Why I’m Buying the Sears Spin-Off … Now

It’s no secret that spin-offs often offer investors superior returns. One can point to a number of successful spin-off opportunities, all with substantial upside for the wise investors who got in early. Some are intimidated by spin-offs, thinking the ‘special situations’ are beyond their investing ability; but there’s nothing fancy going on --it’s no different than any other opportunity. For this upcoming spin-off, I see the most profitable (and the only profitable) parts of a business packaged together and ready to be sold to investors -- likely for a discount to its intrinsic value. The offering hasn’t come out yet, but you can get in now. Read below to find out how.

Bad parents
It would be a hard argument to say that Sears (NYSE: SHLD  ) is a worthwhile investment. I'm one of the few remaining believers in the profit-potential for some big-box retailers, but Sears does not have a place on my list. The bull arguments for the company include its real estate holdings, improving operating efficiencies, and a conservative balance sheet. All the points are valid, though I don’t know if they are enough to save the retailer from obsolescence. This is especially so considering the upcoming spin off of Sears Hometown and Outlet Stores (Nasdaq: SHOSR  ) .

Sears Hometown owns and operates 940 Hometown stores, 88 Sears hardware stores, and 77 Sears Home Appliance stores. Make no mistake, these three elements are the most valuable parts of Sears today, and will quickly prove to be a lucrative investment once the spin-off is complete.

Let’s do a quick breakdown of the parts, so we know exactly what we are dealing with:

Sears Hometown stores offer smaller urban areas and rural communities consumer electronics, appliances, hardware, and home and garden goods. These are some of the few things that consumers still like to buy in a store, as opposed to online. The goods sold in these stores are mainly Sears proprietary brands, such as Craftsman tools, Kenmore appliances, and DieHard batteries.

Sears Hardware Stores sell … hardware. The store is mainly comprised of Craftsman and Diehard goods. These stores are the equivalent of your neighborhood hardware store, abandoning the big box model that we all know isn’t working these days.

Finally, Sears Home Appliance stores are very simple, straightforward appliance showrooms placed in urban areas. Appliances are one of the last bastions of brick-and-mortar profit centers, as consumers like to come in and take look at the thing before shelling out the cash. Appliances are often cited as one of the last few profitable parts of Best Buy (NYSE: BBY  ) stores. Best Buy is devoting more and more space to these products, while phasing out things like DVDs and video games, which are cheaper online and available via streaming services.

The spin-off will also run Sears Outlet stores, which, yes, are outlet stores.

The numbers
Sears Hometown and Outlets has been slowly increasing its store count over the last couple of years, while still under the reign of Sears Holdings. Net profits have been rather comatose, but I am focusing more on the substantial pay down of long-term lease obligations, zero debt, and the growth prospects once separated from the parent company.

Now, you may be wondering how it's possible to get your hands on shares before the new entity becomes available on the public markets. Well, Sears Holdings is offering rights to purchase Sears Hometown and Outlet shares via the ticker Nasdaq: SHOSR. Upon purchasing one exercise right, an investor is entitled to roughly .21 of a share in the new company. The exercise price of the stock is $15. Now, since the rights have become available on the Nasdaq exchange, the price has gone from around $2.30 per right to nearly $3 in today’s trading, so the move is already in play. Between the rights and the $15 exercise price, you would currently be paying around $30 per share for the new company, valuing it at around 1.5 times equity value. If you believe the price will come in shy of $30, go ahead and wait for the stock offering to go through, and get your shares the old fashioned way. Either way, I strongly believe investors will witness substantial capital appreciation within the first couple of years.

They should all be doing something like this
Big box retail is, as is quite evident, a brutal business to be in, given the disruptive technologies available. Retailers like JC Penney (NYSE: JCP  ) and Best Buy are scrambling to save their businesses, bringing in top tier management teams, and conducting complete overhauls of the business model. For JC Penney, it's been an uphill battle, and one that has rewarded bears while depressing the bulls.

This spin-off, though, represents the trend that should be taking place in big box retail -- separating the value-generating businesses from the dying ones. Names like Craftsman, Kenmore, and DieHard are reliable names in their industries, and will continue to attract loyal customers, regardless of overall market trends. By giving these brands a chance to stand out, Sears will reward itself, and investors. JC Penney could be doing something similar -- though tuned more to real estate than branding. Best Buy should be doing the same with its mobile and appliance businesses -- two great profit centers for the company.

Will this happen for the other companies? I have no idea. But it is happening for Sears, and you are wise to get in on the action now before everyone else does.

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Fool Contributor Michael Lewis owns none of the stocks mentioned above. You can follow him on Twitter @MikeyLewy. The Motley Fool owns shares of Best Buy. The Motley Fool has a disclosure policy.
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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 28, 2012, at 6:52 AM, Eeeeeek wrote:

    I agree with you that the spinoff is cheap. I do however believe that Eddie is most interested in the Craftsman and Kenmore brands and views the rights offering and spinoff of Sears Canada as steps to seperate the distribution of the brands from the parent.

  • Report this Comment On September 28, 2012, at 6:19 PM, hypezero wrote:

    1. SHOSR at $3 is equivalent to ~$28.77 not $30

    2. How do you explain the decreasing comps for the company year after year? You can't blame on the parent company and leave it that?

    3. Profits are actually healthy not "comatose". It is that are going to decrease year after year.

    Please see "Avoiding Sears Spinoff" for a contrary opinion http://hypezero.co/?p=276

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