Financial Management Case Study

Journal of Case Studies Nov. 2018, Vol. 36, No. 2, p. 144-162 www.sfcrjcs.org ISSN 2162-3171

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Sears’ Spinoff of Lands’ End

Shane Van Dalsem, Washburn University

This case was prepared by the author and is intended to be used as a basis for class discussion. The views

represented here are those of the author and do not necessarily reflect the views of the Society for Case Research.

The views are based on professional judgment. Copyright © 2018 by the Society for Case Research and the author.

No part of this work may be reproduced or used in any form or by any means without the written permission of the

Society for Case Research.

Introduction

Following several years of declining revenues and profits, in late 2011 Sears Holding Inc.

("Sears") began to hive off its business divisions. As part of its series of divestitures Sears

announced its intention to spin off one of its clothing divisions, Lands’ End, in a stock

distribution to the existing Sears’ shareholders on December 6th, 2013 (Sears Holding Corp.,

2013b).

To explain why Sears was spinning off Lands' End, along with Sears’ Auto Centers business,

Sears released the following statement:

We believe separating the management of these two businesses from Sears

Holdings would allow them to pursue their own strategic opportunities, optimize

their capital structures, attract talent, and allocate capital in a more focused

manner (Hammond, 2013).

With the spinoff Sears would receive a cash payment of $500 million dollars from Lands’ End

which would be funded from the proceeds of a $515 million term loan from Bank of America.

Each Sears shareholder received approximately 0.3 shares of Lands’ End stock for each share of

Sears stock that they owned and (Sears Holding Corp., 2014a). The spinoff of Lands' End would

result in the same stockholders retaining their proportional ownership of the same basket of

assets.

In light of the terms of the spinoff the stockholders and other stakeholders of Sears and Lands’

End needed to evaluate their relationships with the firms. Should Lands’ End’s shareholders

keep their shares or sell them? What assets were transferred from Sears to Lands’ End as part of

the spinoff? Would the terms of the spinoff hurt the ability of Lands’ End to operate in the

future?

Background of Lands’ End

Lands’ End was a multi-channel retailer of apparel and home products. The firm’s channels of

distribution were: standalone stores, stores within Sears’ stores, internet, phone, and catalogs.

Lands’ End had operations in the US, Europe, and Asia. The firm was founded by Gary C.

Comer in 1963 as a catalog retailer selling sailboat hardware and equipment. In 1977, Lands’

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End began to focus its operations on clothing and luggage. In 1978, Lands’ End moved its

operations to Dodgeville, WI. The firm went public in 1986 and began its international

operations in 1991. Through the late 1990s, Lands’ End launched its website and developed

innovative methods to improve the customer experience such as tools that allowed customers to

create 3-D models of themselves and create custom pants.

Sears, Roebuck & Company Acquires Lands’ End

Sears, Roebuck & Co. (“SRC”) acquired Lands’ End for approximately $1.9 billion in cash in

2002. At the time of the announcement of the acquisition, the amount provided Lands’ End’s

shareholders with a 21.5% premium over the existing market value of the stock. The acquisition

provided Lands’ End the potential to grow their in-store retail sales by providing 870 new stores

for their products. For SRC, the acquisition provided the opportunity to improve the brand

image of its apparel and make the brand recognition for apparel more consistent with that of

SRC’s hardline categories (e.g. Craftsman, Diehard, and Kenmore) (CNNMoney, 2012).

Ultimately, SRC’s goal with the acquisition was to improve its waning sales and improve profit

margins in softlines by offering higher quality apparel with existing brand recognition.

K-Mart Acquires Sears, Roebuck & Co.

In November of 2004 K-Mart announced that it was acquiring SRC for a price of approximately

$11 billion, which existing SRC shareholders could receive in cash or in stock of the new Sears

Holding Corporation. At the time of the announcement K-Mart and SRC had approximately

3,500 locations between them. This expansion offered Lands’ End the opportunity to expand its

sales (Sears Holding Corp., 2005).

Edward Lampert, the chairperson of Sears, founded ESL Investments (“ESL”) in 1988 (Berner,

2004). In 2002 ESL Investments purchased a significant amount of K-Mart's debt during K-

Mart's bankruptcy. When K-Mart emerged from bankruptcy in 2003, ESL owned a controlling

interest in K-Mart's stock and Lampert was the new chairperson of K-Mart. In 2004 K-Mart

began its acquisition of SRC. The firm resulting from the merger was renamed Sears Holding

Corporation (Hays, 2004). At the time of the spinoff of Lands' End, ESL Investments owned

approximately 48.5% of Sears' stock (Sears Holding Corp., 2014b).

Sears’ Divestitures

The spinoff of Lands’ End was the fourth divestiture in three years for Sears.

Orchard Supply Hardware (“Orchard”) was spun off by Sears on December 30th, 2011. Similar

to what occurred with the Lands’ End spinoff, Sears’ stockholders received pro rata ownership of

Orchard. Specifically, Sears’ stockholders received one share of Orchard’s Class A Common

Stock and one share of Orchard’s Series A Preferred Stock for each 22.14 shares of Sears’ stock

that they owned. However, Orchard did not pay a dividend to Sears’ as part of the divestiture.

