Description

Note: Not submitting this as one of my required ideas, just thought I would share this brief analysis in case an opportunity arises in Sears’ rights offering.

Disclosure:

This is not a recommendation to buy or sell shares.  Our views are subject to change without notice and we may trade in any manner, whether consistent or inconsistent with this recommendation.  The information below is from public sources.  We have not independently verified this information and we make no representations as to the accuracy or correctness of any such information.  We undertake no obligation to update any information below.

Summary:

Sears recently announced a rights offering to raise capital in advance of the upcoming holiday shopping season. The offering will raise up to $625MM. Shareholders of record on 10/30/14 received rights (trading as SHLDZ) which entitle them to subscribe to (1) $500 principal senior unsecured bond yielding 8% and (2) 17.6 warrants to purchase SHLD stock struck at $28.41. Thus, anyone exercising the rights will pay $500 to receive 1 bond and 17.6 of the warrants. Often in these deals, a lot of existing shareholders receive the rights and simply want to sell them for cash, putting significant downward pressure on them. This was the case with the rights offering Sears has been conducting for Sears Canada where the rights sold-off significantly after a few days. Using a simple Black-Scholes calculation to value the warrants and a range of assumptions on the market YTM for the new senior unsecured bonds, gets to a midpoint valuation of ~ $130 per right. I’m posting this despite the rights currently trading at/slightly above my estimate of fair value. I think there is a decent chance these will trade off as we get closer to expiration and people who don’t want to subscribe look to sell their rights. It is important to note that if you do purchase these rights, you need to be prepared to put up another $500/right to actually participate; if the rights sell-off it will likely be close to expiration and thus in order to realize full value you will need to exercise the rights and wait for the bonds and warrants to be listed.

Below is the valuation of the warrants, calculated using Damodaran’s template for valuing dilutive warrants:

Below is a valuation of the bond and the rights, along with a sensitivity analysis:

Catalyst