Street Cold on Sears' Canadian Exposure

Investors waiting for big asset sales to revive shares of Sears ( SHLD) awoke Monday to news of an acquisition.

The retailer unveiled a plan to buy the publicly traded shares of its 54%-owned Sears Canada ( SEARF) unit for $715 million.

"A lot of people expected them to be sellers, not buyers," said Morningstar analyst Kim Picciola. "This is certainly not what I was expecting."

Shares of Sears Canada more than doubled 100% this year after it announced the sale of its credit card portfolio to J.P. Morgan ( JPM) for C$2.3 billion. The company is in the process of returning proceeds to shareholders via a special dividend of C$18.64 a share.

Investors had also bid up the shares on speculation that once the credit card transaction was completed, Sears Canada would be converted to an income trust, seek to merge with another retailer or be spun off completely from its parent company. The Toronto-based chain slashed payrolls earlier this year and adopted other aggressive cost-cutting measures that smacked of the influence of Ed Lampert, the hedge fund guru with ESL Investments who became chairman of Sears Holdings after orchestrating the merger of Kmart and Sears last year.

But rather than sell Sears Canada, Lampert has chosen to buy. The acquisition price comes out to C$16.86 a share. Sears Canada's stock closed at C$34.10 Friday, but after the C$18.64 dividend its shares had an implied value of C$15.46 apiece before the parent's offer surfaced.

"The offer represents a 8.7% premium over Friday's closing price and a 22.2% premium over the average closing price since Aug. 31, 2005," the date the credit card deal was announced, Sears Holdings said.

"They must see some value in the business that they think they can extract by controlling it," Picciola said. "Rather than sharing it with someone else, they want to take full advantage of the fruits of their labor. They still could sell off some of the assets at some point in time."

Credit analysts see little long-term value at Sears Canada after the sale of its credit card operations. S&P analyst Don Povilaitis cut his debt rating on the company to junk in September, saying he did not expect that Sears Canada would be able to improve its long-term operational performance or market position.

"Sears Canada's retailing operations had shown lackluster earnings thus far in 2005 and we believe that the curtailing of the company's capital expenditure program illustrates that while a focus on profitability is important, growing revenues of the core department store business through new store concepts is not a priority for the company," S&P said in a release.

Sears Holdings noted Monday that the Canadian unit faces an increasingly competitive retail environment, one that it can better navigate with a wealthy parent.

"Sears Canada has long been an important part of the retail landscape in Canada and, with our shared brand name, is strategic to Sears Holdings. With the benefits that will accrue from 100% ownership, we believe we will be able to provide Sears Canada's associates and customers with the opportunity to continue their relationship with this Canadian institution," the retailer said.

Credit Suisse First Boston analyst Gary Balter said in a research note that Sears Holdings doesn't need to own the entire unit to control the operations of Sears Canada, so it "must have another reason" for the acquisition.

"While the receivables have been monetized, Sears Canada may have underlying real estate value that has not been recognized," Balter said. "Last time we visited up north, that economy was much stronger than this one, and real estate values have risen significantly."

Balter also speculated that another party may have expressed interest in buying Sears Canada for a price tag that the parent viewed as unacceptable. Also, he said, there may be a tax benefit to reinvesting the proceeds from the dividend back into Canada or the company.

Balter holds a buy rating on shares of Sears Holdings, with a price target of $180. Currently, the stock trades below $120, having shed over 25% of their value since the beginning of August.

Sears Holdings is expected to report its third-quarter earnings results on Tuesday. Analysts on Wall Street are forecasting earnings of 28 cents a share, according to consensus estimates reported by Thomson First Call. Meanwhile, most observers expect the retailer to continue posting same-store sales declines as rivals such as Wal-Mart ( WMT) and Target ( TGT) continue to steal market share.

Shares of Sears Holdings were recently down $1.08, or 0.9%, to $118.42. Shares of Sears Canada were up 6.4%.

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