Orchard did have approximately $220 million in long-term debt at the time of the spinoff

(Orchard Supply Hardware, 2012).

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Sears Canada Inc. was partially spun off by Sears on November 14th, 2012. Sears distributed

44.5% of Sears Canada to the Sears’ stockholders on a pro rata basis and retained approximately

51% of Sears Canada stock. Each Sears’ stockholder received 0.4283 shares for each share of

Sears’ stock that they owned (Sears Holding Corp., 2012).

Sears Hometown and Outlet Stores (“SHOS”) was divested from by Sears on October 11, 2012.

Sears created and sold shares of the new company for which Sears received $346.5 million

(Sears Holding Corp., 2012). Additionally, SHOS was required to pay Sears $100 million, a

continuing commission of its online sales, and fees for shared services with Sears. For the first

four months following the divestiture, SHOS reported that these costs were approximately $5

million. The dividend paid to Sears was financed with a long-term debt with a variable interest

rate which was 4.50% as of February 2nd, 2013 (Sears Hometown and Outlet Stores, 2013).

With each of the spinoffs, the newly created firms were required to maintain a business

relationship with Sears. For Lands’ End this relationship included maintaining a presence in

Sears’ retail locations and remaining a partner in Sears’ Shop Your Way® rewards program.

Lands’ End was required to pay for the expenses of maintaining a presence in Sears’ retail

locations, including the cost of personnel (Lands’ End Inc., 2014).

Table 1 provides a timeline of the history of Lands’ End and Sears.

Table 1. Timeline of the History of Lands’ End and Sears

Date Event

1963 Lands’ End was founded by Gary C. Corner as a sailboat hardware and

equipment retailer.

1977 Lands’ End changed its focus to clothing and luggage.

1986 Lands’ End became a publicly-traded corporation.

2002 Sears, Roebuck & Company purchased Lands’ End for $1.9 billion.

2002 ESL Investments purchased a large proportion of K-Mart’s debt during

K-mart’s bankruptcy.

2003 K-Mart emerged from bankruptcy with ESL Investments owning a

controlling interest of the stock. Edward Lampert was the new

chairperson.

November 2004 K-Mart announced the acquisition of Sears for approximately $11

billion.

December 30th, 2011 Orchard Supply Hardware was spun off from Sears.

October 11th, 2012 Sears Hometown and Outlet Stores was divested from Sears.

November 14th, 2012 Sears Canada Inc. was partially spun off from Sears. Sears retained

approximately 51% of the stock.

December 6th, 2013 Sears announced its intention to spinoff Lands’ End.

The spinoffs were seen as a Sears’ response to declining performance. Prior to and following the

merger of K-Mart and SRC, the combined firms faced declining sales and profitability. The

divestitures of its business divisions and sales of its brands had been seen as a slow liquidation of

the assets of a firm in distress. Tables 2 and 3 provide the annual income statements and balance

sheets, respectively, for the five fiscal years ending January 31st, 2015.

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Table 2. Sears’ Income Statements

(Standard and Poor’s Capital IQ)

For the five-year period just prior to the spinoff of Lands’ End revenue for Sears had fallen from

$43.36 billion to $36.19 billion. While the decline in revenue may have been attributable to the

prior divestitures, the divestitures did not improve the profit margins of Sears over the same

period. Likewise, the divestitures may have contributed to the declining value of assets over the

same period, but the continued losses on the income statement contributed to the declining value

of retained earnings and total equity on the balance sheet.

As of May 3rd, 2014, Sears’ corporate family debt ratings were Caa1 from Moody’s Investors

Service, CCC+ from Standard & Poor’s Ratings Services, and CCC from Fitch Ratings. As of

the same date, Sears had $159 million in commercial paper outstanding, with $150 million of

that held by ESL. The portion owed to ESL included $86 million held personally by Edward

Lampert. Sears’ had $2.6 billion in long-term notes and debentures outstanding, of which ESL

held $208 million. The remainder of Sears’ interest-bearing debts consisted largely of an asset-

backed revolving line of credit (Sears Holding Corp., 2014c).

For the Fiscal Period Ending January 30, January 29, January 28, February 2, February 1, January 31,

(amounts in millions of US Dollars) 2010 2011 2012 2013 2014 2015

Revenue 43,360 42,664 41,567 39,854 36,188 31,198

Cost Of Goods Sold 31,337 30,988 30,836 29,305 27,377 23,980

Gross Profit 12,023 11,676 10,731 10,549 8,811 7,218

Selling General & Admin Exp. 10,279 10,411 10,528 10,577 9,382 8,076

Depreciation & Amort. 882 859 845 808 721 573

Other Operating Exp., Total 11,161 11,270 11,373 11,385 10,103 8,649

Operating Income 862 406 (642) (836) (1,292) (1,431)

Interest Expense (248) (293) (289) (267) (254) (313)

Interest and Invest. Income 33 36 41 94 207 132

Net Interest Exp. (215) (257) (248) (173) (47) (181)

Currency Exchange Gains (Loss) (67) (14) – – – –

Other Non-Operating Inc. (Exp.) 6 – (2) 1 2 4

EBT Excl. Unusual Items 586 135 (892) (1,008) (1,337) (1,608)

