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Sears Tries a REIT in the Face of Falling Ebitda and a Cash Burn

Richard Collings

Sears Holdings Corp. is exploring a Real Estate Investment Trust (REIT) for 200 to 300 of its owned properties through a rights offering to its shareholders, the company said in a regulatory filing Friday.

The news sent the company's stock up almost 42% to more than $46 per share in early morning trading.

It would be a step toward significantly monetizing a real estate portfolio estimated to have a book value of $5 billion. Sears said that it would specifically sell selected stores through a sale-leaseback transaction to a newly formed REIT, with Sears continuing to operate the locations under one or more "master" leases.

A potential wrinkle, however, in Sears pursuit of a REIT is that the tenant of a REIT, in this case Sears Holdings, typically needs to maintain a good credit rating.

The REIT option was made public as the Hoffman Estates, Ill.-based parent of the Sears and Kmart department store chains, commenced a rights offering for $625 million in 8% unsecured notes due 2019 and warrants to purchase shares of its common stock.

According to a source familiar with the situation, Sears was beginning to feel the effects of rising vendor concerns over the retailer's ability to pay for goods delivered, with the source attributing much of that concern to press reports on the state of Sears' near-term financial viability.

The rights offering may go a way toward helping alleviate vendors' concerns as well as improve shareholders position in the company's capital structure, Mary Ross Gilbert, managing director at investment bank Imperial Capital, previously told The Deal.

Sears is expected to burn through at least $1.5 billion in cash this year, and at least another $1.5 billion in cash next year, Gilbert said. The rate of the current cash burn will make it a challenge for Sears to honor all its obligations if it also attempts to stay out of bankruptcy, Gilbert said.

Sears has made a number of other moves in addition to the rights offering in order to allay liquidity concerns.

So far this year, Sears Holdings has received a $500 million dividend from the spinoff of apparel retailer Lands' End Inc. (LE), $164 million from the sale of real estate and $400 million from a short-term loan by affiliates of ESL Investments Inc. — Edward Lampert's investment company that still has a 48% stake in Sears. It had undertaken a share offering in former affiliate Sears Canada Inc., which had raised $300 million as of Friday morning, and could raise another $80 million — that rights offering closes at the end of the business Friday. All together, that would equate to more than $2 billion in liquidity raised.

Sears included updated estimates on its third quarter ended Nov. 1, in the Friday filing. It said it expects adjusted Ebitda to fall within negative $275 million to $325 million, similar to last year, and that comparable store sales will be flat, also as compared to the same period a year prior.

Cash as of Nov. 1, however, had dropped to $330 million, while availability under its credit facility now stands at $234 million. Its cash includes nearly $170 million raised from the sale of shares in Sears Canada, but does not include about $130 million that either has been received or is in transit. The cash balance also excludes any proceeds from the rights offering for $625 million in senior unsecured notes.

In terms of assets, in addition to the $5 billion in real estate, Sears has $5 billion to $7 billion in inventory that is paid for.

The company said it had debt at the end of the third quarter of $6.3 billion, including pension and retirement obligations of $1.3 billion. As of Aug. 2, Sears had roughly $4.3 billion in total debt, according to filings with the Securities and Exchange Commission. The retailer said that compared to the same period a year prior, it has reduced debt and pension and retirement obligations by $400 million. Debt by year's end is expected to be "materially lower" than the $5.9 billion debt level at the end of 2013.

In Sears' last quarterly report for the 26 weeks ended Aug. 2, it recorded a $1.02 billion net loss. It had $16.43 billion in assets and $15.52 billion in liabilities as of Aug. 2. It also had $829 million in cash on its balance sheet.

As of Aug. 2, Sears also had $1.4 billion in outstanding borrowings on its $3.275 billion asset-based revolving credit facility, along with $646 million in outstanding letters of credit and $995 million outstanding on its term loan.

The revolver, which is being provided by a syndicate of lenders, expires on April 8, 2016; the term loan comes due on June 30, 2018.

The term loan is priced at either Libor plus 450 basis points, with a 1% floor on Libor, or the highest of prime, 50 basis points over the federal funds rate and 100 basis points over Libor, plus an additional 350 basis points. The revolver bears interest at Libor plus 225 basis points.

Moreover, Sears has $1.2 billion in outstanding 6.625% second-lien notes due Oct. 15, 2018. Lampert and ESL Investments hold $205 million of the second-lien notes, SEC filings said.

Wachtell, Lipton, Rosen & Katz is providing legal advice to Sears. Bank of America Merrill Lynch is providing financial advice.

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