Tick, Tock, Says The Clock

NoahBlacker

Brad Thomas wrote this article and it has appeared previously on Seeking Alpha.

Summary

  • Sears has a piggy bank called Seritage Realty Group that was formed as a REIT to allow the struggling department store company to monetize its vast real estate holdings.
  • "The '$10k' question in the eyes of most real estate investors involves the timing of the eventual Sears bankruptcy filing." - Floris van Dijkum.
  • It certainly seems like Seritage is a time bomb. tick, tick, tick, tock, says the clock.
  • If you decide to "roll the dice," be prepared to lose it all.

According to Haley Paterson with Business Insider, "time is running out for Sears (NASDAQ:SHLD)." The business reporter recently wrote that "S&P Global Market Intelligence has identified Sears as the most vulnerable public retail company in the US, saying it has a 24% chance of default with a year."
Paterson went on to explain that "this comes after Sears revealed (in April) that it has lost its second chief financial officer in six months, just as it begins talks with lender over a looming $500 million debt payment."
Talk about a hot seat!
Wait though, Sears has a piggy bank called Seritage Realty Group (NYSE:SRG) that was formed as a REIT to allow the struggling department store company to monetize its vast real estate holdings.
If you may recall, billionaire investor Edward Lambert, the hedge fund titan, has been working feverishly to keep Sears afloat, and by selling off the pieces (Lands' End, Sears Canada, Sears Hometown, etc.), he has kept the lights on, at least for now.
Seritage, formed by Lambert, was just another outlet for Sears to liquidate its real estate portfolio, essentially obtaining $2.7 billion in capital for Sears in return for a promise to pay in the form of a large-scale sale/leaseback.
According to REIT analyst Floris van Dijkum with Boenning and Scattergood, Inc., "the '$10k' question in the eyes of most real estate investors involves the timing of the eventual Sears bankruptcy filing." Dijkum went on to explain:
Even Sears recent SEC filing has said it may not last as a going concern, but clearly Eddie Lampert (the largest shareholder and unsecured debtholder) has defied expectations before.
So it seems that in the game of musical chairs, the song is almost in the last stanza. The key question for Seritage Property investors is whether or not there are adequate returns to compensate investors for the outsized risk.
According to Dijkum, there are "shrinking options," and he adds that "a delayed bankruptcy scenario for Sears buys Seritage time to commence as many redevelopments as possible to boost third party income," cautioning that "with approximately 30% of Seritage shares sold short, the company could have significant potential equity demand for an equity raise as hedge funds cover their short position."
It certainly seems like Seritage is a time bomb... tick, tick, tick, tock, says the clock...

The Looming CashSqueeze
In a research report, Dijkum suggests that Seritage has a "looming cash squeeze," as the company continues to burn through its remaining cash before completing its existing recaptured Sears space. He writes:
The company is in a race to hasten redevelopment of former SHLD-leased space in order to prepare for its lead tenant's widely anticipated demise. While management continues to deliver strong releasing spreads and attractive returns, we see a looming cash shortfall without a major capital raise. The recent recapture notices that top properties will require larger development capital outlays, exacerbating an imminent liquidity crunch.
Did you say "liquidity crunch?" I thought Lambert and fellow billionaire Warren Buffett were funding the Seritage redevelopment story...
As I wrote in a previous article, Buffett is aninvestor in Seritage (he also owned Tanger (NYSE:SKT) at one point of time), but he appears to be a passive investor. Lambert is kind of wearing two hats here - he's the landlord and the tenant - and he has never been a big fan of raising equity (because it dilutes his ownership stake).
Also, according to Dijkum, "Seritage missed the opportunity to raise fresh equity at much higher levels, investors have asked what options the company has remaining to refinance either the $200 million ESL (Lambert's fund) facility that matures in December or its $1.1 billion restrictive CMBS facility that matures in July of 2019."
Dijkum believes management is undoubtedly trying to obtain other debt funding, but banks and the capital markets appear closed for Sears credit. The company, however, could look to combine refinancing its stabilized assets with select asset sales to pay down its CMBS.
At the end of Q1-17, Seritage's remaining unrestricted cash went from $52 million to $26.5 million during the quarter, while total outstanding debt of $1.2 billion rose by $7 million. The company has $73 million of cash available from its $100 million line, $113.9 million of restricted cash (including $11.4 million for environmental remediation) and $200 million (in staged drawdowns) from the ESL facility.
According to Dijkum, the "simple math suggests approximately $423.4 million of available cash ($506 million if we include two years of estimated free cash flow of $81 million) with $394.5 million to spend on committed wholly-owned projects."

