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Sears Holdings' Incredible Hidden Value

Mark Holder
September 12, 2013

Anybody following Sears Holdings (NASDAQ: SHLD) over the last few years knows that several major investors have proclaimed that the value of the real estate holdings vastly exceed the current stock valuation. The rub with Sears remains that the retail operations are difficult for the average investor to separate from the valuation of the assets that go far beyond the real estate holdings. Investor after investor proclaims the company worthless due to a lack of profits from the retail operation, but the company has a vast array of assets worth billions upon billions that are hidden.

In the last week, the stock has soared due to a massive 139-page research report by Baker Street Capital, which owns 1.5 million shares or over $80 million at recent prices. The investment theme hearkens back to the real estate holdings that most investors know haven't led to stock market gains, but some of the research unearthed by Baker Street suggests now could be different.

Though the opinion that Sears is valued favorably to Simon Property (NYSE: SPG) or General Growth Properties (NYSE: GGP) is nothing new, the research by Baker Street actually unearthed a plethora of discoveries regarding real estate developments that aren't being marketed by the company to investors.

Simon Property and General Growth Properties
One of the biggest outcomes from the advent of online shopping (and, in part, the financial crisis) was the supposed destruction of the mall shopping experience. As the theory goes, consumers were no longer interested in driving to malls to shop when it was so convenient to shop online. Ironically, the mall owners are now telling a different story. Not only are rental rates up at the major malls (ones where Sears owns stores), but also new malls aren't being built. In essence, demand is at a five-year high while supply is at a 35-year low.

Simon Property owns or has an interest in 324 retail properties comprising 241 million square feet. The stock is valued at an incredible $46 billion, further providing reason why Bruce Berkowitz and the Fairholme Fund invested so heavily in Sears. Note that Sears has roughly 250 million square feet of real estate. In addition, Simon Property has over $22 billion in debt while Sears has the real estate assets virtually unencumbered. That places the enterprise value of Simon Property at over $67 billion while Sears has a market cap of only $6 billion with cash and inventory to cover any debt.

Another premium and regional mall owner, General Growth Properties owns 123 malls that encompass 128 million gross square footage. With a market cap of $18.3 billion and net debt of nearly $15 billion, General Growth again trades at a significant premium to Sears. The company is valued at roughly $143 per square foot and closer to $250 when considering the large debt position.

Lackluster retail operations
A common mistake made by retail investors is to invest in a stock based solely on the price-to-sales or price-to-earnings multiple without even analyzing the assets of the stock. The common theme with Sears is to focus on the inability of Eddie Lampert to turn around the retail operations of Sears and Kmart. The typical analyst rehashes the concept that Lampert has constantly under invested in sprucing up stores to attracting consumers. That theme, though, is mostly misplaced as Lampert never had a sole focus to turn around the stores; instead he hoped to develop an online presence, which now ranks only behind and Wal-Mart, while limiting the capital improvements on stores since the plan was to sublease and redevelop the assets anyway.

As an example of the weak retail operations, the company reported a large $194 million net loss, or $1.83 per share. While the adjusted EBITDA loss was only $55 million, it compares negatively to the $116 million gain in the prior year quarter. In general, analysts expect large losses to continue for the next