In his annual letter to Sears Holding (SHLD) shareholders, Eddie Lampert reviews the progress of SHLD on its journey to transforming into an integrated retail experience via their Shop Your Way membership program. He also expounds upon the reasons for the turnover of top management across all major retailers (not just Sears).

This is all nice stuff for shareholders, but what interested me most was the section on creating long-term value. Lampert gives a good summary of how, why, and the net effect of store closures:

Since 2006, we have closed just over 300 Sears Full-line and Kmart stores, or 13% of the Sears Full-line and Kmart stores we operated at that time, with about half of these store closings coming in our last fiscal year. Obviously, this is disappointing to us because in most cases we were unable to take low performing stores and make them successful. However, there are several benefits that come with closing poorly performing stores.

First, we no longer suffer the operating losses of the money-losing stores. Second, in most cases, we are no longer penalized by the rating agencies for the lease expense (or obligation) associated with those stores. Third, we are usually able to generate significant cash from the net inventory invested in the stores, as the net inventory proceeds typically exceed the severance and closing costs. Fourth, we are able to realize the value of the real estate in situations where we own the stores or where the lease terms are attractive to third parties.

The following paragraph is where it gets interesting to me (emphasis is mine):

Now, let's look at the stores we have closed to see how much profit they contributed in 2006, our peak operating earnings year. While we have closed just over 300 domestic stores since 2006, we have retained most of the stores that contributed significantly to our profitability in that year. We calculate that the amount of EBITDA that the closed stores generated in 2006 was a little more than $100 million of the $3.2 billion in domestic Adjusted EBITDA that the company had in 2006. Through a combination of net inventory and real estate proceeds, we estimate that we have generated roughly $1 billion in value from these stores. While we closed these stores at different times over the past six years, if you combined their performance for the twelve months prior to the start of the process to close each store, they generated an EBITDA loss of over $50 million in aggregate.

So $1 billion from the sale of 300 under performing stores? That works out to about $3.33 million per store. SHLD currently has 2,548 Sears and Kmart stores which would be valued at about $8.5 billion using this baseline metric. It's important to note this is a baseline because the stores that Sears has chosen to retain are better and more profitable (probably due to good location) than the 300 stores SHLD has chosen to sell. Thus, if SHLD had to or wanted to sell any of its current stores, it would probably receive more (or a lot more) than $3.33 million per store.

This post just focuses on the value that can be received from the closure and sale of SHLD stores, which could be at least $10 billion, if not more. Compare that to SHLD's enterprise value which is about $11 billion.

Although it has been long and arduous journey for many SHLD shareholders, I think it's very interesting that Lampert has detailed the value generated from store closures. I think Lampert's goal is to convey to shareholders there is substantial value in the remaining Sears assets in addition to demonstrating the thought process behind his capital allocation and the net positive results.


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