New Amazon Disclosures Reinvigorate Bull Case For Investors

Amazon (AMZN) is a fascinating company for many reasons and their latest investor relations move has gotten the markets excited about their stock once again (it's up 57 points today alone as I write this). Bulls and bears on the shares have long had a disagreement about the company. Shareholders argued that Jeff Bezos and Co. were purposely "losing money" in order to invest heavily in growth and attain massive scale. Bears insisted that the spending was required to keep their customers coming back, and that if the company started to show profits the business would suffer dramatically. Regardless of which camp you are in, one thing is clear; Amazon chooses growth over profitability in the short term if it thinks they can be successful.

So when the company announced that it would break out the financial results of its Amazon Web Services (AWS) business segment for the first time in its nine-year history starting in 2015, the consensus view was that the division would show losses. After all, if Amazon embraces short term losses in exchange for growth, and AWS is its fastest growing business, why would you think otherwise? So imagine the surprise last evening when Amazon announced that AWS is profitable, and not just a little bit. Operating margins for AWS during the first quarter of 2015 were 17%. Add back an estimate of depreciation expense and EBITDA margins are likely approaching 50%. And the stock price is rocketing higher on the news.

All of the sudden it is possible that Amazon does not hate reporting profits (some have speculated that income tax avoidance is a motivating factor). Instead, maybe they are being sincere and simply invest capital when they think they have a good reason, regardless of whether it results in short-term GAAP profits. And maybe the thesis that Amazon's business model does not allow for profits is incorrect. That is surely what investors today are thinking. Given their corporate philosophy, there is no reason Amazon should be running AWS at a large profit, but they are. Why? Perhaps they have built a very good business. Simple enough.

The implications for the stock are important. We now have evidence that AWS is probably worth the $60 billion or so that the bulls have long thought. At the lows of the last year (below $300 per share), Amazon's total equity value was only a little more than double that figure ($130 billion). The bears on the stock will probably stick to their guns that the current share price (approaching $450) is irrational, but if you actually run the numbers, it is not that hard to value Amazon in a range of $200-$250 billion based solely on what we know today, given that non-AWS annual revenue will approach $100 billion this year and AWS alone can account for 25-30% of that valuation. The stock is getting close to my personal fair value target, but is not quite there yet. And given that Amazon could very well surprise investors more going forward (they don't exactly set the bar very high), I am not in a big rush to sell.

Full Disclosure: Long shares of AMZN at the time of writing, but positions may change at any time

Eddie Lampert Correctly Equates Sears And Kmart With Land Line Phones, Then Keeps Pitching Them To Consumers

With operational losses mounting at Sears and Kmart stores nationwide quarter after quarter, an interesting thing has happened. CEO and largest shareholder Eddie Lampert has started to speak publicly about the company, the reasons behind his previous decisions, and his vision for the future. This is notable because Eddie never used to speak to anyone about Sears Holdings. If you were a shareholder you could attend the annual meeting for a couple of hours and read his annual letter to investors, but that was it. Now that creditors, suppliers, and customers are becoming more and more concerned about the company's viability as a retailer, Eddie is giving interviews and is writing on multiple blogs on a regular basis. For the first time, investors are getting a better sense of where Eddie's company is headed.

Despite the policy of silence over the last decade, it has not been difficult to gauge the company's progress under Eddie's leadership (either as CEO, majority shareholder, or both). The operational results have been dismal, which made it clear to any financial analyst that Lampert and his team lacked the retail experience and were ill-equipped to compete against other large mass merchants. Eddie has been quick to admit that the company is struggling but he has also insisted on drawing parallels in history to describe the journey he is taking with Sears as it tries to transform and return to growth and profitability. The more Eddie speaks and writes, the more obvious it becomes that he does not have a firm grasp of why Sears and Kmart are losing a billion dollars every year. For example, consider this excerpt from a blog post Eddie published on December 15th:

"How much retail floor space do we need to deliver great experiences that meet or exceed our members’ expectations? Are our locations where they need to be? With more and more of our sales and member engagement happening online or via mobile and shipping straight to home, do we need the same kinds of stock rooms and warehouses?

Sears Holdings is far from alone in tackling these questions. To take just one example, in virtually every city across the country, real estate owners and communities are trying to figure out what to do with large, windowless buildings that once held essential – now useless – telephone equipment to make landlines work. Some developers are trying to convert them into offices or apartments. Other entrepreneurs think the solid construction and robust electric power could support data centers for new generations of businesses. None of these transformations are simple.

Similarly, some of our stores are simply too large for our needs, given that populations shift, new roads are built and new retail areas open constantly. Restoring them to profitability has been a challenge. At the same time, many of our stores are in some of the most attractive mall locations in the country. Though we expect most of them to stay open for the foreseeable future, in some places mall owners and developers have approached us with the opportunity to reposition our stores for other uses and are willing to compensate us. When they’ve offered us more money to take over a location than our store there could earn over many, many years, we’ve accepted offers. We’ve used this funding to invest more in our transformation. We have also adjusted the size of our stores by partnering with retailers like Whole Foods, DICK’s Sporting Goods, Forever 21, Primark, and others. In these cases, we continue to operate in the same location, in a smaller (but still large) space, leasing out the rest to retailers who will drive traffic and who compensate us for that space."

So to summarize: Eddie would like you to believe that with the advent of e-commerce big box retail is dead. His company is losing money hand over fist because they have too many stores that are too large and therefore cannot be operated efficiently to serve today's customer. The Sears and Kmart stores you grew up with are like land-line telephone equipment facilities and now you have disconnected your land-line, leaving those locations grossly misappropriated.

Do you buy this argument? I don't and I think it illustrates that Eddie and his team do not understand why Sears and Kmart are getting clobbered in the retail sector. Before I share my view on what the problem is, let's first squash the idea that it is too many stores that are too big. Below I have put together some data on store counts and retail selling square footage for major big box retailers from 2013.

