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peruse the Sears balance sheet and cash flow statement and see if they can make the payments to debt holders in liquidation?


OK. Take the most recent balance sheet, for Sep 30, 2011, keeping in mind that market cap is $5bn.

Liabilities: $17.9bn
Total assets: $25.5bn.

So equity is $7.6bn, easily covering the market cap. In other words, at first glance, yo might think that in the event of bankruptcy, not only are bondholders ok, even shareholders will get all their money back and a little more.

But all equity is not created equal, so we should haircut some of the things in there. Q3 is the worst time of the year for this, since they have stocked up for Xmas, but let's do it anyways. Current assets are:

cash: .6
receivables: .7
inventory: 11.1 (the biggie)
prepaid expenses: .5
other: .1

The traditional handicap for these is that cash is cash, receivables get a 1/4 haircut, and inventory 1/2. That seems a little harsh for Sears, since most of that inventory is perfectably good sellable stuff, and a good part of that is going to be gone after Xmas, most of it for full price. It's not as though these are thingummy gadgets in inventory, of questionable value, these are washing machinges and underwear and power tools. I would say a 1/4 haircut is ok, and zero for the other stuff, so I would put the current assets at .6+ .75*11.6 = 9.3 bn. Liquidate those, and you have paid off 9.3 out of the 17.9 total liabilities, leaving 8.6 that we have to find elsewhere.

Going down the balance sheet, next we get to property, plant and equipment, on the books for 7.0. Goodwill we ignore, and there's also 3.1 of intangibles, presumably the company's assessment of the worth of their brands, and 1.0 of other long term assets.

So basically, your question boils down to, are those 11.1 of assets really worth enough to cover the 8.6 in liabilities that the liquidated current assets haven't already paid for.

Since the lion's share of those assets is stores and real estate, the question really comes down to their value, in liquidation. Bruce Berkowitz famously claimed that they were worth over $10bn, about 5 years ago, before the housing collapse, the market crisis, the Geithner mess, Obamacare, the European debt crisis, etc. But how much is it worth now? If it has lost 40% of its value (just pulling a number out of nowhere, but that's roughly the residential housing market haircut), then we might have $6bn worth of real estate, and you only need the intangibles and the other assets to be worth about 2.6 out of their stated 4.1 value.

So bottom line, I think the bonds are fairly safe. In addition, the company is basically breaking even, and this is a very controlled liquidation, if it is a liquidation at all. Lampert has the luxury of choosing his timing, at least as long as margins stay around 0 or slightly positive, or even if they are slightly negative.

Regards, DTM
Occasional seller of long-dated puts, with a few shares that have come to me from the December expiration, and which I intend to hold onto unless prices get back up over 70...
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