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Sears - Going Private?

January 17, 2012 | About:
Todd Sullivan

Todd Sullivan

22 followers
It been a while but the “SHLD is going private" drum beat is back. I looked at this in 2008, and really the case against Lampert taking private has strengthened. This isn’t to say he may not want to or try, just that his ability to do it has been reduced.

From the SEC Website:

“If the transaction is initiated by an affiliate (an insider) of the company, or the company could be deemed to be making an acquisition of its own shares Rule 13e-3 of the Securities Exchange Act of 1934 requires the affiliate and/or the company to file a Schedule 13E-3 with the SEC. When Rule 13e-3 applies, the company is said to be “going private” under SEC rules. While SEC rules don’t prevent companies from going private, they do require companies to provide information to shareholders about the transaction that caused the company to go private. The company also may have to file a merger proxy statement or a tender offer document with the SEC.

The filing of a Schedule 13E-3 is also required when issuer-initiated or affiliated transactions result in a company’s publicly held securities no longer being traded on a national securities exchange or an inter-dealer quotation system, such as Nasdaq.

The Schedule 13E-3 requires a discussion of the purposes of the transaction, any alternatives that the company considered, and whether the transaction is fair to all shareholders. The Schedule also discloses whether and why any of its directors disagreed with the transaction or abstained from voting on the transaction and whether a majority of directors who are not company employees approved the transaction.

Going private transactions require shareholders to make difficult decisions. To protect shareholders, some states have adopted corporate takeover statutes that provide shareholders with dissenter’s rights. These statutes provide shareholders the opportunity to sell their shares on the terms offered, to challenge the transaction in court, or to hold on to the shares. Once the transaction is concluded, remaining shareholders may find it very difficult to sell their retained shares because of a limited trading market.”

So the “Lampert can force a share sale” is erroneous. While he could take the shares off the market by “going private”, he cannot force you to sell your shares to him if Sears’ decided to go private. You could still opt to retain your ownership percentage. It is different from a merger in which you “exchange shares” from one company for another.

“Fairness of offer”. This was a large bone of contention in the failed Sears takeover of Sears Canada. Sears USA owned 53% of the outstanding shares of Sears CA at the time of the offer. The buyout was fought in court by minority shareholders who eventually prevailed. The fact that Lampert has been buying share at prices far above where they sit now, would eliminate any argument he would make that a “going private” price he is offering does NOT violate this element.

Let’s look closer here at the “fairness”:

Fair Value of Consideration entails…

  • A statement regarding whether the consideration offered to unaffiliated security holders constitutes fair value in relation to:
  • i. current market prices;
  • ii. historical market prices;
  • iii. net book value;
  • iv. going concern value;
  • v. liquidation value;
  • vi. the purchase price paid by the filing person or entity in any acquisition of the subject company’s stock within the previous two years;
  • vii. any report, opinion, or appraisal described in Number 8 herein; and
  • viii. any other firm offers received by the subject company within the past two years involving a merger, or consolidation, a sale of all or substantially all of the company’s assets, or a purchase of the company’s securities that would effect a change of control.
  • Statements to the effect of “The Rule 13E-3 transaction is fair to unaffiliated security holders in relation to net book value, going concern value and future prospects of the issuer”, are not sufficient.


Lets look at statements from some recent Chairman Letters of Lampert to shareholders:

Feb 2008 Letter

During the year we increased our buyback activity and reduced our shares outstanding by nearly 15% as we repurchased approximately 22 million shares at an average price of $135 per share. In hindsight, although we believe it was a prudent use of cash, it would have been better if we had exercised more patience in the buyback as our share price continued to decline as the year progressed. However, my experience is that it is difficult to predict short-term stock price performance and that one should make the best decisions one can with the available information and a long-term perspective.

From the Feb 2011 letter

At Sears Holdings, we seek to create long-term value for our shareholders. Like Apple, we seek to do so by improving our operating performance, innovating, and delighting customers. In this area, we have fallen far short of our goals and what we aspire to do in the future. On the second dimension of capital allocation, I believe that our behavior and focus has served our shareholders well over the past eight years and will magnify the value creation when our operating performance improves. We built cash when we felt that it was the right decision for our shareholders, and we delivered cash to those who elected to sell their shares when we felt that it was the right thing to do.

