Sears Sells Craftsman: A Deal With Power

| About: Sears Holdings (SHLD)


Sears and Black & Decker agree on a Craftsman deal.

Sears or Black & Decker, Craftsman's sales are here to stay (and improve).

Sears will pocket more money than assumed.

Keeping up with our articles on Sears Holding (NASDAQ:SHLD), we wanted to share our thoughts on the recent Stanley Black & Decker's (NYSE:SWK) Craftsman deal.

We think that what has been commonly relayed by the media as "Sears sells Craftsman to SWK for $900M" understates the reality. To fully understand the complexity of the deal, we need to keep in mind that the sale's proceed is made of four stream of cash flows. The upfront cash component ($525M), the cash to be received in three years from now ($250M), the royalty on the Craftsman tools sales from SWK and the ongoing Craftsman sales in the Sears galaxy.

Last year, Craftsman's revenues were $1.7B inside Sears and $200M outside. What's been sold to SWK are the sales made outside of Sears and only a royalty on the sales made inside Sears after 2032. The present value of this transaction was said to be $900M in the Sears press release announcing the transaction, but Sears's left with the possibility to sell Craftsman in its own stores for free during the next 15 years and for a fee after that.

It is quite possible, even probable, that Craftsman sales at Sears will decline because SWK is offering the same products. But it is also possible that Sears could benefit from SWK marketing efforts.

In order not to appear too rosy, let's stick with the bears and say that sales inside Sears will decline toward $800M annually and stabilize after that. From there we need to figure out the projected earnings generated by those revenues. This is where SWK helps us a lot.

In their press release following the announcement of the deal, they indicate that the $200M revenue made outside Sears are expected to grow by $100M / a year for ten years reaching $1.2B in year 10. They also indicate the contribution in earning of those expected revenues, $0.10-$0.15 in year one to $0.75-$0.80 in year 10. Since there are 150 million shares outstanding of SWK, the earning contribution of Craftsman will vary from a low $15M in year one to a high $120M in year ten. To me, it looks like SWK is expecting net earnings between 8 and 10 %.

If, as we think, Sears will continue to sell Craftsman products for an indefinite period of time, it might earn an additional $80M to $100M / year on average for the next 15 years. After 2032, Sears will have to pay a 3% royalty on Craftsman's tools sold at Sears but they would still retain a safe 5 % to 7 % (not taken into account in our deal present value calculation)

One way or another, there is no reason that the current pace of Craftsman's sales should decline, be it at Sears or at SWK. Between the two entities, $30B in sales are expected for the next 15 years. If they are all sold at SWK, Sears will pocket $1B. If the sales are split 50-50, Sears earnings will be $2B. If all made at Sears, $3B.

It is important to state that the present discussion makes no sense for people thinking that Sears will go bankrupt this year or the next. We do think that Sears will not go bankrupt and we'll explain why shortly but for the time being it would be safer to say that "Sears sold Craftsman's outside operations to SWK and WILL RETAIN MOST OR ALL EARNINGS MADE AT SEARS."

Assuming no more revenues after 2032, the net present value (discount rate 5.2% on the whole curve) of the deal is more than $2B. ($500M up front, $250M in year three and $1.3B over 15 years).

Piece by piece, the CEO and major owner, Eddie Lampert, is transforming his company from a failing brick and mortar retailer into a HOLDING company with many different assets.

It would be unwise to give a price target or a date, only fools do that (and Jim Cramer). We will try our best to give you the keys about how he is doing it.

Disclosure: I am/we are long SHLD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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