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Thomas De Wever/iStock Editorial via Getty Images
Thomas De Wever/iStock Editorial via Getty Images
Seritage Growth Properties (NYSE:SRG) is an attractive event-driven investment opportunity. The base-case scenario is a 100% return over the next three years (equates to a 25% annualized return) as the company looks to liquidate its assets, pay off its debt obligations, and return the remaining proceeds to shareholders. The downside risk, in my view, is low while the upside potential is significantly more than 100%.
Seritage Growth Properties is an ex-Real Estate Investment Trust (REIT) with 150 properties in its portfolio (as of June 2022). The company was spun-off from Sears Holding Corp. in 2015 when it purchased 235 properties and 31 joint-venture interests from Sears for $2.72 billion. On its debut, the company traded at $36.02 per share.
Since listing back in July 2015, the company attempted to unlock value by redeveloping many of its properties while at the same time renegotiating its leases with Sears, which were ridiculously low at between $17 and $18 per square foot. Unfortunately, Sears filed for bankruptcy in early 2019, leaving Seritage with 77 wholly owned properties and 19 JV properties that were leased to Sears and vacant. Seritage lost 73.2% of its 2018 rental income (approximately $114 million) due to Sears’ bankruptcy, while being burdened with $90 million in interest expenses due to its $1.6 billion debt to Berkshire Hathaway (BRK.A). Interestingly, from the time of the spin-off up to even after the bankruptcy, SRG traded at around $40 per share.
After the Sears bankruptcy, SRG worked on repositioning itself by redeveloping properties and attracting new tenants in the hopes of improving rental income while selling off some less desirable properties. But then the pandemic hit – the dagger in SRG’s side. SRG lost a significant amount of rental income as the company initiated rental freezes to help businesses struggling with nationwide lockdowns. Revenue dropped from $169 million in 2019 to $117 million in 2021, while the heavy debt burden continued to plague the business.
Seritage was still selling off properties to help generate cash to meet debt obligations, but was burning through cash faster than it could produce it. The fear was that SRG was going to go bankrupt itself, and was troubled with high management turnover as a result of the problems it faced. Unsurprisingly, the share price dropped to under $10 at the start of the pandemic, and is yet to recover to pre-pandemic levels.
As mentioned above, when Seritage was spun off it controlled well over 200 properties. However, it has sold off “less desirable properties” for various reasons. As of June 2022, the company owned 150 properties.
The investment thesis for the last couple of years has been that Seritage’s remaining properties are worth far more than the enterprise value of the business. This has been discussed in great detail by many before me, so I will not rehash it here. If you’re interested there are many public resources available, such as Brad Kaellner’s valuation of each property.
To summarize, after smart individuals have spent time valuing each property, the consensus is that the total value of SRG’s assets is easily worth over $3 billion, with even SRG itself valuing its assets at $2.6 billion. The common view is that if Seritage were to be liquidated it would easily fetch $30 per share after paying off its liabilities. The appeal of this investment is such that even the “greats,” such as Guy Spier, own shares in the company. However, this is all irrelevant because of where we stand today.
As of now, Seritage is in the process of liquidating its entire portfolio either in chunks or selling the business as a whole. With the proceeds, it will first pay off its debt to Berkshire Hathaway, which currently stands at $1.27 billion after SRG recently made a $70 million loan repayment, followed by the preferred shares valued at $70 million. Whatever is left will be returned to shareholders (post-expenses).
As per the 2022 annual general meeting (AGM) proxy statement, after thorough analysis and consultation with third parties, management believes the “estimated total shareholder distribution range” will be between $18.50 and $29.00 per share. However, they did say that due to the current economic environment, “it is unlikely that the net proceeds ultimately distributed to our Class A shareholders from the plan of sale will fall within the upper portion of the $18.50 and $29.00 per share estimated total shareholder distributions range.”
As of the market close on Oct. 3, 2022, SRG’s share price was $8.99. Based on the estimated total shareholder distribution range, this implies that we stand to gain between 105.1% and 221.5% return on our investment should we buy shares today.
Let’s be conservative, however, and assume that the company is only able to return $18.50 per share. Let’s also assume that the $35m (or $0.62 per share) it recently settled with Sears due to long-standing litigation, which it is trying to recoup from its insurer, is not recovered. Then we only get back $17.88 per share. Still, this implies an upside of 99%, which is pretty attractive.
