You say the glass is half empty, but Sears Holdings (NASDAQ:SHLDQ) prefers to look at it as half full.
The financially troubled department store is said to have accelerated payments to its vendors to as soon as 15 days in some cases: a far cry from the industry standard of 30 days to 60 days. This could be an indication of a company trying to keep its suppliers from bolting. Yet Sears says it will gladly transfer more cash to suppliers quickly in exchange for deeper discounts on the merchandise it is buying from them. Rather than a problem, it's a good deal.
A problem of its own creation
Sears has made analysts and investors skittish. Sales have been in a tailspin ever since Chairman and CEO Eddie Lampert merged Sears with Kmart, and he's used his hedge fund financial wizardry to keep the company afloat instead of building a retail operation that can sustain itself.
In years past, Lampert's ESL Investments hedge fund routinely lent Sears money on a short-term basis, but he abruptly stopped the practice a year ago and reduced his exposure in the retailer to zero. That was a red flag to analysts who thought he might be preparing for the worst, causing suppliers to get nervous.
Last September, though, Lampert was forced to reverse himself on this practice in a bid to keep Sears from burning through all its available cash and to keep vendors in line who might otherwise be fearful they wouldn't get paid. ESL gave Sears a $400 million short-term loan secured by a first-priority lien on 25 of its choicest properties. Had Sears defaulted, Lampert would have gotten some prime real estate on the cheap.
Walking on a knife's edge
But Sears did make it through Christmas, even if only just barely. Revenue slid to $8.1 billion from $10.6 billion the year before, due in part to spinning off assets like its Lands' End business, but also because same store sales continued falling. Comparables were down 7% at Sears in the fourth quarter while they were off 2% at Kmart.
Last week, MarketWatch reported Sears was changing payment terms to vendors to "compensate them for the risk of shipping to the troubled retailer." While Sears may be getting additional discounts from the vendors -- anywhere from 3% to 5%, according to the media outlet -- this move ties up more of its limited capital.
Analysts say that for every day Sears pays its suppliers early, it uses up $48 million of available cash. Cash and equivalents -- or the most liquid assets the retailer has -- shrunk from over $1 billion to just $250 million over the course of the 2014 fiscal year.
Now Lampert's resorting to financial engineering again to infuse the company with cash. He hopes to raise more than $2 billion by converting 300 of Sears' best stores into a publicly traded real estate investment trust. He's also loaning Sears $200 million more to get it through until June, when he expects the deal to be completed.
Keeping an eye on the exits
That vendors may be getting nervous about whether they'll get paid is understandable. If the conversion goes through, Sears will be left with few valuable assets, primarily its Craftsman, Diehard, and Kenmore name brands. It may also have a hard time raising money in the future as many of its previous financings were based on the value of the real estate it owned.
It's already getting difficult for vendors to buy insurance to protect them from a default by Sears. One insurer has already canceled policies covering receivables from the retailer and a firm that lends money to Sears suppliers is using a rarely used (and expensive) option to insure accounts receivables.
The cost of insuring against a Sears default is also on the rise, though as the retailer points out, insurers have never had to pay a claim against it. But having never done so before doesn't mean they won't have to in the future.
As Sears' business dwindles away, its suppliers are increasingly concerned about this possibility. That Sears was able to secure discounts for paying early may be a case of making lemonade when handed lemons -- but it still does not mean Sears makes for a good investment.