Sears Holdings Corp. (SHLD) Chief Executive Officer Eddie Lampert is almost 10 years into his turnaround effort and he’s finally doing what many investors wanted him to do from the start: sell the company’s real estate.
Sears said yesterday that it was considering selling 200 to 300 stores to a newly formed real-estate investment trust, the first step in a plan that could offload most of the chain’s 1,800 locations. Spinning off the property into a REIT could generate $1.8 billion to $1.9 billion, according to Evercore ISI. Sears would then lease the properties back.
The move was cheered by investors, who have been clamoring for a real-estate deal since Lampert first merged Sears Roebuck & Co. and Kmart Holding Corp. in 2005. Sears has suffered nine straight quarterly losses and exhausted many other avenues for raising cash, including the spinoff of its Lands’ End chain and the sale of part of its Canadian operations. That’s turned real estate into a final frontier. Still, the latest fundraising venture would leave Sears with a hefty annual rent bill and spotlight the uneven quality of its properties.
“There is no doubt that there is underlying value in Sears real estate,” said DJ Busch, an analyst at research firm Green Street Advisors in Newport Beach, California. “Most of the value, however, is located at the higher-productivity malls. There is little to no value at the lower end of the quality spectrum.”
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Household Incomes
A Sears property in Thousand Oaks, California, for example, boasts a surrounding median household income of $101,000. Another that’s available for rent in northeastern Philadelphia, meanwhile, has a median of $38,390.
Companies typically create REITs to lower taxes and boost returns to their shareholders. The trusts don’t pay federal income taxes so long as they distribute at least 90 percent of their taxable earnings as dividends. Earlier this week, casino operator Pinnacle Entertainment Inc. became the latest company to announce it was creating a REIT, following pressure from an activist investor.
Speculation that Sears was forming a REIT grew last year after it established its Seritage Realty Trust as a separate legal entity. That business, based in Greenwich, Connecticut, spotlights properties that Sears is offering for rent or redevelopment. Chris Brathwaite, a spokesman for Hoffman Estates, Illinois-based Sears, declined to comment on whether Seritage would be the vehicle for spinning off the company’s real estate.
Stock Soars
Sears shares jumped 31 percent to $42.81 yesterday after the REIT plan was disclosed, marking the biggest gain since April 2003. Before the surge, the shares had declined 13 percent during the past six months.
Sears would be different than most REITs in that its stores would be the only tenant in most cases. That makes it “a tricky proposition,” Busch said. The trusts tend to be prized “because most own good quality real estate with a diversified tenant base.”
The company’s Sears and Kmart chains have suffered years of declining sales, making them less-than-ideal tenants. Still, Sears has already been working to entice other retailers to its properties — either to share the space or take it over entirely. Last month, Sears announced plans to rent out space in seven Northeastern stores to Primark Stores Ltd., a British budget-clothing retailer. In Pennsylvania’s King of Prussia Mall, Sears will vacate its space and Primark will move in.
If Sears could eventually install other retailers at most of its locations, “you could be left with a REIT that has value,” said Matt McGinley, an analyst at Evercore ISI in New York.
‘Substantial Proceeds’
If the company completes the REIT deal, it may ultimately own 400 to 500 stores and lease the remainder, said Chief Financial Officer Rob Schriesheim.
“We would realize substantial proceeds from such a sale, which would further enhance our liquidity,” he said.
Still, spinning off the real estate wouldn’t solve Sears’s cash shortages, McGinley said. He estimates that the amount raised by the REIT deal is “only sufficient to offset their current operating losses.”
Sears’s operations used $1.1 billion in cash in the last fiscal year, a rate McGinley estimates will accelerate. It posted a $1.4 billion loss.
Sears is taking other steps to raise money. In the past two months, it has announced rights offerings for $625 million in notes and warrants, along with as many as 40 million shares ofSears Canada. (SCC)
Funding Needs
The company aims to raise as much as $2.07 billion this year if the offerings are fully subscribed. Fitch Ratings calculated in September that the company would need $4 billion of capital to avoid running out of cash in 2016.
Ideally, the company would rent out some of its space to specialty tenants, which would pay higher rent than Sears pays as an anchor, McGinley said. Anchor retailers — traditionally large department stores — typically get better deals on rent because they’re meant to draw traffic to malls.
Getting tenants into less affluent locations may be a challenge, though. About 27 percent of the company’s square footage lies in what CoStar Portfolio Strategy calls “weak local trade area demographics.” That means households in the surrounding neighborhood aren’t big spenders.
An additional 23 percent of Sears’s space is in “questionable” locations, with somewhat better buying power, according to Suzanne Mulvee, CoStar’s director of research in Boston.
Target Pressure
Though REITs have become increasingly popular, ones with a single retail tenant have been rare. Hedge-fund manager Bill Ackman urged Target Corp. (TGT)’s shareholders to spin off the company’s real estate in 2008, valuing such a move at $5.1 billion. Investors voted down the proposal.
While the department-store chain Mervyn’s separated its real-estate portfolio into a REIT, the company ended up liquidating in 2008.
For Sears, the approach also would bring additional expenses. McGinley estimates that the company would pay about $150 million in mall rents if it goes through with the plan.
“It’s one additional burden on a company that’s burning over $1.5 billion in free cash flow,” he said. “This places Sears as a retailer in a more precarious predicament.”
Date: November 08, 2014