Ackman's Sears Sale: An Expression of His Activism 9 comments
-
Font Size:
-
Print
- TweetThis
From Pershing's Q3 letter:
Click to enlarge
I have received many emails over the past few weeks asking "should I sell my Sears". I have said no, and it appears that Ackman agrees based on what was said above.
The sale reason was interesting. At the Value Investing Congress I attended at Ackman's press briefing he said in a question regarding Sears (SHLD) and any potential activism on his part, "I think when we invest in a company with a controlling shareholder it is their activism we are dependent on".
In short, Ackman has decided he does not want to invest in situations in which he is powerless to enact the change he wants, in the time frame he wants it. Notice he did not say they were bad investments, just that he essentially didn't want to NOT be the activist.
Disclosure: Long SHLD
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 9 comments:
Take a walk through the stores - I did. It's not pretty - traffic is poor (but that's true everywhere right now) and merchandise often looks cheap and shoddy. This is the slow-mo KMart-ization of Sears.
The tools and appliances are OK - Craftsman is still a strong brand. But other areas, like electronics, are poorly stocked, and there are few bargains, just a bunch of stuff that is not selling sitting on shelves. Softlines are a wall-to-wall disaster. Housewares and kitchen can't hope to compete with BBBY, or even Penney's for that matter.
Unless Lampert can keep borrowing to buy in shares, giving them a totally artificial boost, this thing could fall into the teens, IMO.
I think Ackman got disgusted and threw in the towel - maybe it is roughly the bottom for SHLD - but I doubt it. I seriously question the premise that because Ackman can't be "activist" enough, he bolted. Rather, I think he feared this would continue to drag down his returns for some time, and that there is no fix available.
the market cap is less than half of the inventory at cost.
thank god I don't borrow to buy shares, as the market is absolutely irrational on this deal.
he could have a fire sale of all the inventory, selling it all at cost,
ruining christmas for all other retaliers,
and bid $150 per share for the 60 million shares outstanding with the proceeds.
or he might have already locked up the outstanding shares with call options, creating a VW scenario where shareholders name their prices. I've got limit orders in to sell at $1000 just in case.
It's hard to be long this stock, but the downside at a 4 billion market cap does not exist.
If he sold the inventory at half of cost, he'd have to pay off the $3.5bn in trade payables first, leaving him with less than $1.3bn, then he'd be in default of his credit agreement, so he'd have to pay off his revolver of $800M, and he'd be in default on his other debt so he'd have to pay that off too and that'd be $2.2bn, netting out that with cash on hand he'd net owe $1.7bn. Then he'd have to settle up on accrued expenses and other liabilities, which is another $3.3bn, netted out with $1.0bn of receivables, he'd owe $4.0bn. Throw in another $4.4bn of unfunded pension and other long term liabilities, he's $8.4bn in the hole before equity could get paid one cent!
Further, he owns only a fraction of his RE (<30% according to Pershing Square, probably why they sold), and they lease the rest. So there are significant off balance sheet obligations that would need to be funded before equity could be paid anything, making the $8.4bn net liability even higher.
The math is pretty simple. Sears is worthless unless the business starts to generate cash flow, and significantly more than it is generating now. If you do not believe that the cash flows that Sears generates in the future are significantly higher than they are today then this business will go bankrupt.
Given that comps will be negative double digits and Eddie will likely need to borrow to fund his operations next year, it's clear that this story will get worse before it's gets better. Equity value massively relies on a huge consumer rebound in late 2009, otherwise he will not be able to renew his line of credit and SHLD's trade partners will walk, and at that point all the debt becomes due and Sears will be worthless.
I know a lot of smart people taking the short side of this bet (assume it's going to zero) and it seems a stretch to assume that they're analysis is wrong.
On Nov 18 04:48 PM sclarksons wrote:
> Artificial boost?
>
> the market cap is less than half of the inventory at cost.
>
> thank god I don't borrow to buy shares, as the market is absolutely
> irrational on this deal.
>
> he could have a fire sale of all the inventory, selling it all at
> cost,
> ruining christmas for all other retaliers,
>
> and bid $150 per share for the 60 million shares outstanding with
> the proceeds.
>
> or he might have already locked up the outstanding shares with call
> options, creating a VW scenario where shareholders name their prices.
> I've got limit orders in to sell at $1000 just in case.
>
> It's hard to be long this stock, but the downside at a 4 billion
> market cap does not exist.
You two seem to think there are only 1 scenario for Sears-liquidation. That Sears is essentially a balance sheet, not a business.
The problem with this thinking, in my opinion, is that Eddie has run this company like a business, not like a balance sheet, and not like a holding company. And it appears, to me, that he will continue to do so.
