Sears Holdings Corporation (SHLD): Fairholme Case StudyVW Staff
This is just a “teaser” ahead of an upcoming presentation on Sears Holdings Corporation (NASDAQ: SHLD) according to Bruce Berkowitz- so stay tuned for more!
“Traditionally the investor has been the man with patience and the courage of his convictions who would buy when the harried or disheartened speculator was selling.”
— Benjamin Graham & David Dodd
While we continue to work on the forthcoming Sears Holding Corporation (“SHC” or the “Company”) presentation, we would like to offer investors some of the high level observations from our thesis.
For years, Sears Holding has remained a misunderstood sum-of-parts story. Few investors have both the inclination and the wherewithal to examine the Company’s myriad pieces, which we estimate to have a net asset value that is multiples of where the stock has recently been trading (approximately $40). To arrive at our estimation of fair value we have committed thousands of hours of study and a significant amount of capital in corroborating analyses, nationwide site tours, and a dedicated analyst solely covering the Company. We are as confident as ever in our evaluation, and in our belief that Sears Holding’s true value is grounded in its vast real estate holdings.
For many retail-centric analysts who have traditionally analyzed Sears Holding, it’s hard to accept that the company is as much about realty as it is about retail. One veteran analyst with 15 years of consumer-related research experience valued the SHC real estate at $20 billion ten years ago. Despite having approximately 650 fewer locations today, SHC has retained its most valuable locations, which we believe have increased in value since then. Perhaps some facts are in order:
Sears Holding’s 979 Kmart and 717 Sears properties comprise over 200 million square feet of commercial real estate space. To provide further perspective on SHC’s real estate, on a square foot basis its portfolio exceeds that of Simon Property Group (NYSE: SPG), America’s largest mall REIT with an enterprise value of $92 billion.
SHC recently announced plans to create a REIT with 200-300 properties. How does SHC’s portfolio stack up against the mall REITs?
The chart above shows us that Sears Holding controls more square footage than any of the nation’s top mall REITs, yet its price, which is much lower by comparison, tells a different story. SHC is taking the proper steps to bridge the gap in values. A few examples:
- In early 2012, Sears Holding sold its store in Ala Moana to GGP for $200 million. Since then GGP has invested an additional $460 million to redevelop the property. A recent assessment valued the former SHC location at $1.5 billion. (This is the one that got away. This example demonstrates the significant value creation opportunities that exist in redeveloping the most valuable acreage.)
- On March 22, 2013, Seritage Realty Trust was established to undertake leasing and development initiatives for Sears Holding. They have been successful for two years in establishing relationships and subleasing arrangements with growing tenants such as Primark, Nordstrom Rack, Dick’s, Whole Foods, Kroger’s, and others.
- In October 2014, SHC sold its 17 acres at the Vallco Fashion Center in Cupertino, CA, for $102.5 million.
- On November 7, 2014, SHC announced its intention to create a REIT.
- On December 18, 2014, Seritage Growth Properties was established in Maryland. Many newly formed public REITs choose to incorporate in Maryland because of that state's special, business-friendly REIT law.
Over 50% of Sears 717 stores are located within the top ten mall REITs. Over 400 Sears Holding properties are located within 30% of the “Super Zips” (zip codes identified by high median incomes and high educational attainment) in the United States. Executives at mall and shopping center REITs have spent the last few quarters discussing the value of SHC real estate and the willingness to work with the Company as its transformation continues.
A significant amount of Sears properties date back to the 1950s through 1970s, when regional malls were first being constructed. Sears was awarded favorable operating agreements. A significant amount of Kmart’s operating leases were signed with base terms of up to 25 years along with renewal options extending for another 25 years or more. For the valuable locations, Sears Holding will have the flexibility to lease, sell back, or redevelop. For the not-so-valuable locations (primarily leased), SHC has the ability to exit 80% of its lease agreements in the next four years. In 2014, SHC showed a commitment to exiting unprofitable locations, shutting down 234 stores. This is almost the same amount of store closures that occurred from 2012 and 2013 combined, and more than 40% of all closures that occurred between 2006 and 2011. Not to mention, the store closure process has been efficient. Through a combination of net inventory and real estate proceeds, Sears Holding generated roughly $1 billion from the 300 store closures between 2006 and 2012.
A list of recent transactions suggests that patience pays and that investors are willing to pay fair value for Sears Holding properties. In some cases SHC has the ability to buy out ground leases that were set in the 1940s. The full list of transactions and opportunities are beyond the scope of this introduction but here are some highlights:
- Freestanding Sears in Brooklyn (Beverly Rd) This 190,000 square foot Sears is located on over four acres. This property was one of 14 properties subject to a sale-leaseback agreement with an insurance company in the 1940s. In the last ten years Sears Holding was able to repurchase the property for an immaterial amount. SHC has the ability to build more than 200,000 square feet in excess of the Sears building based on the maximum allowable buildable square footage. There are still more examples of valuable ground leases with cheap buyout options.
- Sears King of Prussia, PA This ground leased location is located in one of the largest malls in the U.S. SHC has already announced leases with Dick’s Sporting Goods (2nd level) and Primark (1st level). Although SHC will not have a retail presence at the mall, they will have essentially turned a somewhat successful store into a valuable cash flow stream. We estimate that rents for both levels are between $15 and $25 per square foot and Green Street ascribes a less than 5% cap rate to King of Prussia.
- Freestanding Sears in Santa Monica, CA Sears Holding owns 3 acres within a block of the Santa Monica Pier. Although it would take time to get the proper zoning approvals to fully realize the value in this property, we are confident that investors today would pay over $70 million for the property “as is.”
- Sears Aventura Mall, FL This 200,000 square foot store is located on 12.3 acres in one of the top malls in the U.S. While most would value just the store and ignore the rest of the property, it is important to recognize that SHC could build more than 400,000 square feet and build vertical up to 120 feet if they chose to utilize the maximum allowable buildable square footage. A recent proposal submitted in 2014 shows Sears Holding redeveloping the property with 250,000 square feet of retail, 40,000 square feet of office, a 120-room hotel, and a two-level parking deck. This is a game changer, and whether or not SHC goes through with the plan, they created value simply by announcing these plans.
- Kmart Penn Plaza & Broadway, New York City These properties are leased through 2036. We estimate that Kmart is currently paying roughly $30 per square foot on these approximately 150,000 square foot stores. Vornado is spending significant capital redeveloping these areas. Tenants renting in Manhattan are currently paying $100 to $150 per square foot. We believe these stores are profitable for Sears Holding.
In our opinion, the core brands (Kenmore, Craftsman, Diehard), Home Services and Protection Agreements, Sears Auto Centers (excluding real estate), Sears Mexico, Sears Canada, and other assets effectively net out the debt and pension liabilities.
We believe that opportunities at Sears Holding grow by the day. Although some investors remain distracted by lackluster holiday retail sales figures and store closures, which actually represent positive developments, we remain patient and have confidence that SHC will work through the cash burn and allow shareholders to take advantage of its real estate holdings through the anticipated REIT rights offering announced in 2014, Yes, we do believe Sears and Kmart have a profitable, core customer base within. They will shrink to grow.