SRG - Seritage Preferreds Offer Tempting Potential 12.86% Yield To Maturity

2024-01-19 09:26:30 ET

Summary

• Seritage common shares have been a difficult investment with negative 70% returns since IPO.
• Seritage Growth Properties' preferred shares offer a 7.38% yield and the potential for a 12.86% yield to maturity/call.
• There are risks involved, here and we tell you why you have to consider this carefully before buying.

It has been a long ride for those that tried and hitch on to Berkshire Hathaway's ( BRK.A ), ( BRK.B ) investment in Seritage Growth Properties ( SRG ). One would have thought that investors would distinguish between BRK's position, which was a loan to the company, versus the potential performance of the common equity. As we are nearing the finish line, it appears that only Berkshire will be the one making money on this and almost no one else on the common equity long side. Our coverage of this had been strongly negative, up until January 2022, where we saw the possibility of 0% returns. That obviously meant a switch from the Strong Sell rating.

Ironically, and this was in no way what we had predicted, SRG is in almost the same spot, two years later.

As we approach the finish, investors are getting a rather interesting setup with the preferred shares. We look at the setup and tell you we were tempted but gave it a pass.

The Bull Case

Seritage Growth Properties 7% CUM PFD SR A ( SRG.PR.A ) offers a 7% yield on par. The preferred shares are past their call date. With the last ex-dividend date of December 28, 2023, these are trading with a stripped yield of about 7.39%.

That might sound ho-hum in today's era, with short term risk-free rates near 5.5% and a lot of shorter term quality plays that can give you a good percentage point over that. SRG with all of its troubles is not exactly a get rich situation. But SRG's liquidation timeline is what potentially makes this attractive. On our last coverage, we were relatively skeptical of SRG delivering a lot of value for common shareholders, beyond what the stock was trading for. But we were wrong on the extent of the Fed's change in tune. BB high spreads have compressed and SRG stock has taken off.

At this point, we see a very high probability that SRG can get enough sales done to pay off the remaining debt in the next 6–12 months. At the minimum, this makes SRG.PR.A safer. So you have a really safe 7.38% yield (a company with no debt in a few months) to play. On top of that, asset coverage, even if you assume the current market value reflects fair market value, is at least six-fold the preferred shares. So 6X asset coverage with no potential debt. We keep saying "potential" here, because SRG has still not finished executing these sales. But we believe the current credit conditions offer it enough of a window to get it done. All said and done, SRG.PR.A should look really tempting here with a 7.38% yield. They should look even more tempting if SRG ends up redeeming the preferreds within 12 months. In that case, your yield to maturity/call/redemption (what you want to call it) becomes about 12.86%. SRG is of course in full liquidation mode, and it is hardly stretching one's imagination to believe this will get done at some point.

The Risk

The clauses in the preferred share prospectus, do offer good protections for investors. For example, the one below.

Upon any voluntary or involuntary liquidation, dissolution or winding up of our affairs, then holders of the Series A Preferred Shares will be entitled to be paid out of our assets legally available for distribution to our shareholders a liquidation preference of $25.00 per share, plus an amount equal to all accrued and unpaid dividends (whether or not earned or declared) to, but excluding, the date of payment, before any payment is made to the holders of our common shares, our non-voting shares or any of our other equity securities ranking junior to the Series A Preferred Shares.

Source: SRG Preferred Share Prospectus

It would be very hard for SRG to argue down the line, and all the steps it has taken over the last 12 months don't fit that definition. So it should almost certainly have to redeem these.

SRG's operating losses might make it a tempting target for takeover, that goes beyond just the real estate value. So one must investigate what happens in that case. SRG also has a change of control clause, which allows investors to convert into common shares if the common shares are bought in whole by the acquiring company and the company has no publicly traded common shares. But there is one thing here that does not fit.

Upon the occurrence of a Change of Control, each holder of the Series A Preferred Shares will have the right (unless, prior to the Change of Control Conversion Date, we have provided or provide notice of our election to redeem the Series A Preferred Shares) to convert some or all of the Series A Preferred Shares held by such holder on the Change of Control Conversion Date into a number of our common shares per Series A Preferred Share to be converted equal to the lesser of:

• the quotient obtained by dividing 1) the sum of the $25.00 liquidation preference plus the amount of any accrued and unpaid dividends to, but excluding, the Change of Control Conversion Date (unless the Change of Control Conversion Date is after a dividend record date for a Series A Preferred Share dividend payment and prior to the corresponding Series A Preferred Share dividend payment date, in which case no additional amount for such accrued and unpaid dividend will be included in this sum) by 2) the Common Share Price (as defined below), and

• 1.26008 (the “Share Cap”), subject to certain adjustments,

Source: SRG Preferred Share Prospectus

SRG went public near $40 a share, and this was not a big deal back then. But today, a buyout could create an unpleasant situation.

Upon such a conversion, the holders of the Series A Preferred Shares will be limited to a maximum number of our common shares equal to the Share Cap multiplied by the number of Series A Preferred Shares converted. If the Common Share Price is less than $19.84 (which is approximately 50% of the per-share closing sale price of our common shares on December 6, 2017), subject to adjustment, the holders of the Series A Preferred Shares will receive a maximum of 1.26008 of our common shares per Series A Preferred Share, which may result in a holder receiving value that is less than the liquidation preference of the Series A Preferred Shares.

Source: SRG Preferred Share Prospectus

In fact, at any price of under $19.84 (an amount that seems impossible today), SRG.PR.A would be undesirable and create a loss.

Verdict

SRG.PR.A might still work out as the best long term investment in SRG. Since the IPO, the preferreds have offered investors solid returns, while the commons will almost certainly have negative returns even including dividends. This will be true even if the ultimate liquidation value turns out to be $15 a share.

But that 12.86% yield to maturity is not exactly "free money". Tell us whether you agree or not on these risks in the comments.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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