Restructuring Charges (131) (36) (911) (175) (289) (284)

Impairment of Goodwill – – – (295) – –

Gain (Loss) On Sale Of Assets 74 67 64 468 667 207

Asset Writedown – – – – (13) –

Legal Settlements 32 – – – – –

Other Unusual Items (170) – (12) – – –

EBT Incl. Unusual Items 391 166 (1,751) (1,010) (972) (1,685)

Income Tax Expense 111 27 1,369 44 144 125

Earnings from Cont. Ops. 280 139 (3,120) (1,054) (1,116) (1,810)

Earnings of Discontinued Ops. 17 11 (27) – – –

Extraord. Item & Account. Change – – – – – –

Net Income to Company 297 150 (3,147) (1,054) (1,116) (1,810)

Minority Int. in Earnings (62) (17) 7 124 (249) 128

Net Income 235 133 (3,140) (930) (1,365) (1,682)

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Table 3. Sears’ Balance Sheets

(Standard and Poor’s Capital IQ)

Balance Sheet as of January 30, January 29, January 28, February 2, February 1, January 31,

(amounts in millions of US Dollars) 2010 2011 2012 2013 2014 2015

ASSETS

Cash And Equivalents 1,689 1,359 747 609 1,028 250

Accounts Receivable 652 689 695 635 553 429

Inventory 8,705 8,951 8,407 7,558 7,034 4,943

Prepaid Exp. 327 295 332 397 287 211

Deferred Tax Assets, Curr. 30 – – – – –

Restricted Cash 11 15 7 9 10 –

Other Current Assets 24 251 56 57 47 30

Total Current Assets 11,438 11,560 10,244 9,265 8,959 5,863

Gross Property, Plant & Equipment 11,392 11,329 11,210 11,244 10,109 8,313

Accumulated Depreciation (3,683) (4,227) (4,633) (5,191) (4,715) (3,864)

Net Property, Plant & Equipment 7,709 7,102 6,577 6,053 5,394 4,449

Long-term Investments – – – – – 111

Goodwill 1,392 1,392 841 379 379 269

Other Intangibles 3,208 2,993 2,937 2,881 2,850 2,097

Deferred Charges, LT – – – – – 16

Other Long-Term Assets 1,061 1,313 782 762 679 380

Total Assets 24,808 24,360 21,381 19,340 18,261 13,185

LIABILITIES

Accounts Payable 3,335 3,046 2,912 2,761 2,496 1,621

Short-term Borrowings 325 360 1,175 1,094 1,332 614

Curr. Port. of LT Debt 482 489 230 83 12 13

Curr. Port. of Cap. Leases – – – – 71 62

Curr. Income Taxes Payable 534 546 523 480 460 380

Unearned Revenue, Current 1,012 976 964 931 900 818

Def. Tax Liability, Curr. – 165 516 382 387 –

Other Current Liabilities 3,098 3,061 2,892 2,683 2,527 2,087

Total Current Liabilities 8,786 8,643 9,212 8,414 8,185 5,595

Long-Term Debt 1,698 2,344 2,088 1,943 2,559 2,877

Capital Leases – – – – 275 210

Unearned Revenue, Non-Current 829 794 778 843 836 739

Pension & Other Post-Retire. Benefits 2,271 2,151 2,738 2,730 1,942 2,404

Def. Tax Liability, Non-Curr. – – 816 955 1,109 1,195

Other Non-Current Liabilities 1,789 1,814 1,408 1,283 1,172 1,110

Total Liabilities 15,373 15,746 17,040 16,168 16,078 14,130

Common Stock 1 1 1 1 1 1

Additional Paid In Capital 10,465 10,185 10,005 9,298 9,298 9,189

Retained Earnings 4,797 4,930 1,865 885 (480) (2,162)

Treasury Stock (5,446) (5,826) (5,981) (5,970) (5,963) (5,949)

Comprehensive Inc. and Other (721) (779) (1,609) (1,459) (1,117) (2,030)

Total Common Equity 9,096 8,511 4,281 2,755 1,739 (951)

Minority Interest 339 103 60 417 444 6

Total Equity 9,435 8,614 4,341 3,172 2,183 (945)

Total Liabilities And Equity 24,808 24,360 21,381 19,340 18,261 13,185

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Spinoff of Lands’ End

Over the years of his leadership of Sears, Edward Lampert had developed a reputation for candid

communications about the operations of the firm. Lampert described the relationship between

Sears and Lands’ End and the decision to spin off Lands’ End in a blog post dated April 13,

2014. An excerpt of that blog post is provided in Table 4.

Table 4. Excerpt from Edward Lampert’s April 13, 2014 Post on Sears Holdings’

Blog

(Sears’ Holdings blog: http://blog.searsholdings.com/eddie-lampert/spinoffs-and-lands-end/)

Sears shoppers definitely liked having Lands’ End’s products in Sears and loved how easily

they could return or exchange the products they bought from catalogs or online in Sears’

stores across the country. But this did not directly translate into higher earnings and the

company and investors suffered: by 2004, Lands’ End’s earnings had hit their lowest level of

the entire 12 year period (2002 to 2014) that Lands’ End was associated with Sears.