As per the proxy statement, management believes that this whole process of selling its assets, paying off its debt obligations, and returning proceeds to shareholders will take 18 to 30 months post-approval. Shareholders will be voting on the sale at the next AGM on Oct. 24, 2022. So let’s assume that, worst-case scenario, we receive our proceeds of $17.88 per share in 36 months, or three years, from today. That implies a 25.7% annualized return over the next three years. I’ll take that!
I place a high probability on earning at least $17.88 per share, hopefully in a far shorter time frame than 36 months, for the following four reasons (which can be found in the 2022 AGM proxy statement).
1. Management is close to selling half of the properties, in terms of value. As per the proxy statement (linked above):
As of the date of this proxy statement, we, at the direction of the Board, have commenced sales processes with respect to assets representing approximately half of the aggregate value of all our assets, with such sales currently targeted to be completed or under contract by the end of 2022.
2. Berkshire Hathaway has agreed to the sale of assets. Before the release of the proxy statement, SRG and Berkshire Hathaway entered into an amendment of their term loan agreement allowing SRG to sell its assets. This cleared the way for the company to seek shareholder approval for the sale.
3. The main shareholder is in favor of the “sale plan.” Eddie Lampert, who has been involved with Seritage since before the spinoff of the business, is the largest shareholder. He owns 29.1% of the business as of the time of the proxy statement’s release. He has pledged to vote all his shares in favor of the sale. With his vote of confidence, the sale is likely to be approved this month’s AGM.
4. Management stands to gain from the sale. The CEO and other members of the management team are shareholders of the company and have unvested shares that will vest at the time of the sale. Management, therefore, has a substantial interest in not only negotiating a successful sale of the assets, but also an interest in obtaining the best prices and returning proceeds to shareholders as quickly as possible.
Of course, no investment is without its risks. One risk is that the sale doesn’t go through. However, I place a low probability on this, given that the largest shareholder and board are in favor of the dissolution of the business and that half the assets are close to being sold.
Another potential risk is that the sales price is below the low range of estimated total shareholder distribution range. In the proxy statement, it clearly states that there is a risk that the low range value is not achieved. However, it also states that the company will communicate this before the AGM should they believe it will not be achieved. I believe that the sale plan remains as per the proxy statement; that’s because on Sept. 22, 2022, management communicated the following to me via an email: “There have not been any changes to the plan since the definitive proxy was filed.”
Another risk is if the main shareholder has a change of heart. On Sept. 16, 2022, Lampert sold 65,917 shares at $11.8212 per share. This prompts the question of why the main shareholder would sell before the dissolution of a company that he is in favor of. It is important to point out the common saying that there are many reasons to sell a share. The majority of Lampert’s shares are held through his investment company, whereas the shares sold on Sept. 16 were through his family trusts. Therefore, the reasons for the sale are numerous and, I believe, unrelated to the outlook of the business. That’s because management confirmed the following last week, via the same email mentioned above:
We do now know why Mr. Lambert sold some of his shares. He is no longer on the Board, and we are not privy to his personal financial decisions.
Furthermore, the record date for shareholders eligible for voting on the sale plan has long since passed. Therefore, he still holds the voting rights for the shares he has sold. He has not sold any shares since Sept. 16, 2022.
One last potential risk is an economic downturn that prevents the company from achieving its objections. The biggest risk will be a significant downturn in the property market due to rapidly increasing interest rates and a recession in the U.S. economy, reducing the price SRG receives per property or the ability to sell the properties. Unfortunately, the future is unknowable, but what we do know is that SRG’s consultants and management themselves have the same – and probably even better – information we do concerning the direction of the property market. So they would have already built that into the price range estimation. Plus, half the company’s assets are already in negotiation to be sold.
Despite the risks mentioned above, I place a high probability on the company achieving its estimated sales range. However, to protect ourselves on the downside, we can be even more conservative in our return calculations. If we assume the company is only able to return $12.50 to shareholders (a 30% discount to my base case), this still equates to an 11.5% annual rate of return over the next three years. This is not great, but still acceptable.
There has been much controversy surrounding SRG as an investment over the last few years, with bears believing the company’s cash burn rate has the potential to wipe out the entire equity value of the business, while bulls believe the long-term potential to be far greater than the current share price. All of that is in the past, and the real opportunity today is that the company has a set strategy it has openly communicated to the market to liquidate assets of the business and return cash to shareholders.
I place a very low probability on this sale not going through, and believe that there is a high probability that we will earn at least $17.88 per share within the next 36 months, earning a 25.7% annualized return over the next three years. And the potential to the upside is an over 60% annualized return over the next two years (assuming $23.44 is returned to shareholders in 24 months). As such, the reward far outweighs the risk here.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of SRG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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