Why Sears Holding Corp. Will Go Bankrupt
[Pages:13]Why Sears Holding Corp. Will Go Bankrupt
Wagner College
Bryan Maley Edward Wolf
Frank Abt
Why Sears Holding Corp. Will Go Bankrupt
Why Sears Holding Corp. Will Go Bankrupt
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Which company will file for Chapter 11 Bankruptcy by 2020? We feel that it will be Sears Holding (Sears).
Sears is a company with an ever increasing amount of debt and an ever decreasing amount of equity. Unfortunately Sears has an organizational structure that is not geared for the competitive retail environment. Sears equity price reflects these problems. Edward Lampert the CEO of Sears, a seasoned financier, will be looking towards an exit strategy in order to avoid the type of litigation revolving around an inevitable bankruptcy. It is our opinion Sears will eventually devolve into an equity "death spiral". A visit to any of their stores confirms this, they have more retail clerks than customers, and the aisles are depressingly empty. Sears' fate seems unavoidable and Lampert must strategize a plan to file for a Prepackaged Chapter 11 Bankruptcy in order to escape even worse consequences.
The situation at Sears is clearly presented in their financial statements. Revenues have fallen from $41.6 billion in 2012 to $39.8 billion in 2013, and now stand at $36.1 billion as of year-end 20141. The sale of Lands' End, a thriving brand, confirms to us that management is jettisoning good cargo in order to save the sinking ship. The company's balance sheet is a complete disaster. Sear's burned through $714 million dollars last year2. Sears' asset base has declined by $1.27 billion dollars in Q4 of 20143. In November Sears raised $2.2 billion in part from a loan from ESL Investments, and the partial sale of the company's stake in Sears Canada.4 Sears Canada, like Lands End, represented robust assets. This partial liquidation is another
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Why Sears Holding Corp. Will Go Bankrupt
ominous sign. Additionally Sears' debt is weighing heavily on management as they have $1.3
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billion in due in 12 months as well as their increasing unfunded pension obligations to retired workers.5 All told, Sears has $4.9 billion dollars in debt which leaves them with a debt to equity ratio of approximately 40 to 1.6 We feel these figures confirm an inevitable insolvency. Sears equity has been extremely volatile. At one point Sears looked like a solid revenue producing company. Lampert, who was chairman of Kmart engineered the purchase of Sears in 2004. Given the tailwinds prior to 2008, Lampert's strategy of leveraging real estate assets proved brilliant. However like many of the other failed financial firms during this period, over leveraging proved fatal as the real estate market crashed.
Sears dismal performance is reflected in its share price which currently trades in the high 30's. It once sported a price handle in the 170's less than ten years ago when there was more confidence in Lampert and his team7. Lampert was well known for squeezing money out of poorly managed businesses. In the first year the combined company produced revenue in 2005 of $48.9 billion. The balance sheet was strong with liabilities to equity ratio of 1.6 to 18. While Kmart and Sears employees were productively operating the retail stores during a challenging environment, top level management implemented a "hedge fund like strategy". They, in effect, strip mined its balance sheet. This approach proved ruinous and weakened the company. Combined with equity buybacks its debt to equity ratio was severely diminished. As ugly 3Q results were announced in December 2014 Lampert still spoke to the public in a positive tone. A share buyback program which was supposed to enhance shareholder value has done the opposite.
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Why Sears Holding Corp. Will Go Bankrupt
Management failed to foresee the economic decline of the traditional retail industry which is
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constantly confronted by ever increasing online sales. Ironically it was Sears Roebuck's use of mail order catalogs that revolutionized the retail industry in the United States. Internet based shopping which can be viewed as a progeny of that technique is fiercely working against Sears. In many ways Sears Roebuck and Company was the grandfather to Amazon. Now it is being undone by the same sales strategy it once championed.
The company has seen 4 different CEO's since the merger, yet many have said that Lampert has been running the show. Critics have commented for years that Lampert's style of operating a retail organization like a hedge fund portfolio is wrong headed. One cannot run a company like Sears in the same manner one would run a hedge fund portfolio. With multiple business segments competing with one another for Lamperts attention he now has an organizational structure which is decentralized. Instead of cooperating with each other, which is crucial in retail given inventory and sales complexities, they are competing with one another over a scarce resource base. One particular detractor, Shaunak Dave, who left Sears in 2012, said that Lampert created "warring tribes" and "cooperation and collaboration aren't there". Yet Lampert still refutes this by stating that decentralized systems can appear messier than centralized systems, but they still tend to work better and produce better information over time.
Lampert is no doubt a talented business person with a proven track record. However, as many management experts will agree, the strengths of the entrepreneur do not easily translate to the operational structure. One must ask, could anyone have saved Sears? Brick-and-mortar retailers have been struggling from declining economic activity for years, while losing market share from online retailers. These companies cannot afford the real estate overhead. The latest proof of this is Radio Shack's decision in 2014 to close more than 1000 stores. Sears Holding
Why Sears Holding Corp. Will Go Bankrupt
closed 300 stores as part of a larger strategic refurbishment in order to free up more capital and
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reduce risk9. As the equity value lurches its way to zero, we feel that a Prepackaged Bankruptcy may be the best alternative. The challenges facing this company are too great. It is for this reason that we are confident that Sears is the answer to your question.