After Sears and Kmart merged in 2005, Lands’ End’s fortunes started to turn around. During

each year from 2005 to 2010, earnings were significantly higher than they were in 2004,

including several years of record profits. Dedicated shops were created inside Sears’ stores to

bring the Lands’ End brand even more distinction, in contrast to the initial approach of having

merchandise spread throughout the store.

However, in 2011 and 2012 the company stumbled for a variety of reasons that were described

in its public filings. Just one example: in 2011, cotton prices hit heights unseen since supply

and distribution were disrupted during the Civil War (impacting most other apparel retailers as

well). Lands’ End’s performance improved significantly in 2013, but it was clear to us that

bigger changes needed to be made to really unlock the potential of the business.

Sears Holdings opted for a spinoff – a legal split that allows each company to focus on

managing its own business, yet still work together in some ways. Sears Holdings stockholders

– I am one myself – were given approximately three shares of the new Lands’ End for every

ten shares of Sears Holdings they own. This gives investors a choice, and the ability to

continue to participate in the results of the Lands’ End business going forward.

Lands’ End and Sears Holdings can each focus on the management of their businesses

separately and Lands’ End is able to optimize its capital structure and enter capital markets

independently from Sears. Lands’ End will be able to invest its profits without having to

distribute them to Sears Holdings. Meanwhile, Sears Holdings received $500 million in cash

from Lands’ End (the equivalent of many years of after-tax profits), which increases Sears

Holdings’ liquidity.

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Lampert’s blog post provided some information on the terms of the spinoff of Lands’ End. A

few weeks later the details of the spinoff were provided in Sears’ 10-Q statement. As Lands’ End

was a division of Sears at the time of the spinoff, the management of Lands’ End did not have a

say in the terms of the spinoff. The terms of the spinoff were determined by the management of

Sears. The details of the spinoff are provided in Table 5.

Table 5. Information from Sears' 10-Q on the Spinoff of Lands' End

Separation of Lands' End, Inc.

Note 1, Pg. 6.

On April 4, 2014, we completed the separation of our Lands' End business through a spin-

off transaction. The separation was structured to be tax free to our U.S. shareholders for U.S.

federal income tax purposes. Prior to the separation, Lands' End, Inc. ("Lands' End") entered

into an asset-based senior secured revolving credit facility, which provides for maximum

borrowings of approximately $175 million with a letter of credit sub-limit, and a senior

secured term loan facility of approximately $515 million. The proceeds of the term loan

facility were used to fund a $500 million dividend to Holdings and pay fees and expenses

associated with the foregoing facilities. We accounted for this spin-off in accordance with

accounting standards applicable to spin-off transactions. Accordingly, we classified the

carrying value of net assets of $323 million contributed to Lands' End as a reduction of capital

in excess of par value in the Condensed Consolidated Statement of Equity for the period

ended May 3, 2014.

Additionally, as a result of Mr. Lampert's role as our Chairman and Chief Executive

Officer, and Chairman and Chief Executive Officer of ESL Investments, Inc. (together with its

affiliated funds, "ESL"), and the continuing arrangements between Holdings and Lands' End

(as further described in Note 14), Holdings has determined that it has significant influence

over Lands' End. Accordingly, the operating results for Lands' End through the date of the

spin-off are presented within the consolidated continuing operations of Holdings and the Sears

Domestic segment in the accompanying Condensed Consolidated Financial Statements.

Note 14, Pgs. 20-21

ESL owns approximately 49% of the outstanding common stock of Lands’ End (based on

publicly available information as of April 8, 2014). Holdings, and certain of its subsidiaries,

entered into a transition services agreement in connection with the spin-off pursuant to which

Lands’ End and Holdings will provide to each other, on an interim, transitional basis, various

services, which may include, but are not limited to, tax services, logistics services, auditing

and compliance services, inventory management services, information technology services and

continued participation in certain contracts shared with Holdings and its subsidiaries, as well

as agreements related to participation in the Shop Your Way program and rental agreements.

Amounts due to or from Lands’ End are non-interest bearing, and generally settled on a

net basis. Holdings invoices Lands’ End on at least a monthly basis.

(Sears Holding Company 10-Q dated May 3rd, 2014)

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The terms of Lands’ End’s spinoff required Lands’ End to pay an approximate $500 million cash

dividend to Sears. The dividend, as well as some additional expenses, was funded using a $515

million loan from Bank of America. The terms of that loan, as well as Lands’ End’s other debts,

are provided in Table 6.

Table 6. Lands’ End Debt Related to the Spinoff from Lands’ End’s 10-Q

NOTE 5. DEBT. Pgs. 8 & 9

Debt Arrangements In connection with the Separation, Lands’ End entered into an asset-based senior secured

credit agreement, dated as of April 4, 2014, with Bank of America, N.A., which provides for

maximum borrowings of $175.0 million (“ABL Facility”) for Lands’ End, subject to a

borrowing base, with a $30.0 million sub facility for a United Kingdom subsidiary borrower of

Lands’ End (the “UK Borrower”). The ABL Facility has a sub-limit of $70.0 million for

domestic letters of credit and a sub-limit of $15.0 million for letters of credit for the UK

Borrower. The ABL Facility is available for working capital and other general corporate

purposes, and was undrawn at the Separation and at May 2, 2014, other than for letters of

credit. The Company had borrowing availability under the ABL Facility of $160.2 million as

of May 2, 2014, net of outstanding letters of credit of $14.8 million.