The numbers are striking. Compared with four major big box chains (Costco, Sam's, Target, and Wal-Mart), Sears and Kmart stores are not too big. In fact, if you combine Sears and Kmart the average store is approximately 112,000 square feet in size, less than all four of the competitors. It is also hard to argue that they simply have too many stores, relative to the competition. Sears and Kmart together have about the same number of stores as Target and less than half as many as Wal-Mart.

Simply put, if big box retailing was dead and there was a glut of selling square feet across the country, all of these other brands would be struggling like Sears and Kmart are right now. But they're not. Even with Target's credit card hacking issues recently, they are still extremely profitable. As you can see from the chart above, Sears and Kmart lag other stores considerably on a sales per square foot basis. They have the same selling space to work with but are failing as merchandisers. Consumers are simply voting with their wallets and they prefer shopping at other stores. No surprise there to anyone who has a pulse.

Eddie Lampert seems to be ignoring the obvious when it comes to fairly and accurately assessing his company's fortunes. To me the problem is clear as day; the Sears and Kmart brands are dead. Unless you offer something very compelling and unique (and therefore have brand loyalty), consumers do not want to shop at your stores and will not do so. Even when Eddie took control of Kmart in 2004 the brand was dying (it was in bankruptcy proceedings at the time after all). He either didn't see the brand's shrinking relevance, didn't place enough importance on it, or thought he could energize it. In 2005 when he merged Kmart with Sears, it added fuel to the fire. The Sears brand was also dying, so merely combining those two retail brands was not a recipe for success. As long as people think that Sears and Kmart are not good places to shop, like Target and Costco for example, there is nothing that Eddie can do.

Now, you may have noticed that Eddie's team created a rewards program for Sears and Kmart called "Shop Your Way." It's not called "Sears Rewards" or "Kmart Rewards" so kudos there. A separate name is the first step towards a new, fresh brand. Progress? Maybe a little, but it's not being emphasized. The TV commercials for Sears and Kmart this holiday season mention the old brands multiple times but barely reference Shop Your Way. They say things like "Members get more" but then you ask yourself "members of what?" The Shop Your Way program is not being advertised as the focus. Sometimes they flash the logo up silently at the end of the commercial for a split second, which is hardly engaging. It's still all about Sears and Kmart for the most part. And that is why things are not going to get materially better unless the current strategy is changed and the company moves away from Sears and Kmart brands. Put a fork in them.

As Losses At Sears Holdings Continue, The Need To Raise Cash Helps Simplify The Investment Analysis

The bullish case for Sears Holdings (SHLD) stock has always been a sum-of-the-parts story. But for many years since CEO Eddie Lampert orchestrated the merger of Kmart and Sears in 2005 the company has been quiet about its various businesses and seemed content to stick to business as usual. That strategy has not worked in the face of intense retail competition, and over the last three years a slow break-up of Sears Holdings has been ongoing. Shareholders have yet to benefit, even though the bullish thesis was predicated on such an event, mainly because the core retail operation has been losing so much money and accumulating so much debt in the process, but there are many investors who remain hopeful.

Consider the moves made and/or announced since 2011:

*Orchard Supply Hardware spin-off (2011)

*Sears Hometown and Outlet Stores rights offering (2012)

*Partial Sears Canada spin-off (2012)

*Sears Canada special dividends (2012 & 2013) *Lands End spin-off (2014)

*Partial Sears Canada spin-off (2014)

*Proposed Sears REIT rights offering (2015 - estimate)

Cumulatively, SHLD investors have reaped approximately $20 per share of value from these transactions, assuming they held onto all of the separate entities. Now, that has not resulted in any profits (SHLD shares started calendar year 2011 trading at $73.75 and presently trade for $43), but the company has been liquidating slowly like they wanted. The 15% or so loss sustained by equity holders over the last four years has been driven by less-than-expected financial performance of the retail operations.

Today we learn that yet another transaction is in the works; the rights offering of a REIT that will hold 200-300 stores owned by Sears Holdings. The new entity will lease back the properties to Sears. The stock is up more than 30% today on this news, but in reality nothing has changed. The company has the same asset base and is operating at the same level of losses as it has been. Combine short covering with a small float and the clear sign that the liquidation is accelerating, and you can explain the $10 increase in the share price today.

So if the assets are the same, but the price is higher, is there anything positive to come out of this for those investors who are watching from the sidelines? Yes, simplicity. As Sears breaks up it becomes a lot easier to value each of its parts. First, with every spin-off we get to see the segregated financial statements for each entity, which we could not previously. Second, as the parent company becomes smaller and smaller, it becomes far easier to value. SHLD today really consists of the retail operations of Sears and Kmart in the U.S., the proprietary brands Craftsman, Kenmore, and Diehard, and about 700 owned properties. As a result, it is a much less tedious process to value SHLD than it was when you had the Canadian operations, a clothing company, a couple thousand franchised hometown and outlet stores, and a hardware chain in the mix. And if SHLD goes ahead with the plan to sell nearly half of its owned real estate to a public REIT entity, we will be able to better pinpoint the value of the real estate owned by each company with the additional disclosures.

Despite today's announcement, my view of SHLD has not changed. I did not like the equity when it was worth $3 billion yesterday because of the $6 billion of debt in front of it and the continued operating losses. That same equity at a value of $4.5 billion today is even less attractive. However, if we get a new real estate entity it will be a worthwhile exercise to value that and see how the market prices it. Given that Sears will be the main tenant (the more diversified the REIT, the higher the valuation), coupled with the fact that small spin-offs often fly under the radar, it is possible the new REIT could be a good investment. We will know more when SHLD discloses which stores it will hold and what the ultimate price will be.

