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Fairholme Bulks Up its Position in Sears Holdings

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Fairholme Capital and Sears Holdings

Bruce Berkowitz remained fairly confident about the prospects of struggling US retailer Sears Holdings (SHLD). In 4Q14, Fairholme increased its stake in Sears Holdings by 7.4 million shares, including 6.4 million in the form of warrants to 26.5 million shares. SHLD currently accounts for 12.0% of the assets in Fairholme’s portfolio.

SHLD is a component of the SPDR S&P Retail ETF (XRT) with a portfolio weighting of 1.04%. The ETF’s top positions include pharmaceutical retailer Rite Aid Corporation (RAD) with an allocation of 1.30%, department store chain J.C. Penney (JCP) with 1.21%, and specialty retailer Cabela’s (CAB) with an allocation of 1.10%.

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Overview of Sears

Sears Holdings (SHLD) is an integrated retailer with more than 1,700 full-line and specialty retail stores in the United States that operate under the Kmart and Sears banners. Sears offers Shop Your Way, the member-based online social shopping platform that offers rewards and personalized services.

Asset reconfiguration, store closings

In 4Q14, Sears witnessed a 26% year-over-year (or YoY) decline in revenue to $8.1 billion, due to closing 234 stores during the year, a stake reduction in Sears Canada, and the spin-off of Lands’ End (LE). On a comparable store basis, revenues decreased by 4.4% over the same period, driven by same-store sales declines at both Sears stores and Kmart in the holiday quarter.

However, earnings before interest, taxes, depreciation, and amortization (or EBITDA) came in at a positive $125 million compared to an EBITDA loss of $92 million in 4Q13. The improvement in profitability was due to expense reductions in payroll, insurance, advertising, and the asset reconfiguration. The net loss for the fourth quarter was $159 million versus $358 million for the same period a year earlier.

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Sears real estate

In a conference call, Berkowitz noted, “The real estate within Sears is a unique position. It’s a once in-a-lifetime opportunity you cannot recreate. I really don’t understand the market’s ignorance as to the values within Sears.”

Berkowitz also stated that the company’s substantial portfolio of real estate assets (~195 million square feet of retail space) is the company’s most valuable component. Sears’ real estate portfolio is larger than the largest mall REIT, Simon Property Group, which has an enterprise value of $100 billion. Berkowitz believes that due to its conglomerate structure, the company’s ongoing financial struggles wouldn’t have any adverse impact on its real estate assets.

Possible sale to a REIT

Edward Lampert, chairman and CEO of Sears Holdings, has made it clear that he intends to create value through monetizing the company’s real estate assets. The tax-efficient spin-off of Lands’ End created substantial shareholder value and at one point, the company’s market cap rivaled that of its former parent, Sears Holdings.

In a letter to shareholders, Lampert revealed a potential sale of 200 to 300 less-profitable stores, via a sale-leaseback transaction, to a newly formed Real Estate Investment Trust (or REIT). Such a transaction could potentially be accretive, or adding to earnings per share, to long-term shareholder value.

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