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Murray Stahl's Horizon Kinetics on Sears Canada

January 18, 2014 | About:

It can take weeks or even months to qualify a security or sector for purchase in our portfolios. Recently, it required not so many days, perhaps a Horizon Kinetics record, and it couldn’t have been done without the assistance of the press. This is the article that caught my eye some weeks ago. Note the decisive, emotive terminology. From the headline itself: “Sears Canada…In Bid to Survive”, and from the 2nd sentence in its own standalone paragraph: “…lightens its ballast in a bid to stay afloat.”

At the time, I was familiar with Sears Canada mainly in the context of its parent company Sears Holdings, rather than having evaluated it as a standalone investment. I did not have the impression that financial distress was one of the company’s failings. Here is the analysis, which required very little in the way of special training—no ‘deep dive’ here, no databases or Excel spreadsheets. The October 29th article reported that the company agreed to surrender the leases at five of its full‐line department stores to the landlords, in exchange for which the company received a payment of $400 million. These are not stores that Sears owned, mind you; they were leased, which is usually shown on the balance sheet as an obligation. But these leases probably had decades before they expired, and apparently the landlords were willing to pay substantially to control those properties again. At the time, the entire stock market value of Sears Canada was only $1,450 million, so surrendering those five leases provided cash equal to over one‐quarter of the company’s market value. Moreover, the company still had 111 additional full‐line stores remaining as well as over 300 smaller‐format stores and other assets.

Well, looking at some older articles, it seems that several months earlier Sears Canada had done the same thing: in June it agreed to vacate two stores, for which the landlords paid the company $191 million, and the landlords have an option to have the company vacate a third store within five years for an additional $53 million. And the prior year, the company did the same, receiving $170 million for vacating three stores. If you try this yourself, you’ll see that this part of the analysis doesn’t require much effort.

The above article suggested that Sears Canada was in financial trouble, so one must review the balance sheet. Here is what was on that balance sheet as of August 2013: net current assets: $559 million, of which cash was more than $300 million; debt: $46 million; and retirement liabilities: $415 million, and heading down. That’s a rather liquid balance sheet if a company is not losing money. As to losing money, the company’s operations were cash‐flow positive in the preceding year. This didn’t take too much time either.

So, if the company agreed to vacate six stores for $644 million, how much might the rest be worth? The annual report provides information that the average size of the full‐line department stores is a bit over 128,800 square feet. In that case, the $644 million, for those 11 stores amounts to about $450 per square foot. Now some would say, and they’re probably right, that these were among the best located, most valuable Sears Canada stores, and that the remaining 111 full‐line stores are worth far less.

Ok. Our investigations suggest that merely to construct a mall store costs well above $100 per square foot. If we assume that the remaining full‐line stores are worth only that much, then 111 stores x $100/sq ft x 128,800 sq ft/store = $3.03 billion, or $29.78 per share. That was over twice the market value of Sears Canada at the time. Nor does that calculation include the 300‐plus other properties. Nor does it include the top four full floors of the Toronto Easton Centre, the premier shopping center/office tower/hotel complex in Toronto, which the company did not vacate as part of the October transaction. Nor does it make allowance for development or redevelopment opportunities at certain locations, a major one of which is currently in process. This part of the analysis involved no Excel spreadsheet and no Bloomberg terminal. It did involve the equity yield curve—most investors are not as interested in value 2, 3, or 4 years from now as they are in what can be seen or reported in the here and now, and that disinterest can translate into very significant discounts. That is an intrinsic part of our portfolio construction process.

Source: Horizon Kinetics Market Commentary - 4th Quarter, 2013

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