Lastly, since I anticipate many will ask about my current position (long Sears debt maturing in 2017 and 2018), I can tell you that little has changed on that front as well. The thesis for owning the debt is that Sears has enough assets to pay back its creditors for at least several more years. Today's announcement does not change that, it just maybe gives some people more confidence that it is actually true. Accordingly, I am happy that the debt is trading up nicely today and I will continue to hold it (after all, it has outperformed the equity with lower risk).

Sears' Shop Your Way: Not A Better Mouse Trap

"We believe we can build a better mouse trap."  

-- Eddie Lampert (CEO), 2014 Sears Holdings Annual Shareholders Meeting

Sears believes that they can build "Shop Your Way" into a profitable and successful multi-channel online retail platform and that it will have a meaningful position in the marketplace alongside Amazon, eBay, Wal-Mart, Target, Macy's, and every other retailer out there. Given how much the Sears and Kmart brands have eroded over the years, coupled with retail industry competition that has only increased during that time, I believe such an investment is a waste of shareholder capital. Skeptics aside, the company continues to press on, but it's not pretty. Sears Holdings today reported more red ink in their second quarter results.

Now, it's true that the jury is still out to some extent. Just because Sears and Kmart have been losing customers by the boatloads and burning cash for several years running does not mean that Shop Your Way can't work. When you have more than 1,800 stores nationwide and tens of billions in annual sales, there are clearly people who are willing to do business with you. It really comes down to whether or not you can serve them in a satisfactory way.

Along those lines, I decided to give Shop Your Way a try. They've been building this platform for several years, so most of the kinks should have been worked out by now. And while I would never suggest that anyone make investment decisions based on their own personal anecdotal evidence, I do think it is fair to say that one's own experience is likely to be indicative of what is typical in many instances. Below I will detail my two recent experiences with Shop Your Way.

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First I downloaded the company's Shop Your Way mobile app just to play around with it. After linking my wife's Shop Your Way account (she is already a member thanks to sporadic purchases over the years from Lands End -- which until recently was a subsidiary of Sears), I was unimpressed (the $0.88 worth of points in her account notwithstanding). The app lacked a lot of features. Perhaps most glaring was the lack of an order history. If you want to look-up a past purchase you have to login to their full web site rather than use the app. That seems rather odd. You can also not change personal information in your Shop Your Way account, such as password, phone number, email address, etc.

So while there are lots of features missing, there are others that Sears seems to think are important. One is GPS tracking that allows the app to know when you are in a Sears or Kmart store. Your phone will vibrate upon detection of your presence, ask you to post a status update (yes, just like Facebook) and offer you coupons that you can use that day. For avid Shop Your Way users, I can see this being a nice feature.

That said, the other day my wife and I were in Starbucks enjoying a beverage when my phone vibrated. I assume it was a new text message, but no, it was the Shop Your Way app. It wanted me to "check-in" (they call it "shop'in"). At this point I was baffled. Why would I check-in to Shop Your Way at a Starbucks? Are they doing some sort of cross-promotion with the coffee chain?

Well, it turns out there used to be a Sears store in the same complex as this particular Starbucks and since I was within a few hundred feet of it, the app thought I was actually shopping at Sears. Normally I would give them a pass here, since GPS tracking on mobile phones typically is only accurate to within a few hundred feet. But this instance is a little different because this particular Sears store actually closed permanently a few months before. In fact, the app seems to know something isn't quite right. Under the store's details it shows the store's street address as "lease ending 12/31/2015."

So the whole experience is bizarre, but at least I know sales at that Sears store were so bad that they closed the store before the lease was up even though they are still paying rent on vacant space. Pretty telling if you ask me. Anyway, I obliged and submitted a status update as requested. Answering the question "what are you up to?" I simply typed "having breakfast at Starbucks, that Sears store closed months ago." Talk about a first impression.

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Okay, so the app isn't updated with the company's current store base, but what about making an actual purchase with it? After all, e-commerce is what's of utmost importance here, right? Well, a chance to test things out presented itself recently.

My wife wanted to buy a mini refrigerator for her office at work and I suggested we look at Sears since they are big in the appliance market. After comparing selection and prices, Sears actually did have a fridge that matched best with her desired parameters, so I offered to fire up the Shop Your Way mobile app and complete the purchase, hoping to have the item shipped to the Sears store at our local mall. The purchase went smoothly and the app told us the item would be ready for pick-up in 6-8 days, at which time they would email both of us (I added myself as a pick-up person in case it was more convenient for me to get the item). The time estimate of 6-8 days seemed on the long side (especially if we are comparing the convenience of Shop Your Way to the competition), but since this purchase was not super time-sensitive, waiting a week was fine (the fridge was shipping from Illinois -- where Sears and Kmart are based, which is likely why it would take that long to get to Seattle).

Exactly 7 days later we both received an email alerting us that the fridge was ready to be picked up at the Sears store we had designated. Kudos to Sears for being on-time relative to what was promised. It was downhill from there, however. Here is a screenshot of the email my wife received as it was displayed in Gmail:

Oh boy. Where to begin. Of the four sentences in this email meant to give the customer important information, three of them have problems.

The second sentence appears to be trying to tell me where in this particular store the online order pick-up area is located. That would be very helpful information that would reduce the likelihood that I find myself wandering around the store looking for where to go. But that field was left blank.

The third sentence says that upon arrival at the store you can either scan the bar code at the top of the email or enter the salescheck number in order to initiate the pick-up process. That would be great, aside from the fact that there is no bar code at the top of the email and the salescheck number appears to be a media file that does not load when you view the email (and yes, I made sure that Gmail was set to display all media attachments).

Lastly, the fourth sentence contains another blank field that was clearly supposed to insert my name letting my wife know that I received the same email and could pick-up the item for her.

If you are trying out Shop Your Way for the first time, does this experience scream out "better mouse trap!" to you? Hardly. And we have yet to even make the trip to the store yet. Needless to say, I was dreading the trip since I knew that 1) I did not know where to go, and 2) I knew I was likely to have issues once I got there since I had neither a bar code nor a salescheck number to provide them.

