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Sears Hometown Investors Should Sell Before It's Too Late

By Adam Levine-Weinberg – Sep 23, 2019 at 8:09PM

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Sears Hometown and Outlet Stores is on track to be sold for $3.25 per share next month -- unless the sale falls through, in which case the business would probably be worth even less. So why are Sears Hometown shares trading for more than $3.25?

Sears Hometown and Outlet Stores (SHOS) stock crashed in late 2018, as the bankruptcy of former parent Sears Holdings threatened to undermine the spinoff's business. Yet the stock has rebounded this year, despite plunging sales, due to the company's plans to sell itself.

In fact, shares of Sears Hometown and Outlet Stores have roughly doubled since early April, ending last week at $3.75. That's higher than the price at which the company has agreed to sell itself to the new owner of Sears and Kmart.

SHOS Chart

Sears Hometown and Outlet Stores Stock Performance, data by YCharts.

Sears Hometown and Outlet Stores isn't likely to get better acquisition offers than what's already on the table. Meanwhile, the core business continues to deteriorate in the face of withering competition from the likes of The Home Depot (HD 3.19%) and Lowe's (LOW 3.88%). As a result, this is a great opportunity for shareholders to sell.

Sears Hometown is selling itself -- probably

Under pressure from Eddie Lampert -- whose hedge fund, ESL Investments, owns more than half of the company's shares -- Sears Hometown and Outlet Stores agreed to sell itself to Transform Holdco in June. Transform Holdco is another affiliate of ESL that was formed to buy Sears and Kmart out of bankruptcy earlier this year.

Transform Holdco agreed to pay $2.25 per share for the whole company. However, the merger agreement gave Sears Hometown and Outlet Stores a brief window to try to sell the Sears Outlet business and its Buddy's Home Furnishings stores separately. The contract calls for Transform Holdco to increase the price it pays for Sears Hometown if the other businesses can be sold for more than $97.5 million.

Late last month, Sears Hometown and Outlet Stores succeeded in striking a deal to sell Sears Outlet and its Buddy's Home Furnishings stores to Liberty Tax. Sears Hometown expects the deal to generate net proceeds of $121 million -- just enough to avoid giving Transform Holdco the right to match the offer.

Assuming this transaction is completed as expected, Transform Holdco would end up paying approximately $3.25 per share to buy Sears Hometown, an increase of $1 per share. The sale of the Sears Outlet and Buddy's Home Furnishings businesses to Liberty Tax and the sale of Sears Hometown to Transform are both expected to close next month.

The exterior of a Sears full-line store

The new holding company for Sears and Kmart plans to buy Sears Hometown. Image source: Sears.

Sears Hometown's struggles are mounting

While the Sears Outlet business returned to profitability last year, Sears Hometown has been losing money and bleeding sales rapidly. In fiscal 2018, revenue fell to $959 million from nearly $1.2 billion a year earlier, due to a 6% comp sales decline and the closure of more than a quarter of Sears Hometown's stores during the year. Comp sales then fell 13.2% for the Hometown business in the first quarter of fiscal 2019 and 21.7% last quarter. Sears Hometown's total revenue plunged nearly 40% to $337 million in the first half of fiscal 2019.

Some of these revenue declines were driven by inventory availability issues for the Kenmore and Craftsman brands. Both are sourced from Transform Holdco (and Sears Holdings before that), and together the two brands account for more than half of Sears Hometown's sales.

That said, tough competition from the likes of Home Depot and Lowe's is also hurting Sears Hometown. Both home improvement giants reported strong growth in appliances and tools last quarter. Historically, Sears Hometown's main competitive advantage has been its store locations in small towns where there was no direct competition. However, Home Depot and Lowe's both have big e-commerce businesses. (In fact, Home Depot is the No. 5 e-commerce retailer in the U.S.) Additionally, when making a big purchase like a major appliance, consumers are often willing to make a long trip to a larger store that has better prices or a bigger selection.

Thus, Sears Hometown's competitive moat is not what it used to be. Furthermore, even excluding one-time items like store-closing expenses and merger costs, Sears Hometown is unprofitable. As a result, it's no surprise that Transform Holdco has offered a pittance for the company.

There's literally no upside for shareholders

In its recent earnings report, Sears Hometown and Outlet Stores emphasized that under no circumstances will Transform Holdco pay more than $3.25 per share to acquire the company. Meanwhile, if the deal to sell the Outlet business and Buddy's Home Furnishings stores to Liberty Tax falls through, the sale price could fall to just $2.25 per share. In this context, it's hard to understand why the stock trades for more than $3.25.

In fact, with Sears and Kmart continuing to perform dreadfully, Transform Holdco may not even have the wherewithal to complete the Sears Hometown acquisition. That wouldn't be good news for investors. Between the company's weak margins and stiff competition from Home Depot and Lowe's, any stand-alone option -- even liquidation -- is likely to result in a much lower value for Sears Hometown stock.

In other words, the options for Sears Hometown investors at this point are a buyout at a discount to the current stock price or a failed buyout, in which case the stock price will fall even more. Shareholders should thank their lucky stars that the stock has risen as far as it has and get out while a favorable price is still available.

Adam Levine-Weinberg has no position in any of the stocks mentioned. The Motley Fool is short February 2020 $205 calls on Home Depot and long January 2021 $120 calls on Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Sears Hometown and Outlet Stores, Inc. Stock Quote
Sears Hometown and Outlet Stores, Inc.
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
$284.75 (3.19%) $8.81
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
$195.09 (3.88%) $7.29

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