SRG - Seritage Growth Properties

[Foreign Tuffett]

So now that Sears is effectively bankrupt, how does this effect SRG? The market seems to have taken a 6% hit on the news. Rational?

I would argue that SHLD has effectively been bankrupt for some time. The news is that it may literally go bankrupt in a matter of days.

While it's tough to judge how much SRG should decline, I think the decline is at least directionally correct: the prospect of SHLD filing bankruptcy is bad for SRG. Anything might happen with the master lease in a bankruptcy scenario.

[scorpioncapital]

The question is if the 47% or so of Sears rent to SRG has also been discounted to zero by the market.

[Saluki]

As part of the spinoff SHLD had a right to put 20% of it's stores back each year to SRG if it paid 1 year's rent on the properties.  (so it should take 5 years for SRG to slowly go from 90% SHLD tenant revenue to something more diversified).  SHLD will still have to pay rent on the stores it decides to keep, but might not have to give the 1 year payment to SRG.  I think prior to BRK lending $2 billion at favorable rates to SRG, this would be a problem (how do you get the $$$ to redevelop stores if the biggest tenant goes under), but it should be workable for SRG now.  Not the best outcome, but not an existential threat anymore.

The bankruptcy timing is surprising though, when I worked at a retailer in college 30% of the stores revenues occurred in December, so i'm surprised SHLD didn't try to stick it out another 60 days and get one last wave of money coming in. 

[bizaro86]

ESL is so far into the debt now I wonder if they want to hold the liquidation sale in Nov-Dec to try and get the inventory sold off fast.

[vince]

On 3 different occasions I bought and sold SRG and lost money on all 3.  Im not touching it

[Foreign Tuffett]

As part of the spinoff SHLD had a right to put 20% of it's stores back each year to SRG if it paid 1 year's rent on the properties.  (so it should take 5 years for SRG to slowly go from 90% SHLD tenant revenue to something more diversified).  SHLD will still have to pay rent on the stores it decides to keep, but might not have to give the 1 year payment to SRG.  I think prior to BRK lending $2 billion at favorable rates to SRG, this would be a problem (how do you get the $$$ to redevelop stores if the biggest tenant goes under), but it should be workable for SRG now.  Not the best outcome, but not an existential threat anymore.

The bankruptcy timing is surprising though, when I worked at a retailer in college 30% of the stores revenues occurred in December, so i'm surprised SHLD didn't try to stick it out another 60 days and get one last wave of money coming in.

Re the bolded: what makes you think that? IMO one of the things the market is afraid of is that a bankruptcy court will invalidate the master lease.

Re the second paragraph: there is a game of "chicken" going on here between Lampert and some of the bondholders. Seeking Alpha user "fxfx" (no affiliation) explains the situation well.

https://seekingalpha.com/news/3396248-sears-minus-20-percent-bankruptcy-looms

[Saluki]

Sorry, I can't read the seekingalpha article b/c of the paywall. 

I'm assuming (based on my general understanding of retail, not from having read SHLDs annual report) that not every location is losing money.  Some must be profitable and others losing money, but on average the whole is losing money.  Since they've been handing back store leases for almost 3 years now, they must be handing back the ones that are losing the most and holding onto the ones that are profitable or could be turned around.

I'm not an expert but my understanding is that in bankruptcy the judge can decide which executory (contracts in which both sides have to perform, like a lease, as opposed to debt where only one side has to perform) contracts to keep and which to discharge.  If they do away with the master lease completely, they would lose the remaining profitable stores, the rights to sublet some of the valuable leases that they don't give back and the right to get paid if SRG wants to take back a lease that SHLD didn't want to give up.  So, for instance, if SHLD gave SRG back half the square footage of a giant box and SRG paid to redevelop it, the remaining half is worth a lot more if you can assign the lease to a 3rd party.

If SRG had individual leases for the properties, I think it would look a lot different, but if it's all under the master lease and the options are take it all or leave it all, then I think SHLD has some strong incentives to hold onto it or to use the threat of cancelling to renegotiate.  But they can't have it both ways, if they want to stay in the properties, then the master lease has to be accepted.  It's still too early to guess how this will play out.     

