“Confusion about NOLs”
You say potayto I say potahto, you say tomayto, I say tomahto
When you ask: “why can’t this be answered with a simple yes or no?”, it’s because there are no rules of thumb that can be used for quick problem solving and decision making regarding this issue.
If these things have real value, why can’t you just go to a company’s financial statement and just look it up? The answer is that a company will only show value for these types of assets on its balance sheet if there is a greater than 50% chance the company’s accounting income will be positive in the following accounting period.
Since Sears (SHC) has not shown positive accounting income for a number of years (which is why they have all of these deferred tax assets), when you look at their balance sheet under the line item “Current Assets” you will see minimal to zero value.
So you ask, if there is minimal to zero value, why the fuss? Because a company which has positive income can acquire these deferred tax assets which can then be used to offset their positive income and reduce their income tax liability potentially for many years to come. (recall the recent post in which Lampert commented he expected the assets which he purchased under Transform Holdco to be EBITA positive in 2019). EBITA means “earnings before interest, tax, and amortization”. For Lampert, positive EBITA means the ability to utilize deferred tax benefits and reduce taxes owed.
If you look at the Asset Purchase Agreement (the “APA”), there are 33 pages of definitions. There is not one single definition for NOLs, Tax Credits, Tax Assets, or Tax Attributes. The only suggestive definition is for “Tax Result” which brings us to the “word salad”.
Tax Result is defined as the minimization of liability and maximization of benefit associated with tax attributes. So you ask, “what are tax attributes?, there’re not defined in the APA”. Well, in the Tax Result definition it references IRS CODE 108(b)(2) and also IRS CODE 1504(a). What the hell is that you ask? Now, if you’re not completely frustrated, you are required to look up those two IRS Code #’s.
Finally, some light at the end of the tunnel you think. IRS Code 108(b)(2) talks about “tax attributes” and then you see that the IRS considers one of these “tax attributes” to be NOLs and some tax credits are discussed here as well.
So, problem solved you say. NO, that still begs the question “who gets to realize the benefit of these tax attributes since SHC declared bankruptcy?
So, if you now go back to when SHC was trying to solicit bids for all or various components of the company, it hired Lazard Frere to be its advisor. Lazard Frere sent out a letter to many parties who had expressed an interest in all or some components of SHC and ask them to consider making bid(s).
Going back to November 21, 2018 (from page 6/46 of docket 862) you can see the letter Lazard sent out. Following is an excerpt from that letter:
“We also note that the tax profile of the Company (SHC) represents the potential for substantial future value, and prospective bidders should take into account that an acquisition of the equity of the entire group pursuant to a Chapter 11 plan, through an acquisition of Sears Holdings Corporation, is most likely to preserve this potential value as part of the assets and value acquired”
As you can see, Lazard was looking for someone to acquire everything suggesting that to be the simplest and best way to preserve “tax profile” interests.
The letter also suggested if SHC did not get an acceptable bid that SCH might attempt a reorganization from which it could emerge and utilize its own tax profile benefits.
Now, flash forward to December 2, 2018. SHC filed a 13D/A and the following excerpt is from Exhibit 99.1. It is another letter from Lazard which discussed the bid submitted by ESL (Lampert’s company) in which it described a bid from an ESL entity (what became known to us as Transform Holdco). That letter indicated ESL was making a bid to acquire substantially all of the assets (but not the stock which we know as shldq) pursuant to a sale under section 363 of the U.S. Bankruptcy Code.
That letter went on to say that ESL’s company would acquire Sears’ tax assets, the value of which we have incorporated into this Indicative Bid.
So, it seems pretty plain to me that if ESL’s bid were to be approved by the bankruptcy court that ESL would be acquiring the tax assets of SHC and these tax assets include NOLs.
So, if it’s that plain and straight forward, why the continuing confusion?
Remember, the Unsecured Creditors objected to the sale of substantially all of Sears’ go forward assets to ESL as a going concern and they filed an objection with the court. Sears filed a response to the Unsecured Creditors’ objection and some confusion was sowed in that response. It’s important to remember that both the objection and response were filed before Judge Drain had issued his ruling on the ESL/Transform Holdco bid. Why is that important? Because the Unsecured Creditors were making their arguments hoping the ESL bid would not be approved and Sears responded to those arguments with some assumption that if the ESL bid were not approved that Sears might utilize the tax benefits in some type of reorganization.
