Investors reacted with joy when Sears Holdings Inc. (Nasdaq: SHLD) announced on November 6 that it would sell 200 to 300 of its stores to a real estate investment trust (REIT) in 2015.
It was the "Big Bang" announcement investors had been waiting for since hedge fund billionaire Eddie Lampert combined Sears with the bankrupt retailer Kmart a decade ago.
But, after a quick share price pop, "be-careful-what-you-wish-for" investors have figured out that the REIT transaction will saddle the company with an additional $150 million in operating expenses and gut the company of its last remaining valuable assets.
And that makes the endgame for this iconic American retailer a foregone conclusion...
Lampert's Questionable Strategy Is to Blame
After rising some 31%, from $32.67 to $41.81 on November 7, Sears stock has given back all of those gains and is now trading at just over $33 per share at the time of this writing.
After all, Sears has effectively been in liquidation from the day Mr. Lampert bought it. Whether liquidation was his original motive will forever be debated by investors; the secretive Mr. Lampert is unlikely to spill the beans.
And while he has talked a good game about wanting to be a retailer, he has acted like a liquidator; even when he was purporting to focus on Sears' retail operations, Mr. Lampert was engaged in a series of financial engineering transactions that loaded the company with debt while doing nothing to improve the business.
For years he starved the stores of capital expenditures while buying back stock at prices as high as $180 per share. Besides myself, very few people were critical of these buybacks at the time since Mr. Lampert was being hailed as the "new Warren Buffett" by the consistently clueless financial media.
It was obvious that the retail business was being deprived of capital while Mr. Lampert was attempting to shrink the share count and maximize his ownership of the company.
There are two ways to interpret this. Either he was being extremely shortsighted in seeking to increase the ownership of his hedge fund, ESL Investments, and squeeze out minority shareholders, or alternatively he realized that changes in the retail industry doomed Sears, and rather than squander precious capital on the stores he decided it was more prudent to purchase stock.
The only problem with the latter explanation is that the prices at which he bought back stock were egregiously high at the time and a waste of corporate resources. Sears was an obvious short-selling candidate, but Mr. Lampert's significant equity ownership, coupled with the large ownership position of mutual fund manager Bruce Berkowitz, made shorting the stock difficult.
The strategy has proven to be a very profitable trade, however, and its profitability is likely not over even after the stock has lost more than 80% of its value.
The Financial "Bust Out" Continues
In recent years, Lampert's financial engineering has morphed from shrinking the share count to shrinking the business through a series of sales of Orchard Supply Hardware and Land's End, as well as Sears Canada.
Mr. Lampert has always participated in these transactions, which are structured as rights offerings to Sears' shareholders, which effectively allows him to shift assets off of Sears' balance sheet and onto that of his hedge fund.
Rather than spin these assets off to their owners, Sears' shareholders who already owned them were forced to pay for them again if they wanted to keep them in Mr. Lampert's ongoing efforts to keep funding Sears's growing losses.
But none of these businesses are all that attractive in a changing retail landscape, and the proceeds realized by Sears from their sale have been swallowed up by losses that are now running at more than $1 billion per year.
The latest financial shenanigans involve Sears borrowing $400 million from Mr. Lampert's hedge fund in a loan secured by 25 of the company's stores in order to fund Christmas inventory, as the factoring companies who finance inventory have started to abandon the company, the kiss of death in the retail industry.
The net of the cash squeeze is that a REIT deal has become a necessity for Sears to make it through Christmas in 2015, since external financing of inventory would likely be unavailable otherwise.
Of course, none of these moves will change the eventual outcome...
Sears Can't End Up Any Other Way
A word should be said about the involvement of Bruce Berkowitz in Sears. Mr. Berkowitz is known in his Fairholme Fund (MUTF: FAIRX) for taking large contrarian positions in controversial companies that are out of favor, like American International Group, Inc. (NYSE: AIG), Bank of America Corp. (NYSE: BAC), Federal National Mortgage Assctn Fnni Me (OTCBB: FNMA), Federal Home Loan Mortgage Corp. (OTCBB: FMCC), and Sears.
Sears' second-largest shareholder is Bruce Berkowitz; Fairholme Fund owns 25% of the company.
He has a good long-term track record although his fund is down 3% this year, largely due to losses on his Fannie Mae and Freddie Mac positions (which are likely worthless).
Mr. Berkowitz likes to think he sees value where nobody else does, but in Sears (as in Fannie and Freddie) he is hallucinating.
He once said that Sears' real estate could be worth $150 per share but we now know that was delusional. The 200 to 300 stores targeted for sale to the REIT will at best produce net proceeds of $1.6 billion of net cash for the company, about enough to fund, at most, 18 months of losses.
As I wrote recently, investors should shop elsewhere for the holidays, lest they find a lump of coal in their stockings come next Christmas.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.