Can This Retailer "Build" a Profitable Future?
Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Predicting what Sears Holdings (NASDAQ: SHLD) might look like in three to five years brings to mind the parable about the blind man and the elephant. It really does depend upon which part of the Sears story you feel most comfortable grasping. We all know that Sears has been struggling to become more competitive with fellow retailers: Wal-Mart, Target, Macy's and Kohl's. Sears has also rolled out a member loyalty program and online strategies to fight with Amazon.com and others for its share of internet commerce. These are the parts of Sears most investors instinctively grasp.
But how many investors expected that this iconic retailer would be gearing up to compete with datacenter and communications real estate giants like Digital Realty Trust (NYSE: DLR) and American Tower (NYSE: AMT)?
So how long will it take to staunch the bleeding?
In a piece recently written for Motley Fool readers, I pointed out that Sears’s operations have consumed $571 million in cash during the past two years -- while over 500 K-Mart and Sears locations have been closed. Some former executives and retail analysts have grave concerns regarding Sears' retailing future due to the continuing decline in same store sales. During 2012, a group of 11 stores were sold to mall owner General Growth Properties for $270 million, and three leases totaling 1 million square feet were returned to Canadian landlord Cadillac Fairview, generating $170 million for Sears Holdings.
Where is more money likely to be found?
Unfortunately, deals of this type are unique and can't be used to infer a value for remaining Sears and K-Mart stores due to local market and site specific factors. The conventional leasing and sales activity for available facilities listed on the Sears SHC Realty website began in 2010 -- including leasing space to grocer Whole Foods in mall locations sprinkled throughout the U.S. Sears still has a remaining real estate portfolio of approximately 240 million square feet including 750 owned and 1,520 leased Sears, K-Mart and Sears Canada stores.
Panning for high tech gold
Newly minted in May, Ubiquity Critical Environments is both a real estate and a technology initiative. It is tasked with "the mission of converting some of the more than 330 closed Sears and Kmart stores into facilities for data warehousing, network co-location centers, and business continuity operations." According to a May 23 Datacenter Knowledge report, the first step has been to evaluate the portfolio and identify properties that could work as data centers. Chicago engineering firm ESD has been conducting a “data center fitness test” on promising properties to size up their power, fiber and risk profiles.
The first nugget will be found in Chicago
The first Ubiquity project will be a 127,000 former Sears store on the south side of Chicago that has 5 megawatts of existing power capacity with the potential to expand. It is planned to be retrofitted as a multi-tenant data center.
This puts Ubiquity directly in competition with companies such as Digital Realty, a global leader in the data storage REIT space with over 23 million square feet leased to tenants in 123 properties. According to the Wall Street Journal, analysts are concerned about rising capital expenses and declining rent at data-center REITs. Shares of all REITs have been hit hard the past couple of months due to a rising interest rate environment.
In spite of that trend, Digital Realty still has a market capitalization of $7.6 billion, and generates enough cash to pay out a hefty $3.20 per share dividend, a yield of 5.3%. The good news for Sears Holdings investors is that Digital Realty is doing this with a real estate footprint that is one-tenth the square footage of the existing Sears real estate portfolio.
Digital Realty has historically grown by acquiring properties, some already built out and leased to tenants, and some vacant to be held for future development. During the past three years, it has acquired an average of 12 facilities per year. During the quarter ending March 31, consistent with this growth rate, four more properties were acquired. Ubiquity/Sears could be a source of "pre-engineered" datacenter sites for Digital Realty, as well as competitors Core Site Realty, CyrusOne, DuPont Fabros, and Equinix.
If Sears chooses to compete in this space, a future Ubiquity spin-off of a datacenter REIT could be a tremendous boost for investors in Sear's stock. It should be noted that the IRS has not yet awarded Equinix REIT status, and this is something investors interested in this sector should watch closely.
The alchemy of turning dirt into gold:
Sears launched Seritage Realty Trust, LLC in 2013 as a "nationwide developer of commercial real estate" to help oversee a Sears portfolio containing over 200 properties in 33 states that totals over 18 million square feet. The Seritage stated strategic objective is "to provide access to mature suburban and urban markets for quality retailers, office tenants, and other commercial uses in tailored redevelopment projects." Unlocking the value contained in this real estate "treasure chest" appears to be part of Sears Holdings blueprint for future success.
