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Sears Holdings – Edward Lampert's ESL Files Revised $5bn Bid, Offer on Table Until 5pm on January 13, Has it Changed Enough?

January 10, 2019 – In a letter dated January 9, 2019 addressed to Lazard Frères & Co. and filed with the SEC, ESL Investments, Inc. (“ESL”) submitted a revised bid (the “Revised Proposal”) detailing the terms upon which its subsidiary Transform Holdco LLC would proceed with a bid at an auction scheduled for January 16, 2019. According to ESL, the Revised Proposal raises its aggregate offer by more than $600mn over its proposal of December 28, 2019 (the “Going Concern Proposal”), principally through the assumption of additional liabilities; resulting in a purchase price of over $5bn. The price increase is not, however, merely a sweetening of the pot. The Revised Proposal also adds assets not previously included in the Going Concern Proposal which have a combined book value of over $600mn. Exactly how the assumed liabilities and newly added assets are to be valued, and how they net, is far from clear. The Debtors' Board seems sufficiently impressed to have accepted the Revised Proposal as a "Qualified Bid" on the heels of rejecting the Going Concern proposal. Whether or not the Debtors' Official Committee of Unsecured Creditors (the "Creditors Committee"), who have repeatedly questioned the Debtors' relationship with ESL and Eddie Lampert, agrees...remains to be seen.
 
What Changed?
 
The Revised Proposal builds on the Going Concern Proposal which is only altered/amended as explicitly set out in the Lazard letter (“Except as modified by this Revised Proposal, the terms set forth in the Going Concern Proposal are incorporated by reference herein.”). From a consideration perspective, the changes relate almost entirely to the assumption of further liabilities, which ESL values at up to $663mn. Although the increased consideration is not specifically linked to any specific assets, the Revised Proposal also includes the acquisition by ESL of assets not included in the Going Concern Proposal; these assets have a combined book value of over $600mn. 
 
Assumption of Liabilities
 
The Lazard letter provides the following detail as to the assumed liabilities, “In addition to the liabilities described in the Going Concern Proposal, Buyer proposes to assume up to $663 million in additional liabilities identified in consultation with the Debtors. This amount consists of the following, to be paid by Buyer in accordance with the Revised Asset Purchase Agreement: 

  • Up to $166 million of payment obligations with respect to goods ordered by Debtors prior to the closing of the proposed transactions (but as to which goods Debtors have not yet taken delivery and title prior to closing); 
  • Up to $139 million of 503(b)(9) administrative priority claims; 
  • Up to $43 million of additional severance costs to be incurred by the Debtors; 
  • All cure costs related to contracts to be assumed by Buyer (estimated to be up to $180 million); and 
  • Up to $135 million of property taxes with respect to the properties to be acquired by Buyer. 

Acquired Assets  

The Revised Proposal includes the acquisition by ESL which were not included in the Going Concern Proposal, including: 
 
  • Approximately 57 additional real estate properties; 
  • Accounts receivable with respect to certain home warranties sold in FY 2018 with a book value of approximately $53.6 million; 
  • Other accounts receivable with a book value of at least $256 million, inclusive of netting for allowances for bad debts; 
  • Additional inventory with a book value of up to $166 million with respect to which Buyer shall assume payment obligations as described in item 1.a. above (and as to which inventory Debtors have not yet taken delivery and title prior to closing); 
  • Prepaid inventory with a book value of at least $147 million as to which Debtors have not yet taken delivery and title prior to closing; and 
  • All of the Debtors’ rights relating to the claims set forth in the class actions consolidated in the multi-district litigation In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, No. 1:05-MD-01720 (E.D.N.Y.). 
 
Release and Credit Bidding
 
It has been reported that two of the major sticking points for the Debtors’ Board had been ESL’s insistence that it be released from any liability from pre-petition liabilities and that it be cleared to credit bid certain secured debt that it holds. On its face, the fact that the Debtors have allowed ESL to proceed with a further proposal suggests that discussions have materially advanced towards resolution of these issues. It is not entirely clear, however, how the Revised Proposal will materially alter the Creditors Committee's view that these two issues stand to seriously dilute recoveries.
 
