How does a Company navigate highly publicized credit issues with its vendor base, announce a 2011 loss of $1.5 billion and yet increase its market capitalization by $4 billion in ninety days? How is it that a Company whose imminent bankruptcy filing is a fait accompli according to the factoring community but is the best performing stock in the S&P for 2012 as of March 27th? What does Wall Street know that we ordinary folks just don’t understand? Welcome to the enigma of Sears Holdings Corporation.
Sears Holdings (NASDAQ: SHLD) is controlled by the hedge fund magnate, Eddie Lampert. Between his personal holdings and hedge fund, Mr. Lampert controls approximately 60% of Sears. While many people have questioned Mr. Lampert’s purported micromanagement style, no one has accused him of being stupid. He controls an asset worth $8 billion, so why would he bankrupt it? Legally, unsecured debt comes before equity in any liquidation or reorganization, so he’s last money out. Wouldn’t common sense dictate that Mr. Lampert would do everything and almost anything to protect his equity? The answer is an obvious yes, however how he best protects or maximizes his equity is the subject of great debate between Mr. Lampert and the factoring community.
Sears Holdings is a complex web of subsidiaries and special purpose entities, several of which are bankruptcy remote. Contrary to market rumors, this financial engineering was effectuated years ago and may have been as much tax and securities regulations driven as asset protection. Two of those entities, KCD IP, LLC (KCD) and Sears Reinsurance Company Ltd. (Sears Re) own significant assets. KCD (Kenmore, Craftsman and DieHard) was formed in 2006 and owns the intellectual property which it licenses to the Sears and Kmart operating entities. Sears Re was formed in 2001 and is a vehicle for Sears to self manage its insurance risks but it also holds debt securities of certain of the subsidiaries including $1.8 billion of securities of KCD. As such, KCD collects royalties from the operating entities and the cash flow is used to pay the interest on the bonds owned by Sears Re. The net effect is the cash flow required to service the debt is drawn from the operating entities which finds its way into Sears Re and then back to Sears Holdings. On a consolidated basis this all nets to zero; however, the structure in part explains the dichotomy as to why your factor won’t check a $25,000 order on a company Wall Street values at $8 billion. A few reasons our factoring friends are concerned:
• The factors believe the underlying business can’t be turned around and will continue to bleed significant cash.
• KCD IP valued at $1.8 billion is held in a bankruptcy‐remote entity.
• Sears Re in addition to holding KCD securities owns 125 Full Line Sears stores which are owned not leased. Sears recently sold 11 stores for $270 million to General Growth Properties, ascribing a value to the remaining stores of over $1 billion. Sears Re is a Bermuda Company and is bankruptcy remote.
• The complex structure of Sears challenges credit grantors to fully understand what other assets beside KCD and Sears Re are bankruptcy protected.
• Sears won’t cross‐collateralize or grant liens against KCD and Sears Re to the unsecured creditors.
• Bottom line is the factors believe a filing of the operating entities will not adjoin the most valuable assets.
So let’s get back to the question at hand, why/how Wall Street values a company at $8 billion that you can’t get credit checked. The easy answer is the sum of the parts is greater than the whole and the prized assets are bankruptcy remote. The more provoking hypothesis suggests there remains significant owned assets that are not bankruptcy remote which contribute to Sears Holdings’ market capitalization. Bankruptcy has significant uncertainties and one can argue regardless of the structure, a voluntary filing puts a portion of Mr. Lampert’s equity at risk and at a minimum reduces his control significantly. If you owned $5 billion of Sears Holdings, what degree of risk would you be willing to expose your equity to in a bankruptcy? It may be possible that the magnitude of Mr. Lampert’s holdings will dictate a solution that avoids a filing. Let’s hope so!
About CoMetrics Partners LLC
CoMetrics Partners LLC was founded by Managing Partner Gary Herwitz. The firm specializes in working with middle market companies providing the leadership and expertise to synergize operations, technology and finance to maximize operating efficiencies and drive profitability.
The firm’s services include strategic advisory, supply chain management, lender advisory services, and financial resources.