Monday, September 24, 2018

Eddie Makes a Sears Restructuring Proposal $SHLD

Eddie put out a presentation today called "Transforming Sears Holdings - A Proposal from ESL Investments, Inc." as a 13D exhibit. Some highlights:

  • Sears must act immediately to have sufficient runway to continue its transformation. To obtain this runway, Sears must extend near-term debt maturities, reduce its long term debt and eliminate the associated cash interest obligations.
  • We continue to believe that it is in the best interest of all stakeholders to accomplish this as a going concern, rather than alternatives that would substantially reduce, if not completely eliminate, value for stakeholders.
  • Sears now faces significant near-term liquidity constraints, including a $134mm maturity for Second Lien Notes due October 15, 2018.
The proposal to the second lien loan and noteholders is to choose between options A and B. The first option gives them new mandatorily convertible, zero coupon debt that would mature December 2021 instead of July 2020 for the 2nd lien loan and October 2019 for the 2nd lien notes. It would be convertible at the higher of $1 per share or the 20 day VWAP. The second option only applies to the 2nd lien notes, giving them the option to re-strike the conversion price to be equal to option A plus $1.25. Under option B, they get PIK interest at their existing rate. The maturity is pushed out until December 2022.

The unsecured debt holders also get two different options. (Actually, there are only two options for the holders of the cash unsecured notes, who did not accept Eddie's earlier exchange into PIK notes.) Option A is to exchange into mandatorily convertible, zero-coupon unsecured debt. The strike price would be $1 above the secured debt conversion price, and the conversion would take effect in December 2021, same as for the 2nd lien debt. Option B is that they can get taken out for 25 cents on the dollar.

So that is funny - zero coupon debt that is mandatorily convertible into equity is not really debt, it is just equity with a three year waiting period. There would never be any interest payments or cash flows for any secured or unsecured debtholders who exchanged into this. 

Eddie also proposes a "Real Estate Transaction". This is an odd one where a "Consortium" including ESL would refinance the debt encumbered real estate portfolio that Sears is currently marketing for sale. The members of the consortium would convert their loans to a PIK at an interest rate of 12.1%.

Overall, debt would be reduced from the current $5.6 billion to $1.2 billion (excluding the mandatorily convertible, zero-coupon debt). The result, if it takes place, is huge dilution of the current equity by the current 2nd lien debt and unsecured notes.

In the most recent quarterly report, there was a section called "Actions to Address Liquidity Needs".
The following actions, which are intended to fund liquidity needs over the next twelve months, are in various stages of completion as of the date of this filing. We believe these actions, some of which we expect, subject to our governance processes, including the process being overseen by the Special Committee, to include related party participation and funding and, in the case of Sale Assets that are sold to ESL, subject to approval by a majority of the disinterested stockholders of Holdings, if completed, would be sufficient to satisfy our liquidity needs for the next twelve months from the issuance of the financial statements.

[List:] Sales of properties securing the remaining principal amount of the Secured Loans to fund the repayment of such Secured Loans; Additional borrowings under the Mezzanine Loan Agreement, Term Loan Facility and the Consolidated Secured Loan Facility; Monetization of the Sale Assets; Extension of maturities beyond September 2019 of Line of Credit Loans under the Second Lien Credit Agreement; Additional borrowings secured by real estate assets, borrowings under the short-term basket, or other borrowings; Amendments to the terms of certain of our financing arrangements, including to allow interest on some of our debt to paid-in-kind; Further evaluation and right-sizing of our store base, including evaluation of our business categories; and Further restructurings to help manage expenses and improve profitability, including additional store closures and the accomplishments of our planned cost savings initiatives.

While we believe that completion of these actions would be sufficient to satisfy our liquidity needs for the next twelve months from the issuance of the financial statements, these actions have not been fully executed as of the date of this report and certain of the actions have not received necessary approvals (including but not limited to approval of the Special Committee and approval of a majority of the disinterested stockholders of the Company in the case of certain proposed transactions with ESL), and/or are at too early of a stage in the process to be considered probable of occurring under applicable accounting guidance as of the date of this report. Accordingly, because we cannot at this time conclude that these actions are probable of occurring under such accounting standards, substantial doubt is deemed to exist about our ability to continue as a going concern. The Company continues to move forward with these proposed actions, including the process being overseen by the Special Committee, and discussions with lenders, in order to complete these actions. The Company believes that completion of these actions, or in some cases substantial progress towards such completion, would alleviate or eliminate the substantial doubt. The Company will continue to reevaluate this assessment.