The Going Concern Proposal stated that it was “conditioned on (1) confirmation of Buyer’s right to credit bid the secured debt in the amounts described herein (and without any requirement to cash collateralize or otherwise backstop any portion of the credit bid) and (2) a full release by the Debtors of ESL and certain ESL-related parties from any liability related to any prepetition transactions involving ESL.” It is not clear that the Revised Proposal significantly changes ESL’s position; although ESL at least recognizes the concern, noting that it is offering “$35 million in cash [not new], and the assumption of the additional liabilities of the Debtors” as nominal consideration for the release of the blanket release of liabilities. So does the assumption of additional liabilities, when the Debtors’ are otherwise parting with (on a book value basis anyway) a roughly equivalent set of additional assets, make the release/liability problem go away? 
 
Although the Going Concern provides some added assurance as to the mechanics related to ESL’s ability to credit bid (eg noting that ESL has been granted the authority of relevant agents to do so), ESL’s ability to credit bid up to $1.3bn appears to be unchanged from the terms of the Going Concern Proposal (which are summarized below). 
 
Will the Revised Proposal Fly?

One would have thought that the Debtors’ Board, fully cognizant of the allegations of insider dealing on the part of ESL lodged by the Debtors' Official Committee of Unsecured Creditors (the "Creditors Committee"), and the proven willingness of the Creditors Committee to press forward those concerns in the courtroom, would have insisted on very real comfort as to those concerns in any further ESL proposal before re-opening the door to ESL. Hemorrhaging cash (October and November MORs report a total of $310mn in operating losses and  $529mn in net losses) and reportedly close to engaging a trusted liquidator (Abacus Advisory Group LLC with whom the Debtors have already worked with on store closings); why would the Debtors allow for a deal that didn’t have the Creditors Committee pre-boarded? Surely, the very fact of a new ESL proposal reflects the Debtors’ confidence that ESL has offered up a comprehensive and inclusive solution?

Perhaps, there is an 11th hour equivalent of a clean prepack waiting behind courtroom doors to provide an improbably happy ending. It is not clear, however, from the Revised Proposal where unsecured creditors will have found the necessary comfort to welcome yet another lifeline for the Debtors and ESL. ESL can still credit bid $1.3bn in debt, a sum that the Creditors Committee views as unfairly accumulated. The Revised Proposal still gives ESL a blanket release for a series of transactions that the Creditors Committee views as suspect. The additional consideration that on paper upgrades the ESL offer from $4.4bn to $5.0bn is in the form of assumed liabilities; liabilities which appear to be largely netted out (based on book values, anyway) with the further Debtors’ assets to be acquired by ESL. 

Opposition of Creditors Committee
 
On November 6, 2018, the Creditors Committee filed a motion [Docket No. 485] seeking authority “to conduct an examination of and seek discovery from the Debtors, their advisors and controlling shareholders, and other third parties…in connection with a series of prepetition transactions that the Committee (and the Debtors FN1) believe may give rise to material claims and causes of action in favor of the Debtors’ estates… arising from affiliate transactions involving ESL and Lampert.” 

The motion continues, “The Committee is convinced that there exist potential estate claims and causes of action (collectively ‘Claims’) arising from the Debtors’ various attempts to finance the Company’s operations, often involving related-party transactions with controlling shareholders ESL and Lampert….The circumstances surrounding the various transactions raise the possibility that ESL and other insiders may have exercised undue influence to siphon value away from the Company on favorable terms. In addition, these parties may have used their insider status to obtain an ever-increasing percentage of the Debtors’ senior debt, positioning them to exert undue influence over, and obtain beneficial positions in connection with, the events leading up to, and the trajectory of, these chapter 11 cases. Indeed, through an escalating series of transactions in the years and months leading up to the Petition Date (as defined below), ESL has managed to obtain $2.6 billion, or 46%, of the Debtors’ funded prepetition debt, including approximately 73% of the second lien debt.”
 
The motion lists a series of transactions which the Creditors Committee believes the Debtors’ Board, led by its insider Chairman and CEO Lampert, have approved for the benefit of the Debtors majority shareholder and most significant debt holder. Those transactions include:
 
