For years, Sears (SHLD) has been subjected to massive short squeezes. This stemmed from a high short interest coupled with a low free float.
Short interest over the last year floated between 7.6 million shares, and most recently, 14.4 million shares. While this is not incredibly high versus the 106.5 million shares outstanding, a whole different picture emerges when we compare to the roughly 43.4 million or so free float. This low free float results from the positions taken by Edward Lampert (holds 25.1 million shares directly), Edward Lampert's ESL Partners (now holds 21.99 million shares, from 29.41 million previously) and Bruce Berkowitz's Fairholme Capital Management.
These funds kept the free float low and this led to a difficulty in locating shares to borrow and sell short. This in turn led to high short rebate rates (the commission rates shorts must pay to lenders of shares), as high as 80% at times, and even yesterday at around 16.25%. It was obviously painful to keep a short position in SHLD for any amount of time.
This might all change now
Indeed, Sears, which has been seeing its risk of insolvency rise over time, might finally be freeing itself of this grip which made for successive short squeezes. The reason is simple: ESL Partners is letting go of shares.
It's not really voluntary, but ESL Partners is seeing redemptions, and in turn it either had to sell SHLD shares or it would have to distribute those shares to those seeking their money back. As it happens, ESL Partners chose the second path: it is distributing SHLD shares. And those aren't few either:
ESL distributed 7.4 million shares in just this instance, as many as 50% of the outstanding short interest, and enough to increase free float by 17%. But more importantly, these shares will likely bring down the cost of holding a short position in SHLD plus the receiving investors are very likely to sell these shares into the market.
In short, these distributions are likely to break the hold which had kept SHLD at levels which weren't compatible with its risk or prospects. The process has already started in the last couple of days, and it's likely that it will continue going forward.
A vicious cycle
With ESL Partners having nearly 40% of the fund in SHLD shares, when SHLD does badly, ESL Partners tends to do badly. And when ESL Partners does badly, it gets redemptions. As we have seen, redemptions lead either to selling of SHLD shares or the distribution (and selling) of those same shares. This selling leads to SHLD doing badly, which in turn creates a vicious cycle of ESL doing badly and needing to sell more.
With the stranglehold of the SHLD free float being broken, it's now likely that SHLD will adjust to more realistically reflect the risk of insolvency. For instance, J.C. Penney (JCP) trades at 1.15 times book value, whereas SHLD stands at a lofty 2.76 times book. It would seem that with a higher free float, SHLD might stand to lose up to half of its value, and that's before insolvency risk manifests itself.