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Summary

  • Sears keeps spinning off assets.
  • This is unusual. Usually creditors would impede these moves.
  • As Sears spins off more valuable assets, the likelihood of bankruptcy increases, and the recovery for creditors in the event of bankruptcy decreases.

Sears (NASDAQ:SHLD) is on a path to bankruptcy (see this article). This has been evident for a while, given the ongoing revenue and earnings deterioration, which for the full year of 2013 already led to $337 million in negative EBITDA. This outcome was made even more likely due to the fact that Sears actually decided to sell some of its best stores. On the other hand, the outcome is delayed by ever more measures to produce additional liquidity.

But in the midst of this journey towards the inevitable, there is something which is amazing and unusual. Sears has debt on its books, yet the creditors are allowing Sears to pluck off profitable feather after profitable feather. Sears keeps on spinning off valuable assets. And this is unusual.

It's unusual because usually creditors in a stressed situation do not let the borrower spin off assets, as such increases the likelihood of bankruptcy and diminishes the credit recovery in the event of bankruptcy.

Yet, just take a look at what happened with Lands' End (NASDAQ:LE). Though Sears got a $500 million dividend by spinning it off, Lands' End still took with it $150 million in positive EBITDA. That means the same Sears which produced -$337 million in EBITDA in 2013, would have produced -$487 million without Lands' End. For the creditors, this is significantly different, it's like Sears sold the asset for 3.33 times EBITDA!

The same can probably be said of today's news regarding Sears Canada. It's not likely that someone will buy Sears Canada, but the process with Lands' End was similar - Sears first tried to sell it. So it now seems likely that at some point Sears will spin off Sears Canada as well. And again the shareholders will receive an asset which will no longer be available for Sears creditors.

This impediment to take assets out of a stressed financial situation is also the reason why such indebted companies are usually not allowed to pay dividends. But Sears has, in a way, been paying dividends by regularly shedding assets.

At this point Sears has negative tangible book value and has increased its borrowings in 2013 by more than $1 billion. By spinning off Lands' End, it also increased its EBITDA hole by 50% even before it sees further deterioration in revenues and earnings. At this point one has to ask how many more assets will the creditors allow Sears to shed. Not many, I suppose.

Conclusion

It's quite rare for one to see a stressed situation like Sears' where the creditors allow the stressed company to spin off assets to its shareholders. These moves increase the likelihood of bankruptcy and decrease ultimate recovery in the event of bankruptcy. This is the reason why usually creditors don't allow for them.

As bankruptcy draws ever nearer, one would expect this ability to spin off assets to be shut down. Indeed, it's amazing that it hasn't been shut down this far.

Source: The One Amazing Thing About Sears