly, the pundits who say that they've got tons of cash never mention where the cash is coming from. It's coming from Eddie's hedge fund and from the revolvers that they are drawing down. Also troubling is that even if they find a format that WORKS, how are they going to finance the conversion to the new format. That takes a ton of capital, and their cost of capital is going through the roof. The time window is quickly closing for them to succeed at a turnaround.

One last thought: Apple computer has about $40 BILLION in cash on their balance sheet and has almost no long term debt. They have 929 million shares outstanding. So that's $43/share in cash! So, with the stock trading at 400 minus $43(cash) = the stock is really trading at about $350/share. They are supposed to earn $35/share next year. So the stock is trading at 10x earnings *net of cash* for the "premier" sexy tech/retail(cult) stock that is financially strong and doing great (right now). I have no opinion on Apple. I mention this only because as an investor, one should not only consider whether Sears is "cheap" or whether it will succeed. One should also consider alternative uses of one's capital …. and I subtract out Apple's cash in this example because Charles' theme was to subtract out Sears' real estate. Just a thought.

Finally, Eddie & Co own about 61% of the outstanding stock now. The company has repurchased about $6 Billion in stock over the past 7 years (at much higher prices). So, the float is thin. The stock could be extremely volatile (in both directions) because of this.

Happy new year.


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