Docket 2042 is the objection filed by the Unsecured Creditors. On page 43 of that docket, the Creditors Committee expressed its view to the Debtors (SHC et al) that ESL’s bid failed to offer sufficient consideration for the assets contemplated to be purchased, including … valuable tax attributes that ESL would acquire as part of its bid…
It’s important here to realize the lawyers for the Unsecured Creditors recognized and acknowledged that ESL would acquire valuable tax attributes if ESL’s bid was confirmed by Judge Drain.
Now, let’s look at SHC’s response to the unsecured creditors filed on February 1, 2019 as docket 2320, again keeping in mind their response was filed before knowing whether or not Judge Drain would approve the sale to ESL/Transform Holdco.
In their Preliminary Statement, SHC says : “in less than four months since the petition date, the Debtors have negotiated a transaction that will maximize the value of their estates for the benefit of all creditors.”
Notice, they don’t say ALL Stakeholders.
Furthermore, in the Debtors’ Omnibus Reply in Support of the Going Concern Sale Transaction, docket 2328, also filed on February 1, 2019, they have some interesting as well as confusing comments.
Starting on page 57 of docket 2328, the Debtors acknowledge in (v) that “Administrative Solvency is Not a Precondition to the Sale Transaction”. In other words, the inability of the Debtors to pay administrative costs at any time after the sale to ESL is approved is not a reason to deny approval of the ESL bid. The Debtors go on to acknowledge that Debtors cannot get any plan of reorganization approved unless ALL administrative claims and secured and priority creditors are paid.
That means that if the Debtors ultimately become administratively insolvent after a sale to ESL there will be no reorganization of what’s remaining of Debtors and since no plan can be confirmed, IMO the Debtors would be liquidated.
So, with the Unsecured Creditors asserting the Debtors will become administratively insolvent, the Debtors in their own reporting have acknowledged that possibility, and Judge Drain also warning that possibility could occur after his approval of the sale, it seems the likelihood of what remains of SHC after the ESL/Transform Holdco sale is approved to be reorganized is fading. To me, that means the possibility of monetizing any tax attributes which might remain with the Debtors is also fading.
In fact, footnote 14 on page 32/112 of docket 2328 supports this contention. It states: “A reorganization around a smaller business division of the Debtors was considered but the potential value attributable to an effort to preserve and utilize net operating losses or other tax attributes was recognized as speculative and significantly discounted when compared with the actual value presented by the Sale Transaction.”
Everything I have stated above has been reference back to documents which have been filed in this bankruptcy matter. It seems to be that (i) the Debtors (SHC as the parent company together with all of is debtor subsidiaries), (ii) Lazard Frere, advisor’s to the Debtors, (iii) the lawyers representing the Unsecured Creditors, and ESL have all acknowledged that the tax attributes (NOLs and tax credits) were purchased by ESL/Transform Holdco and will be assets which ESL/Transform Holdco will acquire once the bid is closed.
Again, if you look at the APA and the first amendment to the APA, ESL/Transform Holdco is still needing to get its own tax opinion regarding utilization of these tax attributes and ESL/Transform Holdco are required to direct the Debtors to take specific actions required for ESL/Transform Holdco to maximize these tax attributes.
This still leaves the lingering questions about “shift in ownership” and preserving the equity structure unanswered. While I think the shldq stockholders will survive in some way, I will only be sure once I have seen something official and in writing setting forth this will in fact be done.
Was last week’s run up and subsequent beat down of the stock anything more than a pump and dump? I don’t know. Was it an attempt to shake out nervous nellies so that shares could be acquired by others who “think” they know what’s going on? I don’t know. Is it possible the tax attributes could go to ESL/Transform Holdco and shldq stockholders would not be included as part of that deal given the language around “shift in ownership” and preserving equity structure. I don’t know.
What I think I know is that ESL/Transform Holdco will be getting the majority of the tax attributes. How that impacts shldq stockholders is yet to be determined. So, flip the stock, buy and hold, get out with your current profit or loss and sit on the sidelines waiting for certainty. That’s an individual choice.