Dijkum points out that Seritage is also doing at least nine JV projects in its GGP JV (all 12 at roughly $110 million), while it has newly committed to at least another $62 million spend on its seven recapture boxes. He expects costs for the GGP JV and newly recaptured boxes could be significantly higher than these estimates.
So, even with approximately $40 million of annual retained free cash, the REIT analyst suggests there is a "looming shortfall of over $61 million."
Tick, tock, tick, tock, says the clock...
Who Wants a Ticking TimeBomb?
Mr. Market's alarm clock appears to have no alarm button. In other words, Seritage remains the only mall REIT that trades at a premium to estimated NAV and a massive NAV relative premium.

I just don't get it. Seritage leases a majority (~60%) of its space to a junk bond tenant, and Mr. Market thinks Seritage is a Tiffany's - Seritage trades at more than a 43% relative NAV premium to its "A" mall peers.
Even more telling, Seritage reported first-quarter FFO of $0.56 per share. Overhead costs increased by $3 million compared to the previous quarter, while reimbursements declined by $1.5 million. Excluding the $6.1 million Sears lease termination payment, company FFO came in at $0.48 per share.

I get it, Seritage is chopping wood in an attempt to redevelop as many Sears stores before "the fat lady sings." During the quarter, the REIT signed 535,000 square feet of space at $16.41 per square foot, or 4.0 times rent multiple over previous rent. Also, Seritage generates around 12-13% returns on capital spent to redevelop Sears' recaptured space.
But again, it's a game of musical chairs, and if Sears files for bankruptcy, Seritage will have to scramble to put the wheels back on the bus. As Dijkum explains:
(Seritage) has insufficient third party rental income to service its debt at the time Sears files, Eddie Lampert becomes part of any debt restructuring through his unsecured loan. With approximately 30% of SRG’s shares sold short, the company could have significant potential equity demand for an equity raise as hedge funds cover their short position.
Dijkum adds that "large shareholder Fairholme Capital has continued to add to its SRG position, having bought over 240,000 shares since ESL has distributed 2.2 million units."
Tick, tock, tick, tock...
Don't Be Too Cute
I know you get tired of me saying, "Don't Get Too Cute," but I'm simply trying to steer investors to safety, and that means always reminding folks to protect their hard-earned principal at ALL costs.
Some have criticized me for not jumping on the Washington Prime Group (NYSE:WPG) bandwagon, but given the continued volatility in the retail sector, I am just becoming a more defensive investor. Most all Retail REITs, except for SRG, are trading at deep discounts, so when the blue light specials are flashing, why not buy the best instead of the worst?
As I explained, Sears' days are numbered, and J.C. Penney (NYSE:JCP) is not too far behind. Although WPG does appear to have a well-protected dividend, a loss of rent from Sears means the landlord will also have to fund taxes, insurance and maintenance expenses. In addition, many leases have co-tenant clauses, so the loss of an anchor store could set off a chain reaction that could erode the margin of safety of the dividend.
My point is, I consider SRG to be highly speculative and WPG to be speculative. If you decide to "roll the dice," be prepared to lose it all.
There's a reason that Buffett owns shares in WPG... he is RICH, he can afford to take a hit. Can you?
I have provided a list of Mall REITs, based on projected FFO/share data (obtained from F.A.S.T. Graphs). As you can see, SRG's forecasted growth is above average in 2018, "if the company can successfully execute on its development pipeline." However, if Sears "bites the dust," the music could end and you could be standing with no chair. Tick, tock, says the clock.

Source: F.A.S.T. Graphs
To get a first look at my upcoming article, "The Evolution of My Durable Income Portfolio," click here. I also include all of my Rhino REIT Ratings in my marketplace product, REIT Beat.
Author Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Other Mall REITs mentioned: Taubman Centers (NYSE:TCO), Simon Property Group (NYSE:SPG), SKT, GGP, Inc. (NYSE:GGP), WPG, Pennsylvania Real Estate Investment Trust (NYSE:PEI), and Macerich Co. (NYSE:MAC).

I am days away from launching my re-branded REIT Investor site that will include real-time REIT data (including portfolios) for over 125 REITs. For the first time, investors will be able to access REIT research reports and exclusive CEO interviews, including leading financial metrics that are institutional quality.
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Disclosure: I am/we are long APTS, ARI, BRX, BXMT, CCI, CCP, CHCT, CLDT, CONE, CORR, CUBE, DLR, DOC, EXR, FPI, GMRE, GPT, HASI, HTA, IRM, KIM, LADR, LTC, LXP, O, OHI, PEB, PK, QTS, ROIC, SKT, SNR, SPG, STAG, STOR, STWD, TCO, UBA, VER, WPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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