Sears Bond Rally Casts Doubt on Debt Cut Plans, Lampert Says

(Bloomberg) -- A rally in Sears Holdings Corp.’s bonds triggered by the company’s search for buyers of some assets is casting doubt on plans for reducing the retailer’s debt, according to Chief Executive Officer Edward Lampert.

In a letter to a special committee of Sears board members, Lampert said the company’s unsecured debt has posted significant gains since his ESL Investments Inc. proposed in late April that Sears divest assets including real estate and the Kenmore brand. The rising bond prices could make it harder to sell creditors on the idea of swapping their holdings for equity, or a discounted debt buyback, according to the letter. Even if the exchange or repurchase goes through, the higher price of the bonds could cut the impact of the debt-cutting effort, Lampert wrote.

Some of the company’s most actively traded senior unsecured bonds stood between 35 and 42 cents on the dollar in March and April, and are now trading around 75 cents to 78 cents, according to the Trace bond price reporting service.

Lampert asked the board to let ESL expand its role beyond the limits set by the special committee to include finding and speaking with potential third-party buyers who are not already in discussions. That would help bolster the value and certainty of a deal, Lampert wrote.

If traders in the credit-default swaps market are correct, the economics of the possible debt tender and exchange offer could be influenced by more than just the price of the bonds. That’s because hedge funds and other investors have sold more than $550 million of default protection via the CDS market on a net basis, making the deal attractive for investors looking to prop up those bets by ensuring the company can stay afloat for longer.

In fact, the cost of default protection on Sears has plunged in recent weeks on speculation that the Lampert transaction is an example of such a creative financing transaction -- where CDS-market players agree to help a company refinance its debt under terms designed to influence the value of the CDS. A company’s lowest-priced debt is typically used to determine payouts on credit derivatives, so retiring the borrowings could translate to bigger profits for anyone that has sold default insurance.

Lampert is the retailer’s biggest shareholder, and has been using his own money for years to keep the 125-year-old chain open. His fund emerged as an interested buyer of certain Sears assets and pushed for the department store to put parts of itself on the block. The fund presented its offer as a “holistic” solution to give Sears the ability to cut its debt burden and turn around the business, based in Hoffman Estates, Illinois.

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