Searsdog

Ackman's Sears Sale: An Expression of His Activism

Difference between HD, TGT, and LOW is that they have also been investing in their businesses, remain viable, and earn money every quarter. Sears has been negative comping for 5 years now.

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.

Ackman's Sears Sale: An Expression of His Activism

The supposition that the inventory was worth 50% was in response to the math that 50% of the inventory was equal to the market cap. The bulls throw around stats like that all the time on this name and it's quite deceiving to the retail investors who have lost massive amounts on this name.

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.

Ackman's Sears Sale: An Expression of His Activism

In response to avove:

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.