But before we get to that, how about a screenshot of the email they sent me as the designated secondary pick-up person:

So much for thinking/hoping that the first email may have just been a glitch. Houston Hoffman Estates, we have a problem.

The same day my wife and I head to the Sears store to pick-up the fridge. There is one sign on the lower level designating the corner where online pick-up area is located and we walked right past it due to where we happened to park and enter the store, so that was not a problem (but it might very well be if you entered from the interior mall entrance directly, as there were no signs pointing us in the right direction). In the designated pick-up area there is a kiosk sitting outside of the warehouse area where they keep the inventory stored. Fortunately, you can use your credit card or phone number to look up your order if you don't have a bar code or a salescheck number (I guess we are not the only ones to have this problem, but in that case, why not do away with both and just let people use the phone number linked to their Shop Your Way account for order retrieval?).

After finishing with the kiosk, which was quick and easy, our order is shown on a monitor on the wall that is tracking how long it takes for the item to be brought out to us. The company's goal is 5 minutes or less and on that mark they succeeded. There were two employees working the warehouse area so while there was nobody in plain sight to answer any questions you might have, the kiosk worked just fine. So despite the issues with their email system, this particular Sears store has a perfectly adequate pick-up area. In fact, there were 3 other people picking up items in the 5 minutes or so we were there. If you are looking for a silver lining in all of this, there you go.

Summing everything up, it isn't hard to understand why Sears is losing money. This $100 item likely cost them $70-$75 wholesale. They had to ship it from Illinois to Seattle on their own dime (it was about 50 pounds, so shipping wasn't cheap). Then they incur costs at the store to get the item to the customer when they arrive. The idea that they can compete with Amazon or Wal-Mart or Target or Home Depot in this fashion seems suspect to me. And so far their financial results aren't proving otherwise.

Sears Holdings: Confirmed Third Party Tenant Leases

As has been discussed on this blog, Sears Holdings (SHLD) has been devoting material resources in recent years to leasing out space in the company's stores. That way the company can close or reduce the size of money-losing locations and lease them to other retailers in order to boost cash flow. This post will keep a running list of confirmed Sears and Kmart locations where retailers have signed a lease to occupy space. Since the company discloses minimal information about its leasing activities, my hope is that others will contribute to this list (please use the comments section to share links to articles or other evidence of leases not listed here) and it can be a valuable shared online resource for those who are watching the ever-changing operations of Sears.

Update: 04/01/15 - Today Sears Holdings announced the formation of Seritage Growth Properties, a new REIT that will commence trading on the public market in June 2015. Seritage will purchase and lease back 254 stores from Sears Holdings, as well as own a 50% interest in a joint venture with GGP that will operate another 12 stores. As a result, going forward the list below will only be updated with third party leases signed by Sears Holdings itself. Since Seritage will be filing publicly there is no need to reproduce updated information about that entity on this site going forward. The list below will be rearranged to better reflect these developments. Please continue to provide new leases for the list, as Sears Holdings is selling less than 40% of their owned stores to Seritage and will retain a large number of valuable properties for the time being. 

Update: 05/18/15:  - Seritage Growth Properties has updated their registration filings to include Q1 2015 pro-forma financial results:

Total revenue: $68 million

Operating expenses: $24 million

G&A expenses: $5 million (including $4 million of public company costs)

Joint venture income: $6 million

Pre-tax income: $45 million

Interest expense: TBD (example: debt of $1.25 billion at 5% implies interest of $16 million per quarter)

For those of you trying to pinpoint a value for Seritage, annualized funds from operations (FFO) should be in the neighborhood of $120 million annually. This figure assumes $1.25 billion of debt (leverage ratio of 6.9), which is simply a guess given that we do not know the capital structure yet. I will update these figures when the terms of the deal and the ratio of equity to debt is known.

Last Updated 04/01/15

LIST OF CONFIRMED SEARS HOLDINGS LEASES

Entire Kmart Stores (3 locations, ~250,000 SF)

Ansar Gallery - Free-Standing Store (Tustin, CA) - 108,000 sf >>> link Fiesta Mart - Free-Standing Store (Houston, TX) - 42,000 sf >>> link Zion Market - Free-Standing Store (San Diego, CA) - 94,500 sf >>> link

Kmart Box Splits (5 locations, ~200,000 sf)

Best Buy (proposed) - Free-Standing Store (Rockford, IL) - 45,000 sf >>> link Gold's Gym - Free-Standing Store (Charlottesville, VA) - ~25,000 sf (estimate) >>> link (photo only) Kroger - Village Square at Kiln Creek (Yorktown VA) - 90,000 sf >>> link Planet Fitness - Free-Standing Store Sublease (Sacramento, CA) - 22,000 sf >>> link Rio Ranch Market - Free-Standing Store (Desert Hot Springs, CA) - 29,000 sf >>> link

Sears Box Splits (7 locations, ~350,000 SF)

Forever 21 - South Coast Plaza (Costa Mesa, CA) - 43,000 sf >>> link Level 257 Restaurants - Woodfield Mall (Schaumburg, IL) - 40,000 sf >>> link Primark - Willow Grove Park Mall (Willow Grove, PA) - 77,500 sf >>> link Primark - Freehold Raceway Mall (Freehold, NJ) - 66,500 sf >>> link Primark - South Shore Plaza (Braintree, MA) - 70,000 sf >>> reader tip Sears Hometown Stores - Offices at Sears HQ (Hoffman Estates, IL) - 36,000 sf >>> see SEC filings Whole Foods Market - Friendly Shopping Center (Greensboro, NC) - 34,000 sf >>> link

Sears Full Property Redevelopments (1 location, ~80,000 SF)

Marianos/Sears/TBD Rebuild (Elmwood Park, IL): ~80,000 sf (planning stages) >>> link

Sears Auto Center Redevelopments (9 locations, ~150,000 SF)

