Seritage is an American real estate company already featured here earlier this year
The company first came on the radar of investors in 2015 when Warren Buffett personally acquired 8% of the shares in circulation; and a second time last spring, when Berkshire Hathaway granted Seritage a loan of $2 billion; and then a third time just recently, with the bankruptcy and the chapter 11 reorganization of Sears Holdings, Seritage’s main tenant.
Bear in mind that Seritage is a vehicle designed to ‘recapture’ and ‘redevelop’ the commercial space abandoned by Sears as the latter liquidate its activities. The investment thesis here is remarkably clear: once the commercial space is redeveloped, a square foot is rented to new tenants for an average price of $17 against $4 previously when Sears occupied the space.
This spectacular revaluation, even if it’s costly because the company needs to invest considerable amounts to get the space up to today’s standards - forms the basis of a net growth of the rental income and splendid returns throughout the next decade.
We could comment on the nature of the different redevelopment projects - ongoing or already finished - the latest investor presentation
offers several illustrative samples in that regard, but, to keep it short, so far the management has been efficient in its initiatives to transform antiquated properties into attractive living spaces.
In this context, the bankruptcy of Sears could potentially - note the reservation here - be good news. It could accelerate the process of recapturing and redeveloping properties; the bad news, because there’s bad news too - well reflected in the recent fall of the share price by the way - is that Seritage risks to lose almost a third of its current rental income.
The management, however, seems to be well prepared for this possibility
Let’s continue with a back of the envelope kind of valuation: the company possesses 248 properties, for a total of 39 million square feet across the United States, 36.4 million of which belong to Seritage once the parts that belong to various joint ventures have been subtracted; half of the rental income comes from the best States - California, Florida, New York, Illinois, and Texas.
Seritage still leases 12.4 million square feet to Sears: let’s assume the worst is going to happen and count this as zero; this leaves us with 24 million square feet available for lease, 6 million of which have already found tenants, while the remaining 18 million square feet is either in redevelopment or left on standby - with 88 redevelopment projects that are either finished or just started, the transformation seems well underway.
By capitalizing the rent per square feet over a period of ten years - a hypothesis that is conservative and that everyone is free to adjust as they see fit - the value of these 18 million square feet comes down to $4.1 billion. Once the $1.7 billion of debt - preference shares included - is subtracted the net asset value comes down to $2.4 billion.
Seritage possesses 64% of the operational partnership that manages the real estate company. ESL - the hedge fund of Sears president Edward Lampert, has the other 36%. The part of the net assets that belongs to the shareholders of the company comes thus down to around $1.5 billion, or around $41 per share - compared to the current price of $38, but we’ve counted the 12.4 million square foot that’s still leased by Sears as zero.
At this price, the safety margin is thus considerable, and the 12.4 million square feet to redevelop are ‘free of charge’ - notwithstanding a real cost of opportunity. Apart from a disastrous scenario in the North American commercial real estate sector, the opportunity to benefit from the bankruptcy of Sears seems to be particularly attractive thanks to Seritage.
The main challenge will be to obtain the necessary funding for the reconfiguration of the properties. Recent projects have demonstrated that a redevelopment costs around $200 per square feet: in this regard, the 18 million square feet that have been upgraded or is currently being upgraded require an investment of around $3.5 billion - exactly the entire capitalization of Seritage, debt, and equity accumulated.
Once the 12.4 million square feet that are still occupied by Sears are added, the bill goes up to $6 billion. If Seritage doesn’t manage to get the necessary credit, the value creation could take a while…. The bet is thus not without risk - but at the same time what investment is? - and is mainly meant for patient shareholders.
However, with $1 billion of available cash, a leverage that is still modest and an appreciable latitude to monetize either individual assets, or its stakes in joint-ventures, Seritage seems to be well disposed to face the delicate current situation.
(The author is a shareholder.)
Article published on 10/31/2018 | 02:10