A Former REIT on its Way Out Was Unusually Active Wednesday

The usual suspects were at the top of Barchart.com’s list of unusual options activity on Wednesday. Microsoft (MSFT) and Alibaba (BABA) were among the large-cap stocks with high volume-to-open-interest (Vol/OI) ratios. 

When it comes to call contracts, there was one stock that stood out from the rest of the names with high Vol/OI ratios. Of course, I’m speaking of Seritage Growth Properties (SRG). Its Vol/OI ratio of 13.9  put it in the top 100 among 718 call options experiencing unusual options activity yesterday.  

Honestly, I lost track of the former REIT a long time ago after it became apparent that Eddie Lampert was hell-bent on destroying any Sears memories in American consumers' minds. 

If you’re unfamiliar with Seritage, it was spun out from Sears in 2015. 

Sears got $2.7 billion in gross proceeds from the sale-and-leaseback of 235 stores and its 50% interest in joint-venture real estate partnerships with Simon Property Group (SPG), General Growth Partners -- owned by Brookfield Asset Management’s (BAM) Brookfield Property Partners subsidiary -- and The Macerich Co. (MAC).

Seritage got the potentially lucrative real estate and lease payments from the 235 stores. The proposition was attractive enough that Warren Buffett was an early Seritage investor. 

In August 2018, Berkshire Hathaway (BRK.B) lent Seritage $1.6 billion at 7% interest with an option to borrow an additional $400 million within five years. At the time, Buffett owned 5.7% of the company.

Fast forward to October 2022. Shareholders voted for the company to liquidate its assets, returning the proceeds to shareholders. Once that’s complete, Seritage will cease to exist. 

This is why it was a little strange to see the company’s Jan. 17/2025 $12 call among the top 100 unusually active call options on Wednesday. Relative to many of the more prominent names, the 1,606 call contracts traded were exceptionally high. Especially given the circumstances surrounding the company. 

With 744 days to expiration and a $380 premium, call buyers are betting that shareholders will receive more than $15.80 a share from the liquidation.

Here are the pros and cons of making this bet.

The Pros of Buying SRG Call

First and foremost, the $380 premium won't break the bank. For those who are into special situations and merger arbitrage, this is an interesting play for very little money upfront.

In November, the company updated investors about any progress it was making on its asset sales. 

“During the quarter and subsequent to quarter end, our gross proceeds from asset sales totaled $411.6 million, and we have now monetized $583.9 million of assets year to date,” stated CEO Andrea Olshan. 

In addition to those sales, it has contracts to sell another $800 million in assets. It will use these proceeds to pay down its debt to Berkshire Hathaway, which stood at $1.03 billion as of Dec. 29, 2022.

At the end of September, Seritage’s total assets were $2.05 billion, with $1.42 billion in total liabilities. That leaves approximately $631 million to distribute to shareholders before tax. Based on 55.36 million shares outstanding, that’s roughly $11.40 a share.

While that’s less than the $15.80 needed to break even, the company plans to sell off the properties over as much as 30 months. Then, if it can get its debt down to $800 million by the end of July, it can extend the loan’s maturity date by two years to July 31, 2025.

As interest rate cuts end and then start coming down slightly in 2024, it’s more than possible to extract greater value from the approximately 121 properties still owned at the end of September.

The company’s September proxy statement estimated that after all debt repayment, expenses, and taxes, it could generate between $18.50 and $29 per share for shareholders.

The Cons of Buying SRG Call 

Barclays was hired to sell the entire company, but there were no takers. That in itself is indicative of how much has changed in the past year when it comes to real estate investments. 

Investors can no longer write blank checks, given the rapid rise in interest rates. If this liquidation had happened a couple of years ago, the upside on proceeds generated would have been much greater. 

If. If. If. 

The bigger negative with this particular bet is that a lot has to go right over the next 744 days for it to pay off in a big way. The ask price is 32% of the strike. I generally look for option premiums less than 10% of the strike price. 

However, given the total outlay per call contract in a scenario where Seritage was to continue trading is just $1,580 plus commissions, it’s not a significant loss were the company to get less than $15.80 a share from the liquidation.

Lastly, there is the opportunity cost of putting $380 into a business with a finite lifespan. It might make sense to put it toward a company with a future. After all, by buying a contract yesterday, you’ve theoretically agreed to put $1,580 into play, ultimately holding the stock for the long haul.

That’s not going to happen here. 

As I write this on Thursday, the Jan. 17/2025 $12 call has yet to be traded today with 1,721 contracts open. The ask is almost $2 higher at $5.70. I would be hard-pressed to bet more than $380 on Seritage’s liquidation success.

Nonetheless, it’s an interesting play for options buyers to ponder.

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