Sears Is Worth More Dead Than Alive

Last week, ESL Investments -- the hedge fund controlled by Eddie Lampert that is Sears Holdings' (NASDAQOTH: SHLDQ) largest creditor and top shareholder -- made a bid to buy the floundering retailer out of bankruptcy. The fund prefaced its proposal by stating, "Sears is an iconic fixture in American retail and we continue to believe in the company's immense potential to evolve and operate profitably as a going concern with a new capitalization and organizational structure."

That couldn't be further from the truth. Indeed, the details of ESL's bid for Sears Holdings make it more obvious than ever that Sears isn't worth saving.

What ESL is offering

ESL wants to buy Sears Holdings lock, stock, and barrel. This includes roughly 500 stores, the Kenmore and Diehard brands, the auto center and home services units, the Shop Your Way loyalty program, and other smaller ancillary businesses. Importantly, ESL would also get Sears Holdings' tax assets (net operating losses that could be used to offset future profits).

The hedge fund valued its preliminary offer for the full company at $4.6 billion. However, some creative accounting was needed to reach that figure.

The biggest chunk ($1.8 billion) comes from a credit bid. ESL is offering to forgive secured loans totaling that amount in order to acquire Sears' assets. Additionally, roughly $1.2 billion worth of loans and cash collateral supporting Sears' letter of credit facility would be refinanced or rolled over. Another $1.1 billion comes from assuming various obligations for Sears Home Services protection agreements, gift cards, and Shop Your Way loyalty points. The source for the remaining $500 million was not definitively identified.

Notably, ESL doesn't contemplate injecting any additional cash into the business under its proposal.

Selling the company in pieces might fetch a better price

Sure, $4.6 billion might seem like a lot of money for what is still a dying retailer. However, the details of a rescue plan proposed by ESL prior to Sears' bankruptcy filing suggest that creditors might be better off if the company is liquidated in pieces.

Earlier this year, ESL offered $500 million for two parts of Sears' home services unit and $400 million for the Kenmore appliance brand. In its September plan for restructuring Sears Holdings' debt outside of court, ESL estimated that the company could raise $1.75 billion by selling Kenmore, its entire home services business, and other related assets.

In that same plan, ESL noted that Sears' real estate had an appraised value of nearly $2 billion, or $1.3 billion on a "dark" basis (i.e., assuming that all of the properties were vacant). Sears has received plenty of interest for its real estate since the recent bankruptcy filing -- particularly for stores in major markets. This could also include leased properties that weren't included in the appraisal referenced by ESL.

Thus, Sears' real estate, brands, and services businesses may be worth more than $3 billion on a combined basis. Additionally, ESL expects that it would receive $1.8 billion in inventory and pharmacy receivables if its bid is successful. Even if the inventory would be worth slightly less than full value to a liquidation company, it's very likely that Sears could bring in more than $4.6 billion in a liquidation.

From creditors' perspective, a liquidation would also remove substantial gift card and loyalty program liabilities -- and possibly protection agreement expenses as well, depending on the fate of Sears Home Services. Thus, they would get a larger proportion of the sale proceeds than they would under ESL's proposal.

Sears has no long-term future

ESL Investments' bid for Sears Holdings is likely to face plenty of competition. The real estate can be sold off piecemeal, other companies have already expressed interest in several of Sears' services businesses, and brands like Kenmore and DieHard should still have some value. Liquidators would be only too happy to buy the inventory and run store-closing sales.

With such opposition likely to materialize, ESL noted in its proposal that its bid would allow Sears to maintain 50,000 jobs and meet its ongoing commitments to its customers. If Sears were really a viable enterprise, these might be worthy considerations. However, the retailer's financial position is still deteriorating. It expects to continue burning cash rapidly -- even during the holiday season, which will be quite lucrative for virtually every other U.S. retailer.

If ESL were to buy Sears as a going concern, the company would likely land back in bankruptcy court before long, due to its ongoing losses. (In a similar case, RadioShack declared bankruptcy in early 2015, emerged, and filed for bankruptcy once again in early 2017.) If Sears is going to die one way or another within a few years (which seems almost certain today), there's no reason to drag out the pain -- and the losses.

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Adam Levine-Weinberg has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.