Investors of Sears Holdings Corp. told chairman and chief executive officer Edward Lampert what they thought of his $400 million loan to the retailer: The stock fell to a new 52-week low.
Shares of Sears dropped 9.4 percent to close at $30.37 in Nasdaq trading. More than 3.6 million shares changed hands, compared with a three-month average volume of 819,323 shares. The stock also hit a new 52-week low of $30.16 in intraday trading. Investors have been taking a bearish stance on Sears for some time. As of May 30, about 60 percent of Sears shares that float on the open market were sold short. Investors make money when a shorted stock declines in value.
Vendors on Tuesday also were busy reaching out to the credit community for answers so they can determine whether or not to continue shipping goods to the retailer, which operates stores under the nameplates Sears and Kmart.
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One factor, who requested anonymity, said he’s still approving orders. While the credit community as a whole, as of Tuesday, seemed to be doing the same, there’s definite concern about how the loan agreement with ESL Investments Inc. was structured and why.
The next test for Sears will be at the end of the month when factors and credit analysts begin making decisions on whether to continue approving client orders that come due Jan. 1.
In a regulatory filing Monday with the Securities and Exchange Commission, the retailer disclosed that entities of Sears entered into a $400 million loan agreement with entities of ESL, the hedge fund controlled by Lampert in which he is the sole stockholder. The short-term loan, which carries a 5 percent interest rate on a per annum basis, matures on Dec. 31, but can be extended until Feb. 28 under certain conditions.
One red flag for investors and vendors is that Lampert is now a secured lender: The loan is secured by a first-priority lien on 25 real estate properties owned by Sears.
Bob Carbonell, chief credit officer at the Bernard Sands unit of Credit2B, said, “If Lampert had confidence in the company, why didn’t he just let them issue commercial paper as they have in the past? ESL purchased the commercial paper as an unsecured creditor. Now Lampert has become a secured creditor by taking 25 pieces of real estate [as collateral].”
ESL, which in the past provided unsecured commercial paper funding up to $500 million, began pulling back at the beginning of this year. At the end of the second quarter, it no longer held any Sears commercial paper.
An individual familiar with Sears’ thinking said the loan provides a “more predictable source of funding through the holidays, as opposed to the short-term nature of commercial paper.”
Companies use commercial paper to raise cash for current projects and find it is typically a cheaper option than bank loans. Maturities on average are around 30 days, but the range can go up to 270 days.
Carbonell believes the loan was a necessity to keep the operations running because Lampert has been unsuccessful in selling the “$1 billion in asset sales that were promised. So far, they only succeeded in selling Lands’ End, but that was through a spin-off. Apparently, there are no takers for either Sears Canada or Sears Auto Centers at the price Lampert is asking.”
The negative news on Sears worsened last month after the company reported a wider second-quarter loss to $573 million, or $5.39 a diluted share, versus a net loss of $194 million, or $1.83, in the same year-ago quarter. Net sales fell 9.7 percent to $8.01 billion from $8.87 billion.
Last Wednesday, credit-ratings agency Fitch Ratings downgraded the long-term issue default ratings on Sears to “CC” from “CCC,” pushing it deeper into junk bond status. At the time, Fitch said it “expects that the risk of restructuring is high over the next 24 months.”
On Friday, Diana Allmendinger at Fitch Solutions noted that Sears’ five-year credit default swaps have been widening steadily since March. “Credit protection against a default on Sears’ debt is now pricing at the highest levels seen since January 2012, deep in distressed space,” she said, adding that souring market sentiment has likely attributed to the company’s “declining profitability, significant cash burn and funding concerns.”
The cash burn rate was cited in a Fitch note Tuesday regarding the Dec. 31 loan maturity date as an indication of “how tight liquidity is going into the holiday season with the need for additional capital to fund inventory build-up.” The Fitch report cited the $400 million loan as a short-term fix to a much larger need for liquidity infusion, given significant cash burn in the business. Fitch said Sears needs to generate minimum earnings before interest, taxes, depreciation and amortization of $1 billion annually between 2014 through 2016 to service interest expense, capex and pension plan contributions. Fitch is projecting EBITDA to be negative $1 billion or worse, with the cash-burn rate to be around $2 billion or higher annually.
Efraim Levy, equity analyst at S&P Capital IQ, reduced his 12-month target price for Sears stock to $5 from $28, and reiterated his “strong sell” opinion on the stock.
While the loan may have been necessary from a liquidity standpoint, it was an “expensive borrowing” for the retailer, Levy concluded. He noted that each parcel of the collateral averages $16 million in value, although Levy said that he’s heard average valuations “well above that.” And since the agreement allows ESL under certain circumstances to substitute properties, Levy said, “Lampert can cherry-pick the good properties. Eddie Lampert is giving himself a good deal. What is a win-win situation for him is not necessarily good for the company.”
A spokesman for Sears said, “As we have shown consistently over the past three years, we have the benefit of an asset-rich portfolio that enables us great flexibility in ensuring that we can continue to invest in our transformation while meeting all of our financial obligations. Moreover, we want to be proactive in demonstrating to our vendors and other constituents that we will continue to generate liquidity needed to invest in our business and meet all of our financial obligations.”