Share repurchases are not a panacea, nor are they a singular strategy. Yet, they are more than just the return of capital to shareholders. They represent an investment by the non-selling shareholders in the future of the business and the company. By repurchasing shares from selling shareholders, the remaining shareholders increase their ownership stake, thereby taking the additional risk and additional upside potential based upon future performance. When coupled with outstanding operating performance, share repurchases magnify returns. When the price paid is attractive relative to future performance, share repurchases magnify returns. As a form of discipline on alternative capital allocation strategies, share repurchases can magnify returns. But, at the wrong price, with poor future performance, share repurchases can harm returns.

Despite our challenging performance over the past several years, the difficult economic environment, and the dramatically changing retail environment, we have generated very attractive returns for shareholders since May 2003, when we assisted Kmart in its emergence from bankruptcy. Others in our industry have grown their revenues since that time, some have grown their profits, but many have been unable to deliver shareholder performance in the past eight years.

Lampert is going to have a hard time convincing a court (yes it will end up there) that an tender offer of even $50/share is “fair”. When you spent the last two years using shareholder funds to purchase shares over $100 each saying the LT value was higher, how can you now turn around and say anything less in “fair”? You can’t. Further, Lampert, as stated above would then have to provide supporting documentation as to why the company is now only worth $50/share after saying last year, when the price of the stock was >$80 that using stockholder funds to buy it at those prices is was a good use of funds? Anyone else think Lampert would avoid that at all costs?

Even if Lampert succeeds in getting Bruce Berkowitz to back a going private transaction (or do it together), the same problems remain. Berkowitz himself has said he views this as an asset play in which the value of the assets if >$100/share. He can’t support anything less now unless he is simply being cashed out, if he retains equity or participates in it, then he can’t. Anything other than a straight cash out of large minority shareholders means that their compensation has to be factored in with future residuals. For instance, if I am buying company “A” and there are two minority shareholders and I offer them both the same $ per share but offer person “B” 10% of the company for their vote, person “C” is getting a lesser deal and legally can demand more per share.

Lampert’s issue is that he a a majority shareholder seeking a buyout. That places a whole other level of scrutiny on any deal.

A way around this for Lampert is to offer current shareholders a stake in the privately held SHLD. The offer would be for “X” per share and those shareholders who did not wish to sell could retain their proportional ownership and receive annual payments of their proportional share of the profits or some similar structure. They could always sell the share later on secondmarket.com.

I’m not sure this is what Lampert would want, but it may be the best he gets.

So, bottom line is that if trying to do the deal now costs Lampert $15-$20 a share more, why not just continue to use shareholder $$ to shrink the float that much cheaper? He still has unfettered control and can use OPM to increase his ownership stake.

About the author:

Todd Sullivan
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.5/5 (20 votes)

Comments

steven149
Steven149 - 2 years ago
There is some reasoning in the article. Lampert seems determined to do that. From his trades in the past few days, I wonder if he can really be called a value investor. It is kind of gambling. I won't give him my money to manage. As a manager, stay calm and look at the balance sheet. Find good managers to the business. Don't look at the tape.
mo77
Mo77 - 2 years ago
I think the biggest problem with owning shares of Sears Holdings is that you don't get really get Eddie Lampert, highly regarded allocator of capital, what you get is Eddie Lampert, CEO of a 3rd rate retail company (we can talk all day about the perceived value of the real-estate).

If you regard Lampert as master allocator of capital ("The Next Warren Buffett?", as Businessweek so wondered) then you really don't benefit from that w/ an investment in SHLD.

Eddie Lampert's primary interest is not interested in growing value for shareholders of SHLD, but rather he is interested in returns for ESL investments and SHLD happens to be a large part of his portfolio. If he was interested in growing the value of SHLD, Lampert would use it as a long-term vehicle like Buffet did w/ Berkshire.
mrd
Mrd premium member - 2 years ago
Mo77 you are correct, but for it to be Lampert's investment vehicle, he would need to get personal control of SHLD, he presently has control of ESL with OPM.

