Over the past six months, Sears Holdings (SHLDQ) CEO Eddie Lampert -- who is also the company's largest shareholder and largest creditor through his ESL Investments hedge fund -- has made several proposals to inject liquidity into Sears by buying various assets.
ESL Investments laid out its latest -- and boldest -- restructuring proposal in an SEC filing on Monday. While the proposal held out the prospect of dramatically slashing Sears Holdings' debt, it's very unlikely that third-party bondholders will go along with the plan. As a result, Sears could be forced to file for bankruptcy even sooner than I had previously expected -- perhaps before the end of 2018.
What ESL Investments is proposing
ESL Investments believes that Sears Holdings can return to profitability, but only if it is possible to buy more time for a turnaround and reduce the company's debt load (and interest expense). The proposal unveiled on Monday calls for jettisoning all of Sears Holdings' encumbered real estate, along with the associated debt, plus various other asset sales and the conversion of much of Sears' second-lien and unsecured debt to equity.
Specifically, Sears Holdings would try to sell as much of its real estate as possible over the next 12 months, using the proceeds to pay down $1.5 billion of real estate loans. At that point, an ESL-led consortium would take over the remaining encumbered real estate and associated debt. Sears Holdings would be able to capture a share of the upside if the real estate ultimately sells for significantly more than $1.5 billion.
Meanwhile, ESL assumes that Sears Holdings would reap $1.75 billion from selling its entire home services unit, the Kenmore brand, and unspecified "other assets." ESL itself has already made provisional offers to pay $400 million for Kenmore and to pay $500 million for two pieces of the broader home services business.
Finally, the plan calls for up to $1.1 billion of debt to be exchanged for new debt that wouldn't be entitled to cash interest payments and would eventually convert into Sears Holdings stock. The unsecured bondholders would also have the option to tender their bonds for cash at a steep discount to face value: $0.25 on the dollar.
There's no credible turnaround plan
If all went according to plan, ESL's proposal would eventually reduce Sears Holdings' debt from $5.59 billion to $1.24 billion. This would cut annual cash interest expense from $439 million to $88 million.
Yet the proposal ignores the fact that Sears Holdings has been burning cash at an astounding rate in recent years. In fiscal 2017, the company burned through $1.9 billion. Cash interest expense only accounted for $412 million of that cash outflow.
While the transactions proposed by ESL would reduce Sears Holdings' cash burn somewhat, they wouldn't come close to eliminating it. Meanwhile, the profitability of the core business has been heading downhill again (i.e., deeper into negative territory). As a result, Sears would quickly start to accrue new debt following a restructuring. That will make the prospect of converting debt to equity less appealing for current debt holders, aside from ESL Investments.
Lampert hopes that bondholders will take less than par value for their debt in order to keep Sears Holdings out of bankruptcy. However, given that Lampert has shown no sign of turning the company around, bondholders may prefer to send Sears into bankruptcy sooner rather than later, preferring the (more or less) known costs of bankruptcy proceedings over the unknown -- but likely quite large -- cost of allowing Lampert to continue burning cash in Sears' retail operations.
Time is running out
ESL Investments made it clear in its recent filing that time is of the essence. Not only does Sears have a $134 million debt maturity next month, it's also at risk of breaching various debt covenants, which could force it to repay other loans ahead of schedule. Clearly, the company doesn't have the cash to do so.
The tone of the ESL proposal suggests that if other creditors don't agree to the terms, ESL won't provide any further lifelines to Sears Holdings. That would very quickly land the company in bankruptcy -- probably before the end of 2018.
Lampert recognizes that if Sears Holdings enters bankruptcy protection, there's a good chance it won't come out the other side. Yet other creditors may be ready to concede that the company is doomed anyway. There's no reason for them to help Lampert "extend the runway" if there's no meaningful chance of a turnaround at any point in the future. Thus, the end could be near for this iconic retailer.