Should You Bite The Preferred Apple From Orchard?

Whopper Investments asks the question we’ve been puzzling over: What is the purpose of the preferred stock being issued to Sears(SHLD) shareholders as part of the Orchard Supply(OSH) spinoff? We’ve previously written in general terms about the spinoff here, but haven’t much discussed the prospects of the securities that will be distributed.  Sears has its own issues which we discussed recently at Inelegant Investor. The preferred appears to be some way to allow ESL to maintain control or gain cash at some future date, but it’s unclear exactly what the purpose is.

Our quick take is that the company, though heavily leveraged, has more attractive sales and profitability trends then the rest of Sears’ business. The loss in the most recent quarter is entirely due to the sale of real estate at significantly less than carrying value. Further, the dynamics of the situation with ESL owning 61% of the company, a very lopsided distribution ratio(1 share of OSH for every 22 or so of SHLD) which will create many owners of microscopic stakes to dump, and the forced sale of fractional shares, are likely to result in an initial dip as there as selling into a very limited float. This may create an attractive opportunity to purchase shares, particularly the aforementioned puzzling preferred.  We will have an exceedingly small stake in the new OSH, and it is our intention to supplement it should we see the dip we anticipate create an opportunity to buy at a discounted price.

Disclosure: The author owns shares in SHLD and will own shares in OSH post-spin