Woodfield Mall (Schaumburg, IL): ~30,000 sf total >>> link Colonial Park Mall (Harrisburg, PA): ~18,000 sf >>> link Genessee Valley Mall (Flint, MI): 12,000 sf >>> link Lincoln Mall (Matteson, IL): ~13,000 sf >>> link Northwoods Mall (North Charleston, SC): ~16,000 sf >>> link RiverTown Crossing Mall (Grandville, MI): 12,000 sf >>> link Smith Haven Mall (Lake Grove, NY): 8,000 sf >>> link Woodland Mall (Grand Rapids, MI): 20,000-40,000 sf >>>  link

In-Store Embedded Space (~3.65 Million SF)

Lands End: 236 locations (as of 01/22/15), 7,400 sf each = ~1.75 million sf >>> link Sears Optical: 541 locations (August 2014), 1,500 sf each (est) = ~800,000 sf >>> link Jackson Hewitt: 400 locations (December 2012), 2,000 sf each (est) = ~800,000 sf >>> link Sears Hearing Centers: 191 locations (February 2014), 1,500 sf each (est) = ~300,000 sf >>> link

 

SERITAGE GROWTH PROPERTIES STORES PREVIOUSLY LISTED ABOVE:

24 Hour Fitness - The Village at Orange (Orange, CA) - 54,000 sf >>> link

Aldi - Free-Standing Store (Hialeah, FL) - 18,000 sf >>> link

Aldi (Hackensack, NJ) - 17,000 sf >>> no details known, headline only on seritage.com

At Home - Pueblo Plaza (Peoria, AZ) - 105,000 sf >>> link

At Home - Willowbrook (Houston, TX) - 134,000 sf >>> link

At Home - Kickapoo Corners (Springfield, MO) - 113,000 sf >>> link

At Home - Free-Standing Store (Ypsilanti, MI) - 92,000 sf >>> link

At Home - Free-Standing Store (Phoenix, AZ)- 152,000 sf >>> link

Altamonte Mall Auto Center (Altamonte Springs, FL): ~16,000 sf >>> link

Aventura Mall Redevelopment (Aventura, FL): ~275,000 sf (design plan submitted) >>> link

Corner Bakery - Westfield UTC Mall (San Diego, CA) - ~4,000 sf >>> link

Destination XL - Corbins Corner (West Hartford, CT) - 8,500 sf >>> link

Dick's Sporting Goods - Mall at Rockingham Park (Salem, NH) - 79,000 sf >>> link

HomeGoods - Hastings Ranch Plaza (Pasadena, CA) - ~27,000 sf (estimate) >>> link

Kroger - Cumberland Mall (Atlanta, GA) - 93,000 sf >>> link

License Bureau Inc: (St Paul, MN) - ~3,500 sf (est) >>> link

McCain Mall Auto Center (North Little Rock, AR): ~21,000 sf >>> link

Nordstrom Rack - The Mall at Sears (Anchorage, AK) - 35,000 sf >>> link

North Riverside Park Mall Auto Center (North Riverside, IL): ~21,000 sf  >>> link

Oglethorpe Mall Redevelopment (Savannah, GA): ~50,000 sf (actively seeking tenants) >>> link

Old Time Pottery - Free-Standing Kmart Store (Orange Park, FL) - 84,000 sf >>> link

Primark - Staten Island Mall (Staten Island, NY) - 70,000 sf >>> link

Primark - Danbury Fair (Danbury, CT) - 70,000 sf >>> link

Ridgedale Center (Minnetonka, MN): ~25,000 sf total >>> link

Sears Outlet (6 stores in MA/NC/NV/VA/WI) ~150,000 sf (estimate) >>> see SEC filings

Sears Hometown (3 stores in IL/KS/MI) ~30,000 sf (estimate) >>> see SEC filings

Ulta - Marketplace at Braintree (Braintree, MA) - 11,000 sf >>> link

Westland Mall Auto Center (Hialeah, FL): ~43,000 sf (actively seeking tenants) >>> link

Whole Foods Market - Colonie Center (Albany, NY) - 32,000 sf >>> link

Pembroke Mall (Virginia Beach, VA) REI - 27,500 sf >>> link Nordstrom Rack - 32,500 sf >>> link DSW - ~25,000 sf (estimate) >>> link

Landmark Crossing (Greensboro, NC) Floor & Decor - 70,000 sf >>> link Gabe's -  50,000 sf >>> link Sears Outlet - ~25,000 sf (estimate) >>> see SEC filings

Janss Marketplace (Thousand Oaks, CA) DSW - ~25,000 sf (estimate) >>> link Sports Authority - ~45,000 sf (estimate) >>> link Nordstrom Rack - 40,000 sf >>> link

King of Prussia Mall (King of Prussia, PA) Primark -  - 100,000 sf >>> link Dicks Sporting Goods - ~75,000 sf >>> link

Burlington Mall (Burlington, MA) Primark -  70,000 sf >>> reader tip Auto Center -  ~60,000 sf (actively seeking tenants) >>> link

Westfield Countryside Mall (Clearwater, FL) Whole Foods Market -  - 38,000 sf >>> link Nordstrom Rack - Westfield Countryside Mall (Clearwater, FL) - 38,000 sf >>> link

Oakbrook Center (Oak Brook, IL) Pottery Barn - ~16,000 sf (estimate) >>> link Pinstripes - 40,000 sf >>> link Auto Center - ~17,000 sf total >>> link West Elm - ~14,000 sf (estimate) >>> link

 

"Profitless" Amazon Myth Lives On Thanks To Lazy Financial Media

Last night CNBC premiered their newest documentary entitled Amazon Rising. I tuned in, as I have thoroughly enjoyed most of their previous productions. I found this one to have a noticeably anti-Amazon vibe, but none of the revelations about the company's business practices should have surprised many people, or struck them as having "crossed the line." For me, by far the most annoying aspect of the one-hour show was the continued insistence that Amazon "barely makes any money" and "trades profits for success." It's a shame that the media continues to run with this theme (or at least not correct it), even when the numbers don't support it.

