Seritage Growth Properties Stock: A Good Idea on Paper (NYSE:SRG)

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Seritaje growth properties (New York Stock Exchange: SRG)

Seritage is a good idea on paper, difficult to execute in practice. When we made our initial purchase in 2018, we thought of the idea of ​​repurposing existing Sears and Kmart properties at below-market rents in modern spaces, allowing the company to charge multiples of the previous rent, made sense. Raising rents from $5 to $20 PSF with a 10-11% ROI seemed like a no-brainer. The yield profile made sense and applying moderate leverage to the stabilized properties improved the bottom line economics.

Multiple changes at the management level and a $1.44B loan from Berkshire at 7% interest rate and deals (yes, they still exist) made this an impossible endeavor. We thought partnering with Eddie Lampert would align our interests and be a smart move, given the capital and brainpower he has put into this situation.

On paper, it makes sense to sell non-core assets and use the proceeds to fund capex plans and ongoing corporate expenses. The problem is the number of properties that the company needed to sell for this business model to work. Each year that passed considerably reduced the value of the company, since interest expenses proved to be a heavy burden.

Basically, the company went into a death spiral where they were simply selling properties to cover interest expenses with little left for the core of the business plan. Compiling all of this with the lockdowns in 2020 and 2021 and the supply chain mess still being ironed out has further delayed this change.

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Today the company is much smaller. Seritage once owned 253 properties totaling 39 million square feet compared to today where it owns 161 properties and 19 million square feet. During this time, they only paid back $100 million of the term loan. The change has taken too long and the company has been put up for sale. Again, on paper, this seems like a good idea; however, going through a sale of this proportion will take a long time in a calm environment.

Rising interest rates, tight credit markets, and stock market volatility make this a monumental task. I suspect that the number of buyers of these properties, once small to begin with, has dwindled to a handful. A critical problem with the SRG portfolio is that the assets are spread across the country. A player is not going to buy all these assets.

Real estate developers and owners tend to concentrate their efforts in a single region (excluding global players like Blackstone (BX), Simon (SPG) and other private equity groups). Seritage may sell some nearby properties as a package, but you’ll probably get a PV discount, or have to sell each property one by one.

Rising interest rates and subsequent rising cap rates will dramatically reduce the value of the portfolio as the company takes a double hit. Most properties are unlikely to be move-in ready. Construction financing costs will drive down purchase prices as buyers factor in higher interest expenses to finance remodeling.

Also, the steady state value is reduced as higher capitalization rates reduce the value of the property. Companies like Amazon (AMZN) are trying to shed excess storage space, working from home has resulted in more office space being available, and given the current state of the economy, I suspect the number of retailers looking to expand It has decreased. The combination of all these factors presents challenges when modeling leasing and absorption rates. Increased uncertainty translates into lower prices.

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In July, management believed that a 1-2 year sale process could generate between $18.50 and $29 per share. At the time, the stock was trading in the mid-5s and soared nearly 100% on the news. While we are initially skeptical about this range, prevailing market conditions make us doubt that the lower end can be reached. The stock has gone from a high of $14 for the quarter to below $9.

One final concern was Eddie Lampart’s 29.1% stake in SRG. Mr. Lampert resigned from the Board on March 1, coinciding with the announcement of the strategic review of SRG. Mr. Lampert’s most troubling statement was: “I encourage and support the Board’s efforts to explore and pursue strategic alternatives to enhance shareholder value. I have decided to step down in order to have additional time to focus on my other investments and to provide myself with a greater flexibility to explore alternatives for my investment in Seritage, which could include engaging with parties that may be interested in acquiring certain assets of the company and trading shares in open market transactions.

Whether or not Eddie makes an offer for some or all of the assets, it was not something we wanted to have. The company has not shown a history of executing the established plans. While this is not the original management team, the task is daunting. We wish them and the shareholders the best. Given the broader market downturn, we find it prudent to take this capital and deploy it elsewhere.

We have learned some lessons from this investment. The high turnover rates at the managerial level need to be analyzed more, especially when the task is taken into account. Second, having a limited view of a business due to no earnings calls increases risk.

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Finally, some ideas may be good on paper but impossible to execute. Complexity can often trump a great idea. Less is sometimes more.


This document is for informational purposes only. O’Keefe Stevens Advisory is not providing any investment recommendation with the publication of this document, and no company performance data is included in this document.

Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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