Sears Canada Sells Credit Card Business

Sears Canada Inc. shares soared by more than 24% after JPMorgan Chase & Co., the world's second-largest credit card issuer, agreed to buy the Canadian retailer's credit card business for more than $3.4 billion in cash and debt. That's the most the stock ( TSX: SCC), which hit a five-year high of $30 on August 31, has ever climbed during one day of trading in at least 20 years.

While analysts called the sale price a great deal for Sears Canada, Dominion Bond Rating Service said it expects to downgrade the retailer's credit rating as a result of the transaction â?¹perhaps even taking it below investment grade) because Dominion has concerns about the health of the company's ongoing retail operations.

“It's a better-than-expected outcome,” said Patricia Baker, Toronto-based analyst at Merrill Lynch, in a research note. Under the deal, JPMorgan, the third-largest U.S. bank, will pay about $2.4 billion in cash and inherit debt of about $1.1 billion. Sears Canada would ultimately receive $2.2 billion in net cash proceeds after factoring in the value of the unit's unpaid debts as well as unspecified costs and taxes. Baker said she had been expecting after-tax proceeds of between $1.5 billion and $1.8 billion.

The company, 54% owned by U.S.-based parent Sears Holdings Corp., said it will record an after-tax gain of about $650 million from the sale. The retailer said in a release that the money will be used “primarily to make a substantial cash distribution to shareholders and for general corporate purposes.” The amount and timing of any distribution is still to be determined. “We expect a shareholder-friendly use of cash,” said Baker, adding her preferred option would be a share repurchase. Still, she upgraded her rating on Sears Canada to a “buy” from “neutral,” with a 12-month target of $32.50.

Sears Canada CEO Brent Hollister said the move will create “significant value as we expect to return substantial proceeds to shareholders, while accelerating progress toward building a Sears that is completely focused on the profitable growth of our core retail and related services businesses and further simplifying our organization.” Hollister said that over the next few months, Sears Canada, the country's third-largest department store retailer, will be taking steps to align its cost structure “with the Canadian and North American competitive retail industry sector.” Sears Canada has been struggling to boost stagnant sales by remodeling its 122 department stores, 217 off-mall stores and 62 home improvement showrooms. It also has plans to open outlets specializing in areas such as electronics.

While shareholders reacted positively to news of the transaction (unlocking the value of the retailer¹s credit card operations) Dominion Bond Rating Service said in a news release the deal and decision to distribute some of the cash to shareholders “significantly weakens the credit” status of Sears Canada, which it now has “under review with negative implications.” Dominion pointed out the credit and financial services arm of Sears Canada has historically contributed significant earnings to the company while reducing earnings volatility. Dominion added that it is also concerned about Sears Canada's core merchandising business and its ability to “increase sales without compromising margins.” The rating agency said it is now putting the company's credit under review, and it expects to “downgrade Sears Canada's credit rating, perhaps taking it below investment grade.”

The credit card business at Sears Canada has long been a cash cow for the company. It has about 10 million accounts (the third-largest credit portfolio in the country) and brought in $26.3 million in operating income in the second quarter that ended June 30, or 82% of total operating income for the quarter. It employs about 1,000 people at four locations in Vancouver, Toronto and Ottawa. They will become employees of JPMorgan after the transaction closes, which is expected by the end of the year. Sears Canada says the deal includes its private-label cards as well as those co-branded with MasterCard International Inc. Sears Canada and JPMorgan also agreed to a 10-year marketing and servicing pact. Under the alliance, JPMorgan will provide credit and customer service to Sears Card and Sears MasterCard holders in Canada. Sears Canada is expected to receive $100 million in annual performance payments from JPMorgan, based on credit sales, new account generation and sales of additional financial products.

JPMorgan Chase & Co. ( NYSE: JPM), with assets of US$1.2 trillion, has been battling its rivals, Bank of America Corp. and Citigroup Inc., for a larger share of the credit card market. The result has been a spate of acquisitions in the credit card industry, with banks swallowing up independent issuers such as MBNA Corp. and Federated Department Stores Inc. In 2003, Citigroup bought the credit-card operations of Sears Roebuck & Co., a predecessor of Sears Holdings, for US$3.4 billion. Given the fewer options to expand in the United States, American banks like JPMorgan are now looking abroad to increase their portfolios.