Sears Holdings Is Unlocking More Value With Lands' End Spinoff

The transformation of Sears Holdings (NASDAQ: SHLD  ) continues to progress with the recent news that the spin off of Lands' End will occur on April 4. The company will trade on the Nasdaq under the ticker symbol "LE."

The move has long been speculated by investors who have been awaiting Sears Holdings' divestment of non-core retail operations stuck within the giant conglomerate. Based on Lands' End's recent results, it appears that this move isn't happening soon enough. While many investors fret over Sears unloading a profitable business unit, the stalled growth at Lands' End suggests the retailer needs to regain its own identity and capital structure to prosper.

In the retail sector, investors have several examples of what happens when a major retailer either funnels billions into upgrading stores (J.C. Penney (NYSE: JCP  ) ) or spends time separating business units to focus on the successful ones (Kate Spade  (NYSE: KATE  ) ). Even more interesting is that the move turns Sears into a major lessor of real estate, potentially ushering in a shift toward becoming a REIT.

Stalled growth
Investors sometimes forget that Sears remains a gigantic retailer; it generated $36 billion in last year's sales. The Lands' End segment is onlyresponsible for contributing $1.6 billion in annual revenue over the same period, making it a fraction of the revenue base. The retailer reached peak revenue in 2011 of $1.7 billion and in 2008 had revenue of $1.65 billion, surpassing the most recent results. The company remains solidly profitable at roughly $80 million in the last fiscal year, but again numbers were highest back in 2008 at $135 million. As well, adjusted earnings before interest, taxes, depreciation, and amortization peaked back in 2008 at $236 million.

The stalled growth and importantly profits are a good indication that the Lands' End concept was not obtaining proper exposure by the massive conglomerate. Kate Spade experienced a similar situation when it was part of a massive retail group under the old Liz Claiborne business. It took the previous company selling numerous retailers and eventually its namesake to J.C. Penney for the Kate Spade brand to thrive. In the process, the stock changed names to Fifth & Pacific and finally Kate Spade. The end result is that the stock surged from $5 toward year-end 2011 to nearly $40 recently.

It is highly unlikely that Lands' End will reach similar success. But it is clear that an independent unit will have the opportunity to regain growth and further international expansion that virtually stalled under Sears.

Real estate operations
For years, investors have long hoped that Sears Holdings would turn its vast real estate properties into a potentially valuable REIT. In theory, the square footage is more valuable as another retailer than as a Sears store. In this light, Lands' End occupies a large amount of square footage within Sears stores. The company currently operates 275 Lands' End Shops at Sears, though the number is down from 292 in 2010.

Currently, Lands' End only obtains 16% of revenue from Sears stores, so the retailer isn't very tied to the parent. It does, however, obtain virtually all of its retail- store revenue from Sears considering it only operates 16 Lands' End Inlet stores that are not connected to Sears. The majority of sales come from online and catalog operations.

The average store within Sears averages 7,400 square feet for a total of more than 2 million square feet. The company listed related-party rent and occupancy costs of slightly more than $29 million for 2012. Combined with plans to open a Dick's Sporting Goods at a mall in Pennsylvania, a Forever 21 in a California mall, and to split Sears stores (see Seritage.com for more details), Sears suddenly becomes a legitimate lessor of real estate space.

What remains unclear is whether Lands' End values this relationship within Sears stores. With plans to refurbish numerous Sears' properties, its very possible Lands' End could become a focal point of the plans to reduce Sears' square footage and lease the remaining space to other retailers. 

Note this move is in major contrast to the one made by J.C. Penney to upgrade all existing stores in an attempt to make the department store more appealing to consumers. The move nearly placed J.C. Penney into bankruptcy and hasn't necessarily increased the appeal of the retailer. J.C. Penney hit $40 in 2012 on the announcement of plans to spruce up stores and shares were recently trading at $5.

Bottom line
At this point in the process, it's too early to determine the valuation of the spinoff, but it is clear that it needed to happen to reinvigorate the Lands' End brand. Lots will be made of the $500 million dividend that Sears will receive, but it shouldn't change the ultimate value of Sears shares.

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