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Yes, Sears is likely to collapse, but its biggest stakeholder will be just fine

MarketWatch logo MarketWatch 6/2/2018 Tonya Garcia
Edward Lampert wearing a suit and tie eating a sandwich: Eddie Lampert, hedge-fund manager and CEO of Sears Holdings.© Provided by Dow Jones & Company, Inc. Eddie Lampert, hedge-fund manager and CEO of Sears Holdings.

Can Eddie Lampert save Sears?

Probably not, say most experts, despite years of maneuvers and machinations to keep the storied retailer afloat. Long a mainstay of the U.S. retail landscape, Sears is still suffering massive losses and declining sales, and many believe its only hope is a bankruptcy filing.

The twist in the tale is that Lampert, the company’s chief executive, main shareholder and a key lender through his hedge fund ESL Investments Inc., is unlikely to lose much money, even as other shareholders are wiped out. That’s because Lampert, again and again, has positioned himself to benefit from the moves required to keep Sears in business while shielding him from potential downside.

Lampert came to the job with a view to making it work, but “when the attempt looked like it was going to fail, he switched into the hedge-fund role rather than the retail role,” said Chuck Tatelbaum, chairman of the creditors-rights practice group at the law firm Tripp Scott.

Lampert recently proposed that his fund buy out the only remaining assets deemed to hold much value, namely the Kenmore brand, the Sears Home Improvement arm of the Sears Home Services division (SHIP) and the PartsDirect business.

In a letter from ESL to Sears management — effectively Lampert writing to himself — the investor said the move would show that the assets still have value and provide Sears (SHLD) with much-needed liquidity without any further deterioration. 

“We also are of the view that the portfolio of Sears assets has substantial value that is not being reflected in the capital markets or being maximized under the current organizational structure,” said the letter.

The board has just begun the formal process of exploring that sale.

On Tuesday, ESL asked the board to reconsider limits placed on its ability to engage with potential partners in a deal after it said it had received “numerous” inquiries. The fund noted that there has been a significant increase in the price of Sears’s unsecured debt since ESL made the original offer on April 20, making debt repurchases or debt-for-equity exchanges less attractive.

See: This is the one retail category not marked by too many stores

Analysts agree that Sears’s demise is mostly the result of Lampert’s failure to understand the fast-changing retail sector over the last 10 years and his neglect of the actual stores, which are drab and carry an ever-dwindling inventory, much of it heavily discounted.

It’s “the longest-running corporate liquidation probably in history,” said Ted Stenger, a managing director with AlixPartners in New York.

Related video: 130 years of Sears (provided by The Chicago Tribune)

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Untangling the web

An examination of the tangled structure he has created through years of transactions reveals that Lampert wears other hats, too, including that of landlord for some of Sears’s locations.

The Wall Street Journal, in a graphics-driven article published in December, outlined how the real-estate investment trust called Seritage was created in 2015 by a group that included Sears shareholders and ESL, which contributed about $3 billion. Seritage went on to acquire 266 properties from Sears and lease many of them back to the retailer.

Some of the most valuable properties “are protected if Sears Holdings fails, owned by a separate company that can re-lease more profitably to other tenants,” the Journal reported. “Lampert, through ESL, controls much of that entity and stands to benefit as those properties generate higher rent, while also collecting dividends, lending fees and interest payments.”

And Sears has received a number of loans over the years from ESL, its affiliates, the company’s pension plan, and other investors. In one case, a $1.25 billion loan was repaid after Sears sold its Craftsman brand. And Sears sold property to repay $101 million from another loan.

Sears said ESL’s loans were reviewed by a board committee with outside advisers and offered terms that were more favorable than Sears could have found elsewhere, the Journal reported. The company has said it would sell other real estate to reduce debt and meet its pension obligations.

But some experts say the seemingly endless transactions are just smoke and mirrors to mask the dire state of the underlying business.

“It’s in the guise of trying to save this company, which could not be saved years ago and should have been put through a corporate reorganization,” said Elliot Lutzker, chairman of Davidoff Hutcher & Citron’s corporate law practice.

If the board accepts the ESL offer, Lampert will take direct control of the most valuable pieces of the iconic retailer — and could, in fact, walk away having made money off the slow demise of a once-robust operation that stocked just about everything America needed.

