Shares of Sears Holdings (SHLDQ) surged on Monday after Eddie Lampert -- the company's chairman, CEO, and principal shareholder -- offered to acquire several pieces of the business via his hedge fund, ESL Investments. The goal would be to put Sears Holdings on firmer financial footing through a cash infusion and debt reduction.
However, selling off another piece of the Sears Holdings empire won't address the company's underlying problem: The Sears and Kmart chains have become irrelevant to consumers. Sears Holdings is burning cash at a phenomenal rate, and further cash infusions will only delay the inevitable bankruptcy filing for a short time.
What Lampert and ESL are offering
On Monday morning, Sears Holdings announced that its board had received a letter from ESL Investments recommending that it pursue several strategic asset sales. ESL wants the company to divest its Kenmore appliance brand and two pieces of its home services unit: Parts Direct (which sells spare parts, mainly for appliances, tools, and lawn and garden equipment) and its home improvement business.
In the letter, ESL noted that Sears Holdings has been working to shore up its balance sheet via asset sales for more than two years -- mostly without success. The hedge fund wants Sears to sell a significant chunk of its assets as soon as possible.
To assist in this process, ESL made a non-binding offer to purchase Parts Direct and the home improvement business for $500 million. It also indicated a willingness to make offers for Kenmore and for Sears Holdings' remaining real estate, if an independent committee of the board of directors is interested.
There may be a huge catch
The proposal from ESL states that the asset sales would take place in connection with an offer by Sears Holdings to exchange approximately $300 million of second-lien debt for Sears stock and a tender offer for the company's roughly $900 million of unsecured debt priced at a sharp discount to face value -- or paid with stock.
It's not clear whether ESL would require substantial uptake of these offers as a condition for closing any asset sale deals. While ESL said it would consider participating, neither offer seems very appealing for other debt holders.
Third parties hold more than two-thirds of Sears Holdings' unsecured debt. Most of this debt was trading at 50% of par value or less as of last week, including $411 million of debt due in December 2019. The only reason to take $0.50 on the dollar today would be if Sears will be unable to pay its debts by the end of next year -- in which case Sears Holdings stock is worthless.
Some debt holders may take the deal and cut their losses, but most will probably hold out for full payment. This will complicate any effort to reduce Sears Holdings' debt load.
Successful deals might not keep Sears alive for long
Even if Sears Holdings can navigate the potholes involved in trying to pay off debt at a discount or swap it for stock, the proceeds from its proposed asset sales may keep it alive for only one extra year.
Sears' real estate assets are probably worth less than $3 billion. Indeed, the value of its stores has been eroding, due to changing consumer behavior and a rash of store closures across the retail industry. Furthermore, ESL's letter notes that there is $1.2 billion of debt attached, which it would assume in a hypothetical purchase. Thus, the cash proceeds to Sears from selling all of its remaining real estate would be perhaps $1.5 billion.
Kenmore might be worth $500 million or more, according to The Wall Street Journal. That said, multiple reports estimated the value of the Craftsman brand at approximately $2 billion, just months before it was unloaded for total consideration of around $900 million. Kenmore might also sell at a discount to what people currently expect. Moreover, the Sears pension plan has first claim on the proceeds from any Kenmore sale.
Thus, including the $500 million proposed price for Parts Direct and the home improvement business, Sears might only raise $2 billion (net of pension funding) by selling off the majority of its remaining assets. That's roughly equal to the amount of cash Sears Holdings burned in 2017.
To make matters worse, most of Sears Holdings' debt matures within the next three years. Since the company will need most of its asset sale proceeds to cover its cash burn, it will struggle to pay down much debt. Meanwhile, it won't have enough assets to guarantee new loans, whether from ESL or another source. Eddie Lampert's latest rescue plan for Sears Holdings might keep it on life support for the next year, but the company still has little chance of surviving through 2020.