Most savvy business reporters understand the difference between accounting earnings and cash flow, the latter being the more relevent metric for profitability, as it measures the amount of actual cash you have made running your business. There are numerous accounting rules that can increase or decrease the income you report on your tax return, but have no impact on the cash you have collected from your customers. A good example would be your own personal tax return. Did the taxable income you reported on your 2013 tax return exactly match the dollar amount of compensation that was deposited into your bank account during the year? Almost by definition the answer is "no" given that various tax deductions impact the income you report and therefore the taxes you pay. But for you personally, the cash you received (either on a net or gross basis) is really all that matters. One can try to minimize their tax bill (legally, of course) by learning about every single deduction that may apply to them, but it doesn't change the amount of pre-tax cash they actually collected.

As a result, the relevent metric for Amazon (or any other company) when measuring profitability should be operating cash flow. It's fancy term that simply means the amount of actual net cash generated (in this case "generated" means inflows less outflows, not simply inflows) by your business operations. In the chart below I have calculated operating cash flow margins (actual net cash profit divided by revenue) for five large retailing companies -- Costco, Walgreen, Target, Wal-Mart, and Amazon -- during the past 12 months. The media would have you belive that Amazon would lag on this metric, despite the cognitive dissonance that would result if you stopped to think about how Amazon has been able to grow as fast as they have and enter new product areas so aggressively. After all, if they don't make any money, where have the billions of dollars required for these ventures come from? The answer, of course, is that Amazon is actually quite profitable.

As you can see, if we measure "profitability" by actual cash collected from customers, over and above actual cash expenses, as opposed to the accounting figure shown on their corporate tax return or audited income statement, Amazon's profit margins are actually higher than each of those other four companies. Shame on the media for giving everyone a pass when they insist Amazon doesn't make money, or at least "barely" does so. They make more money, on a cash basis anyway, than many other large, well-known retailers whose profit margins are rarely questioned.

Full Disclosure: Long Amazon and Target at the time of writing, but positions may change at any time.

Sears Holdings Third Party Tenant Leased Space Surpasses One Million Square Feet, Capital Needs Remain Overwhelming

As has been well documented, one of the strategies being used by Sears Holdings (SHLD) to try and stop the financial bleeding at the company is to lease out space to third party tenants. Since many of its stores are too large given the company's ever-shrinking customer base, Sears is splitting up some of its stores (many of which are owned outright, not leased) into multiple units in order to reduce its own retail footprint and boost revenue by collecting rent from third party tenants.

For example, here is a picture of Sears' Oakbrook Center store in the suburbs of Chicago:

At first glance it might look like any other outdoor mall, but the Pottery Barn stores are actually part of the Sears building (the Sears entrance is around the corner by the columns). Sears likely collects about $500,000 in rent from Pottery Barn annually for these subdivided spaces.

Former Kmart stores are also being leased out to retailers who can accommodate larger box sizes. Home decor chain Garden Ridge, which is in the process of rebranding their 70+ stores with the "At Home" moniker, is actually Sears' largest third party tenant currently (excluding Lands End, which leases space inside existing Sears stores and until recently was owned by Sears), occupying five closed Kmart stores. Those deals have put Sears over the 1 million square foot mark for third party retail leases. That's the good news.

The bad news is that leasing 1 million square feet, which took the company about 2 years of serious effort to reach (Seritage Realty Trust, Sears' in-house leasing operation, was formed in 2012), is just a rounding error for this $30 billion per year company. In order for third party rental income to reach just 1% of Sears' annual revenue, the company would have to rent out about 20 million square feet of space, which could easily take 5-10 years.

I estimate that between now and the end of 2016, Sears needs to come up with $2.7 billion in cash just to cover its pension obligations, interest on its outstanding debt, and capital expenditures for their current store base. Where will this money come from? That's the problem for the stock right now, and why I see more short-term pain ahead for Sears Holdings shareholders. Even if we were to assume that Sears' retail stores breakeven on an operating cash basis (which they are not doing right now, hence why this capital is not going to come from operating profit), the company still needs to come up with several billion dollars.

Management has announced they are exploring monetization options for both Sears Auto Centers and its ~50% stake in Sears Canada, but even if both were sold they are unlikely to fetch more than $1.2 billion in a very optimistic scenario. That leaves another $1.5 billion to find somewhere. Sears Holdings currently has about $600 million of cash in the bank, so further asset sales or more debt will be required simply to get the company funded for the next two and a half years. After all of that cash goes out the door, the asset base left for shareholders will be materially smaller than it is today.

This is why I am waiting on the sidelines, despite the clear value in Sears' vast real estate portfolio. As long as the company continues to burn through cash operationally, more and more assets will need to be sold simply to cover capital needs. Even if they continue to lease out space to other retailers, it simply is not enough to help financially in any meaningful way. By waiting things out, but continuing to monitor the situation closely, I am hoping that over the next couple of years, more and more assets are shed out of necessity, and I might have an opportunity to buy the stock at a lower price, and with more of the assets concentrated in the owned real estate (the debt holders and the pensioners can have Sears Canada and Sears Auto Centers -- they're not good businesses). If that happens, there might be a time down the road when the price investors have to pay, relative to the assets and liabilities on the books, represent an attractive investment opportunity. Since I don't see things getting better in the short term, I think it's too early to invest in Sears Holdings for the real estate.

Full Disclosure: Long Sears Holdings bonds at the time of writing, but positions may change at any time

The Death of Whole Foods Market Is Likely Greatly Exaggerated

I am always amused (and oftentimes thrilled) when Wall Street wakes up one day and decides a company's fate has changed forever, despite very little actual evidence supporting such a view. Severely harsh winter weather earlier this year put a lid on sales and profits at many retailers, and the result has been very poor stock market performance for many consumer-oriented companies. Others have been hit by worries over online-only competition or simply an increase in the number of players competing in the marketplace.

