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Sears Holdings: It Ain’t Over Till It’s Over

The train wreck had to stop: after rejecting Mr. Lampert’s informal reorganization proposal, apparently to protect itself from litigation, the board gave in and filed for bankruptcy.

No doubt Mr. Lampert is experiencing night sweats at the prospect of losing control of his destiny now that it is handed over to the judges, especially given their merciless record in liquidating failed retailers.

However, the fat lady hasn’t sung yet.

In fact, for those uber-contrarian investors who still believe that Holdings’ assets value outmatches liabilities – albeit to diminishing proportions – the court-supervised reorganization should amount to the catalyst they’ve been so impatiently demanding for years.

They will finally know whether they were right or wrong in their assessment of valuation and of Mr. Lampert’s “buffetesque” ethics – and whether they’ve been the patsy of a gifted financial engineer but disastrous corporate operator during all the time it took for the drama to unfold, or just unfortunate in their timing.

For these faithful but likely disgruntled investors, this is not the beginning of the end, but possibly the end of the beginning. Sifting through the bankruptcy filings, several remarkable elements stand out:

1. Pressure from vendors became unbearable, prompting the decision to seek court protection. Mr. Lampert used to claim that the company had “as much time as its partners were willing to give” to transform itself; the hourglass just ran out.

2. The company was burning $125 million a month, or $1.5 billion a year. This, coincidentally, matches estimates for the cost of the much-mocked “transformation” – closing unprofitable stores, paying severance and building up online capabilities – and gives grounds to the now infamous Mr. Berkowitz’s statement that “if you stop the transformation, you stop the losses”.

3. Mr. Lamperts’ reorganization strategy holds out, but may take a different path than initially planned: ESL will likely offer to buy the 400 “four-wall EBITDA positive” stores that remain, plus several other non-core assets – Parts Direct, etc. – in a “stalking-horse” bid, thereby providing the liquidity needed by Holdings to repay its debts and clean its balance sheet.

4. These dealings, should they occur, may result in significant gains on the underlying assets’ amortized value. In that respect, restructuring advisors are working hard to safeguard the billions in carried tax credits. This may also explain why they didn’t oppose the NASDAQ delisting, as the company may be exposed to a change of control if a massive lot of new shares were issued and purchased on the open market by some high-profile, kamikaze activist investor.

5. According to Mr. Lampert’s comments in The New York Times, ShopYourWay, thought by many to be the crown jewel, could be discontinued. This admission of failure –”If I could have raised billions, I could have done things differently” – must irk Mr. Berkowitz who, almost three years ago, joined the board and made a dramatic plea to cease the cash-burn. With hindsight, he was right.

6. In a perfect world, Holdings will then be left operating one of the largest online marketplace in America – sports a huge inventory and probably does billions in sales, which is no small feat – while its overall corporate structure will get simplified to the bone. The lineup of integrated capabilities – from merchandising to logistics, financing, and rewards programs – should then pop out as obvious as Mr. Lampert once claimed they were – “things are happening to the right but everyone is looking to the left”, etc.

There’s still a lot of value left in the real estate, the online marketplace, the brands, the tax credits and the services business. If Mr. Lampert is let free to reorganize astutely – and fairly for the common shareholders – he may save it, and put it to good use.

Regardless, this investment turned out so disappointing thus far that it could be dubbed after Berkshire Hathaway’s jet plane – The Indefensible.

All Lampert’s supporters, including yours truly, have long fancied themselves as sophisticated investors being capable of seeing things that others could not. But too much second-level thinking can be harmful, especially when it becomes third or fourth-level thinking – a.k.a total nonsense.

Indeed, the three key features longs were banking on have been proven wrong: the capacity for Holdings to cover its liabilities and fund the transformation via asset sales; the ability of top management to pilot the ship and “return to profitability”, as they committed themselves earlier this year, for instance by reducing subsidies to SYW; and, of course, the continuous support of trade partners, lenders, and other stakeholders.

Those who know him are used to portraying Mr. Lampert as prodigious but borderline autistic: save for a few grognards, current events show that he was completely alone to believe in the transformation endeavor; after the great length of support they provided, “partners” and like-minded investors deserted him one after another.

There’s nothing wrong with failure, especially in business – but there’s tons of wrong in refusing to recognize it once it punched you in the face. Hence the purpose of this short note is not to wrap a new bull case; with all prudence that humility commands, it is just to shed a ray of hope in a sea of desperation.

(Long SHLD at an average price of $2 a share.)

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