Description
Sears Canada (SCC CN) is an attractive value investment. At C$28.30 per share, the company trades at a 10% free cash flow yield and 6x EBITDA multiple of the merchandizing operation. In addition to a good retail operation at a reasonable price, you get about $1.50 per share of realty assets (not included in my EBITDA figure), the potential for a recapitalization/sale-leaseback that could generate between $10-15 per share of liquidity, a significant cost cutting operation which could increase EBITDA from its $500 million run rate, and a very sophisticated and incentivized management team.
Sears Canada has been written up on VIC in the past so I suggest readers review the previous postings. Since the last write-up, Sears Holdings failed in its attempt to squeeze out minority shareholders at $18 per share. Also, in the past six months the company sold its corporate jet, made demands for millions of dollars of payments from suppliers, cut back pension benefits, and yesterday announced the sale of corporate headquarters. Margins have increased and capital expenditures have been significantly scaled back. All the while, the top line has stayed intact. Over the past two years the company has moved from a net debt position of $450 million to a $100 million net cash position.
As readers of VIC are probably aware, 70.2% of SCC is held by Sears Holdings (SHLD) which is controlled by ESL Partners. ESL has put in place their own board and management team at Sears Canada.
Financial overview:
Market cap: 107.6MM shares at $28.71 = $3.1 billion
Net cash at 6/30/07: $96MM
EV: $3.0 billion,
LTM MERCHANDIZING EBITDA: $487 million
LTM capex: $63 million
Free cash flow is around $300 million based on 500MM est. EBITDA - 60MM Capex - 35MM in estimated interest expense - 100MM in taxes (assuming 37% taxes on 300MM of pretax income, 165MM in depreciation).
I think the opportunity exists because 1) Canadian research firms continue to value this based on P/E estimates which make the company appear fairly valued; 2) the stock is illiquid; 3) People may be leery of investing given that SHLD attempted to squeeze out minority shareholders at $18, below the appraiser's range of $19 to $22.25 and below other shareholders' estimates of fair value. While anything can happen, a large activist shareholder owns 15.5% of the shares (a majority of the minority shares) and has demonstrated a willingness to protect shareholder value in this situation. To get permission to do anything with the minority shares, Sears Canada will need approval of a majority of the minority. One has to have comfort that the large minority shareholder will act rationally.
For those who are interested, the company publishes very thorough quarterly/annual reports so you can get more details there. They do not, however, have much of an investor relations function and they do not hold conference calls.
Catalyst
Ultimately, it’s my expectation that SHLD sells Sears Canada to a strategic buyer at over $40 per share which would be 8x an estimated $600 million in EBITDA, in line with comparable retail transactions and reflective of the scarcity value of Sears Canada’s retail operation. It’s also possible that the company merges with Hudson’s Bay, the other large department store operation in Canada which could generate very significant synergies and easily be justified at a $40+ per share for Sears Canada. If selling is not a viable option, the company could do a financing that would take a significant amount of capital off the table, or offer to buy out minority shareholders at a premium. Regardless of the outcome, the controlling owner is not a retailer but rather a financier looking to maximize value.