Sears’s $2.5 Billion REIT Plan May Be Blueprint for Deals

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Sears Holding Corp. Chief Executive Officer Eddie Lampert
Sears Holding Corp. Chief Executive Officer Eddie Lampert said, “Sears Holdings is an asset-rich enterprise with multiple levers to generate financial flexibility, while creating shareholder value.” Source: Sears Holdings Corp. via Bloomberg

Sears Holdings Corp.’s plan to raise more than $2.5 billion from its real estate serves as a blueprint for future deals, helping Chief Executive Officer Eddie Lampert deliver the financial returns he’s long promised to investors.

A newly formed real estate investment trust, Seritage Growth Properties, will buy 254 Sears and Kmart locations and then lease them back to the retailer. As part of a plan announced Wednesday, Sears also will contribute 12 properties to a 50-50 joint venture with mall operator General Growth Properties Inc. in exchange for $165 million in cash.

While the company has previously sold locations, leased space to other retailers and developed properties, many investors have been waiting for Lampert to form a REIT since he merged Sears and Kmart more than a decade ago. The shares surged 31 percent when the company announced in November that it was exploring the possibility.

“For mall operators of high-quality malls, there have to be more deals to be done with Sears,” said Cedrik Lachance, a managing director at Green Street Advisors in Newport Beach, California.

REITs composed of a single retailer are rare because investors want to spread risk among multiple tenants. Yet investors could bite if they see the transaction as a way to wring more value from the Sears properties, most likely by breaking them up, Lachance said.

‘Big Challenge’

“The big challenge of the single-tenant REIT is the credit quality, of course, of that tenant,” he said. “In this case, I think it’s universally known that the credit quality of Sears is at best poor, and so buyers of the Seritage REIT will look for a redevelopment angle.”

The deals announced Wednesday mark one of the more dramatic moves Lampert has made to reshape the company after more than three years of losses. Lampert has sold and spun off assets such as the Sears Hometown & Outlet Stores Inc. chain and the Lands’ End brand while working to transform the company into a leaner retailer, focused on generating sales online and from loyalty-program members.

Seritage will fund the purchase with debt and proceeds from a rights offering that’s expected to close by the end of the second quarter.

Lampert’s ESL Investments hedge fund may own 53.2 percent of any Sears REIT spinoff, if the retailer exercises warrants for 10.5 million shares controlled by Lampert and ESL, according to Bloomberg Intelligence analyst Noel Hebert. Hebert estimates that Sears could consume at least $1.5 billion in cash this year.

Flexibility to Redevelop

The structure of the General Growth deal resembles a $1.8 billion agreement announced in February between Hudson’s Bay Co. and Simon Property Group Inc., Green Street’s Lachance said. It gives landlords plenty of flexibility to redevelop the Sears stores.

Green Street lists 131 of Sears’s 628 mall stores as located in A, or top-quality, malls. Other landlords with Sears stores in A malls include Macerich Co. and Simon, Lachance said.

“It’s a big pool of properties where something can be done, but it can only be done with the mall owner,” he said.

Sears fell 0.1 percent to $41.28 at the close in New York. The stock has gained 25 percent this year.

The cash infusions come as Sears struggles to return to profitability under its new model. The retailer’s loss last year widened to $1.68 billion as sales slid 14 percent. All told, Sears has lost $7.12 billion in its past four fiscal years.

Balance Sheet

Those losses have strained the retailer’s balance sheet. Its cash balance as of Jan. 31 was $250 million, down 76 percent from a year earlier. Matt McGinley, an analyst at Evercore ISI in New York, estimated the moves could fund Sears’s operations for about a year and a few months at its current cash-consumption rate.

While the properties that Sears unloaded today are among its best, McGinley said that REITs that own malls with other Sears locations may be interested in similar joint-venture deals. The company said in a filing last month that it had about 1,725 Sears and Kmart stores.

“If you’re a shareholder of Sears, would you rather own a REIT that can diversify itself over time and live on as you redevelop these sites into something different, or would you want to just own this as a consolidated entity with a failing retailer?” McGinley said. “If I was a Sears shareholder, I would want to go with the REIT.”

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