Is Orchard Supply Worth $10 per Sears Share? Morningstar Seems To Think So

A recent report on Sears Holdings(SHLD) by Morningstar analyst Paul Swinand lowers their fair value estimate for Sears by $10 per share due to the Orchard Supply(OSH) spinoff. Given the distribution ratio of 1 share of Orchard Supply for

Old logo of Sears

approximately every 22 of Sears, and Sears’ 80% ownership in Orchard Supply, this would seem to imply a per share value for Orchard Supply of $176-$220. This seems wildly off.  Are we missing something in Mr. Swinand’s analysis? Is our math somehow flawed? Let us know in the comments.

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15 thoughts on “Is Orchard Supply Worth $10 per Sears Share? Morningstar Seems To Think So

  1. Liron

    Hi Dr., love to read your blog.
    A general question to spin-offs I had is, there a way to know what will be the stock distribution price as it hits the market?

  2. Aristarkos

    Would you kindly elaborate on the math of how you arrived at an implied value of $176-220 per share?

    According to Mr. Swinwand’s analysis, the market cap would be $10 per share times 4.806mn shares of commonoutstanding (the # that will be issued in the spin-off), or approx. $48mn in equity.  The prefferreds liquidation right adds another $20mn in equity (4.806mn in preferreds will be issued and each contains a $4.16 liquidation right and no dividends will be paid on it).

    OSH is highly leveraged with $320mn in total LTD & capital lease obligations at the end of FY10 and more than $210mn comes due in FY13–thus re-financing will be an important issue as we move into FY12.

    The challenge for me here is that OSH appears to be entering into sale-leasebacks with its owned property (it even entered the Appliance Agreement three months early) to ensure adequate cash flow to meet interest expense commitments and financial covenants–in particular the so-called ‘Leverage Covenant’.

    Do you suspect that major institutional investors will be likely to dump their shares?

  3. Inelegant Investor Post author

    Mr. Swinwand claims a $10 per share loss in value from the spin. Since SHLD shareholders receive 1 share of OSH plus 1 share of preferred for every 22 shares of SHLD, each OSH pair represents $220 in value lost from Sears. The value has to go somewhere. The $176 number assumed that 20% of the economic benefit went to Ares. Either number is clearly way more than the actual value of OSH, which, I agree with you, is tenuous at best. Hence as near as I can tell, the claim that OSH represents $10 of value per SHLD share is ludicrous on its face. Or am I missing something?

  4. wy

    Checked out an Orchard Supply store in La Verne, CA. Hoping to see a store that could differentiate itself from HD and LOW. Disappointed. Not a small store. Inventory is full. Merchandizing categories look similar to HD/LOW. Store seems too small to compete with HD/LOW but too big to be an efficient niche player. With big debt load and slow business environment, wonder how they can sustain long term? Perhaps there could be value with big selloff. But concerned that this could at best only be a cigar butt.

  5. AD

    They just came out with their 10-Q today. I think the shares should be somewhere between $7 to 8 per share.

  6. Inelegant Investor Post author

    As far as I know, the shares aren’t yet trading “when issued”, but I think your estimate is low. I would be a buyer at $7. I think you need to back the $14MM loss on sale of real estate out of the numbers. 10-q is here, by the way.

  7. Anonymous

    Your math is correct. I wonder where they got the notion that the spinoff will strip SHLD of $10 off the share price. They seem to be attributing that number to higher margins of OSH, but they’re pretty vague about it…

  8. Inelegant Investor Post author

    Thanks. It just makes no sense. If the margins are that high, the value should be there on the other end, and I don’t think they’re actually claiming that.

  9. Matt

    Mr. Swinand seems to claim that OSH is worth $10 per SHLD share, not per OSH share.  With the ~22 to 1 conversion ratio, this implies a OSH share price of $220.

  10. MT

    Can anyone explain to me which date is the correct date for the spin-off?  The CBOE has Ex-date of Dec 16th.  Other sites I have read have Dec 30th as the ex-distribution date.  If it was today OSH isnt trading and SHLD did not adjust its opening price.  If it was the 16th then SHLD’s price did not adjust and OSH has yet to begin trading.  A little help here! 

  11. Adsfas

    he valued OSH at ~900 mm, which makes him a jackass and yes it does seem to imply $200ish per OSH share

  12. GotMojo

     That anal yst must be loading up at these fire sale prices.

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