[Saluki]

As part of the spinoff SHLD had a right to put 20% of it's stores back each year to SRG if it paid 1 year's rent on the properties.  (so it should take 5 years for SRG to slowly go from 90% SHLD tenant revenue to something more diversified).  SHLD will still have to pay rent on the stores it decides to keep, but might not have to give the 1 year payment to SRG.  I think prior to BRK lending $2 billion at favorable rates to SRG, this would be a problem (how do you get the $$$ to redevelop stores if the biggest tenant goes under), but it should be workable for SRG now.  Not the best outcome, but not an existential threat anymore.

The bankruptcy timing is surprising though, when I worked at a retailer in college 30% of the stores revenues occurred in December, so i'm surprised SHLD didn't try to stick it out another 60 days and get one last wave of money coming in.

Re the bolded: what makes you think that? IMO one of the things the market is afraid of is that a bankruptcy court will invalidate the master lease.

Re the second paragraph: there is a game of "chicken" going on here between Lampert and some of the bondholders. Seeking Alpha user "fxfx" (no affiliation) explains the situation well.

https://seekingalpha.com/news/3396248-sears-minus-20-percent-bankruptcy-looms

Sorry, I just re-read this and I think I misunderstood what you were asking.  Yes, you are correct, they probably couldn't just reject the 1 year payments and keep the rest of the master lease in tact.  I assumed they would negotiate and say "if you do away with the 1 year payments, we can keep handing back the leases to you slowly (maybe 25 or 30% a year instead of 20%), or we can cancel the entire master lease and let you drink from the fire hose." 

[Foreign Tuffett]

Sorry, I can't read the seekingalpha article b/c of the paywall. 

I'm assuming (based on my general understanding of retail, not from having read SHLDs annual report) that not every location is losing money.  Some must be profitable and others losing money, but on average the whole is losing money.  Since they've been handing back store leases for almost 3 years now, they must be handing back the ones that are losing the most and holding onto the ones that are profitable or could be turned around.

I'm not an expert but my understanding is that in bankruptcy the judge can decide which executory (contracts in which both sides have to perform, like a lease, as opposed to debt where only one side has to perform) contracts to keep and which to discharge.  If they do away with the master lease completely, they would lose the remaining profitable stores, the rights to sublet some of the valuable leases that they don't give back and the right to get paid if SRG wants to take back a lease that SHLD didn't want to give up.  So, for instance, if SHLD gave SRG back half the square footage of a giant box and SRG paid to redevelop it, the remaining half is worth a lot more if you can assign the lease to a 3rd party.

If SRG had individual leases for the properties, I think it would look a lot different, but if it's all under the master lease and the options are take it all or leave it all, then I think SHLD has some strong incentives to hold onto it or to use the threat of cancelling to renegotiate.  But they can't have it both ways, if they want to stay in the properties, then the master lease has to be accepted.  It's still too early to guess how this will play out.   

It's a link to a news story and comment thread. You might have to create a Seeking Alpha profile to read it, but it's free.

What you're saying makes sense, but I am skeptical that their stores that are 4 wall profitable can generate the cash flow to cover non-store overhead.

Also, at some point they are going to start suffering from reverse economies of scale as the store base continues to rapidly shrink. Let's assume they have 200 stores that are 4 wall profitable. If those 200 stores are scattered across the country it will be very difficult to right size the logistics and supply chain in a way that allows the company to be a viable enterprise going forward. IIRC American Apparel was an example of this issue. 

I'm not a bankruptcy expert by any means, but it wouldn't surprise me if all retail operations of the company are liquidated (a la Toys R Us) if they file.

[TwoCitiesCapital]

This has only be a small position (~2%) for me opened earlier this year around $40. When WB announced the $ and the stock jumped 20-25% shortly thereafter, I let go of the about 20% of the position to take all the gains off the table.

While the long-term development is intact, there are too many headwinds with rising rates and an expected Sears bankruptcy on the horizon to not take quick and easy gains like that.

Ultimately, I'd love to repurchase all of those share, and then some, but I want some of the negativity to be worked out and my guess there will be other opportunities to buy at lower prices than $50/share while that is happening. If we hit $40/share again, I expect I'll be buying back everything that was sold plus some.