Tuesday, April 10, 2007

Sears Holdings (SHLD) Securitizes Main Brands

Eddie Lampert, Chairman of Sears Holdings has created $1.8 billion worth of securities based on the brand names Kenmore, Craftsman, and DieHard. What that means is he essentially transferred ownership of the brands to another entity, which it then pays for the right to use the brands. The deal, carried off last May, was the biggest "securitization" of intellectual property in history, according to Eric Hedman, an analyst at Standard & Poor's. The story hasn't gotten out until now because the bonds haven't actually changed hands, Sears is holding them in its Bermuda-based insurance subsidiary and because Sears has never disclosed them, nor has it had to do so. That would change if Sears were to decide to sell them to outside investors and collect the cash.

How does It work?
Sears has disclosed that it has created a "separate, wholly owned, bankruptcy-remote subsidiary". This is essentially a company within a company. It is called KCD IP (for Kenmore Craftsman DieHard intellectual property) and it has issued $1.8 billion worth of bonds backed by the intellectual property of Sears' three biggest brands, according to filings with the Patent & Trademark Office.

Sears has in effect now created licensing income from it's most known brands. First it transferred ownership of the brand names into KCD. Now, KCD charges Sears royalty fees to license those brands and uses the royalties to pay the interest on the bonds. It has sold the bonds to the insurance subsidiary, where, like any other security on an insurer's books, it serves as protection against future loss. The insurer, meanwhile, protects Sears from financial trouble and because it's a subsidiary of Sears, it does so at a lower cost than they could get from an outside party. Essentially, the deal at its current level allows SHLD to save money on insurance.

The question you are most likely asking is: Who is making money off the transaction? The answer? As it is set up, nobody. The payments net out to zero because Sears owns every piece.

Why Do It Then?
It seems like a whole lot of work to do for no profit. Why do it and how then can Sears turn these bonds into money?

1- Sell the bonds to outsiders. Then, Sears would be holding up to $1.8 billion in cash, and investors would be holding the bonds.

2- License the brands: Many people (me included) feel there is a huge revenue stream for Sears in the value of these brands. Allowing outside manufacturers to make products and use the Craftsman, Kenmore and Diehard brand names in return for royalty payments is an easy way to increase profits without any additional expense. These payments would be virtually 100% profit for Sears. More importantly, by licensing these brands they would be expanding the availability of them. I feel that especially with the Craftsman tool line, this could really have a compounding effect. Tool buyers are a brand conscious lot. If their favorite brand came out with a Craftsman line, given Craftsman's reputation for quality, it would sell.

3- Swap bonds for debt. Lampert acquired K Mart through its debt. These new "brand" bonds allow him a vehicle to do a similar deal. How? Lampert could swap these bonds or a portion of them for the debt of another company. One morning shareholders of BJ's could wake up and find that Sears Holdings owns all their debt. The beauty of this scenario is that it would require none of the cash Sears has in the bank ($4 billion) to be used. Having these bonds as leverage also allows for the possibility of a much larger acquisition.

4- Insurance. In the past I have speculated on the possibility of Sears getting into the insurance business. Now we have an insurance subsidiary of Sears sitting there holding $1.8 billion in bonds that could be used for an acquisition. As I stated in the past, I think there are few acquisitions that would make the stock price of SHLD explode to the upside than the purchasing of an insurer.

The creation of these bonds opens up a plethora of situations in which they can be used to add value to Sears Holdings for shareholders.

At the end of the day, what Lampert will do with this is a mystery. It is great fun for us to speculate though. If we do it enough, eventually one of us are going to be correct. What I do know is that given his past track record, we shareholders will benefit greatly.

Things are getting exciting here.

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