retail

Sears survival seen in spinoff offsetting declining cash

Posted 3/5/12

NEW YORK - For the past two years, Sears Holdings Corp. Chairman Eddie Lampert has argued in his shareholder letters that the company’s future is tied partly to smaller-format stores that sell home goods and hardware.

So when Sears announced it was spinning off a piece of the so-called growth part of its portfolio on Feb. 23, it wasn’t clear whether Lampert, who with his hedge fund owns 60 percent of Sears, was trying yet another strategy to turn around the fortunes of the largest U.S. department store chain or did he have another goal?

The consensus is that the spinoff, which may raise as much as $500 million, will reassure investors and suppliers concerned about a company that has burned through cash and ended 2011 with the worst quarterly loss in at least nine years.

“I wouldn’t call it a desperate move, but I would call it a carefully calculated move to shore up confidence,” said David Stowell, a clinical professor of finance at Northwestern University’s Kellogg School of Management in Evanston, Ill. “Sometimes you make decisions just to survive, as opposed to how to be strategic over the next 10 years.”

Pressure on Sears has been mounting. CIT Group Inc., which provides short-term loans to vendors, told Sears suppliers it would no longer finance their orders, two people familiar with the situation said in January. While CIT’s business represents less than 5 percent of Sears’s inventory, according to Sears, such moves in the past have set off a chain reaction when creditors working with other retailers have yanked loans.

Ample Liquidity

On Feb. 23, Sears reported it had $754 million of cash on its books, about half the previous year’s total. Executives stress that the company has ample liquidity and financing options, including a $3.28 billion revolving credit line with no active financial covenants. In addition to the cash from the spinoff, Sears executives expect to raise another $270 million from the sale of 11 stores. Sears also will receive C$170 million ($171.9 million) for vacating three stores in Canada before the leases are up.

The spinoff of the smaller-format U.S. stores gives “an explicit valuation for an asset that was somewhat lost in a $40 billion company,” Chief Financial Officer Rob Schriesheim said in an interview the day of the announcement.

While investors pushed the shares 19 percent that day, the surge didn’t necessarily mean investors endorsed the strategy, said Matthew McGinley, a managing director at International Strategy & Investment Group. It’s a “realization that it’s very unlikely they’re going to go bankrupt in 2012,” he said.

Sears shares rose 9.7 percent to $75.96 on March 2 and have fallen 7.6 percent over the past 52 weeks.

Unlock Value

Chris Brathwaite, a Sears spokesman, cited CFO Schriesheim’s comment in the interview that Sears’s motivation was to “unlock value” with the spinoff, not raise money.

At the core of the unit to be spun off are Sears’s Hometown stores. In 1993, 12 years before Lampert merged the company with Kmart, Sears began opening independently owned, smaller stores that sold a narrower selection of merchandise.

In 2009, the company rebranded the stores as Hometown locations and began opening more of them even as it shuttered full-line stores. Hometown stores are designed to get Sears’s Craftsman tool, Kenmore appliance and DieHard battery brands in front of customers who live too far from a mall store and offers “the feel and exceptional customer service of a small community store,” according to the company’s website.

Semi-Rural Mall

Today, there are 1,061 Hometown stores, or about one quarter of the store fleet. The owners of the stores hold the lease and pay Sears a commission, ranging from 3 percent to 20 percent of sales, says Kanshan Puri, who with her husband Bhupendra has run a store in Ringoes, N.J., since 1994.

Their Hometown store sits in a low-slung, half-empty shopping center flanked by auto dealerships along a main commercial strip in semi-rural Hunterdon County. Large appliances, lawn and garden gear and tools like $15 Craftsman screwdriver sets are crammed into the 7,300-square-foot store, 18 of which could fit inside a full-line Sears location. Many customers are moms and dads who have been coming since before they were married, said Kanshan Puri, 54.

At a Sears conference call on Feb. 23, executives said the Hometown, hardware and outlet stores generate annual adjusted earnings before taxes, depreciation and amortization of $70 million to $80 million on as much as $2.6 billion in sales. On that basis, Sears as a whole earned $277 million in its most recent fiscal year. Sears had a net loss of $3.14 billion last year as sales declined for the fifth straight year.

Lose Profits

“I don’t ultimately think it’s a good thing for an investor in Sears to lose” profits that help support the business, McGinley said.

Still, the spun-off unit will be managed separately, which could help Sears sell more Craftsman, DieHard and Kenmore products, said Michael Dart, a senior partner at Kurt Salmon Associates in San Francisco.

“Sears still has great appliance and hardware brands, but they need to get these in front of customers in new ways,” he said. “Traditional Sears stores are in disrepair and not located in the best mall locations, and the cost of relocating or refurbishing them or opening new big stores is prohibitive.”

The Hometown stores’ more focused assortment also may appeal more to consumers, especially those used to shopping at specialty retail stores, Dart said.

Increasing Rivals

Traditional Sears stores face an increasing number of rivals -- including J.C. Penney Co., Target Corp. and Home Depot Inc., which has added its own appliance brands. In 2010, there were 4,300 competitors within a 15 minute drive of most Sears stores, about three times as many in 1998, according to a study by Kurt Salmon.

“Having Hometown and other stores stand alone could give them more visibility, help attract capital and be operationally efficient,” Dart said

While those benefits may help in the long run, Lampert has more pressing concerns, said Northwestern’s Stowell.

“He needs cash,” he said. “It’s clear that you can have great ideas, and you can say, ‘I’m going to do this, that and the other, and just be patient.’”

Yet seven years after the merger, shareholders, bondholders and suppliers are getting antsy, Stowell said. They’re saying: “We’ve been patient, Mr. Lampert, but no longer.”

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