Also on April 4, 2014, Lands’ End entered into a term loan credit agreement with Bank

of America, N.A., which provides a senior secured term loan facility of $515.0 million (the

“Term Loan Facility” and, together with the ABL Facility, the “Facilities”), the proceeds of

which were used to pay a dividend of $500.0 million to a subsidiary of Sears Holdings

Corporation immediately prior to the Separation and to pay fees and expenses associated with

the Facilities of approximately $11.3 million, with the remaining proceeds to be used for

general corporate purposes. The fees were capitalized as debt issuance costs within Other

assets on the Condensed Consolidated and Combined Balance Sheets and are being amortized

as an adjustment to Interest expense over the remaining life of the Facilities.

Maturity; Amortization and Prepayments The ABL Facility will mature on April 4, 2019. The Term Loan Facility will mature on

April 4, 2021 and will amortize at a rate equal to 1% per annum, and is subject to mandatory

prepayment in an amount equal to a percentage of the borrower’s excess cash flows in each

fiscal year, ranging from 0% to 50% depending on Lands’ End’s secured leverage ratio, and

the proceeds from certain asset sales and casualty events. The Company’s aggregate scheduled

maturities of the Term Loan Facility as of May 2, 2014 are as follows:

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Table 6. Continued

(in thousands)

Less than 1

year $ 5,150

1 – 2 years 5,150

2 – 3 years 5,150

3 – 4 years 5,150

4 – 5 years 5,150

Thereafter 489,250

$ 515,000

Guarantees; Security All domestic obligations under the Facilities are unconditionally guaranteed by Lands’

End and, subject to certain exceptions, each of its existing and future direct and indirect

domestic subsidiaries. In addition, the obligations of the UK Borrower under the ABL Facility

are guaranteed by its existing and future direct and indirect subsidiaries organized in the

United Kingdom. The ABL Facility is secured by a first priority security interest in certain

working capital of the borrowers and guarantors consisting primarily of accounts receivable

and inventory.

The Term Loan Facility is secured by a second priority security interest in the same

collateral, with certain exceptions.

The Term Loan Facility also is secured by a first priority security interest in certain

property and assets of the borrowers and guarantors, including certain fixed assets and stock of

subsidiaries. The ABL Facility is secured by a second priority security interest in the same

collateral.

Interest; Fees The interest rate on the Term Loan Facility was 4.25% at May 2, 2014. The interest rates

per annum applicable to the loans under the Facilities are based on a fluctuating rate of interest

measured by reference to, at the borrowers’ election, either (i) an adjusted London inter-bank

offered rate (“LIBOR”) plus a borrowing margin, or (ii) an alternative base rate plus a

borrowing margin. The borrowing margin is fixed for the Term Loan Facility at 3.25% in the

case of LIBOR loans and 2.25% in the case of base rate loans. For the Term Loan Facility,

LIBOR is subject to a 1% interest rate floor. The borrowing margin for the ABL Facility is

subject to adjustment based on the average excess availability under the ABL Facility for the

preceding fiscal quarter, and will range from 1.50% to 2.00% in the case of LIBOR

borrowings and will range from 0.50% to 1.00% in the case of base rate borrowings.

Customary agency fees are payable in respect of both Facilities. The ABL Facility fees

also include (i) commitment fees, based on a percentage ranging from

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approximately 0.25% to 0.375% of the daily unused portions of the ABL Facility, and

(ii) customary letter of credit fees.

(Lands’ End 10-Q dated June 12th, 2014)

The management of Lands’ End expressed concern over the effects that the high level of debt

would have on the ability of Lands’ End to operate in the future. Their concerns were detailed in

the Notes to Financial Statements in Lands’ End 10-K Statement from March 25th, 2014. The

excerpt from the Notes to Financial Statements that describes these concerns are found in Table

7.

Table 7. Lands’ End Notes on Indebtedness

Risks Related to Our Indebtedness

Our leverage may place us at a competitive disadvantage in our industry. We expect

that the agreements governing our debt will contain various covenants that impose

restrictions on us that may affect our ability to operate our business.

We will have substantial leverage following the spin-off and, accordingly, will have

significant debt service obligations. Our debt and debt service requirements could adversely

affect our ability to operate our business and may limit our ability to take advantage of

potential business opportunities. Our expected level of debt presents the following risks,

among others:

 we could be required to use a substantial portion of our cash flow from operations to pay principal (including amortization) and interest on our debt,

thereby reducing the availability of our cash flow to fund working capital,

capital expenditures, strategic acquisitions and other general corporate

requirements or causing us to make non-strategic divestitures;

 our interest expense could increase if prevailing interest rates increase, because we expect a substantial portion of our debt to bear interest at variable rates;

 our substantial leverage could increase our vulnerability to economic downturns and adverse competitive and industry conditions and could place us

at a competitive disadvantage compared to those of our competitors that are

less leveraged;

 our debt service obligations could limit our flexibility in planning for, or reacting to, changes in our business, our industry and changing market

conditions and could limit our ability to pursue other business opportunities,

borrow more money for operations or capital in the future and implement our

business strategies;

