Sears Holdings (SHLDQ) has been one of the most prominent casualties of the e-commerce revolution. Over the past decade, revenue has fallen by more than half, and the company has posted a string of big losses. Since 2014, Sears has been burning about $1.7 billion of cash annually.
SHLD Free Cash Flow (TTM), data by YCharts.
The only reason Sears Holdings has been able to absorb these losses and stay in business is by selling and spinning off numerous assets -- mainly real estate -- to raise cash. With losses continuing to mount, Sears continued down this path last week, selling the venerable Craftsman tool and lawn care brand to Stanley Black & Decker (SWK 0.03%).
Sears looks for more cash
Real estate sales have been Sears Holdings' biggest source of cash over the past five years. This culminated with the 2015 spinoff of Seritage Growth Properties, a real estate investment trust consisting of more than 200 properties, most of which are occupied by either Sears or Kmart. The Seritage transaction generated a whopping $2.7 billion of cash for Sears Holdings.
However, it took barely more than a year for Sears to burn through all of this cash. 2016 was Sears Holdings' worst year yet, with double-digit revenue declines more than offsetting the company's cost cuts.
Looking ahead, while Sears still owns hundreds of properties, it has already sold many of its best locations. As a result, the company announced in May that it would "explore alternatives" for its Kenmore, Craftsman, and Diehard brands, as well as its Sears Home Services business.
Sears has already sold a lot of its best real estate. Image source: The Motley Fool.
Craftsman finds a buyer
Among those assets, the Craftsman brand found the most interest. In October, as the deadline for final bids drew near, Bloomberg reported that the sale price could be as high as $2 billion. However, Sears' cash proceeds will ultimately be much smaller.
Rather than buying Craftsman outright, Stanley Black & Decker is buying the rights to use the Craftsman brand outside of Sears-affiliated sales channels. Meanwhile, Sears Holdings will be able to continue producing and selling its own line of Craftsman-branded products in Sears and Kmart stores. Sears will start paying royalties to Stanley Black & Decker for use of the Craftsman brand after 15 years.
Since non-Sears retail outlets account for just 10% of Craftsman sales right now, Stanley Black & Decker is essentially paying for the growth potential associated with making Craftsman products more widely available. The deal was deliberately structured this way to protect Stanley Black & Decker from Sears' ongoing decline.
Stanley Black & Decker will expand distribution of Craftsman products. Image source: The Motley Fool.
Stanley Black & Decker will pay Sears $525 million when the deal closes and another $250 million three years later. It will also pay royalties to Sears Holdings for all Craftsman product sales (starting at 2.5% and eventually escalating to 3.5%) for the next 15 years. Sears estimates the net present value of all of these payments at $900 million.
The good news for Sears is that it can continue selling Craftsman products under a favorable private brand margin structure. However, as Stanley Black & Decker expands distribution of the Craftsman brand to the likes of The Home Depot while Sears continues to close stores, it's virtually inevitable that sales of Craftsman products in Sears and Kmart stores will crater.
The ship is going down
On the same day that it announced the Craftsman sale, Sears Holdings issued another dreadful sales update. During the November-December period, comp sales fell by 12% to 13% at Sears and Kmart. By cutting costs to the bone, Sears hopes to keep earnings roughly flat year over year. That still means reporting a substantial loss in what is typically the best quarter of the year for retailers.
Between the Craftsman sale and two new loans announced in the past few weeks, Sears Holdings has probably raised enough cash to keep going for another year. The Kenmore and DieHard brands remain on the market, and Sears hopes to sell off at least $1 billion of real estate during 2017, as well.
However, there's no reason to think that Sears is on the verge of a breakthrough that will return it to profitability. At this point, management is just buying time and hoping for a miracle. Valuable brands like Craftsman will live on, but the Sears and Kmart chains may soon disappear.
