Sears Hometown and Outlet Stores Inc (SHOS:NAQ)

Recent Share Price: $2.18

Average Purchase Price: $1.85

Accounting: US GAAP

Fiscal Year: Feb. 2nd

Market Cap: $49.5 million

I’ve been working on this as my next post, but due to the recent change of events, I will post this as it is and move on. I tried to avoid this stock (and the Sears empire for that matter) for as long as I could due to its perennial history as a value destroyer. But I heard a presentation by Ryan O’Conner at Crossroads Capital last year that nudged me into changing my mind. The three drivers that made me more comfortable at the time were: (1) the inventory on the books has a stronger floor valuation compared to most retailers, (2) the outlet business is a decent business hidden by a really bad hometown business, and most important (3) the closing of the hometown locations do not appear to be costly and free up working capital.

But in the end (as he has a history of showing), Eddie Lampert does not appear to be concerned with maximizing shareholder value, but is more interested in maximizing ESL. The next Warren Buffett? Unless his idea of playing the long game is a generational long game, it sure doesn’t look like it.

Although the returns should work out for us, I think this was a bad decision on my part. There is a long list of not-so-good treatment of shareholders at Sears Holdings (that I was fully aware of) that should have kept me from buying this stock.

A buyout at $2.25 is highway robbery. But I should be thankful they didn’t drive the stock to $0.50 and buy it then or do a takeunder.

Sears Hometown and Outlet Stores, Inc. is a national retailer focused on selling home appliances, lawn and garden equipment, tools, and hardware.

The Company operates through two segments:

  • Sears Hometown and Hardware segment (Hometown)
    • Its Hometown stores are designed to provide its customers with in-store and online access to selection of national brands of home appliances, lawn and garden equipment, tools, sporting goods, and household goods. Hometown segment included 497 dealer-operated stores, 18 franchisee-operated stores, and 34 Company-operated stores, including all eight Buddy’s Home Furnishing Stores.
  • Sears Outlet segment (Outlet).
    • Its Outlet stores are designed to provide in-store and online access to purchase outlet-value products across a range of merchandise categories, including home appliances, mattresses, apparel, sporting goods, lawn and garden equipment, tools, and other household goods, including furniture. Five of the 128 Sears Outlet stores were operated by franchisees.

SHOS became a publicly held company following their October 11, 2012 separation from Sears Holdings Corporation.

Sears Holdings

https://www.dividend.com/how-to-invest/the-complete-visual-history-of-sears/

In 2015, Seritage Growth formed and purchased 235 properties from Sears Holdings and leased all of them (except for the eleven third party properties) back to Sears Holdings, and also purchased the JV Interests.

Following the Chapter 11 bankruptcy filing of Sears Holdings on October 15, 2018, Transform Holdco LLC (“New Sears”) purchased substantially all of the assets owned by Sears Holdings for $5.2 billion. The new company is owned by Edward Lampert’s ESL Investments.

As the folly continues, Old Sears is suing New Sears.

Sears Holdings has been the textbook value trap, even for the most sophisticated value investors. For example, Chou Associates put nearly $50 million into SHLD beginning in 2005. I was interested to learn, however, that the investment was nearly only dead money (not including opportunity cost) due to the material earnings on lending their stock out for short selling.

Chou Associates 2018 Annual Report

Eddie Lampert has a hall-of-fame track record. And when Eddie merged K-mart with Sears, I think value investors assumed Eddie would focus on increasing shareholder value via asset conversion. I don’t think anyone was expecting Eddie to use the assets in an attempt to do a turn-around.

Bruce Berkowitz has been a long time believer in the value opportunity at Sears Holding, but has recently thrown in the towel as well.

Management has given up on Hometown

The Hometown segment has experienced multiple successive years of operating losses that have continued, and are continuing, to worsen. For SHO’s 2014 fiscal year the Hometown segment’s operating loss was $11.9 million, excluding the impact of goodwill impairment. The segment’s operating losses have grown each year since then, and the segment suffered an operating loss for our 2018 fiscal year of  $58.3 million. […] SHO believes that these cost increases and Kenmore and Craftsman availability issues are unlikely to improve in the near term and perhaps longer. We also believe that we have exhausted all of the means at our disposal to turn the segment’s businesses around. We also believe that, regardless of our commercially reasonable efforts to improve the Hometown segment’s operating results (which efforts we intend to continue), the segment likely will continue to experience operating losses.

2018 10-K

Freeing up working capital

Store Activity: 
In the third quarter of 2016, we opened four new stores and closed 12 under-performing stores in Hometown. For the first three quarters of 2016, we opened six stores and closed 51 stores in Hometown and had no openings or closures in Outlet. The Hometown closures, which unfavorably impacted EBITDA $0.6 million during the first three quarters of 2016, are largely part of our previously disclosed intent to close the portion of our Hardware stores and Home Appliance Showrooms that have historically underperformed. We continue to take proactive steps to make the best use of capital and reduce costs. In the fourth quarter of 2016, we anticipate closing approximately 100 locations (90 Hometown segment; 10 Outlet segment) resulting in one-time charges of $17.0 million to $19.0 million related to inventory markdowns, future rent obligations, and impairment of fixed assets. These closings will also free up approximately $30.0 million to $40.0 million of net working capital that can be used more productively.

2016 Third Quarter Press Release

2019

On April 5, the company received a proposal from Eddie Lampert, via Transform Holdco LLC, an entity affiliated with the company’s majority stockholder ESL Investments, to acquire all of the outstanding shares of the company’s common stock not already owned by ESL and its affiliates for a purchase price of $2.25 per share.

This has to be considered a low-ball offer and certainly not in the interest of existing shareholders. I view this offer as another strike against Eddie. (I assume he wants to use Transform Holdco instead of ESL for tax reasons, i.e., to better utilize the NOLs.)

The company granted a special committee of independent directors (Kevin Longino, William Phelan and David Robbins) exclusive authority to review and evaluate the proposal.

The special committee countered at $9.50 per share, which ESL Investments considered “unrealistic”. In addition, the special committee and board communicated to ESL Investments, that, absent a deal, they would move to liquidate the Hometown Division. This must have been a hail-Mary plan, in the hopes of pushing Eddie towards a more reasonable number.

Not surprisingly, on April 15, ESL Investments stepped in and fired board members William Phelan and David Robbins, replacing them with Alberto Franco and John Tober. In addition, they amended the by-laws to prevent any future liquidation without better board representation.

From current Proxy

2018

Completed the sale of a property in Newington, Connecticut. The sale price of the property was $2.8 million net of closing costs, and recorded a gain on the sale of approximately $1.4. Did not sell any owned property in fiscal 2017. There remain a few pieces of hidden property for sale.

Risks

  1. Eddie comes in with another low ball offer
  2. See #1

Write-Ups

Multiple write-ups on VIC

csinvesting blog [here]

Disclosure: We currently own shares, but are in the process of closing our position. I don’t see the probablity of the buyout going above $2.25 to be very high.

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