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Table 7. Continued

 our level of debt may restrict us from raising additional financing on satisfactory terms to fund working capital, capital expenditures, strategic

acquisitions and other general corporate requirements;

 we expect that the agreements governing our debt will contain covenants that will limit our ability to pay dividends or make other

restricted payments and investments;

 we expect that the agreements governing our debt will contain operating covenants that could limit our and our operating subsidiaries’ ability to engage

in activities that may be in our best interests in the long term, including,

without limitation, by restricting our and our subsidiaries’ ability to incur debt,

create liens, enter into transactions with affiliates or prepay certain kinds of

indebtedness. However, we expect that the credit agreements governing our

debt will not contain any financial covenants unless we fall below a minimum

level of borrowing availability under the ABL Facility; and

 the failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of the applicable debt, and may

result in the acceleration of any other debt to which a cross-acceleration or cross-

default provision applies. In the event our creditors accelerate the repayment of our

borrowings, we and our subsidiaries may not have sufficient assets to repay that debt.

We may need additional financing in the future for our general corporate purposes,

and such financing may not be available on favorable terms, or at all, and may be dilutive to

existing stockholders.

We may need to seek additional financing for our general corporate purposes, such as to

finance our international expansion and the growth of our Retail segment. We may be unable to

obtain any desired additional financing on terms favorable to us, or at all. If adequate funds are

not available on acceptable terms, we may be unable to fund our expansion, successfully develop

or enhance our products, or respond to competitive pressures, any of which could negatively

affect our business. If we raise additional funds through the issuance of equity securities, our

stockholders could experience dilution of their ownership interest. If we raise additional funds

by issuing debt, we may be subject to limitations on our operations due to restrictive covenants.

(Lands’ End 10-K dated March 25th, 2014)

Table 8 provides financial information on Lands’ End and a group of comparable firms at the

time of and just prior to its acquisition by Sears, Roebuck & Co. and at the time of its spinoff and

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the prior period. The additional debt for Lands’ End from the spinoff is not included in the Debt

Ratio and LTD-to-Equity calculations, but is included in the calculation of the Enterprise Value

as of May 2nd, 2014.

Table 8. Financial Information for Comparable Firms to Lands’ End

Panel A. At the Time of Lands’ End Acquisition by Sears

NM stands for Not Meaningful. Market Capitalization is calculated as the number shares outstanding multiplied by

the price per share. The Enterprise Value is calculated as the Market Capitalization less Cash & Short-Term

Investments plus Total Debt plus Preferred Equity plus Total Minority Interest.

(Standard and Poor’s Capital IQ)

Dollar amounts in millions

Firm Name

Market

Capitalization

Enterprise

Value

Lands' End, Inc. -$ -$

ANN INC. 1,105.65$ 1,235.24$

The Children's Place, Inc. 840.85$ 839.56$

HSN, Inc. -$ -$

Urban Outfitters, Inc. 444.79$ 437.22$

American Eagle Outfitters, Inc. 1,781.87$ 1,721.46$

The Buckle, Inc. 431.72$ 329.71$

Carter's, Inc. -$ -$

Columbia Sportswear Company 1,265.75$ 1,241.39$

Dollar amounts in millions

Firm Name Revenues

Net Profit

Margin EBITDA

Current

Ratio Debt Ratio

LTD-to-

Equity

Times Interest

Earned

Lands' End, Inc. 1,462.28$ 2.37% 85.09$ 1.78 0.38 – 40.78

ANN INC. 1,232.78$ 4.25% 159.11$ 2.22 0.32 0.20 15.45

The Children's Place, Inc. 587.39$ 7.27% 92.19$ 1.71 0.28 – 61.32

HSN, Inc. 3,622.92$ 1.83% 1,306.27$ 1.68 0.25 0.08 5.62

Urban Outfitters, Inc. 295.33$ 3.55% 29.88$ 1.95 0.23 – NM

American Eagle Outfitters, Inc. 1,093.48$ 8.57% 169.75$ 2.14 0.32 0.07 NM

The Buckle, Inc. 393.25$ 8.78% 62.80$ 4.81 0.16 – NM

Carter's, Inc. 518.51$ -0.80% 70.69$ 3.06 0.74 1.88 2.23

Columbia Sportswear Company 779.58$ 11.39% 164.92$ 3.83 0.26 0.07 34.62

As of Feb. 1, 2002

For the Fiscal Year 2001

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Table 8. Continued

Panel B. Following Lands’ End Spinoff from Sears

NM stands for Not Meaningful. Market Capitalization is calculated as the number shares outstanding multiplied by

the price per share. The Enterprise Value is calculated as the Market Capitalization less Cash & Short-Term

Investments plus Total Debt plus Preferred Equity plus Total Minority Interest.

