Seritage Growth Properties 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2015. Seritage Growth Properties (the "Company") was organized on June 3, 2015, and is a newly formed, self-administered, self-managed Real Estate Investment Trust (REIT). As of the reporting date, the Company had no operating history and held only minimal cash assets ($2,958). The filing primarily details the preparation for and subsequent completion of a major transaction on July 7, 2015, in which the Company acquired a portfolio of 235 properties and joint venture interests from Sears Holdings Corporation for approximately $2.7 billion.
Key Financial Metrics
As of June 30, 2015, the Company's consolidated balance sheet reflected only formation costs and minimal cash. Significant financial data is presented on a pro forma basis or as subsequent events regarding the July 7, 2015 transaction:
- Transaction Value: Approximately $2.7 billion total purchase price for 235 acquired properties and 50% interests in three joint ventures (JV).
- Pro Forma Revenue: Estimated at $19.2 million for the period from June 3, 2015, to June 30, 2015, assuming the transaction occurred on the formation date.
- Pro Forma Net Loss: Estimated at $(10.8) million for the same period, driven by non-recurring acquisition costs ($18 million) and depreciation/amortization ($8.5 million).
- Debt: The transaction was financed with approximately $1.16 billion in debt, consisting of a $925 million mortgage loan and a $236.2 million mezzanine mortgage loan.
- Equity Financing: Proceeds included $660.6 million from a rights offering to Sears Holdings stockholders, $200.9 million from Class C shares, and private placements totaling $66.6 million from General Growth Properties (GGP) and Simon Property Group.
- Liquidity: The Company secured a $100 million undrawn funding facility for future redevelopment projects.
Material Changes and Subsequent Events
The most material event disclosed is the completion of the acquisition of Sears Holdings' real estate portfolio on July 7, 2015, which occurred after the reporting period. Key changes include:
- Portfolio Acquisition: Acquisition of 234 owned properties and one ground-leased property (the "Acquired Properties"), plus 50% interests in three JVs owning 31 additional properties.
- Lease Structure: Substantially all space is leased back to Sears Holdings under a Master Lease with an initial base rent of approximately $134 million annually, increasing 2% per annum.
- Capital Structure: Transition from a shell company with $2,958 in assets to a leveraged REIT with over $2.7 billion in assets and significant debt obligations.
- Legal Proceedings: Consolidated shareholder lawsuits filed in May and June 2015 allege the sale price of the properties was unfairly low due to fiduciary breaches. The Company intends to contest these vigorously.
Outlook, Risks, and Management Commentary
Management's strategy focuses on diversifying the tenant base by recapturing space from Sears Holdings (up to 50% of space) to lease to third parties, thereby reducing reliance on a single tenant. The Company expects to incur approximately $15 million in annual incremental operating costs as an independent public company.
Key Risks and Contingencies:
- Tenant Concentration: Sears Holdings represents approximately 90% of existing rent. The Company's financial health is heavily dependent on Sears' ability to pay rent and avoid bankruptcy.
- Termination Rights: Sears Holdings retains the right to terminate leases for unprofitable stores (up to 20% of aggregate annual rent per year) upon payment of one year's rent.
- REIT Status: The Company must distribute at least 90% of taxable income to maintain REIT status. Failure to qualify would result in significant corporate tax liabilities.
- Related Party Transactions: Edward S. Lampert (Chairman of Sears Holdings and Seritage) and his entity ESL hold significant interests in both companies, creating potential conflicts of interest.
Investor Verification Checklist
- Verify the financial stability and creditworthiness of Sears Holdings, the primary tenant responsible for ~90% of revenue.
- Review the specific terms of the Master Lease regarding termination rights and the definition of "unprofitable stores."
- Assess the status of the consolidated shareholder litigation alleging fiduciary breaches regarding the transaction price.
- Confirm the Company's ability to meet the 90% distribution requirement for REIT status given the high debt service costs (~$56 million annual cash interest).
- Monitor the execution of the space recapture strategy and the ability to re-lease space to third-party tenants at favorable rates.