If you need any more proof that Sears Holdings (NASDAQOTH:SHLDQ) is headed straight for bankruptcy court, look no further than its first-quarter earnings report, released May 31, as it gives the clearest example of what happens to a company when you continuously strip it of anything valuable.
The troubled retailer said revenue nosedived 31% in the period as comparable-store sales tumbled 11.9%, the 26th straight quarter of a year-over-year comps decline and the sixth straight they were down by double digits. That's almost seven straight years of no growth in comps and it shows that customers find little of value at its stores, which include Sears and Kmart. It's a remarkable record of failure.
It also announced it had identified 100 unprofitable stores it would close, with 72 of them being shut down in the "near future." This is in addition to the 103 stores that have already closed this year.
The reason Sears remains in its current predicament -- and why it hasn't yet collapsed under the sheer weight of its decline -- is the same: Chairman and CEO Eddie Lampert, who is also Sears' largest shareholder.
Plucking yet another fruit from the tree
After years of neglect that relied more on the financial gymnastics of a hedge fund operator to maintain the appearance of profits than having any retail chops, the facade was finally ripped away as more valuable assets were spun off or sold off to raise cash to keep the lights on. In recent years, it has only been because of Lampert's deep pockets that Sears has not already sought bankruptcy protection. He has continuously extended short-term lines of credit after other lenders would not, just to make it through the next crisis point.
Now we're getting down to the end game. Sears has only a few assets left that hold residual value: Kenmore appliances, Diehard batteries, and its auto service centers. Lampert is apparenlty attempting to extract Kenmore for himself, and if all that Sears has left is to be the neighborhood garage, well, that's not much of a future at all.
In April, Lampert, through his ESL Investments hedge fund, offered to buy Kenmore, Sears' appliance parts business, its home-improvement business, and some real estate, which the board of directors said its was considering. It should be noted that the board consists of just six directors, one of whom is Lampert and another who is the president of ESL. The independent directors are reportedly the ones considering the proposal.
Late last month, however, Lampert said he's received "numerous inquiries from potential partners" and he wanted permission to "engage with" them to be able to put forward an even better deal for Sears. The board had placed limits on Lampert's ability to meet with potential partners, and he wants it to reconsider those barriers.
He also said that since he first broached the idea, the cost of Sears' unsecured debt had risen considerably so the debt-for-equity plan originally envisioned, or the debt repurchases, are now not nearly as attractive as they were then and make completing them more difficult.
Although Sears may reap some benefit if the board doles out more leash to Lampert, it's also clear the main beneficiary will end up being Lampert if his ESL Investments gets control of yet another important asset.
Emerging relatively unscathed
ESL is a significant shareholder in Seritage Growth Properties (NYSE:SRG), the real estate investment trust Lampert created to buy hundreds of prime Sears properties, many of which have been leased to new tenants at substantially higher rent. In a presentation last month, Seritage noted average rent per square foot is now almost $18 compared to the $4 Sears used to pay, and the number of properties it owns that no longer have a Sears as the primary tenant stands at 126 versus the 11 it had when it first acquired them.
Seritage is quickly losing its dependence on Sears as a tenant, yet even for those properties where it remains, ESL and Lampert are protected because Seritage received some of the retailer's most valuable properties. If Sears goes under, it will just be able to lease the rest of the space out at higher rents. Ultimately, Lampert would get to recover a good portion of his investment in Sears even if outside shareholders are wiped out.2
Dramatically falling sales, mounting losses, fleeing customers, and a dwindling asset base are what investors have to show for their belief in a 12-year turnaround effort. They've seen the best parts of the retailer calved off and those that remain look like they'll soon be gone, too. When Sears Holdings has finally been picked clean of its last remaining assets, that will be the point when it goes under. And from the looks of it, that will happen much sooner rather than later.