For years now, an investment in Sears Holdings Inc. (SHLD) has mostly hinged on how much the company’s various bits and pieces were worth to someone else on the open market.
The next bit of Sears merchandise expected to hit the market is Lands' End, the venerable direct seller of clothing and outdoor gear the company acquired for $1.9 billion in 2002. Sears is now preparing to spin Lands' End off to shareholders.
The news on Friday that men’s apparel retailer Jos. A Bank Clothiers Inc. (JOSB) agreed to acquire Eddie Bauer from its private-equity owners, Golden Gate Capital, for $825 million offers a decent benchmark for gauging what Lands' End might be worth once it's set free.
Both Lands' End and Eddie Bauer are long-established American brands that began selling a similar mix of outdoorsy, utilitarian clothes and gear and have since broadened the fashion mix. The bottom line: Based on a rough comparison, Lands' End appears to be worth at least 10% and perhaps more than 20% of Sears’s current $4.5 billion stock-market value.
Jos. A. Bank is paying for Eddie Bauer in a mix of cash and stock, as well as a possible earn-out payment based on future performance. Jos. A. Bank — which has traded hostile takeover bids with Men’s Wearhouse Inc. (MW) in recent months — said the purchase price essentially equals Eddie Bauer’s 2013 revenue and amounts to 9.5-times its adjusted earnings before interest, taxes, depreciation and amortization.
A generous valuation
This looks to be a somewhat generous valuation of adjusted EBITDA. In 2010 J. Crew was taken private at a multiple of about 9-times the prior year’s Ebitda (a proxy for cash flow). J. Crew is arguably a stronger brand and appeared to have had higher profit margins than Bauer.
Sears has filed financial information for Lands' End through October of 2013, but not yet for the full fiscal year. The company over the past couple of years has collected about $1.5 billion in annual revenue and was on target in 2013 for around $100 million in adjusted EBITDA. So at the revenue multiple Jos. A. Bank is paying for Eddie Bauer, Lands' End would be worth some $1.5 billion and, at Bauer’s cash-flow valuation, just under $1 billion. Lands' End's business is more heavily skewed toward direct sales (Internet and catalogue) than is Eddie Bauer's. This should in theory add to Lands' End's value, though its profit margins don't appear to be appreciably higher.
There are several caveats. First is that these reflect “enterprise value,” which adds equity value plus any net debt held by the company. Based on Sears’ spinoff filing, Lands' End intends to take on a $500 million term loan and use the cash to pay a dividend to Sears prior to the spinoff. (Such maneuvers are relatively common in spinoffs.)
So if Lands' End carries that $500 million in debt, and enterprise value (based on Eddie Bauer’s deal price) is to be in the range of $1 billion to $1.5 billion, it means the equity value of Lands' End to stock investors would be $500 million to $1 billion.
Another complication is that Jos. A. Bank seems to have moved to buy Eddie Bauer with some extenuating motives that could have inflated the price it paid. For one, the company warned of a badly eroding outlook for the core Bank business at the same time it announced the deal. Second, it’s using a complicated structure that gives Golden Gate Capital a 16.6% stake in Jos. A. Bank and provides for a steep $50 million termination fee if the deal is canceled.
This appears intended as a sort of “poison pill” defense, to make an acquisition of Jos. A. Bank vastly more expensive and difficult for Men’s Wearhouse. Breakout's Jeff Macke riffs here about Bank management's desperate hunt to increase shareholder value with a struggling core business. Bank management’s willingness to pay such a full price for Eddie Bauer could reflect its own unique objectives more than the intrinsic value of the Eddie Bauer business – which Golden Gate acquired out of bankruptcy in 2009 for less than $300 million.
Chains in decline
At the core of Sears Holdings, of course, is a pair of broad-line retail chains in decline, a combined total of 2,000 Kmart and Sears stores suffering depressed customer traffic and sliding sales, and operating in the red.
Yet under chairman and principal shareholder Edward Lampert, the company has been aggressively hiving off subsidiaries and real estate. He has spun off Sears Canada Ltd. (SEARF) and Sears Hometown and Outlet Stores Inc. (SHOS). He's also sold a lease on Sears's Honolulu store for some $200 million and created an internal real-estate development division to actively market Sears and Kmart store locations for use as data centers and other non-retail purposes.
Stock investors have run hot and cold in recent years as Lampert attempts this trick of performing surgery on the company in real time, as it also tries to preserve financial liquidity, close stores and pivot the retail business into a membership-driven “clicks and mortar” effort.
The shares have traded as high as $93 and as low as $29 over the past three years, as abundant bears have maintained a heavy short position, and a small group of believers and Lampert hang onto a majority of the shares. The stock rose 7.5% Thursday to $43.42 after investment firm Force Capital Management disclosed a 5.6% stake.
The Lands' End spinoff and resulting value to shareholders – whether on the high or low end of the projected range – will not be a decisive swing factor in whether Lampert can surface more value than is being eroded by a weak core business. But it’s a significant step along the way to the risky, uncertain, slow-motion liquidation of a one-time giant of the American economy.