The story at Seritage Growth Properties (NYSE:SRG) is still the same as it was when the company was spun off from now bankrupt Sears Holdings in 2015. It is the timing of management's action plan that's gotten all screwed up. It prepared as best it could, but at this point it is reliant on the good graces of Warren Buffett's Berkshire Hathaway (NYSE:BRK.A). Here's what you need to know.
Trouble from day one
Seritage was a way for financially troubled Sears to raise cash. The retailer specifically created the real estate investment trust (REIT) so it could quickly sell hundreds of its properties in one swift move. Today, Seritage owns 194 properties outright and has 24 joint-venture assets. Seritage didn't go into this blind; it knew from day one that it would have to replace the Sears and Kmart stores at the properties it acquired from Sears Holdings.
In fact, that was the big story. Seritage would take back old assets with low rents from a struggling tenant, refresh the space, and bring in new tenants that would pay higher rents. Buffett liked the idea so much he put his own money into the stock. It's a classic value play, actually, with unloved assets getting a little TLC to make them more desirable. The key to the whole story was time, since fixing up a building and finding a new tenant doesn't happen overnight. As long as the pace of Sears and Kmart store closures was reasonable, Seritage expected to have ample time to refresh its portfolio.
Sears' bankruptcy, however, threw a wrench into the gears here -- which is where Berkshire Hathaway comes in. Shortly before Sears sought out court protection, Seritage inked a $2 billion debt deal with Berkshire. That, it was expected, would give the REIT the liquidity it needed to keep going, even in a worst-case scenario.
Following the Sears bankruptcy, however, it looks like the best-laid plans haven't worked out exactly as hoped. That's not meant to be a snub against Seritage, it has done a very good job with the hand it has been dealt. But, in the end, management has had to make some hard calls. For example, the REIT has now eliminated its dividend in an attempt to free up as much cash as possible. That's not something a REIT does unless it really needs to, since the whole point of the REIT structure is to pass income on to shareholders.
And, if you dig into the company's SEC filings, you'll find that Seritage is cutting things pretty close with Berkshire. The loan is actually a two-step deal. The first is a $1.6 billion loan that, depending on meeting certain financial targets, could be expanded by an additional $400 million. The problem is, because of the Sears bankruptcy, Seritage isn't living up to its side of the agreement.
According to Seritage's third-quarter 2019 quarterly report:
As of September 30, 2019, the Company was not in compliance with certain of the financial metrics [of the Berkshire agreement]. As a result, the Company must receive the consent of Berkshire Hathaway to dispose of assets via sale or joint venture...
To be fair, Berkshire has, so far, been willing to give Seritage the leeway it needs and has been granting the requested approvals. However, as of the third quarter of 2019, Seritage had not accessed that extra $400 million, so Berkshire isn't exactly letting the REIT do whatever it wants.
So where does Seritage sit today? Sears and Kmart stores account for just 5.5% of its rent roll. When it brings in a new tenant it gets to bump up the rents it charges for a property by roughly four times, on average. That's the good news and shows that Seritage is actively making progress toward its end goal. The bad news is that of the 467 leases it has, a little more than a third fall into what it calls "SNO." That stands for signed but not yet opened. In other words, Seritage has a lot of property that is still in some stage of redevelopment. That development, meanwhile, costs money, and money is tight.
Until the REIT gets further along on these properties it will continue to face high expenses and, likely, bleed cash. It is working as fast as it can, and inking deals with partners to help reduce its own cash outlay. But there's still a lot of work to be done yet, and Berkshire Hathaway holds a very important role in whether or not Seritage can keep moving forward. The giant conglomerate's loan provides it with veto power on some of the key tools Seritage has to muddle through this rough patch.
No big deal for Buffett -- yet
In the end, $2 billion is small-time money at Berkshire Hathaway, which has around $145 billion that it could quickly turn into cash if it needed or wanted to. So, as long as Seritage keeps making progress at its properties, there's no reason to expect Buffett's company to give Seritage problems. That said, if you own Seritage, or are considering it, know that Buffett and Berkshire play a far more important role than you might think. If Seritage's redevelopment efforts hit a rough patch, the relationship with Berkshire could quickly become more important.