Sears is a Bad Takeover Target, Are its Rumors Baseless?

Sears SHLD is a storied company that has recently experienced unfortunate turbulence in its operations. While many analysts believe that it may be doomed in the long-run, rumors sparked up today that may suggest otherwise.

After a few years of despondent earnings, Sears may be considering going private, perhaps at the hand of a financial buyer like a private equity firm. The primary concern for investors, however, is if privatization would be able to help the ailing company. After all, Sears has an impressive brand name that could become wildly profitable if particular changes are made to the company's operational structure.

Contrary to the majority of private takeovers in recent years, Sears is an extremely large company with a market capitalization of about $3.9 billion. Given all the complexities with a large firm like Sears, is it likely that it will eventually be taken private?

Given Sears' sheer size, it appears likely that any sort of private takeover event will have to be assisted with leverage. Especially after the credit crisis in 2008, private equity firms have learned to maintain strict criteria when pursuing takeover targets, and they most likely adhere to those guidelines at this point in time.

The first thing that financial buyers will want in a target is operational health. In the case with Sears, its retail arm seems to have been lagging in the last few years. In the last month, Sears has had to close over 100 stores due to poor performance, primarily due to increased competition from companies such as Macy's M and Wal-Mart WMT. With diminishing operational abilities, Sears' brand name may not be the best investment in an uncertain economic environment.

Private equity firms also look for companies that have limited and clean debt profiles. Over the last three years, Sears has expanded its debt outstanding significantly. In late 2010, its debt outstanding comprised about 10% of its capital structure; its capital structure currently sitting on about 36% debt. Considering the mechanics of a leveraged buyout transaction, the widening debt load may not be appeasing to many private equity firms.

Lastly, private equity firms want cash-flow positive targets. In a leveraged buyout, where the takeover is funded by significant amounts of debt, the company's existing cash and future cash-flows are paramount to successful debt liquidation. Otherwise, the financial buyers are sitting on unnecessary debt and may be floundering to take care of their obligations.

This principle is extremely important during uncertain economic times. As seen in 2007 and 2008, many private equity funds became dissolute when their holdings suddenly turned cash-flow negative due to poor market performance. Sears has not only been cash-flow negative in four of the last five years, but it does not seem to be turning itself around quickly enough. Private equity funds would have to immediately arrest capital expenditures and would have to bolster cash-flows from operations. Otherwise, Sears' cash flow could maintain its poor performance in the future.

From a fundamental perspective, Sears' is unlikely to be an attractive takeover target for many private equity funds. Perhaps some funds that are willing to take significant risks and believe that Sears' brand name can be revitalized may investigate transactions with the company, but the current macroeconomic environment is the primary factor holding progress back.

Benzinga also reached out to Sears to confirm any rumors, but no media outlets were able to confirm nor deny rumors or speculation.

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