In a move long expected, Sears Holdings (NASDAQ: SHLD ) announced plans to go forward with a spin-off of Lands' End. While a timeline wasn't provided, the announcement comes after a chaotic week for the stock. News of ESL distributing shares to investors and speculation that J.C. Penny Company (NYSE: JCP ) is taking back market share hit the stock hard this past week
With Sears Holdings down nearly $20, or roughly 30%, in a few weeks, it is good for long-term investors to take stock of the investment thesis. The important part to be considered is whether these transactions alter the previous investment thesis or whether the moves are only noise that impacts the fringes of any decision. The market has reacted with fear of a cash crunch, but is this fear logical?
The big spin-off
Considering it has been no secret of the intention to spin-off or sell assets, the decision to distribute shares of Lands' End to shareholders isn't much of a surprise though some hoped for a sale of the asset for a cash infusion. Sears previously spun off Sears Hometown and Outlet Stores and Orchard Supply to mixed results.
Lands' End is an apparel and home goods business that Sears bought back in 2002 for $1.9 billion. The business unit filed to list on the NASDAQ exchange under the symbol "LE" and generated $1.6 billion in revenue for 2012. The EBITDA number dropped to only $107 million for 2012 after reaching over $200 million back in 2010.
From these numbers, it is clear that being stuck in the middle of a massive retailer has strained results. Some of the biggest problems when being part of an operation that had over $40 billion in revenue are the inability to attract talent and focus on the business unit. Having its own capital structure, Lands End will be able to expand operations and grow globally.
Analysts spinning negative
As an almost apparent requirement, analysts are already spinning this deal as a major negative for Sears. The removal of the business unit will reduce the already negative earnings of the company and further strains the cash situation at the parent. Not to mention, some discussion has surfaced that the Lands' End value has declined thus preventing the sale for an attractive price.
On the flip side, the analyst community is missing that Sears' is moving forward with distribution of the shares without necessarily collecting cash. It is possible that some sort of structure will lead to a dividend to the parent, but that isn't apparent at this point. Also based on the Lands' End numbers, the split is almost a requirement for refocusing on the brand lost in the shuffle among all the other business units at Sears Holdings.
J.C. Penny rebound immaterial
The recent rebound in J.C. Penny comp sales suggests the retailer might finally return to a competitive threat instead of handing sales to Sears and the Lands' End unit. The 10% gains in Nov. for J.C. Penny were impressive and undoubtedly will cause a hit to Sears if it continues, but the impact on the shares should be limited. Remember that the case for Sears made by Baker Street Capital back in Sept. provided little value to the retail operations. Baker provided a limited valuation of $1.4 billion or so for Lands' End and that might be reduced somewhat by the lower than expected EBITDA numbers.
One needs to remember that the massive sell off in Sears has sent the stock down to a $5 billion valuation that would suddenly drop to $4 billion based on a distribution at a valuation of only $1 billion. Note that a stronger retailers typically trade for valuations over 1x sales so Lands' End could have plenty of upside in a stand-alone situation.
The Lands' End spin-off is almost a requirement to unlock value for the business unit and investors. The fact that Sears isn't focused on obtaining cash for the deal continues to suggest that the analyst community remains fundamentally flawed regarding the need for cash. As usual, investors over-react to the moves surrounding Sears. The real estate holdings should dominate any investment decision and the spin-off of Lands' End is an almost certain requirement to improve the struggling retailer. Investors should not fear this move.
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