By Cotten Timberlake and Miles Weiss - Dec 28, 2011 12:00 PM GMT+0700
When Kmart acquired Sears (SHLD) in 2005, Chairman Edward Lampert said the new company would have the geographic reach and scale to compete with Wal-Mart Stores Inc.
The billionaire hedge fund manager has since presided over 18 consecutive quarters of declining sales. He’s on his fourth chief executive. While Sears Holdings Corp. shares soared in the first few months after the merger, they’ve fallen 55 percent in 2011 alone.
Sears “has been a mismanaged asset,” Gregory Melich, an analyst at International Strategy & Investment, said in a Bloomberg Television interview yesterday. “A lot of traditional department stores have reinvigorated themselves through merchandising, through changing their locations; you think of Macy’s. You haven’t seen that from Sears.”
Yesterday, the largest U.S. department store chain reported that it would close as many as 120 locations after same-store sales fell 5.2 percent in the eight weeks ended Dec. 25. By contrast, such sales in the department-store sector will climb an estimated 4 percent in November and December, compared with the same period a year ago, according to the International Council of Shopping Centers, a New York-based trade group.
The shares plunged, falling 27 percent to $33.38 yesterday in New York, the largest drop since April 29, 2003.
Since becoming chairman in 2005, Lampert, 49, has reduced costs, closing 171 large U.S. stores and cutting the headcount by about 12 percent. Sears employed 312,000 people as of January, down from 355,000 in June 2006, according to data compiled by Bloomberg. Meanwhile, his hedge funds have made money on the original investment.
Ceding Customers
He has tried one strategy after another. An initial push involved converting 400 Kmart stores to a format called Sears Essentials with grocery and convenience items. Sears Grand, another concept, hewed to a superstore model. All have failed to reverse falling sales and ceded customers to the likes of Wal- Mart (WMT) and Macy’s.
“At Sears, a lot of what we sell is tied to housing,” Chris Brathwaite, a Sears Holdings spokesman, said in a telephone interview yesterday. “The recession has had an impact on our company, like most retailers.” The closings will allow the Hoffman Estates, Illinois-based company to focus on “better-performing stores,” he said.
Steve Lipin, a spokesman for Lampert, didn’t return a call seeking comment.
Buffett Inspiration
Lampert founded his hedge fund ESL Partners in 1989, taking inspiration for his approach to finding undervalued stocks from the shareholder letters of Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc. Lampert has specialized in buying stakes in beaten-down retailers, some of which he helped turn around by either collaborating with or shaking up management.
Lampert’s hedge funds bought Kmart Corp. bonds and bank loans and then swapped the debt for stock in a bankruptcy reorganization in 2003. At the same time, Lampert’s funds were also building a 15 percent stake in Sears, Roebuck & Co. by purchasing shares on the open market.
When Kmart acquired Sears in 2005 to form Sears Holdings Corp., Lampert and his funds initially held a 39.4 percent stake, comprised of about 64.6 million shares. Based on what the funds paid for their Kmart stake, as well as the average trading price during the quarters that they bought Sears stock, the funds spent an estimated $1 billion on the investment.
Profitable Investment
Even after this year’s slump in the stock, Sears has been a profitable investment for Lampert. His hedge funds paid about $16 a share for the stake in the chain, based on regulatory filings and Bloomberg calculations.
When Lampert announced his plan to buy the department store chain in November 2004, he said Sears’s service and products were “every bit as good as any of the competition.”
Both Sears and Kmart were struggling at the time. Sears’s annual sales were stuck at $41 billion in each of the four years ending in 2003. Kmart had emerged from bankruptcy after failing to compete with Wal-Mart’s lower prices.
Now Sears is turning upside down a strategy that has prevailed for most of its 118-year history. It’s accelerating franchising efforts -- including Sears Hometown and Sears Auto stores. It’s leasing space to such retailers as Forever 21. And it’s allowing other retailers to sell the popular DieHard, Craftsman and Kenmore products and licensing those brands.
Capital Starved
In the meantime, the larger stores have been starved of capital investment and customers have defected, according to Gary Balter, an analyst with Credit Suisse Group AG in New York.
Sears is spending less than a quarter of the $8 a square foot that retailers typically invest to maintain stores, according to International Strategy & Investment Group. In an August report, the New York-based firm put Sears and Kmart at the bottom of the list of a dozen retailers ranked by sales per square foot and operating profitability.
Earnings before interest, taxes, depreciation and amortization in the fourth quarter will be less than half of last year’s $933 million, Sears said yesterday.
Lampert is a self-styled merchant who has found it difficult to cede managerial control to experienced retail managers, said Jay Margolis, a former executive with Limited Brands Inc. and Reebok International Ltd.
“Sears has just lagged way behind,” Margolis said yesterday on Bloomberg Television. “There is no energy there. We have not seen the results. We have not seen the change in the product. He has found it difficult to let go.”
Dwindling Cash
Cash had dwindled to $624 million at the end of the third quarter, compared with $790 million a year earlier.
“If the vendors are comfortable shipping to them, they could go on for years,” Balter said. “Their balance sheet is fine. But it’s usually vendors who decide and if they pull the plug, then the company has no choice and they have to file” for bankruptcy protection.
Closing the Kmart and Sears stores will generate $140 million to $170 million of cash from inventory sales and leasing or sales of the locations, Sears said yesterday. The chain plans to reduce fixed costs by $100 million to $200 million.
The company will incur non-cash expenses of as much as $2.4 billion in the fourth quarter to write down the value of potential tax benefits and goodwill.
Sears didn’t specify which stores will be closed. In his annual investor letters, Lampert has identified the smaller Hometown and Sears Outlet stores as sources of growth and profit. The company opened 122 of those “specialty” stores last year, he said in his 2011 letter, and now has 945 -- less than a quarter of the total.
Web Operations
New CEO Lou D’Ambrosio, hired in February, is ramping up Web operations. Online sales via Sears’s various websites grew 30 percent year-over-year in the second quarter of this year, and 22 percent in the first quarter. To jog that growth, Sears has given salesmen in 450 of its stores more than 5,000 iPads and 11,000 iPod Touches to help them track inventory and customer orders, and added free wireless access.
“If they can just create enough cash flow to get through the downturn, at some point there is going to be a huge uptick in appliance sales,” Paul Swinand, an analyst with Morningstar Inc. in Chicago, said in a telephone interview. “They just have to make sure that when that happens they are not cut off at the knees, and that it doesn’t all go to Home Depot and Best Buy.”
Sears is to report fourth-quarter earnings on Feb. 23.
“The market is assuming there’s more bad news to come,” Swinand said.
To contact the reporters on this story: Cotten Timberlake in Washington at ctimberlake@bloomberg.net; Miles Weiss in Washington at mweiss@bloomberg.net
To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net
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