  • The July 2015 rights offering and sale-leaseback with Seritage Growth Properties
  • The October 2012 separation of Sears Hometown and Outlet businesses
  • The October 2012 spin-off of the Debtors’ 45% interest in Sears Canada and the November 2014 rights offering for additional shares
  • The April 2014 spin-off of the Lands’ End business 
  • Various financing transaction pursuant to which Sears Holdings increased its debt by nearly $1.7bn since April 2017, including: (i) the Sparrow Term Loan, (ii) the Sparrow Mezzanine Loan, (iii) the IP/Ground Lease Term Loan Facility  and the amendments thereto, (iv) the Second Lien PIK Notes, (v) the Consolidated Secured Loan Facility and amendment thereto, (vi) the Holdings Unsecured PIK Notes, (vii) the SRAC Unsecured PIK Notes, (viii) the Second Lien Credit Facility  and amendments thereto, (ix) the FILO Term Loan, (x) the New Senior Secured Notes, (xi) the New Senior Unsecured Notes, (xii) Unsecured Commercial Paper held by ESL and its affiliates, (xiii) the Stand-Alone L/C Facility and amendments thereto, (xiv) the 2016 Term Loan, (xv) the Revolving Credit Facility, (xvi) the Holdings Unsecured Notes, (xvii) the SRAC Unsecured Notes, and (xviii) the Second Lien Notes

FN1: The Debtors’ Board, fully acknowledging the concerns, filed a motion in support of the Creditors Committee’s request, as did a subcommittee of the Debtors’ Restructuring Committee; the motion was subsequenly approved by the Court [Dockets Nos. 705, 711 and 802, respectively].

Consideration as Set out in Going Concern Proposal
 
The terms of the Revised Proposal build on (and incorporate by reference where not explicitly amended by the Revised Proposal) the following elements of consideration outlined in the Going Concern Proposal:
 
  • $850 million in cash to be funded with the proceeds of a new $1.3 billion ABL facility described in the Debt Commitment;
  • A credit bid of approximately $1.3 billion (FN2)
  • The roll-over of (and release of the Debtors with respect to) $501 million of senior indebtedness (up to $230 million of the Junior DIP facility and approximately $271 million of the L/C Facility) and
  • The assumption of all of the outstanding liabilities of the SRC Entities, in the amount of approximately $592,000,000;
  • $35 million in cash and rights to purchase up to $100 million of non-voting securities of Buyer as consideration for the release of ESL and certain ESL-related parties from certain liabilities as described further below; and
  • The assumption of the Debtors’ liabilities with respect to (i) protection agreements issued by Sears Homes Services, (ii) certain gift cards and (iii) accrued points under the Shop Your Way program, in each case on terms to be agreed with the Debtors. We estimate these liabilities to be approximately $1.1 billion.

FN2: Consisting of (i) approximately $544 million in respect of certain owned real estate assets that are collateral under the Dove Loan Agreement, (ii) approximately $231 million in respect of certain intellectual property and ground leases and related assets that are collateral under the IP/Ground Lease Loan Agreement and (iii)  approximately $559 million in respect of the acquired inventory and receivables that are collateral under the Second Lien Facilities and the FILO Facility. 

Financing and Deposit

The Revised Proposal provides some further clarification as to financing, specifically referencing that it has provided the Debtors with (i) updated executed copies of a debt commitment letter from the lenders with regard to a new ABL facility (the “ABL Commitment”), (ii) a debt commitment letter from ESL and funds managed by Cyrus Capital Partners with respect to the rollover of certain debt facilities of the Debtors (the “Rollover Commitment”), (iii) a debt commitment letter from ESL and funds managed by Cyrus Capital Partners with respect to a new secured real estate loan (the “Real Estate Commitment”) and (iv) an equity commitment letter from ESL (the “Equity Commitment”). ESL states that “Upon receipt of the funds described in the Debt Commitment, the Rollover Commitment, the Real Estate Commitment and the Equity Commitment, Buyer will have sufficient funds available to consummate the transactions contemplated by our Going Concern Proposal,” 

ESL has also deposited $120mn in cash (representing in excess of 10% of the cash component of the purchase price ) with the Debtors’ Escrow Agent selected by the Debtors, this including  $17.9mn “described at the Hearing” and widely reported as being non-refundable.

Termination of Offer

As with ESL’s Going Concern Proposal, the Revised Proposal has a self-destruct feature, this one timed to go off at 5pm on January 16, 2109. The Lazard letter states, “This Revised Proposal and the Revised Asset Purchase Agreement shall automatically terminate and be deemed withdrawn at the earlier of (i) 5:00 p.m., New York time, on January 13, 2019, if Debtors have not confirmed in writing to Buyer that an “Auction” pursuant to the Bidding Procedures will be held on January 14, 2019 at which Buyer shall be allowed to participate and (ii) 5:00 p.m., New York time, on January 16, 2019, if Debtors have not confirmed in writing to Buyer that Buyer has been selected as a “Successful Bidder” (in connection with the transaction contemplated by the Revised Proposal) pursuant to the Bidding Procedures.”

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