Sears: Poor Prospect For Deep Value Investors

After the plummet Sears Holdings (SHLD) experienced since late 2011, value investors like myself have begun to kick the tires and see if Sears might have been irrationally bid down.

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I usually look at large national brands or companies that are still profitable whose stock has begun trading deeply below a price to book ratio of one (i.e. their stock is trading for less than their shareholder's equity (SE) on the balance sheet). After a company like Sears is selected (P/B of 0.48), I look at what exactly the assets are that I would be getting. This is due to the fact that in terms of SE on a balance sheet, a dollar of cash is valued the exact same as goodwill from an acquisition, even though in bankruptcy court cash is far more valuable than goodwill.

So what do we get right now with a share of Sears? Here's the breakdown:

In this chart I've paired up assets listed in order of reported liquidity on the left hand side and the stakeholders of the company in order of most secured (since all liabilities are more senior to stockholders, I have not broken out liabilities).

As we can see, once you start looking at shareholder's equity, you're getting a little bit of property and equipment, but almost excluisively goodwill, trade names/other intagibles, and other assets.

Essentially, if you're buying Sears shares as an asset play, you're getting most of the assets that go out the window in a bankruptcy proceeding. Presuming Sears was able to get every dollar stated in the more liquid assets in a bankruptcy liquidation (very unlikely, especially for line items like inventory), you'd be entitled to every dollar in excess of $5.4B received for the sale of property and equipment (line item value of $7.0B). Sears posted a market cap of $3.59B on 1/13/11.

However, if Sears were only able to get $0.87 on the dollar or less for non cash items (throwing away deferred income taxes of $96M which would be worthless in a liquidation), sales of property and equipment would have to completely exceed their $7.0B book value before investors saw a dime.

In a liquidation, goodwill and intangible assets are worthless unless subsidiaries of the Sears Holdings' business were able to be sold off separately prior to liquidation. Assuming we throw that value out the window, at the $0.87 recovery stated earlier, Sears would have to sell property and equipment at 56% more than it's line item value before investors realized a return on the $3.95B market cap of Sears. If we get to a recovery scenario of $0.60 for the items mentioned above, Sears would have to unload property and equipment at more than 100% above the line item value before investors saw a return.

Obviously shareholders may have expectations that Sears Holdings will return to profitability, or that the break up value is worth dramatically more than what the book value of the assets reveal. However, for a company like Sears that has been struggling for so long with exceptionally strong competitors and practically no strategic moat especially in the context of online retailers, the end game (Chapter 7) for Sears looks absolutely terrible for prospective investors. I do not consider SHLD to be a good prospect for deep value investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.