US Insights

5 Takeaways From the Strange Collapse of Sears

David Marcotte

Senior Vice President, Strategic Advisory Service

Retail 10.12.2018 / 14:00

Sears

Sears’ rapid decline may very well be final this time.

The recent onslaught of news that Sears has stopped paying vendors is reinforcing concerns — and our opinion at Kantar Consulting — that Sears’ rapid decline may very well be final this time. Or not. Very few companies in the world are as complex as Sears Holdings and the surrounding companies owned and controlled by Edward Lampert. Here are the five things we think you should know as the collapse of Sears plays out before us.

1. Sears has stopped payments to vendors. Save for the most stable clients, manufacturers will normally take out vendor insurance (known as accounts receivable puts) that covers the potential nonpayment by a retailer. A normal cost for dealing with other retailers would be less than 2%. In 2017, the fees insurers charge rose to 5%, which was an unacceptable cost to doing business for almost all vendors. Most have shifted to deal terms that include shifting payment cycles from 90 days to 15 days or even payment on delivery. Note that until early 2017, ESL Investments, the overall Edward Lampert fund, was covering this cost, which made the changes in 2018 even more drastic. sear

What it means: While Sears has not clearly stated that it will no longer pay vendors, it is clearly being implied in talks with lenders. Companies that have shipped goods and not been paid will have lost the expected revenue due to lack of insurance. Most products for the holiday season have already shipped and likely been paid for, so Sears could continue as a seasonal pop-up store.

2. This will not be a slow decline. Sears is undoubtedly playing out the string until the last possible moment of seeking court approval as Lampert tries to sell to investors a “new and improved vision” of Sears. Since ESL Investments and Lampert are the largest investors to be paid in this scenario, a court may choose not to grant protection through the various bankruptcy chapters. This would lead to a drastic reaction by the company.

What it means: Store doors may be locked and stores closed without any notice to shoppers, employees, vendors, or commercial property owners. This is the worse-case scenario for all involved.

3. REITs and malls may slow this process. To date, Seritage Growth Properties (also owned by Lampert) and other minor holders of related REITs have done well with Sears Holdings, including the properties that have closed. It is not at all in their interest to allow Sears to go quietly, much less into a court-managed scenario where they will lose leverage. The same can be said for commercial property owners like Simon Properties that will not only lose the income from the store space, but will also have to deal with greater losses from other tenants. Most mall leases have clauses stipulating that if an anchor retailer closes and the mall is without a new tenant for more than 60 days, tenants can negotiate their lease rates to reflect the overall lowered value of the mall to drive traffic. This would cause an overall loss of revenue far greater than simply the loss of one tenant. Simon Properties and other commercial real estate firms  may come back to Sears Holdings with emergency lease adjustments to prevent departure. The same tactic was tried, and ultimately failed, with Bon-Ton earlier this year.

What it means: For many poorly performing malls, Sears is the last major anchor store. This will impact other mall-based retailers along with new commercial real estate development in the next few years. Note that the majority of these properties are over 40 years old and would pose major environmental cleanup costs if they are torn down.

4. There is an alternative scenario. Sears has not been profitable since 2010. However, as the core of a surrounding set of companies and holdings, it has driven profits for Lampert overall and been balanced against his hedge fund activities. If bankruptcy is the remaining option, he will try to strip out the profitable parts, such as those associated real estate holdings, or sell off remaining assets like Kenmore. He could even try to buy them out with other parts of his corporate empire at a fire sale price, which is complicated by all the companies and shell holdings technically being controlled by the same person. This was done in the past on a smaller scale with Land’s End, which failed to sell after being publicly offered for over a year.

What it means: Like Land’s End, Kenmore has been a difficult company for Sears Holdings to sell, so the plan discussed has been to spin it off under the same umbrella ownership. The intent is to realize income from the sale and to have products sold in all retail locations. This may impact JCPenney, Home Depot, Lowe’s and Best Buy.

5. Sears.com may well survive. Other companies that have closed their doors have continued operating online or reopened under other owners who bought the brand rights. Sears.com is a growing business, though it is difficult to judge its profitability since it shares almost all its supporting functions with the stores and distribution centers. It may even become a form of clearance during the holiday buying period. Another company (think Walmart or Kohl’s) may be tempted enough by the brand to establish a partnership, but it would be far more likely to simply buy it out and operate it as an extension.

What it means: Some online disruption going into the holiday season. 

By the time you read this, Sears will have changed, but due to the extreme complexity of its ownership, it is difficult to say definitively what that change will be. Whatever it is, the one winner will almost certainly be Lampert who has been able to leverage a company that has lost revenue, market, and brand power for more than eight years into a large profit engine for his enterprises.

Source: Kantar Consulting

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