Consider Whole Foods Market (WFM). The pioneer of the natural food grocery business has gone from market darling to growth stock has-been in a matter of months, with investors sending the stock down nearly 20% in a single day after the company released its most recent earnings report, and the shares now sit at multi-year lows. How bad was WFM's first calendar quarter of 2014? Well, the company reported record sales and record sales per square foot at its stores. Same store sales rose a very impressive 4.5% versus the prior year. But Wall Street focused on profit margins, which narrowed slightly year-over-year and quickly concluded that Whole Foods is dead, a victim of ever-growing competition. After reaching a high of $65 late last year, the shares now trade in the high 30's.

With all of the new competition aiming squarely at Whole Foods, how can they possibly compete effectively and continue to post strong financial results for their shareholders? Recent stock market action is telling us that investors have given up on the company. The media headlines have been extremely negative too. Nonetheless, in the face of extreme pessimism, I am a buyer of the stock. Let me tell you why.

There is no doubt that Whole Foods is facing more and more competition every day. For years people thought the natural foods business was a niche market, but now they are coming to realize that it has gone mainstream in many markets across the country. Not only have traditional grocery stores added natural and organic sections to their stores, but smaller Whole Foods wannabes are popping up too. In fact, many of them are newly public, such as Sprouts Farmers Market (SFM), Fresh Market (TFM), and Fairway (FWM). But guess what? They can all coexist.

As consumers opt for healthier food, natural foods will increase their share of the overall food market and there will be plenty of room for multiple players to operate stores profitably. Witness Whole Foods' +4.5% same store sales number for last quarter. If people were really leaving Whole Foods and switching to these other stores (the bears say price will be the biggest reason), their sales would not be rising faster than the rate of food inflation. Despite new competition (Sprouts and Fresh Market combined have nearly as many stores nationwide as Whole Foods, and all three are doing very well), Whole Foods has a very loyal customer base and there are few signs that they will abandon Whole Foods.

I think a great way to think about the future of Whole Foods is to compare it to another strong pioneering consumer brand that sells a high-end product to a very loyal customer base and has faced enormous competition over the years; Starbucks (SBUX). The similarities to me are uncanny. Think about how many companies have tried to eat into Starbucks' growth in the specialty coffee market. Scores of local coffee shops have popped up urging you to support your neighborhood business, and big players like McDonalds (MCD) and Dunkin Donuts (DNKN) have littered the market with me-too coffee options. And what happened? Did Starbucks' customers flee in favor of a slightly less expensive drink? Not at all. Interestingly, the new players did well too. Both Dunkin and McDonalds sell a lot of coffee, even as Starbucks continues to thrive.

That is exactly how I see the natural foods story playing out. Whole Foods Market will cross the 400 store mark later in 2014. Ultimately they see room for 1,200 stores in the U.S. alone. Their growth is far from over and I expect them to continue to be seen as the leader and industry pioneer for many years to come (just like Starbucks).

Here's the best part; the stock is cheap and most people don't realize it. At first blush it doesn't look undervalued. Whole Foods will earn about $1.50 per share this year and trades at 25 times earnings. A 50% premium to the S&P 500 for a growth company facing stiff competition doesn't seem like a bargain to most casual onlookers. But you have to dig deeper to see the value.

Since Whole Foods has high capital needs (as it opens new stores at a rapid rate), the company's operating cash flow dwarfs its reported earnings per share. Depreciation expense last year came to $370 million, or about $1 per WFM share. In fact, WFM generated about $2.70 per share of operating cash flow in fiscal 2013. All of the sudden that 25 P/E multiple comes down to about 14x operating cash flow if you look at actual cash generation.

It gets better. Of that $2.70 of operating cash flow Whole Foods spent more than half of it on capital expenditures, and of that, about two-thirds went towards new store construction. As a result, when we calculate how much cash profit every WFM store generates, we arrive at an impressive $2.25 million. With an expected 400 stores at year-end (which will generate $900 million of free cash flow annually), we can assign a value to the existing WFM store base only, excluding all future development. If we use a very reasonable 15x free cash flow multiple (a discount to the S&P 500), we conclude that the existing store base is worth $13.5 billion.

And that's the best part of the story. At current prices, Whole Foods trades at an enterprise value of $13 billion ($14.5 billion equity value less $1.5 billion of net cash). That means that investors at today's prices are buying the existing stores for a very fair price and are getting all future store development for free.

If you share my view of the natural food industry and believe that Whole Foods can continue to be a leader in the market, even in the face of increased competition, then investors at today's prices are likely going to do extremely well over the next 5-10 years. After all, WFM is only about 1/3 of the way to their goal of 1,200 U.S. stores, and today's share price does not reflect the likely upside from years and years of future development.

Full Disclosure: Long shares of WFM at the time of writing but positions may change at any time.

Even Great Investors Like Bruce Berkowitz Make Mistakes

I know, I know, the headline above is not earth-shattering news. Every quarter dozens of the world's best investors disclose their holdings to the world via SEC filings (granted, the data is about 45 days outdated, but it still gets lots of attention). It's easy for individual investors to follow well-known money managers into certain stocks, figuring that they can piggyback on their best ideas. I can certainly find far worse investment strategies for people to implement, but it is still important to understand that even the best investors make mistakes. And there is nothing stopping the stocks you follow certain people into from being one of the mistakes rather than one of the home runs.

I think this topic fits right in with my previous post on Sears. Not only is Eddie Lampert the company's CEO and largest shareholder, but he is one of the best hedge fund managers of the last 25 years. It is perfectly reasonable to assume that a billionaire in his position would be primed to create tons of value for investors. And yet, since Lampert orchestrated the merger of Kmart and Sears, which formed Sears Holdings in 2005, the stock price has dropped from $101 the day the deal was announced to $40 a decade later. Adjusted for dividends and spin-offs received over that time, Sears stock has fallen by about 40%, while the S&P 500 index has risen by about 80% during the same period. Eddie Lampert's ownership and involvement alone has meant little for investors' portfolios. Simply put, Sears Holdings has been one of his mistakes.

