Seritage is an American real estate company (a REIT: Real Estate Investment Trust) founded in 2015 by Edward S. Lampert, the president and main shareholder of Sears Holdings.
The company appeared on the radar of investors when Warren Buffet personally invested in it
(rather than via Berkshire Hathaway) before returning to anonymity – for reasons we’ll elaborate on further below.
Sears Holdings, of which the woes of commercial subsidiaries Sears and K-Mart regularly make headlines
, has formed Seritage to dispose of a third party that’s capable to gradually buy back its sizeable real estate while its commercial footprint reduces.
After raising almost $3 billion of equity at the time of its constitution, Seritage immediately acquired 262 properties occupied by Sears (28 of which in joint-venture with GGP, Simon or Macerich).
After several transactions, the real estate company possesses now 253 properties (23 of which held via joint-ventures) situated all over the American territory and particularly in the heart of the ‘best’ states: California, Florida, New York, Texas, Illinois, etc.
Sears Holdings still rents 142 properties from Seritage. However, as Holdings gradually liquidates its declining commercial activities, the Sears and K-mart stores are being closed.
Seritage thus invests its capital to refurbish its strategically situated properties and then relets them to new tenants: stores (among which Primark
, featured here last month), restaurants, cinemas, congress centers, and consorts.
The last investor presentation
(from January 2018) clearly details the new tenant portfolio and features several iconic properties as a result of the current redevelopment.
The investment thesis here is very simple: after redevelopment, the square foot rented by Sears Holdings at an average of $4 is relet at an average of $17 to the new tenants.
Sears Holdings has indeed acquired its real estate decades ago: the long-term leases with a renewal option have thus been signed at average prices ($4 per square foot) that are completely outdated now.
Since Sears occupies more than half of the properties held by Seritage – but reduces its footprint at a forced pace – Seritage’s rental revenue should increase considerably over the next few years.
Important investments are required to redevelop the properties abandoned by Sears but, by quadrupling its rental revenue, the returns are satisfying: Seritage projects 11% ‘unlevered’ (this means without leverage), a rate that’s above the average of its peers – an industry heavy-weight like Brookfield Asset Management
for example usually redevelops its commercial property at 5-7%.
An appreciable particularity: Seritage is a so-called ‘triple net’ real estate company – this means that the taxes, the maintenance costs, and the maintenance investments are the responsibility of the tenants entirely. In short, the company focuses on the redevelopment and then simply collects the rent.
When it comes to the valuation, we know that Seritage currently disposes of 39 million of square footage. Once this entire surface has been relet to tenants other than Sears, and by valuing it at an average price of $170 (in other words the annual rental revenue of $17 capitalized for 10 years), we get an asset value of $6,6 billion.
We subtract the part that’s linked to the joint-ventures (50% of 23 properties) – prudently estimated at $1 billion – as well as the $1,4 billion of long-term financial obligations, and the net asset value comes down to $4,2 billion.
Seritage common shareholders own 61% of the operating partnership that manages the properties, while ESL Investments (Edward Lampert's hedge fund) owns the remaining 39%, so the net asset value for common shareholders is $2,56 billion.
A substantial discount (45%) appears once this number is reported to the market capitalization of Seritage ($1,45 billion). Let’s note as an extra precaution that the leverage is reasonable: $34 per square foot, or exactly two years of rental revenue once the redevelopment has been carried out.
Why such a discount? Three obvious reasons spring to mind:
First of all, everything that’s linked to Sears – whether it’s closely or from afar – is very unpopular in North America – so Seritage has everything to gain from a progressive liquidation of Sears Holdings.
Secondly, since several quarters, the commercial real estate in North America goes through a difficult conjuncture. This is the result of the rise in online sales and the reconfiguration of numerous obsolete malls – but Seritage comes from very far (a square foot let at $4) and doesn’t seem to encounter any difficulty yet to relet its properties to other parties than Sears.
Finally, the share ‘screens’ very badly, because its previous profitability naturally has nothing to do with its future profitability, where the properties are gradually being redeveloped and relet at much higher rates – the profit multiple shown (P/E) is thus disconnected from the reality of the company.
The major risk is a rushed liquidation of Sears holdings, if it would immediately abandon its properties currently let from Seritage. Faced with such a dry-out of its rental revenue (48% of the total, a number that decreases rapidly, however), it’s possible that Seritage would have to proceed with a capital increase to fill the deficit and to ensure the funding of its redevelopment projects.
This risk seems limited however by the willingness of Edward Lampert to maintain Sears afloat (via loans granted by its hedge fund) so that Seritage has the necessary time to recover and redevelop its impressive real estate.
Finally, let’s note that the company is led by Benjamin Schall, the former vice-president of the excellent Vornado Realty Trust and that the European investors currently benefit from an extremely favorable EUR/USD exchange rate.
The author is a shareholder of Seritage average price of $ 37, and plans to strengthen its participation over the next few months.
Translation of the original article: link
Article published on 02/04/2018 | 21:32