So he will continue to try to turn the inventory 4 times a year like the stores have done in the past, at a positive but modest margin, perhaps a bit or somewhat lower than in the past. The problem is that there may well be this unlocked value in the real estate, and in some of the current assets, but Eddie appears to be reluctant to sell it off. It seems almost like he's bought an empire, and is willing to sit on his a** on it.
I mean, if you're sitting on value, why sit on it? Every day that you wait, that is cash tied up in those assets. So the problem with Sears is that it's tough to time the cash flows resulting from any asset sales, because if they come in 20 years or 10 years or 50 years or not at all, you're left with just the cash generated by the business, and that is roughly 1-1.5 billion in good times, and less than that in bad times. Even is Sears makes $1B this year in free cash flow, which probably is not very likely, investors can get similar yields elsewhere now, in companies less levered than Sears (people seem to be ignoring the "only" $4.4B in pension liabilities completely), so I really do not see the value in this one.
This changes, like I said, if Eddie starts throwing off incremental cash with asset sales, but that hasn't been the case.
Also, I saw a Sears press release on a couple different sites indicating that it bought about $4 million worth of Sears Canada stock on 11/12. Oddly enough, I cannot find this on Sears' website or in any filings. See www.newswire.ca/en/rel.... If this is true, a $4 million purchase last week does not reflect a company with cash problems. Any thoughts?
Finally, it's extremely easy for hedge funds to spread rumors about Sears given that it's retail, there's been top executive turnover in the past couple weeks, Ackman sold his position (even though he explained it somewhat innocuously), and the Company doesn't say anything in between quarterly reports. Add the fact that tax-loss selling is the #1 priority for PM's and that no one thinks Sears is going anywhere before next year and you have a great short over the past week.
It's possible that the bulls are right and Sears assets + future cash flows will be sufficient to cover its $16.6bn in liabilities and another $4.5bn of equity market value. I'm very skeptical.
Sears is a worst of breed retailer that continues to lose market share at a rapid clip, and a hevily levered bet on the consumer, with Eddie Lampert who has levered up and spent billions on buying back shares running the show.
Assuming the Street is right and Sears only comps down 3% next year and can earn $1, then it will generate about $260M of FCF, not even enough to pay off their May maturity, let alone their $800M credit facility.
Perhaps where the bulls and the bears disagree is the timing of the next consumer boom and the appetite of creditors to fund uneconomic retailers. Should the revolving credit facility not want to renew, and Sears is not able to replace it with a new facility for LCs and working capital, Sears will go bankrupt-- it cannot withstand cash calls in the billions of dollars from trade creditors and banks. Many trade creditors will not do business with Sears without LCs. And the timing of this recovery needs to be within the next year. I'm perhaps significantly more bearish than the average SHLD investor, but I'm hard pressed to see a scenario where this is not the case. Consumers have little appetite for big ticket purchases such as appliances and creditors have no appetite for risk. Further the cash flow deterioration at Sears is accelerating and no lender will want to fund an operation that's so rapidly declining.
In terms of investments I can think of many other higher FCF yielding companies with relatively less debt that are asset rich and actually own their own real estate (TGT, HD, and LOW come to mind). I'm hard pressed to find a reason to buy this one at almost 30x earnings, especially since it doesn't even own the vast majority of its own real estate.
It's funny you say that Lampert levered up to buy back stock, and then in the same post you mention HD and TGT as good investment ideas. HD and TGT have done the exact thing you mention, LEVER UP and buy back stock. SHLD debt is down every year since the merger.
It's funny that you claim that if sears comps are down 3%, they will generate only $260 of FCF. Comps have been running worse, and FCF has been much higher.
You also don't seem to be considering the wind down of inventory during the next few months as generating cash. That's typical for how retail is, Shld should sell off a few billion of inventory. On top of that, with comps down 10%, they should reduced further 10% or more from inventory, which frees up perhaps 2 1/2 billion in cash total. enough to pay down the revolver, reduce debt further, and make pension contributions. Since the $4 Billion revolver is backed up by inventory, possibly $7Billion of inventory, i think they will be able to renew it in 2010. Perhaps i'm wrong, but we shall see.
If Sears annual cash flows deteriorate to $260M as the street predicts, that would imply a 64 year payoff for all liabilities, and the inventory is worth pennies without a healthy retailer. This is how the banks will look it-- the last thing that want is to be another claim amongst $16bn when the trade creditors run. If the consumer is still unhealthy next year this will happen just like it has to the countless other retailers that have gone bankrupt this year. The bonds are trading at 30% rates of return are indicative of the creditors view of SHLD right now, and given the state and outlook of the consumer there's little likelihood of improvement by next year.
A bet on Sears at $30 is a risk of 100% capital loss for a 6% FCF off next year's numbers. Hardly seems like a good bet given the current dislocations in the market. Best of luck on your long.