“Our principal interest is seeing that Kenmore, SHIP and PartsDirect are divested in the near term in a transaction that delivers the greatest value for Sears, regardless of whether ESL or a third party is the ultimate buyer,” ESL told MarketWatch in a statement. “This will enable Sears to improve its debt profile and liquidity position, creating the runway to help continue its transformation, and allow these businesses to unlock their considerable potential by further expanding their presence in the marketplace.”

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Creeping cash crunch

Susquehanna Financial Group analysts led by Bill Dreher said the ESL letter “simply looks like another pre-emptive move by insiders to secure the most valuable assets,” according to an April note. “We don’t believe that Sears equity holders will beneficially participate in Sears’s underlying asset value.”

What’s more, Dreher has said he has “ZERO” — in capital letters — belief in a meaningful improvement at the suburban Chicago-based company despite Lampert’s assertions that, under the right conditions, Sears could still turn things around.

”[W]e believe for over a decade, Sears Holdings has been shopping around any and all of their assets for sale,” he said in a more recent note. (Lampert’s Kmart Holding Corp. acquired Sears Roebuck & Co. in 2004.)

Analysts suspect that the cash crunch at Sears is getting tighter, and the company may be eager to sell assets to raise the cash needed in order to make it to Christmas.

Lately, rather than boosting its retail operation, it appears to be outsourcing it to Amazon.com Inc.(AMZN)announcing a partnership with the e-commerce giant to sell and install tires after having previously begun selling Kenmore appliances and DieHard products via Amazon.

“Instead of making a big push, placing eggs in the basket around these two brands [Sears and Kmart], they’ve incrementally invested in things like better online experience and better frequent shopper programs,” said AlixPartners’ Stenger.

What’s required is a new image, new merchandise and a new bricks-and-mortar experience, which can be expensive. “Their operations aren’t worth much, but they’re sitting on a lot of real estate,” Stenger said.

On Thursday, Sears posted a fiscal first-quarter loss and another steep decline in revenue. The full loss for the quarter came to $424 million, or $3.93 a share, after a profit of $245 million, or $2.29 a share, in the same period a year ago. Revenue dropped to $2.89 billion from $4.20 billion, with store closures accounting for about two-thirds of the decline. Same-store sales fell 11.9%, as Kmart store sales declined 9.5% and Sears store sales dropped 13.4%.

On FactSet, Susquehanna’s Dreher is the only analyst offering forecasts, meaning there is no real consensus. (Sears’ number were sharply lower than his forecasts).

For the year ending Feb. 3, 2018, revenue fell to $16.7 billion from $22.1 billion in the previous fiscal year. Revenue for fiscal 2014 was $31.2 billion, nearly twice as much.

Larry Perkins, founding partner at SierraConstellation Partners, said that even with all of the steps Lampert has taken, he could still lose money. “He’ll most certainly lose less money now than if he just let it collapse and tried to sell it later,” said Perkins. “He’s delevering it, putting money in, giving it its last chance.”

But eventually it’s likely there will be no more money or options. Time will simply have run out.

“He’s a highly sophisticated investor,” said Perkins. “At a certain point, he determines there’s nothing else he can really do. This is the highest, best use of these assets, given this scenario.”

Sears shares fell another 12.5% on Thursday, extending their 12-month decline to 62%. The SPDR S&P Retail ETF (XRT) has gained nearly 14% in the same period. The S&P 500 index( SPX) from which Sears was dropped in 2012, has risen 12.2% and the Dow Jones Industrial Average, of which Sears was a component until 1999, is up 17.4%.

Related gallery: 17 photos show the meteoric rise and fall of Macy's, J.C. Penney and Sears (provided by Business Insider)

In the past year, department store chains have announced  a wave of location closures across the United States. Macy's recently revealed plans to shut down 100 stores. In July, Sears  said it's shuttering 43 US stores, in addition to  the 265 closings it announced in early 2017. JCPenney  released a list of 138 stores it will close this year. All three chains are  considering even more closures as they battle declining sales, largely due to changing consumer habits and the rise of online shopping. But these iconic stores weren't always hurting. Over the latter half of the 20th century, they defined and anchored the American shopping mall. Take a look at the rise and fall of three formative department store retailers.
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