U.S. Bankruptcy Court Judge Robert Drain on Thursday, after three days of testimony, ruled in favor of the $5.2 billion offer from Lampert and his hedge fund ESL Investments. The offer was made through ESL affiliate Transform Holdings. The turning point seemed to come earlier in the day when Sears resolved its $1.7 billion dispute with government pension watchdog Pension Benefit Guaranty Corp (PBGC). The PBGC agreed to cut its claim to $800 million and support the ESL offer.
In ruling in favor of the transaction, Drain also overruled the objections of unsecured creditors, who had been pushing for a liquidation because they thought they would get more now from the sales of Sears’ assets than later on, if the reorganized Sears should fail a second time.
But flooding the market with real estate locations at the same time might mean less dollars coming in if the law of supply and demand results in too many options and not enough takers. And worry that Sears as a smaller company might still fail again could just be speculation. One key consideration might have been the loss of 45,000 jobs if Sears were to immediately liquidate. That seems to have weighed on Judge Drain’s mind when he pushed Sears and ESL in early January to reach a going-concern deal, which resulted in the $5.2 billion offer.
Philip Emma, senior analyst at Debtwire, said, “The key question is really what’s going to be different operationally about Sears and Kmart. They’ll be able to eliminate legacy liabilities like the pension expense, but on a pure business level, what are they going to do different? Will shedding those liabilities make them viable? That’s an open question.”
Court testimony earlier in the week disclosed that financial institutions backing Sears’ exit from bankruptcy have included a provision that says they can put in a chief restructuring officer should an ESL-connected person take on the role of chief executive officer. According to Emma, who before becoming an analyst had worked on bank loan agreements, said the provision is “not uncommon.” The key is in the context of how it is “worded, [as in] under what conditions would trigger that action,” the analyst said.
When Sears filed its voluntary Chapter 11 petition for bankruptcy court protection on Oct. 15, court documents in the case noted roughly 400 stores that were deemed profitable on an EBITDA basis, or based on earnings before interest, taxes, depreciation and amortization. Since then it is unclear whether that store count remains the same, or whether the profitable store base has deteriorated over the course of the bankruptcy.
And despite argument from unsecured creditors that the business plan doesn’t hold water, Emma noted that in order for a bankruptcy judge to approve the sale, Sears had to have been able to show a financial projection that indicated a reasonable basis for a viable business going forward. He cautioned that the plan doesn’t necessarily mean Sears would show positive cash flow within the first year, only that there’s “viability within some reasonable time period after they build in the ability to start generating some positive cash flow.”
Sears would need to hire a chief executive officer, and even a chief merchant. And that’s just the start of a list of hurdles that include figuring out how the retailer gets back a customer base for its Sears and Kmart nameplates.
Credit analyst Christina Bona from Moody’s Investors Service said, “Scale, which is critical to competing in retail today, will be lacking and its core customer proposition still remains in question. Further shrinking of the store base and cost reductions may be required as profitability remains elusive.”
And Sears will have to garner the support of the vendor community. Before it filed for bankruptcy, factors had stopped approving orders for fear of a Chapter 11 filing. Suppliers who were filling orders were doing so at their own risk. A reorganized Sears, with a fresh-start accounting balance sheet and new financing in place, should be able to pay its bills initially. It’s further down the road that might be problematical if the company ends up not being able to execute on its business plan. Another concern for vendors is that Sears will become a private company, which means there won’t be any public filings of its financial statements so they’ll likely still be taking the risk when deciding whether to sell to Sears or not.
After bailing out Kmart in 2003, Lampert renamed the company Kmart Holding Corp. A year later he masterminded the merger of Kmart and what was then Sears, Roebuck & Co. The merger was completed in 2005. There was also an expectation that the combined entity would generate about $55 billion in annual volume, but instead consumers shifted their shopping preferences to online from brick-and-mortar. It didn’t help that Lampert stopped investing in the refurbishment of stores, and Sears ended up closing thousands of those stores over the years.