(Standard and Poor’s Capital IQ)

Lands’ End’s enterprise value of $1.371 billion on May 2nd, 2014 represented a significant loss

in value for Lands’ End from its approximate enterprise value of $1.7 billion just prior to the

acquisition announcement in 2002. Despite being a part of Sears for eleven years, Lands’ End’s

sales in Sears’ retail locations only accounted for 15% of Lands’ End total sales for fiscal year

2013 (Lands’ End, 2014).

Tables 9 and 10 provide the Income Statement and Balance Sheet, respectively, for Lands’ End

just prior to its acquisition in 2002 and just following its spinoff in 2014. As can be seen in Table

9, revenues fell slightly for the Lands’ End between 2002 and 2014, while operating and net

income increased. The $500 million in debt is reflected as Long-Term Debt on the May 2, 2014

balance sheet presented in Table 10. Other Intangibles consisted primarily of Trade Names,

which were valued at $528.3 million on May 2nd, 2014 (Lands’ End 2014).

Dollar amounts in millions

Firm Name

Market

Capitalization

Enterprise

Value

Lands' End, Inc. 920.70$ 1,370.80$

ANN INC. 1,818.74$ 1,621.57$

The Children's Place, Inc. 1,041.72$ 805.22$

HSN, Inc. 2,932.73$ 3,009.36$

Urban Outfitters, Inc. 5,142.03$ 4,618.16$

American Eagle Outfitters, Inc. 2,235.58$ 1,806.64$

The Buckle, Inc. 2,243.03$ 2,057.96$

Carter's, Inc. 3,960.92$ 4,269.68$

Columbia Sportswear Company 3,016.08$ 2,472.57$

Dollar amounts in millions

Firm Name Revenues

Net Profit

Margin EBITDA

Current

Ratio Debt Ratio

LTD-to-

Equity

Times Interest

Earned

Lands' End, Inc. 1,585.93$ 3.14% 107.60$ 2.39 0.32 –

ANN INC. 2,375.51$ 4.32% 264.62$ 1.50 0.59 – NM

The Children's Place, Inc. 1,809.49$ 3.50% 173.12$ 2.85 0.33 – 111.50

HSN, Inc. 3,403.98$ 5.24% 308.14$ 1.82 0.60 0.43 42.07

Urban Outfitters, Inc. 2,794.93$ 8.49% 487.67$ 3.49 0.25 – NM

American Eagle Outfitters, Inc. 3,475.80$ 6.68% 557.87$ 2.62 0.30 – NM

The Buckle, Inc. 1,124.01$ 14.62% 292.01$ 2.15 0.39 – NM

Carter's, Inc. 2,638.71$ 6.08% 370.78$ 3.61 0.61 0.84 22.79

Columbia Sportswear Company 1,685.00$ 5.60% 181.66$ 4.15 0.22 – NM

For the Fiscal Year 2013

As of May 2, 2014

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Table 9. Income Statement Comparison for Lands’ End, Inc.

Amounts in millions of dollars Pre-Acquisition Post-Spinoff

For the twelve-month period ending Feb. 1, 2002 May 2, 2014

Revenue 1,569.1 1,574.3

Cost of Goods Sold 880.2 856.6

Gross Profit 688.8 717.8

Selling General & Admin Exp. 575.7 563.2

Depreciation & Amort. – 20.9

Other Operating Expense/(Income) – 0.1

Other Operating Exp., Total 575.7 584.2

Operating Income 113.2 133.6

Interest Expense (1.4) (1.9)

Interest and Invest. Income 1.5 –

Net Interest Exp. 0.2 (1.9)

Currency Exchange Gains (Loss) (1.7) –

Other Non-Operating Inc. (Exp.) (3.7) 0.2

EBT Excl. Unusual Items 107.9 131.8

Legal Settlements – 1.6

EBT Incl. Unusual Items 107.9 133.4

Income Tax Expense 41.0 51.1

Net Income 66.9 82.4

(Standard and Poor’s Capital IQ)

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Table 10. Balance Sheet Comparison for Lands’ End, Inc.

Amounts in millions of dollars Pre-Acquisition Post-Spinoff

As of Feb. 1, 2002 May 2, 2014

ASSETS

Cash And Equivalents 122.1 65.0

Accounts Receivable 13.3 39.8

Inventory 227.2 327.0

Prepaid Exp. 24.1 14.2

Deferred Tax Assets, Curr. 15.9 –

Restricted Cash – 3.3

Other Current Assets – 15.4

Total Current Assets 402.6 464.7

Gross Property, Plant & Equipment 344.2 260.8

Accumulated Depreciation (150.3) (162.2)

Net Property, Plant & Equipment 193.9 98.7

Goodwill – 110.0

Other Intangibles – 530.7

Other Long-Term Assets 2.7 23.7

Total Assets 599.1 1,227.8

LIABILITIES

Accounts Payable 83.4 76.1

Accrued Exp. 51.7 30.5

Short-term Borrowings 16.2 –

Curr. Port. of LT Debt – 5.2

Curr. Income Taxes Payable 25.0 –

Unearned Revenue, Current – 52.5

Def. Tax Liability, Curr. – 3.7

Other Current Liabilities 9.4 20.6

Total Current Liabilities 185.6 188.6

Long-Term Debt – 509.9

Def. Tax Liability, Non-Curr. 12.8 168.3

Other Non-Current Liabilities – 15.6

Total Liabilities 198.4 882.4

Common Stock 0.4 0.3

Additional Paid In Capital 48.0 340.2

Retained Earnings 556.0 5.9

Treasury Stock (206.9) –

Comprehensive Inc. and Other 3.3 (1.1)

