Seritage Growth Properties — Form 10-Q Summary
Reporting period: July 7, 2015, when operations commenced, through September 30, 2015. Seritage was newly formed and acquired its initial portfolio from Sears Holdings on July 7, 2015; the filing therefore has no comparable prior operating period.
Business context and financial position
Seritage is a publicly traded REIT that acquired 235 properties and 50% interests in three joint ventures holding 31 additional properties. Its portfolio spans 49 states and Puerto Rico. Most property space was leased to Sears Holdings under master leases, while Seritage can recapture certain space for re-leasing or redevelopment.
| Metric | Period-end or inception-period amount |
|---|---|
| Total revenue | $54.1 million |
| Net loss attributable to common shareholders | $18.3 million; loss per Class A and C share was $0.58 |
| Operating loss | $16.6 million |
| Operating cash flow | $7.5 million |
| Cash and cash equivalents | $51.5 million |
| Restricted cash | $100.3 million |
| Mortgage loans payable, net | $1.141 billion |
| Total assets / total equity | $2.840 billion / $1.605 billion |
Revenue comprised $41.4 million of rental income and $12.7 million of tenant reimbursements. Expenses included $32.9 million of depreciation and amortization, $18.3 million of acquisition-related costs, and $14.8 million of interest expense. The operating loss was approximately 31% of revenue and the net loss approximately 59% of revenue; these ratios reflect the short start-up period and substantial non-cash depreciation and one-time acquisition costs.
Management reported FFO of $4.8 million, or $0.09 per diluted share and unit, and normalized FFO of $29.0 million, or $0.52 per diluted share and unit. Normalized FFO excludes, among other items, acquisition costs, interest-cap fair-value changes, financing-cost amortization, and up-front hiring costs; it is a non-GAAP measure, not cash flow or a measure of cash available for distributions.
Cash flow, liquidity, and debt
- Investing cash use was $2.732 billion, primarily related to the acquisition. Financing provided $2.776 billion, including $1.644 billion from common stock and non-controlling interests and $1.161 billion from mortgage borrowing.
- Restricted cash included approximately $60 million for future capital investments and $40 million for property carrying costs. Restrictions limit its general availability.
- The $1.161 billion mortgage and mezzanine financing bears floating interest at 30-day LIBOR plus a weighted-average 465 basis points; the reported weighted-average rate for the period was 4.94%. Interest is payable monthly, and the debt matures in July 2019, with two conditional one-year extension options.
- A four-year interest-rate cap has a 3.5% LIBOR strike and a $1.26 billion notional amount. Management estimated that a 100-basis-point rate change would affect annual pretax funding costs by about $11.6 million.
- The loans are secured by the real estate and Seritage’s JV interests and restrict additional indebtedness and certain leases or redevelopment activity. A $100 million future funding facility for redevelopment had not been drawn.
- Management expected operating cash flow and existing cash and restricted cash to fund anticipated needs over the next 12 months. No dividends had been declared by September 30; management expected to declare a 2015 dividend to meet REIT distribution requirements, with amount and timing subject to board discretion.
Material developments, outlook, and risks
- The master lease with Sears has an initial 10-year term, approximately $134 million of annual base rent, and 2% annual increases during the initial and first two renewal terms. Sears may terminate leases on certain unprofitable properties subject to payment and other limits; termination rights are unavailable during the first 12 months and cannot reduce fixed rent by more than 20% per year.
- Seritage may recapture up to approximately 50% of space at 224 properties, subject to exceptions, and may recapture all space at 21 identified stores with a specified termination payment. No recapture rights were exercised during the period.
- Sears generated approximately 84% of period rental income excluding straight-line rent. Third-party tenants accounted for about 16% of period rental income, but approximately 22.5% of annual rental income when signed leases not yet paying rent were included. This creates substantial tenant-credit concentration.
- The company reported $18.3 million of non-recurring acquisition-related expenses and $2.8 million of loss from the interest-rate cap’s fair-value change. The purchase-price allocation remained preliminary; final valuation adjustments could change asset and liability amounts.
- A consolidated shareholder derivative lawsuit challenges the Sears property transaction, alleging an unfairly low sale price and flawed process, and seeks unspecified damages and equitable relief. Seritage said it considers the claims against it without merit and will contest them; management could not estimate any potential loss.
- Environmental liabilities may arise under applicable laws. Sears indemnified Seritage for certain environmental matters under the master leases, and approximately $12.0 million was held in a lender reserve for potential environmental costs identified in due diligence. Insurance deductibles and losses beyond coverage could also be material.
- Seritage intended to elect REIT tax treatment for 2015. Failure to qualify or distribute required taxable income could result in corporate-level taxes and loss of REIT status. The filing states no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether Sears can continue meeting lease obligations, given its large share of Seritage rent and the lease termination provisions.
- Progress on recapturing, redeveloping, and re-leasing properties, including required investment, leasing costs, and actual third-party occupancy and rent.
- Floating-rate debt exposure, compliance with loan covenants, extension conditions, and availability of the future funding facility.
- Final acquisition purchase-price allocation and any material valuation, environmental, or deferred-maintenance adjustments.
- Developments and potential financial effects of the shareholder litigation, and the timing and amount of the first dividend and subsequent distributions.