In my opinion, he has been using his 2and 20 proceeds to "gain" control of SHLD. No one knows for sure what % of the funds in ESL is Lampert's. I would even think that the recent shares that were "bought" from his fund, was his share of the money invested in the one fund that ESL wound up recently, it appears that other investors in that fund took their refund in cash or AZO or AN shares (not many, if any at all, took SHLD shares) so the shares that Lampert "bought" was really his share of personal funds that were invested in that fund, as investors in that fund, would surly want to know that Lampert had skin in the game, they would not have wanted to invest in a ESL fund with a 5 year lock up, if Lampert did not have some of his own money invested alongside them. The additional shares he bought to round up to 5m, is probably new.

Esl still has money under management, so Lampert still has additional exposure to SHLD via this and will continue to make profit from 2 and 20 fees, until such time as the fund is liquidated. My guess on the timing of this would be whenever Lampert can PERSONALLY own 51% of SHLD directly and not via a fund with OPM.

I think that when SHLD posts it earnigs/loss in Feb, we will find out that SHLD has used most of the 500m of the outstanding board approved stock buyback authorization when the stock traded in the 30's. It is too coincidental to me that the proceeds of the 120 store closures is very close to the value of the remaining buyback authorization.

The banks or financial institution should nt be too pissed if they found out that the stores that were burning cash were closed to increase the ownership of Lampert, who they are ultimately depending on to turn around, or "shrink" the company to a more consistently profitable position.

If I were a betting man (I am not) I will say that we are no further than 2-3 years away from Lampert closing down ESL and making SHLD his investment vehicle, similar to Berkshire.

mrd
Mrd premium member - 2 years ago
It shouldn't take more than 2-3 years for Lampert to have control of SHLD personally, if you consider

What he personally owns (that we can see)

What he owns via his investment of his own money in ESL funds (what we don't see)

His increased investment of ESL funds every year (if he reinvests his 2 and 20 fees back into the fund)

SHLD continuing to shrink the float via buybacks at the low share prices we are seeing now.

If you are a Buffett historian, you will see the similarities of Lampert's actions.

Except that Buffett did not do it under a media microscope or with massive expectations from anyone.
mo77
Mo77 - 2 years ago


Mrd,

So you are saying this was Lampert's plan (creating an investment vehicle for himself) from the start w/ Sears Holdings or are you saying the parallel is that like Buffett he is made a mistake in capital allocation and creating the investment vehicle w/ Sears has been thrust on him?

My impression is that he bought Sears for ESL w/ the idea of buying back shares and making a load of money for his hedge fund. However part of the valuation was turning around the retailer, which he was able to do w/ Autozone. Since they have failed at Sears to do that, outside of the real estate he is stuck w/ worthless assets (similiar to Buffet's textile mills). So in that way it could parallel what Buffett ultimately did w/ Berskhire.

Perhaps at this point in time buying Sears shares makes sense w/ the thesis you suggested above, but if you bought them back when Eddie Lampert was on the cover of Businessweek, you were buying it w/ the idea that the real estate had real value and the idea that Lampert could turn it around like he was doing with Autozone at the time.
mrd
Mrd premium member - 2 years ago
Mo77 that is in fact what I'm alluding too. At this point Lampert is trying to make Lemonade from the lemons.

What is happening was not his origional plan, the worst housing market in recent memory and the headwinds facing most retailers as a result of the move to online shopping etc, made it difficult for Lampert to roll out a sustainable turnaround plan.

The company is not terminal in my view, however it does have several cancerous turmors that need removing.
mrd
Mrd premium member - 2 years ago
What puzzles me though, is that Kmart and Eventually SHLD is the first and only of his investments that Lampert positioned himself in the Chairman's position (I stand to be corrected on this)

I think that he was looking to eventually exit the Hedge Fund business, as taking calls from worried investors can be a real distraction and emotional drain (think about what Berkowitz is going through now with his investor redemptions) He may have thought SHLD was it, however I definitely think that he underestimated the challenge (as evidenced by the revolving door in the CEO and other top management positions)

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