Monish Pabrai invested in 4.73 million shares of Seritage Growth Properties (SRG, Financial) in the 2020 second quarter. During the quarter, shares traded for an average price of $10.04 each. He previously sold out of the stock three years ago.
Given that Pabrai owned the stock before, I think it is logical to assume that he knows the company well and has pounced on it because he sees it as very undervalued.
Other guru owners
Hotchkis & Wiley, a value-oriented mutual fund company, has also added about 11% to its Seritage stock holdings in the quarter as the stock took a dive.
Another notable value investor who has recently added to Seritage holdings is Guy Spier of Aquamarine Capital. Gurufocus shows that other Gurus holding Seritage include Third Avenue Management (Trades, Portfolio) with 594,279 shares (which reduced its investment by -8.8% during the quarter) and Mario Gabelli (Trades, Portfolio) with127,500 shares (after reducing the position by -22.45% during the quarter).
Value buy or value trap?
Seritage is selling at less than a third of the market value investors assigned to it prior to the Covid-19 crisis. Based on the median price-book ratio, the REIT appears to be selling at fire-sale prices. Thus, should we join Monish Pabrai is pouncing on this investment? Or is the risk of walking into a value trap too high?
Seritage is a real estate investment trust (REIT) which was spun out of Sears Holdings five years ago (June 2015) as rights offering to Sears stockholders. Sears Holdings has declared bankruptcy in October 2018 and Seritage is in the process of cutting off all remaining ties with its former parent. The value of Seritage derives from the redevelopment potential of the former Sears properties spread across the U.S. Edward Lampert (Trades, Portfolio), the former chairman of Sears Holdings, is also the chairman of Seritage.
The REIT's portfolio consists of over 30 million square feet of existing buildings and approximately 2,500 acres of parking lots and developable land. Seritage owns assets in 44 U.S. states, with the highest concentrations in California, Florida, Texas and the Northeast. These denser markets where the company owns and controls 10-15 acres of contiguous, unencumbered land is a unique and very valuable asset. Many of these sites sit on the front of major shopping nodes, with road networks and much of the physical infrastructure already in place.
Over the last several years, Seritage has completed or commenced 106 projects. Almost all of these projects involved tearing down existing buildings or turning enclosed space to the outside. The strategy is to sell off smaller and less desirable locations and redeploy funds into developing properties in wealthier areas with better potential.
Seritage's business strategy
Seritage's primary objective is to create value for its shareholders through the re-leasing and re-development of the majority of its wholly-owned properties and Joint-Venture properties. It seeks to do so by:
1) converting single-tenant buildings (currently or formerly occupied by Sears or Kmart prior to redevelopment) into multi-tenant properties at a higher rent
2) develop its urban landholdings (it has 2,800 acres of land or an average of 13 acres per site) through mixed-use (retail, residential, office, etc.) densification
3) leverage existing and future joint venture relationships with leading real estate and financial partners (Seritage owns 50% interest in 28 JV Properties, including 23 properties in joint ventures with leading regional mall REITs and five properties in joint ventures with other institutional partners).
Balance Sheet
Seritage has approximately $1.6 billion in long term billion debt on the balance sheet compared to $139 million in cash.
Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (BRK.A)(BRK.B) holds all of its long term debt as a term loan. On July 31, 2018, Seritage entered into a Senior Secured Term Loan Agreement providing for a $2.0 billion term loan facility with Berkshire Hathaway Life Insurance Company of Nebraska. The Term Loan Facility provided for initial funding of $1.6 billion at closing and includes a $400 million incremental funding facility. The Term Loan Facility matures on July 31, 2023.
The following is a summary of key points from Seritage's financials over the last four years.
| Fiscal Year | Revenue (mil) | YOY (%) | EPS | Debt/Equity | Cash (mil) | DPS | YOY (%) | Shares (mil) |
| 2019 | 169 | -21.5 | -3.20 | 2.19 | 139 | 0.25 | -75.0 | 56 |
| 2018 | 215 | -10.9 | -4.17 | 2.05 | 533 | 1.00 | 0.0 | 56 |
| 2017 | 241 | -3.1 | -2.38 | 1.52 | 242 | 1.00 | 0.0 | 56 |
| 2016 | 249 | - | -1.25 | 1.45 | 52 | 1.00 | - | 54 |
The company's Cash Flow from Operations is currently negative (not a great position to be in) and it has discontinued its dividend. Seritage earned a loss of $8 million in cash flow last quarter.
Closing thoughts
It looks like to me that Monish Pabrai is betting that Seritage will be able to sell enough of its properties so that it can continue to fund the development of its remaining higher value properties and be able to renew Berkshire's term loan and line of credit.
Pabrai usually invests in potential multi-baggers, and the upside here is likely several times his buy price. If Pabrai bought the stock in May, he could already be up by about 100%.
However, it is clear that there is a lot of risk in this investment due to most of its projects still being in development, especially if the economy worsens and Seritage is unable to get access to capital. This could force it into bankruptcy, wiping out the equity.
Disclosure: The author does not own Seritage stock at the time of writing.
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