Sears filed for Chapter 11 with plans to close 142 stores — now what?

As previously expected, Sears Holdings filed for Chapter 11 in the early hours on Monday as a $134 million debt payment came due at a time of stark liquidity constraints.

The event marks a turning point for the 125-year-old department store retailer after having shrunk its physical footprint by 75% over the past decade, sold critical assets and laid off thousands from its corporate and store workforces.

Those efforts may have put off bankruptcy longer than many thought possible as Sears, under CEO and majority owner Eddie Lampert, slowed the company's financial bleeding. At the same time, though, the retailer's sales continued to collapse, and the financial band-aids ultimately proved insufficient to stave off a court restructuring, the ultimate outcome of which remains to be written.

Sears filed with plans to restructure around a "smaller platform" of profitable stores and emerge as a "member-centric company," the retailer said in a press release and blog post. Sears said it is moving immediately to close 142 unprofitable stores in Chapter 11, on top of 46 previously announced closures expected to complete in November. Moody's Vice President Christina Boni said in emailed comments that Sears is "likely to sell or close stores beyond these locations to maximize value to creditors."

Sears' chief financial officer said in a filing that there are currently 400 stores with positive EBITDA (earnings before interest, taxes, depreciation and amortization).

To finance the company's ongoing operations in bankruptcy, Sears has commitments for $300 million in debtor-in-possession financing from its asset-based lenders, including Bank of America, Wells Fargo and Citibank. Sears said it is also negotiating with the hedge fund that Lampert runs and which owns the largest chunk of Sears stock, ESL Investments, for $300 million in subordinated DIP financing.

"No one was shocked at the timing of Sears filing... If there is a surprise it might be that it took this long. Sears vendors have already been reacting to the impending problem."

Philip Emma

Debtwire retail analyst

As part of the reorganization process, Sears CEO Eddie Lampert has stepped down as chief executive, though he will remain as board chairman, according to the release. In Lampert's place, Sears created an "Office of the CEO" staffed by Chief Financial Officer Robert Riecker, Chief Digital Officer Leena Munjal and Gregory Ladley, president of apparel and footwear. The company has also appointed as chief restructuring officer Mohsin Meghji, a managing partner of M-III, which has advised Sears on its filing and reorganization.

The filing, as Boni points out, comes as most "retailers are ramping up for the all-important holiday season and recent liquidations such as Bon-Ton and Toys R Us suggest the challenges to reemerging as a going concern." Toys R Us, which made 40% of its sales in the fourth quarter, filed for Chapter 11 in September last year, which caused disruptions in its supply chain at a crucial time and spooking consumers away from its giftcards.

"No one was shocked at the timing of Sears filing," Philip Emma, a retail analyst with Debtwire, told Retail Dive Monday in an email. "If there is a surprise it might be that it took this long. Sears vendors have already been reacting to the impending problem."

Indeed, appliance maker Electrolux, as one example, issued a press release Monday telling investors that the company "has been actively planning for various Sears' contingencies while also growing the business with other customers" and as a result didn't anticipate it needed to assess a "one-time cost" from Sears' filing.

As Sears reorganizes, the company said it is currently in talks with Lampert's hedge fund, ESL Investments, about a potential stalking-horse bid for "a large portion of the company's store base" in Chapter 11. "However, while it is difficult to predict the outcome of Sears' attempt to restructure its business and the various scenarios it may entail, it cannot be ruled out that there may be a material impact on the future sales and earnings of Electrolux business area Major Appliances North America," the company added, noting that Sears represented about 10% of North American appliance revenue.

Other vendors have reportedly been hedging their bets and demanding stricter terms ahead of the filing, while vendors from Lands' End to Whirlpool have been reducing or winding down their relationship with Sears over the past year.

'Longstanding goal'

The possibility that Lampert might buy out Sears in a bankruptcy scenario has already been floated by lawyers and analysts. Emma suggested the possibility in an interview last week with Retail Dive, pointing out that Lampert, through his own holdings and ESL, is Sears' majority shareholder, as well as a major lender and even a landlord and supplier (through his investment in Lands' End).

Some attorneys have suggested that Lampert's many roles at Sears could leave the executive and his hedge fund open to litigation in a Chapter 11 case. In the wee hours of Monday morning, ESL issued a statement noting that the fund's "longstanding goal has been to enable Sears Holdings Corporation to return to profitability, for the benefit of Sears and all of its stakeholders."

The company added, "ESL consistently believed that restructuring the company's finances as a going concern and outside a court-run bankruptcy process would have been a better path for Sears." Additionally, the company said that Lampert and the fund offered Sears' board a proposal to reduce debt and transfer away assets in order to address the retailer's liquidity problems.

The board, apparently, didn't take up that proposal.

The failure to cut a deal sets into motion what may be a contentious bankruptcy process — a process that still doesn't have a clear outcome. While the company said it plans to close a large chunk of its existing stores and potentially sell itself to ESL, there is no exit plan clearly delineated just yet. Often, as was made painfully clear in the Bon-Ton and Toys R Us cases, bankruptcy outcomes come down to dollar signs.

A 'tarnished brand'

As Sears CFO Robert Riecker recounted in a court filing Monday, Sears was founded in 19th century Chicago as a mail-order watch business before growing "exponentially over the course of the twentieth century to become the largest retailer in the United States and the world."

Its catalog model allowed Sears to reach America's dispersed population as it catered to customers in often rural and remote areas, selling everything from "housewares to even houses," Riecer noted. Later in the 20th century, Sears built massive department stores in urban areas, which essentially acted as showrooms for the company's catalog wares.

"Later, in the 1960s and 1970s, as families increasingly migrated to suburban neighborhoods, Sears established itself as a staple of American shopping malls, anchoring such malls and leading all retailers in the tool, appliance, lawn and garden, and automotive repair and maintenance retail sectors," Riecker said in the filing.

Neil Saunders

GlobalData Managing Director

In the early 2000s, Lampert orchestrated Sears' merger with Kmart after the latter fell into bankruptcy. In Riecker's telling, the move was meant to make Sears more competitive in a retail world that was moving away from malls and to big-box power centers. But instead of creating the market and organization synergies executives hoped for, both banners have declined together in the years since.

Lampert and ESL are still projecting hope about the future of Sears and highlighting past efforts to keep Sears afloat and competitive. Few observers outside the company, however, see wisdom in Lampert's financial engineering at Sears or hold much hope for reviving the retailer.

Sears store sales have fallen from more than $30 billion in 2013 to under $11 billion in the past 12 months, according to data from eMarketer emailed to Retail Dive. The company's online business hasn't fared much better. Sears e-commerce sales have dropped from $3.3 billion in 2013 to just under $2 billion in the past 12 months.

"Today is a day that will live in retail infamy. That a storied retailer, once at the pinnacle of the industry, should collapse in such a shabby state of disarray is both terrible and scandalous in equal measure," GlobalData Managing Director Neil Saunders said in emailed comments. "However, it is not surprising because this is a destination that Sears has been headed towards for many years, with virtually no serious attempt having ever been made to change the trajectory."

Saunders added that while current management should "shoulder much of the responsibility, the missteps arguably go back to the 1980s when Sears became too diversified and lost the deftness that had once made it the world's largest and most innovative retailer."

Saunders added that staying open during the holidays is a "reasonable tactic," as it allows the retailer to clear out some merchandise, though he warned that the filing might scare consumers away from big-ticket items should they worry the retailer won't back its guarantees. GlobalData's own survey shows that yet more customers are likely to leave the retailer this holiday season.

"The brand is now tarnished just as the economics of its model are firmly stacked against its future success," Saunders said.