SRG - Seritage Growth Properties

[scorpioncapital]

Also if you will value SRG on cash-flows, I'm thinking their character should change due to the difference between maintenance capex vs growth capex. Growth capex should be higher in the next few years capped only by available cash and rate of redevelopment, but maintenance capex should dominate thereafter so I would bake in a higher FFO to NOI fraction in the end years.

[SlowAppreciation]

Also if you will value SRG on cash-flows, I'm thinking their character should change due to the difference between maintenance capex vs growth capex. Growth capex should be higher in the next few years capped only by available cash and rate of redevelopment, but maintenance capex should dominate thereafter so I would bake in a higher FFO to NOI fraction in the end years.

Makes sense. What do you estimate for growth capex, maintenance capex, and annual depreciation charges?

[scorpioncapital]

I haven't dived in to all the details but I took the (potentially too conservative) approach of assuming average rent per sq = 2x current rent and that if the stated return of 12% is accurate and terminal cash flow is 320m (Sears in place rent: 80% of 150m * 2 - 150m) and today total rent is 200m, then 120m of incremental fcf cash flows @ 12% = 1 billion growth capex.

I'm not sure how to measure maintenance capex. Funny, in the supplement on pg. 9 maintenance capital expenditures has a '-' in both 3 & 6 month periods of 2016. For July to Dec 2015 it's 21m. My suspicion is that if you could separate it out in a few years it won't be large enough to affect the valuation too much but that may not be true.

[SlowAppreciation]

I haven't dived in to all the details but I took the (potentially too conservative) approach of assuming average rent per sq = 2x current rent and that if the stated return of 12% is accurate and terminal cash flow is 320m (Sears in place rent: 80% of 150m * 2 - 150m) and today total rent is 200m, then 120m of incremental fcf cash flows @ 12% = 1 billion growth capex.

I'm not sure how to measure maintenance capex. Funny, in the supplement on pg. 9 maintenance capital expenditures has a '-' in both 3 & 6 month periods of 2016. For July to Dec 2015 it's 21m. My suspicion is that if you could separate it out in a few years it won't be large enough to affect the valuation too much but that may not be true.

I've spent more time on Seritage this weekend, and so far I really like what I see. I've tried "killing" it a number of ways, and even with very conservative estimates, 12%-13% per/yr return seems very attainable.

One thing I'm looking for more clarification on: I read that management estimates $100/sqft for recapturing/capex costs. The model I built has them recapturing ~2m sqft/yr for the next 10 years, but that would require ~$200m/yr in capex costs. AFFO would then be negative for the first ~5 years. Are my cost estimates too high?

[scorpioncapital]

Maybe someone can chime in on the last question, but pg 14 of the sup (dec 2015) shows the current projects at 1 million square feet at $160m or so cost. (June shows 350k sq ft, ~50m, ~10m revenue). Even higher redevelopment cost at 160/sq ft. However, they seem to project cash flow of $33 sq ft. ($20 sq ft June 2016)
 On the face of it, it appears they are going for their highest value developments first and then will move down to lower cost ones.
But I see no requirement to complete this in 1 year. They seem to have 70m fcf so this could take 2-3 years for 1 m square feet. On the other hand, they do have some cash on hand of $250m to dip into. I hope they can self-sustain but I can see the counter-argument that to speed this process up they might need more cash. It's like your own business. If you don't have enough cash you can wait until your bank account builds up or you can go and get a loan if you are in a hurry to do something.

However I'm totally stumped why they pay a $1 dividend at all which doesn't make any sense to me other than a vague thought that they want to pay shareholders for "waiting around". This doesn't strike me as entirely rational. I'm not too clear on REIT laws though and whether they must pay out based on NOI or based on free cash flow after all capex. They could easily engineer to have zero or close to zero fcf if that allowed them to avoid paying a dividend and develop faster. On the other hand, Seritage appears to be a low cost supplier pushing large new supply into the retail real estate market. Perhaps there is also an argument to be made that too fast development would depress prices and the goal is a measured, steady supply coming online in conjunction with economic recovery.

[notorious546]

RBC Initiation report attached. might be of interest.

[scorpioncapital]

"To that end, Seritage has the opportunity to
re-imagine that space with an eye toward adding other elements that may be
missing including entertainment, residential units, office space or even a hotel. "

This is interesting, I've seen a number of these mall/hotel/office hybrids popping up with great success in my suburb. Likewise, atop rail/metro lines. If this goes through, the upside above and beyond just stores redesign could be understated.

[glorysk87]

One comment on the RBC piece - they barely touched on the potential for a Sears bankruptcy...

[merkhet]

If Sears goes bankrupt, then the maximum amount of time that they can extend the time to decide on assuming or rejecting the lease is 210 days. (Starts at 120 days with the option to petition the court for an extra 90 days, but that's it.)

Alternatively, in theory, if Sears vacates those stores, then isn't that better for Seritage as they now can reclaim significantly more square footage (and release at a higher rent) than originally thought under the current agreement?

What's the main worry if Sears goes bankrupt? It's not like they can force Seritage to re-lease the properties to them for $1 per square foot from $4 per square foot.

Are the main considerations here (A) absorption of the additional square footage and (B) possible loss of rent during that period and/or low recovery prospects for 210 days of rent as an unsecured claimant?

[Mephistopheles]

Alternatively, in theory, if Sears vacates those stores, then isn't that better for Seritage as they now can reclaim significantly more square footage (and release at a higher rent) than originally thought under the current agreement?

What's the main worry if Sears goes bankrupt? It's not like they can force Seritage to re-lease the properties to them for $1 per square foot from $4 per square foot.

Are the main considerations here (A) absorption of the additional square footage and (B) possible loss of rent during that period and/or low recovery prospects for 210 days of rent as an unsecured claimant?

My understanding is that since SHLD accounts for 79% of SRG's rental income, and since it's a triple net lease, a bankruptcy would leave SRG not only with a huge lost income stream, but all the maintenance and tax expenses that go with the properties. Sure they can reclaim 100% of the property but before they re-lease it they would need to re-purpose which would require a massive amounts of cash that they don't have yet, while paying all the expenses/loss of income.