1. 1 Neelam Desai
Sears Holding Corporation (SHLD):
When Controlling Shareholders Pillage Minority
Shareholders
Date: April 27, 2017Date: April 27, 2017Date: April 27, 2017Date: April 27, 2017
Position Type: SHORTPosition Type: SHORTPosition Type: SHORTPosition Type: SHORT
Current Share Price: $ 10.83Current Share Price: $ 10.83Current Share Price: $ 10.83Current Share Price: $ 10.83
Fair Value Estimate: $ 0.00Fair Value Estimate: $ 0.00Fair Value Estimate: $ 0.00Fair Value Estimate: $ 0.00
VVVVALUATIONALUATIONALUATIONALUATION MMMMETRICSETRICSETRICSETRICS
Note: SHLD is losing money and is doing so at an accelerating rate. As a result, all of its valuation metrics are
negative.
Metric Value Explanatory Note
Price/Earnings (0.52) Earnings (loss) per common share over the past 12
months was ($20.78)
Price/Book (0.30) Book value (deficit) per share was (35.77)
Enterprise Value (EV) /EBITDA (9.80) EV/share = 130.50; EBITDA/share = (13.31)
Cash from Operations/Share Yr 2016: (12.97)
Yr 2015: (20.27)
Yr 2014: (12.92)
BBBBACKGROUNDACKGROUNDACKGROUNDACKGROUND
Sears Holding Corporation, hereinafter referred to as “Sears”, is the holding company for Sears (U.S), Sears Canada,
and Kmart. Once a storied American company, the Sears story has essentially become the story of two men: Eddie
Lampert, a former investment banker and current managing partner at the hedge fund ESL Investments, and
Bruce Berkowitz, the portfolio manager of the once high-flying Fairholme Fund. Together, Lampert and Berkowitz
control 84.6% of Sears’ stock.1
Over the past few years, Lampert and Berkowitz have treated Sears as their own personal cash cow and begun to
slowly strip the company of its most valuable assets. This process, however, cannot go on indefinitely. At some
point, we believe, Sears will either be forced to declare bankruptcy, or will be taken private by Lampert and
1
As of March 13, 2017.
2. 2 Neelam Desai
Berkowitz at a price that is much lower than its current share price. Over the next few pages, we will detail some
of the ways that Lampert and Berkowitz have diverted Sears’ cashflows and assets to themselves and provide
some context for the grim outlook for Sears as a going concern. To simplify this discussion, we will refer to entities
that are controlled by or affiliated with Lampert and Berkowitz other than Sears as “L&B”.
SSSSALEALEALEALE----LLLLEASEASEASEASEBACKEBACKEBACKEBACK TTTTRANSACTIONSRANSACTIONSRANSACTIONSRANSACTIONS ANDANDANDAND RRRRELATEDELATEDELATEDELATED----PPPPARTYARTYARTYARTY LLLLOANSOANSOANSOANS
The use of sale-leaseback transactions has been the most significant tactic L&B have deployed in their scheme
to strip Sears of its most valuable assets. Using this tactic, L&B have used cash, sometimes financed with debt, to
purchase valuable real estate from Sears and then lease much of that real estate back to Sears. Because L&B
control Sears, they are incentivized to compel Sears to:
• sell these properties to L&B at below market prices
• agree to pay L&B above market rents
• agree to lease terms that are favorable to L&B but potentially disadvantageous to Sears, and thus to its
minority shareholders, such as the right for L&B to reclaim or recapture these properties in whole or in
part.
In the simplest terms possible, these transactions create a situation in which L&B have worked large payments to
themselves into Sears’ operating and capital structure: whenever customers do business at Sears, a significant
portion of the cash generated by their spending is collected by L&B, in the form of rental payments, before
minority shareholders receive any of it. And, should a specific Sears store not be able to pay its rent, L&B can take
control of the store and sell or rent it to someone else.
Indeed, although Lampert and, later, L&B have compelled Sears to sell hundreds of its stores and numerous other
properties over the past decade, no money whatsoever has been returned to Sears’ minority shareholders in the
form of share buybacks or dividends. In the meantime, the price of Sears’ common stock has fallen from a pre-
recession high of $120 to $10.83 while L&B have likely collected billions of dollars in rental payments or from
resales of Sears properties.2
Finally, nearly all of Sears’ borrowings were financed by L&B. As a result, L&B collects hundreds of millions of
dollars in interest payments from Sears every year. Moreover, as lessors and lenders to Sears, L&B have
positioned themselves to take control of whatever intangible assets Sears may have left, such as its Kenmore and
DieHard brands, should Sears be forced into bankruptcy.
PPPPOTENTIALOTENTIALOTENTIALOTENTIAL CCCCATALYSTATALYSTATALYSTATALYST –––– AAAA SSSSUPPLIERUPPLIERUPPLIERUPPLIER SSSSQUEEZEQUEEZEQUEEZEQUEEZE
Many retailers, and especially Sears, with its increasingly large same-store sales declines, simply cannot afford to
pay for their inventory upfront. As a result, such retailers rely on suppliers to provide them with inventory on
credit.
2
Lampert was able to gain control of Kmart in 2002-2003 while Kmart was in bankruptcy. He did so by purchasing a
significant amount of its debt for pennies on the dollar. Then, in 2004, with the economy in recovery, Kmart acquired Sears
and took the latter’s name for the newly merged company. Considering how little he paid for Kmart and how much he has
been able to wrest from the company, Lampert’s investments in Kmart and Sears have likely been very profitable for him
despite the dramatic decline in Sears’ stock price.
3. 3 Neelam Desai
However, many of these suppliers, a significant number of whom are based in underdeveloped countries, operate
on razor thin margins. If Sears were unable to settle its accounts with its suppliers, many of those suppliers might
be forced to go out of business. As a result, Sears’ suppliers are incentivized to mitigate their risk by no longer
supplying Sears with merchandise, supplying it with fewer products, or demanding more favorable terms should
Sears’ business continue to deteriorate.
There are already signs that this is beginning to happen. In its most recent annual report, Sears expressed doubts
about its ability to continue as a going concern. A number of news reports have quoted suppliers who have
discussed reducing the size of their shipments to Sears or demanding shorter payment periods. Finally, according
to Reuters, insurance companies that once insured Sears’ vendors against nonpayment for their goods are no
longer willing to provide such coverage.3
CCCCONCLUSIONONCLUSIONONCLUSIONONCLUSION
While many commentators have proclaimed that because of the rise of Amazon, brick-and-mortar retail is “dead”,
the Sears story is more than just the story of internet disruption. Instead, it is the story of financial engineers who
have taken control of a brick and mortar company in the hopes of exploiting its real estate assets for themselves-
not to increase its sales, please its customers, or turn a profit for its minority shareholders. Sears and Kmart stores
are habitually understaffed, understocked, and dirty. The result has been comparable store sales that are at levels
you would expect to see during a deep recession.
2012 2013 2014 2015 2016
Domestic comparable store sales % -2.5% -3.8% -1.8% -9.2% -7.4%
Sears is already hemorrhaging cash and will continue to do so. Bankruptcy is only a matter of time. In the
meantime, it is a near certainty that its stock price will continue to decline and, thus, SHLD should be shorted.
3
http://www.reuters.com/article/us-sears-restructuring-vendors-idUSKBN16T31S, Retrieved 4/26/2017
4. 4 Neelam Desai
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