The PPPFA contains certain limitations on our ability to sell assets, including the Kenmore brand and related assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the analysis of liquidity needs includes consideration of the applicable restrictions under the PPPFA and the ability to utilize related party borrowings to provide liquidity when there are short-term delays in the closing of transactions.

The success of the foregoing actions is subject to various risks, uncertainties and other factors, including market conditions, interest in specific assets and our ability to close the sales of assets at valuations and within time frames that are acceptable to us, our ability to effectively and timely execute the above actions to improve the operating performance of our businesses and, in certain cases, the approval and participation of third parties, including our creditors and the PBGC.

If we continue to experience operating losses and we are not able to generate additional liquidity through the actions described above or through some combination of other actions, then our liquidity needs may exceed availability under our Amended Domestic Credit Agreement, our second lien line of credit loan facility and our other existing facilities, and we might need to secure additional sources of funds, which may or may not be available to us. A failure to secure such additional funds could cause us to be in default under the Amended Domestic Credit Agreement or other financing agreement. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to our outstanding second lien debt) falls below the principal amount of such second lien debt plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for such debt on the last day of any two consecutive quarters, it could trigger an obligation to repurchase our New Senior Secured Notes in an amount equal to such deficiency. As of August 4, 2018, our borrowing base was below the above threshold, and if our borrowing base is below the above threshold at the end of our third quarter of 2018, it would trigger an obligation to repurchase or repay second lien debt, in an amount equal to the excess of our funded debt secured by liens on our inventory as of November 3, 2018 over the borrowing base. If we fail to make such repurchase or repayment, we would be in violation of our covenants under our Second Lien Credit Agreement and the indenture relating to our New Senior Secured Notes.
On August 4th 2018, Sears only had $193 million in unrestricted cash. The October 2018 debt maturity that is being talked about is "$134 million during October 2018, in addition to $668 million of other debt maturing in the next twelve months."

Here is something I do not understand about Eddie or Elon Musk. They each made a serious entrepreneurial mistake over a decade ago and have been dealing with the miserable consequences ever since. Why keep prolonging it?


Anonymous said...

Great post, as always.

"Here is something I do not understand about Eddie or Elon Musk. They each made a serious entrepreneurial mistake over a decade ago and have been dealing with the miserable consequences ever since. Why keep prolonging it?"

Don't think it is about Sears, probably more about Seritage. Someone needs to pay the rent to Seritage while they switch anchor tenants away from Sears. Keeping them alive just long enough to allow that is the goal IMO.

CP said...

So how about SRG puts? The next domino to topple if this (dubious) restructuring proposal can't be put together in time?

Anonymous said...

Good idea, didn't think of that. I see they run for 6 months out and he can probably prolong SHLD's death for a very long time. Even then, SRG could strike a deal with an SPG.
Seems like a too complicated box for me.
What do you think?

CP said...

Probably too complicated unless you think SRG is overvalued anyway.

But if you think this kooky restructuring deal is going to work to buy more time, then the unsecured notes are interesting at 30 cents - holdout potential.

Mr. Gotham said...

The impact of BK on SRG depends on whether you think there is a going concern possibility. The odds are probably not in favor of that, but if there was a non-liquidation outcome, SRG would still get rent on the stores that stayed open. It might also accelerate the opportunity for SRG to capture the stores that it would like to redevelop, though there is a question of how many of those it can do at once given its balance sheet.

I agree that the odds of Eddie pulling this off don't seem high, at least not with the terms on the table. What I haven't looked at is how much of the debt ESL or Fairholme may own. They may be able to force some of these transactions through with their votes.

On your question about Eddie and Musk, I think a lot is explained by ego.

CP said...

The Dec 2019 debt traded way down today. Only oddlot trades, but a new all time low of 20 cents.

I'm sure one of the things Eddie wanted was to crush the prices and morale of debt holders.

One thing's for sure: I'll be telling eddie to pound sand with his exchange offers.

Unknown said...

What are the odds Sears makes the $134 million payment next month?

CP said...

"To have debt that's convertible into equity when the equity is worthless doesn't appear to be a very attractive proposal at all," said Elliot Lutzker, chairman of the corporate law practice at Davidoff Hutcher & Citron LLP.