When we commented back in March on the unexpected “going concern” notice in Sears’ 10-K which sent the stock crashing, we pointed out the immediate spin provided by Eddie Lampert’s distressed retailer which promised that its comeback plan may help alleviate the concerns, “satisfying our estimated liquidity needs 12 months from the issuance of the financial statements”, to which however we added the footnote that “the question is what happens when vendors start demanding cash on delivery as concerns about SHLD.’s liquidity concerns continue to grow.”

Shortly after, we wrote “Sears Enters Death Spiral: Vendors Halt Shipments, Insurers Bail” in which we described that as Sears financial condition deteriorated, vendors were boosting their “defensive measures”, such as reducing shipments and asking for better payment terms, to protect against the risk of nonpayment as the company warned about its finances.

The managing director of a Bangladesh-based textile firm said his company is using only a handful of its production lines to manufacture products for Sears’ 2017 holiday sales. Last year, nearly half of the company’s lines in its four factories were producing for Sears. “We have to protect ourselves from the risk of nonpayment,” said the managing director, who declined to be identified for fear of disrupting his company’s relationship with Sears.

Furthermore, precisely as we predicted, Mark Cohen, the former CEO of Sears Canada and director of retail studies at Columbia Business School said vendors will keep a close eye on Sears’ finances. “Whatever vendors continue to support them are now going to put them on even more of a short string. That means they’ll ship them smaller quantities and demand payment either in advance or immediately upon delivery.”

He added: “Sears stores are pathetically badly inventoried today and they will become worse.”

Fast forward five month when just after Sears reported another quarter of painfully bad results including an unexpected double-digit drop in same store sales, Reuters writes that the “worst case” scenario we envisioned for Sears is now accelerating, and that Sears is having trouble stocking shelves, “as some vendors have fled while others are demanding stricter payment terms because of difficulties hedging against default risk.”

One reason why Sears’ supply chain is in greater turmoil than ever – in addition to Sears’ woeful financials of course – is due to the scarcity and high cost of a type of vendor insurance known as accounts receivable puts, which ensure a supplier will be paid even if the retailer files for bankruptcy. Think of them as CDS contracts vendors can buy on a counterparty, in this case their (increasingly insolvent) client, and just like CDS, the puts become prohibitively expensive the closer the underlying entity is to bankruptcy.

“It’s too expensive,” Michael Fellner, owner of Montreal-based women’s wear company Lori Michaels Apparel & Manufacturing Inc, told Reuters about the specialized vendor insurance. He also said he stopped shipping to Sears in March, when his insurer stopped providing coverage.

Two other small vendors told Reuters they stopped supplying Sears this year because they could not afford the insurance, whose cost spiked after Sears warned in March of “substantial doubt” over its ability to continue as a going concern. They asked not to be identified discussing confidential commercial arrangements.

Most concerning, however, is the discovery that Eddie Lampert himself appears to be throwing in the towel on the supply chain: as Reuters explains, Sears’ vendors had previously benefited from support from Sears CEO, billionaire Eddie Lampert, who owns almost half of the company’s shares and is also its largest lender.

Through his hedge fund, ESL Investments, Lampert invested in vendor insurance contracts worth $93.3 million in 2012, $234 million in 2013 and $80 million in 2014, according to SEC filings. Lampert’s implicit support of vendors however ended one year ago: filings show no investment by Lampert in vendor insurance contracts since 2015.

A Sears spokesman said the 55-year-old billionaire is not currently investing in these contracts and declined to say why.

In addition to Sears’ top stakeholder dropping support, for whatever reason, other hedge funds such as Avenue Capital Group, and traditional credit insurance firms such as Euler Hermes Group, have also exited the insurance market, brokers and investors said. They did not specify the timing of their withdrawal.