Interestingly, many of the company's steadfast bulls point to the fact that another very smart and successful investor, Bruce Berkowitz of Fairholme Capital Management, owns 23% of Sears Holdings. That's right, Lampert and Berkowitz own or control 70% of the company. Berkowitz isn't new to the Sears investor pool either; he started buying the stock in 2005 just months after Sears Holdings was created. How can both of these guys have been so wrong about Sears for so long? It's not a tricky question. Neither of them is perfect and they have made (and will continue to make) mistakes. It really is that simple. Since I have written about Eddie Lampert many times since this blog was launched ten years ago, I think it would be interesting to try and figure out why Bruce Berkowitz has been on the losing end of Sears.

Berkowitz's background is in analyzing financial services companies, which is why you will often find most of his capital allocated to banks and insurance companies. Those industries are his bread and butter. In fact, Berkowitz's flagship Fairholme Fund had more than 80% of its assets invested in just four companies as of February 28, 2014: AIG, Bank of America, Fannie Mae, and Freddie Mac. If that doesn't signal his preponderance for financial services companies, I don't know what would.

Now, Berkowitz has not been shy about why he invested in Sears Holdings; he thinks there is a ton of hidden value in its vast real estate portfolio. Unfortunately, his trading record in Sears (he first bought the stock during the third quarter of 2005 at prices well over $100 per share) shows that real estate might not be one of his areas of expertise. Warren Buffett has popularized the term "circle of competence" and tries very much to only invest in companies he understands very well. That's why up until recently (his 2011-2013 purchases of IBM shares bucked the trend) Buffett has avoided technology stocks.

I would postulate that real estate investments do not fit squarely into Bruce Berkowitz's circle of competence. As you will see below, his trading record in Sears underscores this, but we have also seen it with his massive and long-standing investment in St Joe (JOE), a Florida real estate developer.

Below is a quarterly summary of Fairholme Capital Management's historical trading in Sears stock (I compiled the data via SEC filings). Of the 24.5 million shares Fairholme currently owns, more than 55% (13.6 million) were purchased over a 15-month period between July 2007 and September 2008, at prices averaging about $110 per share. More troubling is that this was when real estate prices in the U.S. were quite bubbly, coming off a string of record increases (most local markets peaked in 2006 and 2007) and Berkowitz was largely investing in the company for the real estate. The timing was quite poor. All in all, if we assume that Fairholme paid the average price each quarter for Sears, the firm's cost basis is about $85 per share (before accounting for spin-offs).

St Joe (JOE) has also turned out to be one of his relatively few mistakes. It could certainly be merely coincidence that both the Sears and St Joe investments were made based on perceived (but yet-to-be-realized) real estate value, but I'm not so sure. Like with Sears, Fairholme Capital Management has a very large stake in St Joe. In fact, Fairholme is the largest shareholder (owning about 27% of the company) and Bruce Berkowitz is Chairman of the Board (sound familiar?). Berkowitz started buying St Joe during the fourth quarter of 2007, around the same time he was massively increasing his investment in Sears. His largest quarterly purchase was during the first quarter of 2008 (talk about bad timing), when he purchased more than 9.2 million shares (37% of his current investment).

St Joe's average trading price during that quarter was about $38 per share, but subsequent purchases have been at lower prices, so the losses here are not as severe as with Sears. By my calculations (see chart below), Fairholme's average cost is around $28 per share, versus the current price of about $20 each. But again, not only has the investment lost about 30% of its value, but the S&P 500 has soared during that time, so the gap in performance is so wide that it would take a small miracle for either of these investments to outpace the S&P 500 index over the entire holding period, as the returns needed to make up for 7-10 years of severe losses during a rising stock market are significant.

Now, the purpose of these posts is not to point out the few big mistakes two very smart investors have made over the last decade, while failing to mention their big winners. Any of my readers can look at the history of the Fairholme Fund or ESL Partners (Eddie Lampert's hedge fund) and see that they both have posted fabulous returns over many years. The point is simply to show that sometimes these investors make mistakes, even with companies where they own and/or control a huge amount of the stock. Just because Eddie Lampert and Bruce Berkowitz are involved in a major way (either in ownership, operationally, or both), it does not ensure that the investment will work out great for those who eagerly follow them. Just because they are smart investors does not mean these are "can't miss" situations. There are plenty of people who are sticking with Sears because of Eddie, or sticking with St Joe because of Bruce. That alone, however, is not necessarily a good reason to invest in something.

I will leave you with one more example of Bruce Berkowitz making a large bet on a stock outside of his core financial services wheelhouse. At the end of the third quarter of 2008 Fairholme Capital Management owned a stunning 93 million shares of pharmaceutical giant Pfizer (PFE). It was an enormous position for him and was featured in many investment magazines. This single $1.73 billion investment represented as much as 24% of end-of-quarter total assets under management for Fairholme, and all of those shares were purchased over a 26-week period in 2008 (more than 3.5 million shares purchased, on average, every week for six months).

Now, given how large of a bet this was, even by Bruce Berkowitz standards, it would have been easy to assume that this investment would be a home run. But as you can see from the trading data above, Fairholme lost money on Pfizer after holding the stock for only about 18 months. During the fourth quarter of 2009 alone, the firm sold more than 73.4 million shares of Pfizer (after having purchased 73.7 million shares during the second quarter of 2008). Perhaps pharmaceuticals aren't Bruce Berkowitz's bread and butter either. Fortunately for him and his investors, however, his prowess picking banks and insurance companies has helped him compile an excellent track record since he founded his firm in 1997.

Full Disclosure: No position in St Joe or Pfizer at the time of writing, but positions may change at any time.