Why Sears Holding Corp. Will Go Bankrupt

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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