Playing Jenga With Sears Holdings

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A recent analyst note compared the slow dismembering of Sears Holdings (NASDAQ: SHLD) to playing the popular Jenga game. As most people know, Jenga is a game where players take out pieces of a structure hoping that the overall structure doesn’t collapse. The goal is to not be the player that causes the structure to collapse, and in the case of Sears Holdings, you don't want to be there when the last piece is pulled out.

Anybody following Sears knows that Eddie Lambert is the Chairman and majority owner via his RBS Partners LP hedge fund. Unfortunately major differences of opinion exist on whether playing Jenga with the vast resources of the company is a move to unlock shareholder value or if it will ultimately lead to a collapse of the stock that so many shorts expect.

With a market cap of only $5 billion, the company has the potential to unlock tons of value, as a rebounding real estate market could lead to increased demand for the appliance, yard, and tool sectors hurt by the housing collapse. The Jenga assets have had opposite results for investors that have kept those spun-off shares. Sears Hometown and Outlets Stores (NASDAQ: SHOS) has thrived away from the shadow of the parent while Orchard Supply Hardware Stores (NASDAQOTH: OSHWQ) just announced a bankruptcy filing and sale of assets to Lowe’s.

Plenty of assets remaining

Anybody following Sears knows that it has a ton of real estate assets and brands with interesting value potential regardless of the declining quality of the stores.

The real estate assets alone could be worth more than the current market cap. As an example, Sears Canada recently agreed to vacate two store leases in Canada in a deal to raise nearly $191 million with an option on a third store for $53 million. Investors constantly claim that the stores have no value because the common approach is to attempt to value those assets based on what Sears has done with them and not what the value would be to a new retailer. In total, Sears controls roughly 240 million square feet of real estate, and according to this research, using various models the value averages around $31 billion or six times the current value of the stock.

On the brand front, Craftsman remains a valuable lawn and tool brand, and Diehard is highly valued in the battery sector. Kenmore is still an attractive high-end appliance producer. In all cases, the issue has been that Sears has trapped these brands in the outdated Sears stores. Recently though, the company has released these brands to other retailers. Not to mention, Lands End would likely thrive outside the disaster of those stores. The company is also making a huge e-commerce push to where the stores become more distribution centers than retail stores--ideal considering the lack of shoppers in each store should make it easier to collect items for shipping.

Spin-offs: the good

Sears Hometown has been a major winner with the stock roaring from $30 to $57.50 before the recent sell-off. The stores benefit from a focus on the good parts of Sears with a closer proximity to consumers. What consumer wants to buy a refrigerator or lawn mower at a crowded mall?

The company, along with dealers and franchisees, operates 1,253 stores in all 50 states. While the company had declining comparable sales in the last quarter, Sears Hometown still managed to report a $0.65 profit. Having a very profitable business even during a weak quarter is a huge start in the right direction compared to the former parent that is struggling massively to return to a positive bottom line.

Spin-offs: the bad

On the flip side of Sears Hometown, Orchard Supply has plunged from a similar $30 all the way to $1.40 due to the Chapter 11 bankruptcy filling. Orchard Supply operates neighborhood hardware and garden stores with 89 of them in California. The expectation was that the spin-off from the parent would allow the home improvement store to thrive. Instead, the company was never able to overcome the large debt load and larger competitors in the state.

While filing for bankruptcy, the stock is suddenly in play due to the announcement that Lowe’s wants to purchase a substantial portion of the assets. Lowe’s wants to acquire at least 60 of the stores for $205 million in cash, plus the assumption of payables owed to nearly all of Orchard’s supplier partners.

For risky investors, Orchard Supply might be worth a shot that another company will increase the bid for the valuable real estate locations, but it is more for gamblers and not ideal for investors. The Lowe’s offer amounts to roughly $3.5 million per store, suggesting a higher bid might pop up.

Bottom line

No doubt should exist that Sears Holdings continues to control plenty of assets to continue playing Jenga without causing the structure to collapse. The massive real estate  assets and valuable brands will eventually be worth vastly more than the $5 billion awarded to a market focused on the lackluster retail operations.

The previously spun off assets have had mixed results for investors. Sears Hometown shows potential for rewarding investors as the real estate market rebounds and the company benefits from rising demand for appliances, tools, and garden supplies. Ultimately, the parent continues to control a vast amount of assets that exceeds the value of the stock, making it very appealing at these levels.

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Mark Holder and Stone Fox Capital Advisors, LLC own positions in Sears Holdings. The Motley Fool has no position in any of the stocks mentioned. 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!

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