Predictably, as the number of market participants in the receivables puts market collapse, the cost of insurance contracts surged as they became harder to come by, putting pressure on Sears’ ability to maintain a robust inventory of goods. As a result, merchandise inventory at Sears fell to $3.4 billion as of July 29 from $4.7 billion a year ago, the company disclosed on Thursday. Sears has attributed the inventory decline to its transformation to an online-oriented business from bricks-and-mortar stores.

“We continue to work to manage our vendor relationships in a constructive manner… we will continue to ensure that our vendors deliver on their obligations to Sears,” Sears said in its second-quarter earnings statement on Thursday. The reality is that it simply does not have as many suppliers as it once did.

Meanwhile, those who can find puts to buy are simply unable to afford them: brokers and investors said that Sears insurance contracts for vendors are currently quoted at more than 4 percent of the value of the vendor’s shipment per month, making them uneconomical for many suppliers whose profit margins are in the single digits. Three years ago, the contracts were being quoted at about 3 percent per month.

LG Electronics Inc, which makes Kenmore-branded washing machines and refrigerators as well as LG-branded appliances, told Reuters it has not bought vendor insurance in the past year because of the cost.

Instead, LG said it negotiated shorter payment schedules to minimize the risk of not being paid by Sears. It declined to say how short the payment period was. The typical payment schedule in the industry is close to 90 days, though it can vary by item.

Of course, the shorter the payment terms, the bigger the hit to Sears’ working capital and, thus, liquidity, with the most dire option being cash on delivery in which vendors simply will not provide the much needed inventory unless they are paid on the spot. Here’s Reuters:

Sears has promised to pay some suppliers within 15 days, according to a source familiar with the matter who requested anonymity to discuss confidential commercial arrangements. Sears declined to comment.

A 15-day payment schedule gives a vendor priority for repayment in the event of a bankruptcy. This is because claims received within 20 days of a bankruptcy filing are typically repaid in full.

Some vendors are so keen for this protection, that they have offered Sears a small discount of around 5 percent on their merchandise, the source said.

As noted above, the increasingly shorter terms means a sharp erosion in working capital: William Danner, president of CreditRiskMonitor.com told Reuters that at the end of the second quarter, Sears would likely have used $587 million to boost working capital – mostly from asset sales – due to the decision by some vendors to not extend as much credit. Sears’ available liquidity at the end of July was $810 million.

“Even for a huge company like Sears, finding this much more capital is a burden. This apparent loss of confidence in Sears by its vendors is greater now than it was at the end of 2016,” he said. Should more vendors demand the same payment terms, there is a risk that Sears entire liquidity cushion could disappear.

Eddie Lampert, who has valiantly fought for years to delay Sears’ inevitable bankruptcy, has complained on several occasions that vendors are trying to exploit Sears’ woes to negotiate better terms. He said last month that some of its vendors reduced their support, “thereby placing additional pressure” on Sears.

Sears took the issue to court in June, when it sued Ideal Industries Inc after the maker of Craftsman-branded tools declined to fulfill purchase orders because of Sears’ “known fragile financial condition,” according to court documents. Ideal Industries declined to comment.

And while Lampert may no longer be funding vendor insurance, he is still supporting Sears in more “brute force.” He held about $1.7 billion in debt mainly backed by the company’s real estate and inventory as of April 29, according to regulatory filings. The reason for this shift is that unlike secured debt, vendor insurance contracts are not backed by any collateral. Underscoring his “support”, last month, Lampert extended a $200 million 151-day credit line to Sears at an annual interest rate of 9.75 percent.

To be sure, not everyone has thrown in the towel on Sears: at least one investment firm, Blackstone Group LP’s distressed credit arm GSO Capital Partners is backing Sears contracts through December although they did not disclose their value to Reuters.

However, it’s only a matter of time – in this case a few more quarters of declining same store sales – before virtually everyone gives up on Sears, forcing Lampert to decide between directly funding the company’s inventory or finally admitting defeat to the Jeff Bezos juggernaut, and pulling the plug.

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