Vertigo3d
The following segment was excerpted from this fund letter.
Seritage Growth Properties (NYSE:SRG)
Seritage is a good idea on paper, hard to execute in practice. When we made our initial purchase in 2018, we thought the idea of repurposing existing Sears and Kmart properties at below-market rents into modern spaces, enabling the company to charge multiples of the prior rent, made sense. Increasing rents from $5 to $20 PSF with a 10-11% ROI seemed like a no-brainer. The return profile made sense and applying moderate leverage to stabilized properties improved end economics.
Multiple changes at the management level and a $1.44B loan from Berkshire with a 7% interest rate and covenants (yes, those still exist) made this an impossible endeavor. We thought partnering with Eddie Lampert would align our interests and prove an intelligent decision, given the capital and brain power he has put into this situation.
On paper, selling non-core assets and using the proceeds to fund Capex plans and ongoing corporate expenses makes sense. The problem is the number of properties the company needed to sell for this business model to work. Every year that went by materially lowered the company’s value as the interest expense proved to be a heavy burden.
The company essentially turned into a death spiral where they were merely selling properties to meet the interest expense and having little remaining for the core part of the business plan. Compiling all this with the lockdowns in 2020 and 2021 and the supply chain mess still being worked through has further delayed this turnaround.
Today the company is much smaller. Seritage once owned 253 properties totaling 39m SF compared to today, where they own161 properties and 19m SF. During this time, they only paid down $100m of the term loan. The turnaround has taken too long, and the company has put itself 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.
The rise in interest rates, tight credit markets, and equity market volatility make this a monumental task. I suspect the number of buyers for these properties, which was once small to begin with, is down to a handful. A critical issue with the SRG portfolio is that the assets are spread out across the country. One player is not going to purchase all these assets.
Real Estate Developers and owners tend to concentrate their efforts on a single region (excluding the global players such as Blackstone (BX), Simon (SPG), and other private equity groups). Seritage may be able to sell some nearby properties as a package but would likely take a discount to FV, or it has to sell each property one by one.
The rise in interest rates and subsequent rise in Cap Rates will dramatically lower the portfolio’s value as the company gets a double hit. Most properties are unlikely to be move-in ready. Construction financing costs will lower purchase prices as buyers factor in the higher interest expense to fund the redevelopment.
Additionally, the steady-state value is reduced as higher cap rates push down the property’s value. Companies like Amazon (AMZN) are trying to shed excess warehouse space, work from home has resulted in increased office space availability, and given the current state of the economy, I suspect the number of retailers looking to expand has declined. Combining all these factors presents challenges when modeling out lease and absorption rates. Increased uncertainty translates into lower prices.
In July, management believed a sale process over 1-2 years could generate $18.50 to $29 per share. At the time, the stock traded in the mid 5’s and spiked almost 100% on the news. While skeptical of this range initially, prevailing market conditions have us doubting the low end is attainable. The stock has gone from a high of $14 in the quarter to below $9.
One final concern was Eddie Lampart’s 29.1% ownership stake in SRG. Mr. Lampert stepped down from the Board on March 1st, coinciding with SRG’s strategic review announcement. The most concerning statement from Mr. Lampert was, “I encourage and support the Board’s efforts to explore and pursue strategic alternatives to enhance shareholder value. I have decided to retire to allow additional time to focus on my other investments and to provide me with greater flexibility to explore alternatives for my investment in Seritage, which could include participating with parties that may be interested in acquiring certain of the company’s assets and trading shares in open market transactions.”
Whether or not Eddie bids on some or all of the assets was not something we wanted to be around. The company has shown no history of executing on plans laid out. While this is not the original management team, the task is daunting. We wish them and shareholders the best. Given the broader market decline, we found it prudent to take this capital and deploy it elsewhere.
We have taken a few lessons away from this investment. High turnover rates at the management level need to be scrutinized more, especially when factoring in the task. Second, having limited insight into a business due to no earnings calls increases risk.
Finally, some ideas may be good on paper but impossible to execute. Complexity can often trump a great idea. Less is sometimes more.
DisclaimerThis document is for informational purposes only. O’Keefe Stevens Advisory is not providing any investment recommendations with the publishing of this document, and no firm performance data is included in this document. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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