Bankruptcy Prepackage; A Primer
Any conversation revolving around a Prepackaged Bankruptcy for Sears must include a review of the prepackaged process. The following paragraphs explain the procedures used in a "prepack". As one reads through this progression it more clearly demonstrates that this is the best course of action for Sears. As long as Lampert is willing to live with an inevitable diminished equity value, he can help his lien and debt holders realize a partial return of their investment and quite possibly emerge as a relevant retail presence once again. In many ways the restructuring of General Motors, who embraced a similar strategy, serves as a template to companies like Sears.
Chapter 11 bankruptcy, also called reorganization or rehabilitation bankruptcy, allows a firm the opportunity to reorganize its debt and to try to re-emerge as a healthy organization. It is strategically, a company's way of retaining control of their bankruptcy. A Chapter 11 case begins with the filing of a petition with the bankruptcy court serving the area where the debtor has a domicile or residence. A petition may be a voluntary petition, which is filed by the debtor, or it may be an involuntary petition, which is filed by creditors that meet certain requirements. Unless the court orders otherwise, the debtor also must file with the court: (1) schedules of assets and
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Why Sears Holding Corp. Will Go Bankrupt
liabilities; (2) a schedule of current income and expenditures; (3) a schedule of executory
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contracts and unexpired leases; and (4) a statement of financial affairs. Essentially, the main goal of the indebted firm by contacting its creditors is to attempt to
change the terms of its debt but must continue to pay it back through future earnings. Upon filing a voluntary petition for relief under Chapter 11, or in an involuntary case, with the entry for an order of relief, the debtor automatically assumes an additional identity as the "debtor in possession". The term means that the debtor keeps possession and control of its assets while undergoing the reorganization strategies of Chapter 11, without the appointment of a case trustee. A debtor will remain a debtor in possession until the debtor's plan of reorganization is confirmed, dismissed, converted to a Chapter 7 liquidation bankruptcy, or a Chapter 11 trustee is appointed.
Generally a written disclosure statement and a plan of reorganization must be filed with the court. The disclosure statement is a document that must contain information concerning the assets, liabilities, and business affairs of the debtor sufficient to enable a creditor to make an informed judgment about the debtor's plan of reorganization. The information required is governed by judicial discretion and the circumstances of the case. The contents of the plan must include a classification of claims and must specify how each class of claims will be treated under the plan. Creditors whose claims are "impaired," (i.e., those whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan) vote on the plan by ballot. After the court approves the disclosure statement and the ballots are collected and tallied, the court will conduct a confirmation hearing to determine whether to confirm the plan.
In regards to the above aforementioned appointment of a Chapter 11 trustee, Section 1107 of the Bankruptcy Code places the debtor in possession in the position of a fiduciary, with
Why Sears Holding Corp. Will Go Bankrupt
the rights and powers of a Chapter 11 trustee, and it requires the debtor to perform of all but the
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investigative functions and duties of a trustee To give the debtor some breathing room, the automatic stay provides a period of time in
which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition. As with cases under other chapters of the Bankruptcy Code, a stay of creditor actions against the Chapter 11 debtor automatically go into effect when the bankruptcy petition is filed. The filing of a petition, however, does not operate as a stay for certain types of actions listed under 11 U.S.C. ? 362(b). The stay provides a breathing spell for the debtor, during which negotiations can take place to try to resolve the difficulties in the debtor's financial situation.
However, in a Chapter 11 case, a liquidating plan is also an option. Such a plan often allows the debtor in possession to liquidate the business under more economically advantageous circumstances than Chapter 7 liquidation. It also permits the creditors to take a more active role in fashioning the liquidation of the assets and the distribution of the proceeds than in a Chapter 7 case. Moreover, in accordance with Chapter 11 Bankruptcy rules and regulations, once a plan is confirmed, the debtor is required to make plan payments and is bound by the provisions of the plan of reorganization. The confirmed plan creates new contractual rights, replacing or superseding pre-bankruptcy contracts.
An outstanding question that many companies have before filing a Chapter 11 bankruptcy is what will happen to their securities. According to the SEC, a company's securities may continue to trade even after the company has filed for bankruptcy under Chapter 11. In most instances, companies that file under Chapter 11 of the Bankruptcy Code are generally unable to
Why Sears Holding Corp. Will Go Bankrupt
meet the listing standards to continue to trade on the NASDAQ or the NYSE. However, even
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when a company is delisted from one of these major stock exchanges, their shares may continue to trade on either the OTCBB or the Pink Sheets. There is no federal law that prohibits trading of securities of companies in bankruptcy.
Finally, when trying to give a valuation of a company's debt, there are many components one must take into consideration. These components are ones such as but not limited to, Capital Structure, Debt & Coverage Ratio's and Outstanding Bonds. Provided below are charts, graphs and tables of these different components.
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