As Losses At Sears Holdings Continue, The Need To Raise Cash Helps Simplify The Investment Analysis

The bullish case for Sears Holdings (SHLD) stock has always been a sum-of-the-parts story. But for many years since CEO Eddie Lampert orchestrated the merger of Kmart and Sears in 2005 the company has been quiet about its various businesses and seemed content to stick to business as usual. That strategy has not worked in the face of intense retail competition, and over the last three years a slow break-up of Sears Holdings has been ongoing. Shareholders have yet to benefit, even though the bullish thesis was predicated on such an event, mainly because the core retail operation has been losing so much money and accumulating so much debt in the process, but there are many investors who remain hopeful.

Consider the moves made and/or announced since 2011:

*Orchard Supply Hardware spin-off (2011)

*Sears Hometown and Outlet Stores rights offering (2012)

*Partial Sears Canada spin-off (2012)

*Sears Canada special dividends (2012 & 2013) *Lands End spin-off (2014)

*Partial Sears Canada spin-off (2014)

*Proposed Sears REIT rights offering (2015 - estimate)

Cumulatively, SHLD investors have reaped approximately $20 per share of value from these transactions, assuming they held onto all of the separate entities. Now, that has not resulted in any profits (SHLD shares started calendar year 2011 trading at $73.75 and presently trade for $43), but the company has been liquidating slowly like they wanted. The 15% or so loss sustained by equity holders over the last four years has been driven by less-than-expected financial performance of the retail operations.

Today we learn that yet another transaction is in the works; the rights offering of a REIT that will hold 200-300 stores owned by Sears Holdings. The new entity will lease back the properties to Sears. The stock is up more than 30% today on this news, but in reality nothing has changed. The company has the same asset base and is operating at the same level of losses as it has been. Combine short covering with a small float and the clear sign that the liquidation is accelerating, and you can explain the $10 increase in the share price today.

So if the assets are the same, but the price is higher, is there anything positive to come out of this for those investors who are watching from the sidelines? Yes, simplicity. As Sears breaks up it becomes a lot easier to value each of its parts. First, with every spin-off we get to see the segregated financial statements for each entity, which we could not previously. Second, as the parent company becomes smaller and smaller, it becomes far easier to value. SHLD today really consists of the retail operations of Sears and Kmart in the U.S., the proprietary brands Craftsman, Kenmore, and Diehard, and about 700 owned properties. As a result, it is a much less tedious process to value SHLD than it was when you had the Canadian operations, a clothing company, a couple thousand franchised hometown and outlet stores, and a hardware chain in the mix. And if SHLD goes ahead with the plan to sell nearly half of its owned real estate to a public REIT entity, we will be able to better pinpoint the value of the real estate owned by each company with the additional disclosures.

Despite today's announcement, my view of SHLD has not changed. I did not like the equity when it was worth $3 billion yesterday because of the $6 billion of debt in front of it and the continued operating losses. That same equity at a value of $4.5 billion today is even less attractive. However, if we get a new real estate entity it will be a worthwhile exercise to value that and see how the market prices it. Given that Sears will be the main tenant (the more diversified the REIT, the higher the valuation), coupled with the fact that small spin-offs often fly under the radar, it is possible the new REIT could be a good investment. We will know more when SHLD discloses which stores it will hold and what the ultimate price will be.

Lastly, since I anticipate many will ask about my current position (long Sears debt maturing in 2017 and 2018), I can tell you that little has changed on that front as well. The thesis for owning the debt is that Sears has enough assets to pay back its creditors for at least several more years. Today's announcement does not change that, it just maybe gives some people more confidence that it is actually true. Accordingly, I am happy that the debt is trading up nicely today and I will continue to hold it (after all, it has outperformed the equity with lower risk).