Seritage Growth Properties (SRG, Financial) jumped when word got out Warren Buffett had bought 2 million shares for his personal account. Seritage is REIT spin-off from Sears Holding (SHLD) and primarily holds real estate occupied by Sears and Kmart stores. The company has a master lease agreement under which it leases all these properties back to Sears Holding. Sears Holding shareholders and gurus Eddie Lampert and Bruce Berkowitz (Trades, Portfolio) of Fairholme Capital Management subscribed to the rights that were offered along with the spin-off to acquire more equity in the company.
With Buffett now buying shares in his personal account, the company clearly deserves a good hard look. Scaring away people is the counterparty risk because leasing to Sears and Kmart doesn’t sound like you have the most creditworthy occupants in your properties. As a European, I haven’t ever set foot in a single Sears or Kmart, but from everything I've read about these stores, the assessment of them being untrustworthy counterparties is probably at least reasonable.
However, the agreement between Seritage and Sears Holding doesn’t seem to lean very much on Sears Holding continuing to pay rent. The agreement says, among other things, that Seritage can take up to half of the gross square footage of any of its properties and release this space to a third party. It can also kick out Sears entirely under some circumstances where it can make much more money.
The current rent paid by Sears is on the low side of the spectrum, not surprising given the poor state of its operations. I think Buffett’s master plan entails that either the turn-around at Sears gains traction at some point, and when leases have to be renewed, better deals can be negotiated, but he also wins if Sears fails or better tenants can be found by Seritage. Because REITs pay out so much and pay so few taxes, a inbuilt lever for growth is much more valuable than it is in regular companies. Because REITs usually do not retain much capital, they have a hard time growing earnings, however, that isn’t necessarily the case here. Therefore you could argue Seritage should trade at a premium to most REITs, but it doesn’t. Seritage trades at 1.4x book value and 13.5 EV to Ebitda. This with a relatively modest amount of debt equal to about 1x its market cap.
This is more or less a win-win situation, which is exactly the way old-school Buffett likes his investments. With Berkshire, his funds are not very nimble, and he tends to invest in companies that are going to outperform over the next decade(s). But when he was still managing small amounts of money, these types of investments were his bread and butter. It is great to see that the old master is still many steps ahead of the market.