Total Equity 400.7 345.3

Total Liabilities And Equity 599.1 1,227.8

(Standard and Poor’s Capital IQ)

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Post-Financial Crisis Spinoff Activity in the United States

When a spinoff occurs the parent firm separates a division of the firm into an independent

business entity with separate ownership, assets, employees, products, etc. A spinoff differs from

other forms of divestitures in that the division is not being sold off to another party, but that

existing shareholders of the parent firm are given shares of stock in the new business that they

may choose to sell if they choose. With the spinoff of Lands’ End, Sears’ stockholders were

given 0.3 shares in the new Lands’ End for each share of Sears that the owned. Since only the

existing shareholders were given shares in Lands’ End, Sears’ shareholders maintained their

proportional ownership in Lands’ End.

Carretta, Farina, Graziono, and Reale (2013) provided two reasons why firms choose to spinoff

their divisions. The first is that the parent firm has attempted to sell a division, but cannot find a

buyer at a price that they find reasonable. The second is that a firm with many divisions may be

valued at a lower price in the market due to a conglomerate discount.

A conglomerate discount is defined as difference in the value that an investor assigns to a multi-

segmented firm less the sum of the values that an investor would assign to the segments if they

were not part of a conglomerate firm. Spinning off companies may result in a focus premium,

which would increase the value of the firms to shareholders. The difference in values occur due

to the perceived ability of management of a single segment firm to attain and utilize a higher

level of expertise for a single segment and the ability of investors understand and make better

decisions regarding the potential risks and rewards of a single segment compared to a multi-

segment conglomerate firm (see Berger and Ofek, 1995; Burch and Nanda, 2003). Seeking a

focus premium is consistent with the explanation provided by Edward Lampert, found in Table

4, that one reason for the spinoff was so that the management and stockholders of the two firms

could focus on the individual firms rather than the larger conglomerate.

The spinoffs of Orchard Hardware Supply, Sears Canada, Inc., and Lands’ End were part of an

overall trend of increased spinoffs following the financial crisis. A study by Zenner, Junek, and

Chivukula (2015) found that the pace of corporate spinoffs increased following the financial

crisis. Specifically, they found that the average number of spinoffs from firms in the S&P 500

index was only two per year for the years 2008 and 2009; these increased to an average of seven

per year for the years 2010 through 2012; and finally increased to an average of 15 per year for

the period 2013 through the middle of 2015. Zenner et al. attributed the increase to low interest

rates in the post-crisis period and an increased desire by investors to invest in well-defined single

segment businesses. Studying the post spinoff returns of the parent and spun off business

divisions for spinoffs that occurred for the years 2009 through 2013, Zenner et al. found that

parent companies received a 2% to 4% market-adjusted increase in stock price at the time of the

announcement and that the parent and spun off business divisions combined received, on

average, a 10% to 15% market-adjusted increase in stock prices in the two years following the

spinoff.

The reduction in interest rates resulted in decreased spreads in interest rates between investment

grade and non-investment grade debt which resulted in firms being more amenable in issuing

non-investment grade debt. Firms that have been spun off tend not to able to issue investment

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grade debt due to their smaller size and shorter history (Zenner et al., 2015). Table 11 provides

the market interest rates for 30-year corporate bonds and LIBOR at the time of the spinoff of

Lands’ End. In order to get the funds to pay Sears, Lands’ End had to rely on a loan from Bank

of America instead of issuing a publicly traded bond, which would have likely had a lower

interest rate.

Table 11. Interest Rates at the Time of Lands’ End’s Spinoff

Panel A. S&P Capital IQ Corporate Yield Profile Bond

Rating

Yield on 30 Year Maturity Corporate

Bonds as of 5/2/2014

AAA 5.20%

AA 5.44%

A 5.54%

BBB 5.83%

BB 8.57%

B 11.15%

CCC 13.33%

From Capital IQ – All Corporates

Panel B. 12-Month London Interbank Offered Rate (LIBOR), based on the U.S. Dollar Average 12-month LIBOR 2004 through 2013 2.47%

Average 12-month LIBOR 1994 through 2013 3.69%

12-Month LIBOR as of 5/2/2014 0.55%

From https://fred.stlouisfed.org/series/USD12MD156N

Conclusion

Sears had faced several years of poor financial performance. One response to this was the

divestiture of several of its business divisions. With most of the divestitures, the new business

created was required to take with it a portion of Sears’ debt, make a large cash payment to Sears,

or maintain a relationship with Sears and pay the expenses of that relationship. Lands’ End was

required to make a $500 million payment to Sears, maintain a relationship with Sears, and pay

the costs of maintaining that relationship (including paying for personnel in Sears’ stores).

How would these burdens affect Lands’ End’s ability to operate in the future? Should the

shareholders retain their ownership in Lands’ End? Were the assets that were transferred from

Sears to Lands’ End worth $500 million?

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