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Sears management faces many obstacles ahead if they

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Sears management faces many obstacles ahead if they Powered By Docstoc
					Sears’ management faces many obstacles ahead if they choose to continue in their current
course. For the concluding installment in the two-part series titled The Sears Problem, I will
propose a valuation for Sears Holding (SHLD), Lands’ End and Kmart and offer my opinions for
future moves.

Basics

Every proposed valuation contains certain background assumptions usually involving the market
premium, risk free rate, cost of debt, and growth rate. The market premium for this valuation is
the most recent annual returns on the Standard and Poor’s 500 Index (S&P), and the risk free rate
is the 3-month US Treasury Bill. Cost of debt was taken to be the risk free rate plus the spread of
the most recent bond issuance by Sears Holding.i Most importantly, the growth rate was derived
from analyst estimates for future revenue and earnings per share. I also assumed the beta for the
stock price was reported and calculated correctly by a third party.

SHLD Valuation

in millions                               2010      2011    2012      2013             2014   2015
EBIT                                       459    -1,462    -743      -653             -614   -585
EBIT*(1-tax)                               431     -2795    -782      -661             -633   -618
Addback Depreciation                       869       853     830       759              730    715
NWC                          2652         2917      1032     851       900              925    955
(Change NWC)                               265     -1885    -181        49               25     30
(CapEx)                                    426       432     378       291              215    200
FCF                                        609      -489    -149      -242             -143   -133

Terminal Value                                                                          -91
EV                       $146.25

The valuation for SHLD presented a few difficulties mainly pertaining to the negative growth
rate, unique tax situationii, and continually negative cash flows. Even so, I am confident in
integrity of the model and the resulting firm value reflects the company’s present predicament.

Lands’ End Valuation

                                          AEO      CHS       EXPR      GES             Averages
P/E                                          17.18     31.2     11.77          17.03          19.3
Rev/EBITDA                                    20.4       6.5       6.7           7.1          10.2
Net Income/Rev                               0.067    0.070     0.065          0.067         0.067
EV/EBITDA                                    5.440    7.070     5.250          6.550          6.08
Enterprise Value Estimates      $654.55
                                $575.66

Unlike the SHLD valuation, Lands’ End’s value cannot be calculated based on its free cash
flows. Or rather, its valuation would not be as straightforward since, as a wholly owned
subsidiary, many of its financial metrics are not apparent. Therefore, an adequate alternative is a
multiples valuation. For accuracy, each company used has similar revenue figures.


Kmart Valuation

                                         BBBY     DG       FDO          JCP          TJX           Averages
Enterprise Value/Revenue                     1.34     1.28       0.75         0.58          1.59        1.11
Enterprise Value/EBITDA                      8.22    10.68       8.45         -5.5         11.08        6.59

Enterprise Value Estimates   $1,225.00
                             $1,571.70

Much like Lands’ End, Kmart does file its own financial reports because it is a subsidiary of
SHLD as well. Most of the financial operations, however, can be found in SHLD’s annual report.
From the figures provided there, I can propose another multiples valuation.

Suggestions

With an enterprise value of about $146 million, the management team at Sears Holding should
seriously consider the benefits of selling huge parts of the corporation. In order to be a viable
company going forward and in order to have a competitive business model, the corporation has
to reduce its offerings and services to capitalize on its profitable segments. Based on the figures,
Lands’ End and Kmart both are profitable, albeit by a small margin, and could provide SHLD
with capital in order to continue operating. Both subsidiaries contain more value than the holding
company which really speaks to the drag Sears Domestic has on profits.

Along with Lands’ End and Kmart, I am sure there is value in the auto center and the appliance
business that could be tapped and exploited. The company needs to consolidate not only stores
but also departments. Sears as an appliance, hardware and automotive destination deserves
serious consideration.

SHLD and the subsidiary Sears Domestic have a very complicated and convoluted ownership
structure. The firm’s CEO, Edward Lampert, was until recently the largest shareholder through
the hedge fund he manages. Poor performance, stubborn leadership, unfulfilled initiatives and
investor distrust should all indicate to the board that the best move right now would be to release
the Mr. Lampert. From all appearances, he is not willing to relinquish control and allow the
company to be divided into parts in order that it may survive. Sears’ survival depends on its
ability to downsize and become more agile in a consumer market that possesses more
accessibility and expresses more discretion.
i
     Sears Hldgs Corporation 6.625% | Maturity:2018 morning star
ii
 Due to various tax issues, income tax effective rate was 4.4% in 2012 and 78.2% in 2011. The 2012 tax
rate continues to reflect the effect of not recognizing the benefit of current period losses in certain
domestic jurisdictions where it is not more likely than not that such benefits will be realized. The prior
year tax rate is the result of significant tax matters in 2011 which included a non-cash charge of $1.8
billion to establish a valuation allowance against certain deferred income tax assets

				
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