Sunday, September 28, 2008 3 comments ++[ CLICK TO COMMENT ]++

Added to Watch List: Sears Roebuck Acceptance Corp 7.4% Notes Due In 2043

This is just an idea... somewhat wild and risky, as usual. I'm not sure if I will do anything because this one trades on the over-the-counter Grey Market (extremely thin volume--not suitable for large investors or funds) and I'm not sure if I have access to it from my discount broker. Ideally I want to hold it in my tax-sheltered account but I don't believe that broker supports the Grey Market so I'm down to my normal one (not sure if that supports it at a reasonal commission.)

I'm thinking of investing in a super-long-term junk bond. The bond in question is Sears Roebuck Acceptance Corporation 7.4% note due in 2043. You can find the IPO prospectus here (For those not familiar, QuantumOnline is the best free site for exchanged-traded debt/preferred instruments.) Here are some details of this issue:

Security: Sears Roebuck Acceptance Corp., 7.40% Notes due 2/1/2043
Ticker: SBCKO (over the counter Grey Market)
Issuer: Sears Roebuck Acceptance Corporation (subsidiary of Sears Roebuck)
Current Price: $9 (36% of par value)
Current yield: 20.5% (highly illiquid; not sure if one can get it at that yield)
Rating: Ba1/BB+ in 2005 (may not be up-to-date)


This was a baby bond--$25 par value exchange-traded bonds--that used to trade on NYSE but was delisted after Sears called in the bond for redemption. But only a portion of it was tendered and what you see is the remaining. This means that it is hard to get information and I assume interest is still being paid (but since I never dealt or followed a situation like this, I'm not too sure.) The company, Sears Roebuck Acceptance Corp, also does not report to the SEC anymore so nothing has been filed with the SEC since it was delisted from NYSE.

If I understand the corporate structure correctly (haven't read through it fully,) Sears Roebuck Acceptance Corporation (SRAC) is a subsidiary of Sears Roebuck, which is a subsidiary of Sears Holdings. SRAC is essentially used to raise capital for Sears. SRAC holds short-term notes and similar items issued by Sears. This means that the claims against Sears wouldn't be as strong as if you owned bonds directly issued by Sears. I can't tell what SRAC actually owns right now.

The big risk with bonds is inflation. Unlike stocks, where earnings/dividends increase over time, bonds pay a fixed coupon. Usually stocks, even if they started off with a dividend yield of 3%, will beat bonds 15 to 20 years down the road. In this case, I feel that I'm adequately compensated for the inflation due to the bond trading around a third of par. Even if you assume inflation is 4% for the next 30 years, you have around 200% upside simply from the par value (this assumes that the bond will not default and the company isn't bankrupt and unable to return the principal.)

The real risk here is the possibility of bankruptcy. The market doesn't have much faith in the future of Sears, let alone over the next 30 years. Rating agencies, for what they are worth, are also predicting increased default rates for junk bonds:

Non-financial junk bond defaults may top 23 percent by 2010, the highest level since 1981, as the U.S. financial crisis deepens, Standard & Poor's said on Thursday.

That suggests 353 non-financial firms could default between 2008 and 2010, as that three-year cumulative rate rises, with the most defaults coming after the first half of 2009, S&P said.

...

Consumer products, media and entertainment, and the retail and restaurant industries will be among the worst hit, similar to defaults seen in 1990 and 1991, S&P said in a report.


Note that S&P highlights retail as one of the areas that will see increased defaults. Sears is rated way below investment grade and some bears claim it will go bankrupt soon. I have somewhat followed Sears from the equity side and I don't see it defaulting on its bonds any time soon. It's leverage is very low--one of the lowest in the retail industry--and it's hard to see how it can fail to pay bondholders. If the economic environment deteriorates significantly--worse than the 1990 recession and on par with the 1930's--then anything is possible but I don't see it as being likely. Even then, although I can't tell what is backing these bonds (supposedly some short-term liabilities of Sears but it's not clear,) I am somewhat confident that the liquidation will yield sufficient money to pay off the bondholders (at least at current prices of around 1/3 of par.)

So, in terms of default, I don't think the risk is the present cycle (say next 5 years.) Rather, the risk is whether it will default 15 to 20 years down the road. That is a big question mark, but, again, I suspect that there are enough assets to pay off bondholders. To sum up, I don't think the default of default/bankruptcy is high.

Another problem is the conflict between bondholders and shareholders. Even if Sears shares do well, the bond could a disastrous investment several decades from now. For instance, it is possible that Eddie Lampert, the majority owner, will extract much of the value from the company and reward shareholders, while the bondholders are supported by left-overs that may not survive the next few decades. Shareholder and bondholder interests can diverge at critical times, and this is a risk you have in any debt investment.

Anyway, I haven't done much this year (maybe Ambac made me lose my confidence; or maybe the volatile markets make me want to wait) but this is something that is close to a price I like. There are many others on my watchlist that aren't at prices I am willing to buy at.

(There is also another similar one with ticker SBCKP that one may want to consider. Also, I should note that I have also been evaluating the equity for a while now so may make an investment in the shares instead.)

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3 Response to Added to Watch List: Sears Roebuck Acceptance Corp 7.4% Notes Due In 2043

September 28, 2008 at 9:49 PM

There's definitive risk in that investment, but as part of a diversified portfolio taking into consideration the risk tolerance of an investor you might do well in the long-run.

I certainly don't feel comfortable investing in the commons at this time, but I appreciate the contrarian insight.

DA

Anonymous
January 30, 2012 at 9:32 PM

This article was posted in 2008. What is your take on this bond today given another recent downgrade?

January 30, 2012 at 9:56 PM

Hi Anonymous,

I am not sure if those bonds are still trading. Looking at the FINRA site, it's not clear to me what is trading. Which ones are you looking at?

I'm not too familiar with bonds but they are not as cheap as back in 2008. Back then, they were yielding 20%, whereas they are nowhere near that now.

Also, one needs to re-evaluate the whole situation because, if I'm not mistaken, Edward Lampert has taken out a lot of the wealth in Sears. You need to look at the outstanding debt level and the claim it has on the Sears assets.

Overall, Sears or not, my guess is that bonds are not attractive. Because the benchmark yields are so low, market has likely marked up all the bonds to high valuations. You have to do a more thorough analysis but it wouldn't surprise me if Sears stock is more attractive than Sears bonds right now.

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