SRG - Seritage Growth Properties

[Foreign Tuffett]

Traditional retailers have been performing poorly lately and plan to close stores (GAP, M, plenty of others). I have seen arguments in the media that mall space in particular, and physical retail locations in general, are overbuilt in the US. Anecdotally, my limited experience from observing malls in the Nashville area is that malls can fall into downward spirals very quickly once things start to move in the wrong direction.....sort of an anti-lollapalooza effect. Any thoughts?

I don't follow SRG or SHLD closely, so apologies in advance if this has been covered already.

[glorysk87]

Reading through the 10-k, apparently lease termination fees for the Type 1 properties are capitalized and depreciated over the life of the new lease. Is this typical accounting treatment for a lease termination fee?

If so, is the depreciation expense related to the lease termination fees included in the real estate depreciation add-back in calculating FFO?

[glorysk87]

This may be a stupid question.

But the value creation in the SRG portfolio appears to be a no-brainer. The real risk is a SHLD bankruptcy before SRG is able to transition most of their portfolio to 3rd party tenants.  So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD? 

[benhacker]

So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD?

What do you think you would be willing to pay for this insurance?

$13 '18 puts on SHLD are ~$4.50 / share to buy.  So for >30% of the value of SHLD, you can protect a drop for price a bit below the current price.

The problem with hedging this is *everyone* wants to be hedging this.  The cost is very high.  borrow on the stock is in the teens, holdco debt yields 15% annually, etc etc etc.

[scorpioncapital]

You might want to look at the single stock future market for this. True, you have to roll over every 6 months but it may be a better deal - https://www.onechicago.com/?p=1018

[glorysk87]

What do you think you would be willing to pay for this insurance?

$13 '18 puts on SHLD are ~$4.50 / share to buy.  So for >30% of the value of SHLD, you can protect a drop for price a bit below the current price.

The problem with hedging this is *everyone* wants to be hedging this.  The cost is very high.  borrow on the stock is in the teens, holdco debt yields 15% annually, etc etc etc.

I don't agree with you on this. Why would you buy the $13 puts?  The real risk is a SHLD bankruptcy, so you'd want to buy very far out of the money puts.  You could mostly hedge out the risk by buying $5 Jan '18 puts.  That costs about $67k per $1mm of exposure, which isn't too terrible.  You wouldn't have to roll the position either, because by 2018 enough of the SRG portfolio should be redeveloped that the risk of SHLD blowing them up would be greatly diminished.

[peridotcapital]

This may be a stupid question.

But the value creation in the SRG portfolio appears to be a no-brainer. The real risk is a SHLD bankruptcy before SRG is able to transition most of their portfolio to 3rd party tenants.  So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD?

Or maybe that risk is muted once SRG leases out enough 3rd party space that the profit from those leases covers their interest payments, corporate overhead, and the carry costs of the Sears space. As long as SRG could be at cash flow break-even the day after a Sears liquidation began, I doubt their stock would take that large of a hit given the underlying value of the real estate. Given the rent spreads, that point in time will be here well before they have reached a 50/50 square footage split between Sears and third parties.

[glorysk87]

Or maybe that risk is muted once SRG leases out enough 3rd party space that the profit from those leases covers their interest payments, corporate overhead, and the carry costs of the Sears space. As long as SRG could be at cash flow break-even the day after a Sears liquidation began, I doubt their stock would take that large of a hit given the underlying value of the real estate. Given the rent spreads, that point in time will be here well before they have reached a 50/50 square footage split between Sears and third parties.

I put together a pretty comprehensive model. My model concludes that SRG needs to have fully half of their portfolio recaptured in order to have any sort of margin of safety.  The timeline for this to happen, at the current redevelopment pace, is the next year and a half. At that point, SRG should have enough of the portfolio turned over that a SHLD bankruptcy wouldn't doom them.  But that still puts you at the end of 2017.  Which is why my thought was to buy the Jan '18 puts for a hedge.  At a cost of $67k per $1mm of SHLD exposure the cost is not significant.

[peridotcapital]

I put together a pretty comprehensive model. My model concludes that SRG needs to have fully half of their portfolio recaptured in order to have any sort of margin of safety.  The timeline for this to happen, at the current redevelopment pace, is the next year and a half. At that point, SRG should have enough of the portfolio turned over that a SHLD bankruptcy wouldn't doom them.  But that still puts you at the end of 2017.  Which is why my thought was to buy the Jan '18 puts for a hedge.  At a cost of $67k per $1mm of SHLD exposure the cost is not significant.

Last quarter they signed new third party leases totaling 214,000 square feet. How on earth can SRG recapture 50% of all the Sears space over the next 18 months?

[glorysk87]

Last quarter they signed new third party leases totaling 214,000 square feet. How on earth can SRG recapture 50% of all the Sears space over the next 18 months?

On an ABR basis, not a Sq Ft basis. If you're measuring on Sq Footage you're basically missing the entire investment thesis.