A complicated story that could make you a fortune...

A vendor – say, blue jeans maker Levi Strauss – may sell Sears $100,000 worth of merchandise on credit. So Levi's now has a $100,000 receivable due from Sears. But given Sears' shaky financial footing, Levi's may choose to buy "trade put agreements" on its $100,000 receivable. These trade put agreements insure that, in the case of a Sears bankruptcy, Levi's will be paid in full for the receivable it is due.

 

Large financial institutions like banks often sell trade put agreements. Guess which financial institution has historically been extremely active in the market for Sears' trade put agreements? ESL Investments. In 2011 alone, ESL was insuring hundreds of millions in Sears inventory. At lousy companies, these puts can sell for around 10% of receivable value. In bad times, the cost can rise to 30%. So in its heyday, ESL was making tens of millions per year insuring Sears' inventory.

 

This is vintage Lampert. Think about it. If times get really tight at Sears, and it can only pay certain bills before declaring bankruptcy... what do you think happens to that money Sears owes Levi's?

In September 2014, Lampert (through his hedge fund, ESL) loaned Sears Holdings $400 million to finance its Christmas inventory. Sears must repay the loan no later than February 28, 2015 (roughly six months). Under the terms of the agreement, Sears pays ESL $7 million up front and another $2 million if it wants to extend the loan beyond February (which it obviously will). Interest will be $6 million over this period. So it's a total gain of around 8% annualized.

 

The loan is secured by 25 stores, which values each store at around $16 million each. For the last few years, Sears has been selling properties between $20 million and $50 million, and it recently sold one for $102 million. So the collateral is almost certainly worth more than the loan. Here's the best part: Lampert can substitute the stores used as collateral, if necessary. So he can swap them out as needed.

Once upon a time, Sears Holdings owned approximately 95% of its northern neighbor, Sears Canada. In 2012, Sears Holdings spun off around 44% of the company, retaining a 51% stake for itself. Lampert kept the 28 million shares that spun in his direction. Berkowitz maintained his allotment of Sears Canada shares as well. In conjunction with the spinoff, Sears Canada paid a C$1-per-share special dividend to shareholders. Thus, almost $30 million went straight into Lampert's pocket. And all shareholders received their pro-rata portion of this benefit.

 

Now read the next part carefully... In 2013, Sears Canada went on a selling spree. The company sold seven trophy properties, including Eaton Centre – its "crown jewel" in Toronto. At that point, despite retail operations that were burning through cash, Sears Canada announced a C$5-per-share special dividend. This cash went directly to the shareholders of Sears Canada. So for investors who retained their shares, like Lampert and Berkowitz, it was a cash windfall. Lampert and his hedge fund collected nearly $150 million.

 

No one who was truly interested in building a retail business would make these decisions. This is liquidation, not a turnaround. And this is exactly what we expect Lampert to do next, but with the Sears real estate in the U.S.

This is classic liquidator strategy. Lampert has been making similar moves with almost all of Sears' operating groups. Look at home-improvement chain Orchard Supply, a Sears business Lampert spun off in 2011. First, he loaded up the company with $340 million in debt. Then, Orchard paid that money to Sears via a special dividend just before the business was spun off. Orchard went bankrupt shortly thereafter, but not before Lampert and his hedge fund got another $19 million from the sale of its stock.

 

Whenever Lampert "burns some furniture," he walks away with $30 million-$130 million in cash. Shareholders like Berkowitz, who invest alongside Lampert, also receive some cash.

In November, Lampert announced plans to do a "sale and lease back" deal involving 200-300 wholly owned Sears store locations. Such deals have been common for a long time... when they involve an independent lessor. Normally, businesses agree to these arrangements when they want to extract capital from their real estate holdings and invest it in more profitable areas of their operations. They will sell their office buildings or other land holdings to a REIT and then sign a long-term lease agreement. This allows corporations to remain in their office towers, but no longer own them.

 

With Sears, the rationale for a deal like this is different. It has no more-profitable areas to use the capital. So instead, it needs to be sold to shareholders. So Lampert is creating a new Sears REIT to hold these stores and handing its shares to Sears shareholders.

 

As you may know, REITs are simply tax-advantaged entities created to hold real estate properties and funnel the cash they generate directly to shareholders. So the move essentially means that Sears stores will be paying rent to their own shareholders... including, of course, Lampert and ESL.