Staking out a claim in Minnesota
Seritage is initially focused on entitlements for a 17 acre redevelopment project in downtown St. Paul, Minnesota. The proposed development would include 111,700 square feet of retail space, 121 apartments and 18 townhomes, and a new four-level 586 space parking garage to create a "cohesive village atmosphere" anchored by the existing free standing Sears store, including 701 retained surface parking spaces.
An appraisal of this mixed-use development as if completed -- and then discounted back to present value to account for approval, design, construction and marketing time frames -- should yield a valuation significantly in excess of the legacy Sears retail property. Investors need to decide if projects like this will lead to a meaningful increase in Sears Holdings perceived market value.
Can you hear me now?
Ubiquity is also spearheading a new initiative to lease communication towers to be built at existing Sears Holdings facilities. Ubiquity could be looking to emulate the successful business model employed by wireless communication tower operator American Tower -- currently the second largest U.S. REIT valued at $28.3 billion. American Tower along with competitors SBA Communications and Crown Castle International can leverage existing relationships with their major telecom tenants when competing with a start-up like Ubiquity.
How can Sears capture a piece of this pie?
American Tower owns or operates about 50,000 tower sites and also provides customized co-location solutions through its Distributed Antenna Systems. American Tower CEO Jim Taiclet was bullish on catalysts for U.S. growth during a May 1 conference call: "Leading the charge toward pervasive 4G services are our four major U.S. tenants, who we believe will need to substantially upgrade their existing networks to meet the capacity and elevated signal quality required to deliver services such as LTE video and voice over IP."
During the quarter ending March 31, American Tower reported a 15.2% increase in total revenue ($802.7 million), and a 9.2% increase in operating income ($299.7 million). American Tower reported a U.S. (domestic) rental and management segment operating profit margin of 78%. These are the kind of numbers that investors in Sears Holdings would like to see!
What could this mean for Sears earnings?
Ubiquity/Sears has over 2,000 urban and suburban sites in densely populated areas to evaluate and use to jumpstart this business segment. In contrast to American Tower, they do not have to pay out money to acquire or lease these locations. If we annualize the first quarter results for American Tower, and divide by 50,000 towers we get a metric of revenue per tower of about $64,000.
If Ubiquity/Sears could erect 1,000 towers, (about half of their existing locations), and lease them out in a fashion similar to AMT -- that would infer a revenue figure of about $64 million per year. These new Ubiquity towers would all be built to the latest 4G standards, and that combined with the high population density around each of the sites might result in a higher per tower revenue figure. A tower at each location could contribute $128 million per year of revenue. My metric may have flaws, but it is intended to give investors a sense of the potential impact of communication towers for Sears moving forward.
In the U.S., necessary approvals by the Federal Aviation Authority and Federal Communications Commission can create time delays in the construction of new towers. Sears could choose to partner with some of the dominant players in this sector to reduce the amount of capital required and attempt to generate income at a faster pace.
"Eureka!" Or is it fools gold?
Given the scale of Sears Holdings, I believe that depends upon how quickly Seritage and Ubiquity will be able to "morph" from start-up boutiques into dynamic national development companies. An announcement of strategic partnerships and/or regional joint ventures with highly experienced and well capitalized development partners might go a long way to convince Wall Street that majority shareholder and CEO Eddie Lampert is serious about "reinvention and avoiding profitless prosperity."
Investors need to see progress
Datacenters, communication towers, and real estate developments are all notoriously capital intensive. This may be Sears Holdings highest hurdle to overcome. Sears current market valuation is only $5 billion. Investors should look closely at Sears operating results for the quarter ended in June. Will the trend of operating losses and lower year over year same store sales finally come to a halt? Will CEO Lampert offer any forward guidance or make a significant announcement regarding the monetization of Sears' valuable real estate assets? Time is of the essence.
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Bill Stoller has no position in any stocks mentioned. The Motley Fool recommends American Tower . The Motley Fool owns shares of American Tower . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!