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I have spent the last few days going through the Baker St research (I have no affiliation with them nor have I had any contact with them), it is great stuff. Last night the WSJ came out with a counter to it (below) and at first read it just did not sit well with me. When I realized much of it came from an “analyst” who, to put it kindly does not think Sears (SHLD) is worth much of anything and has a $20 price target on the stock, my antenna went way up. As I got into it more, I caught the error. We need to focus on the last highlighted paragraph below to understand the flaw in this piece …

From the WSJ

When Sears Holdings SHLD +3.87% struggles, it has a knack for turning from a retail turnaround story into a real-estate play. So once again, the notion has arisen that there’s gold in them thar malls.

A recent report from hedge fund Baker Street Capital Management, which owns a 1.4% stake in Sears, argues its real estate is “conservatively worth over $8.6 billion,” which compares with a current market value for the entire company of $5.9 billion. About $7.3 billion, or $69 a share, of that rests in Sears’s top 350 owned sites and top 50 leases—assets it reckons would be relatively easy to sell in an environment where high-quality mall assets are scarce. Throw in the value of Sears’s brands such as Kenmore, its Lands’ End operations and so on, and the firm says the company is worth $13.9 billion, or $131 a share.

The report has resonated, helping drive Sears shares about 25% higher this month to around $56. But it is also out of whack with other sum-of-the-parts analyses. Wednesday, Credit Suisse analyst Gary Balter struck back, arguing Baker Street wildly overvalued Sears’s real-estate holdings, while putting too high a price on the rest of the company, as well.

Consider: Baker Street says Sears’s top 350 stores are worth $98 a square foot. Contrast that to a May presentation J.C. Penney JCP gave to lenders, where it provided appraisal values for its stores from real-estate firm Cushman & Wakefield. The going-dark value of Penney’s stores in A-grade malls—what the retailer could get for its best locations if it shut down—was $55 a square foot.

A real reason to buy Sears shares would be signs that it was shoring up sales, not its real estate.

“Going dark” is not what the $SHLD valuation at Baker Street was about. “Going dark” implies an empty location most likely due to a Sears Chapter 11 or wholesale forced asset liquidation. Sears is not that case. The Baker St analysis was about $SHLD transitioning good properties for other uses. Think of it more like the 2012 transaction with $GGP when Sears sold 11 sites at $GGP malls to $GGP for $150sqft.

But lets dig a bit deeper. Here is the applicable slide from the $JCP presentation to lenders:

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Notice the “lit” valuation at the “A” Malls? It comes out to ~$86sqft. That is more than a little different than the $55 in liquidation. Now, what do we mean Sears locations are “lit” and not “dark”. Take the Burlington Mall in MA here:

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This means that Sears has tremendous options with its top locations. They can hold them and operate, sell the entire site, or redevelop it (pgs 15-22 of the presentation). That give the sites tremendous value and they can in no way be considered a “going dark” scenario. Now, to be sure there are plenty of shitty Sears locations. That is why in the report Baker St assigned a paltry value of $8 sqft for the remaining 1600 locations (below). Many of those are in fact “going dark” … in this case I’d gladly take the $55 sqft assigned to $JCP locations in a similar scenario.

Finally, here is the Baker St applicable slide regarding their value of Sears’ top 350 locations :

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The WSJ also made a math error in their calculations. Since there are 150 location in the bottom quartile, that value needs to be weighted more, making the value $93 sqft for the top 350 locations, not the $98 stated in the article. This means the true difference in the two presentations (JCP/SHLD) is ~ $7 sqft.

Even if we went with the $JCP figures it is inescapable that $SHLD, based on now two separate analyses (CRE of JCP/SHLD is similar) has a price sqft valuation of its top locations of $85-$95 sqft. That alone tells us there is material undervaluation in shares.

Source: The WSJ's Bad Math On Sears