In my last blog post on Owner Driven Transformations, I noted that successful transformations require three critical elements: (1) financial staying power to fund the necessary investments, (2) leadership committed to seeing things through challenging circumstances and (3) long term investors who are willing to place their capital at risk. The $400 million of funding we received this week clearly demonstrates all three elements, but has been seriously mischaracterized in the media and elsewhere. I want to take this opportunity to put our financial position into its proper context. I hope this post clarifies some key points and provides the facts that were lost in the recent headlines.
First, we were able to secure a loan on terms that were fair and reasonable to Sears Holdings. These terms include a significantly lower interest rate than other loans in the retail sector and required much less in the way of collateral obligations (i.e. the amount of real estate backing the loan). No two companies are exactly alike, but we can look at the news articles and regulatory filings of other debt issuers in the retail sector to understand that the terms of our loan were favorable to Sears Holdings.
- Just last week, another large retailer issued $400 million of unsecured debt at an interest rate of 8.125 percent for five years to refinance debt coming due over the next several years at a higher rate than the existing debt.
- In 2013, as another example, this same large retailer executed a large real estate financing, secured by substantially all of its real estate portfolio. The five year $2.25 billion real estate loan has an interest rate of 6 percent with an upfront fee of 50 base points in the form of a fee paid to the lenders at closing plus other undisclosed fees (e.g., for committed financing paid to the arrangers of the loan at closing). Again, this loan was collateralized by substantially all of their real estate with an appraised value in excess of $3 billion, as well as liens on substantially all of the personal property of the company, in each case according to materials filed with the SEC.
We believe the terms of this financing compare favorably to other deals and are fair and reasonable to us. Our $400 million loan has an interest rate of 5 percent and an upfront fee of 175 base points, is secured by only 25 of our stores (or 2 percent of our stores) and is expected to be paid off at the end of the year or, at our option, by February 2015.
Second, the 25 stores that collateralize this loan represent only 2 percent of our total store base. The commentary in the media suggests that this was a way for ESL (an entity controlled by our largest shareholder and CEO, Edward S. Lampert) to buy the real estate cheaply – or that it removes the real estate as potential collateral that may be useful to us in other ways. In fact, at the end of this year (or two months after if extended at our option to the end of February) the loan will be repaid and the underlying collateral will be released – meaning that the 25 stores are still owned by SHC and we would have the flexibility to monetize them again. In addition, while the articles mention it is 25 out of about 1900 stores, they do not take the next step to extrapolate what the value could be for the entire real estate portfolio – and I have noted in the past that the book value (or accounting value) of our real estate portfolio is about $5 billion, noting that I would not engage in the speculation on the fair market value of the real estate portfolio. Again, contrast this to the collateral for the other large retailer real estate secured loan which is tied up for many years and represents substantially its entire real estate asset portfolio.
Third, we entered into the loan now to provide SHC with a stable source of funds during the holiday season as we buy inventory and continue to honor all of our financial commitments to our vendors, our pension plan and our debt holders. Many people have speculated as to why we did not fund this with commercial paper. Commercial paper, by its terms, is generally very short-term in nature (typically 30 days in time or less with renewals/extensions at the lender’s discretion). By contrast, at the company’s discretion, this loan will be in place for up to 5.5 months and should give comfort to all of our suppliers – and to those institutions that support our suppliers – that they will be paid. As a result, this form of funding is more predictable and reliable for our partners and provides us a reasonable rate. It also helped us meet our stated objective of raising $1 billion of liquidity this year as we had already raised approximately $665 million through the $500 million dividend from Lands’ End and approximately $165 million from real estate monetizations through the second quarter of this year. We have a number of other actions and alternatives underway, as we always do at any point in time given our substantial asset base and we are committed to creating long-term value for our shareholders while generating the appropriate liquidity to fund our transformation and meet all of our obligations.
There has also been consistent misrepresentation of our financial performance. While we acknowledge our performance has been poor, the use of the term “cash burn” misrepresents what is a combination of operating losses and funding of pension obligations, which we consider to be a form of debt repayments. For example, when another large retailer issued $400 million of debt last week, it did not borrow money because it had a $400 million “cash burn.” It did so to repay outstanding obligations. Similarly, when we fund our pension plan with payments of over $400 million this year, we are not funding “cash burn operating expenses.” Instead, it is a financing transaction in which we are honoring a legacy obligation. If we use debt to fund our pension, we substitute one form of debt for another. If we use proceeds from asset sales, we reduce outstanding obligations by the amount of funding. It is also worth noting, as Eddie points out regularly, that many other giants in the retail industry have no similar legacy pension obligations. We will have contributed over $2.9 billion to our pension from 2006 to 2014 as we indicated in our second quarter earnings materials that we posted on our website. We also showed in the same presentation that the outstanding balance on our revolver would have been $339 million at the end of Q2 2014 (as compared to the actual $1.4 billion outstanding) absent the last 10 quarters of pension contributions (which totaled about $1.06 billion). In any event, we have taken actions that have generated significant cash for the company, allowing us to meet all of our commitments as they have come due.
As we have stated, we are working to put in place a longer term, more flexible capital structure that should address lingering concerns about our liquidity and provide time and resources to continue our transformation. Further, as we continue our transformation leveraging Shop Your Way® and Integrated Retail we believe that we have options that will allow us to highlight our significant real estate value and crystallize how we intend to transition away from an asset intensive, historically “store-only” based retailer to an asset light, integrated membership-focused company. We are investing in our future while at the same time honoring all of our financial obligations, and creating value by rightsizing and redeploying our assets.
Finally, as I said in my prior post, I believe we are very fortunate to have a large and supportive shareholder who has demonstrated his commitment to our transformation in numerous ways over a long period of time, including this favorably priced loan. It not only gives us additional financial flexibility over the holiday season and proactively demonstrates to vendors and other constituents our steadfast commitment to meet our obligations but also allows us to continue the difficult but necessary work of dramatically repositioning our company for a very different future.
**Note – In response to inquiries, Sears Holdings confirms that the financing transaction announced on Form 8K on Sept. 15, 2014, was approved in accordance with its related party transactions procedures, including approval by independent directors who were advised by independent counsel, Weil, Gotshal & Manges. Sears Holdings has a Code of Conduct for its directors and officers, which provides that any direct or indirect monetary arrangement for goods or services between a director and the company must be approved by the Board of Directors.