There were, until the financial crisis, two main schools of thought on Sears Holdings in the hedge fund community.
One school consisted of those hedge funds that made early, and profitable, bets that Eddie Lampert would turn Sears into a Berkshire Hathaway of the new millennium.
This school held the view that there was enormous value in Sears; that Eddie Lampert would find a way to unlock that value; that short-term earnings were meaningless; and that anyone who focused on the dilapidated nature of Sears (and K-Mart’s) stores; on the aging and coupon-clutching customer base; and the resulting, lousy comp-store sales, was missing the vast potential in Sears’ real estate portfolio.
Students of this school never actually shopped at Sears, although they may have visited the stores once in a while—like when Eddie launched a new initiative, for example (see “Wal-Mart 9, Sears Holdings Corp 2” from June 30, 2005). And they probably wouldn’t have been caught dead in a K-Mart.
But they made a lot of money in the stock.
The other school of thought on Sears Holdings consisted of hedge funds which, for the most part, had invested in retailers over the years; knew a good store from a bad store when they saw it; and couldn’t believe the gap between what they saw with their own eyes whenever they walked into a Sears or a K-Mart versus what Sears’ hyperventilating stock price was suggesting might be going on inside those stores.
That school of thought was short Sears’ stock—and quite painfully, for several years.
Then Lehman came along, consumer spending collapsed, and the Great Leveling began in American business, separating good companies from the bad, retailers included.
And Sears Holdings especially.
Even the imprimatur of the great Eddie Lampert —and we do mean ‘great,’ with not a bit of sarcasm—combined with a billion dollars worth of share repurchases, could not hold up the stock.
Of course, as the crisis took hold and the formerly unprofitable school of thought that regarded Sears as a deteriorating pile of rotting stores—Eddie Lampert or no Eddie Lampert—began to take hold, well, the piling-on began by Wall Street’s Finest and the fickle press.
Even Barron’s—which had once published a $300-plus a share value for the business—recently jumped in, with a cover story titled “Washed Out.”
Thus it was that this weekend, in an uncharacteristic move, Lampert himself finally spoke out, in a public letter to the pilers-on at Barron’s, defending his company:
To the Editor:
The Barron's Aug. 24 article that discusses Sears and ESL Partners was misleading, inaccurate, and poorly researched. Without responding to each inaccuracy, I want to correct some of the more important misstatements and address the overall negative bias in the presentation of facts.
What exactly did Barron’s say to provoke the unusual response from the famously secretive, non-blog-publishing hedge fund manager?
a) Recapped the bad news that has come out under the ticker “SHLD” recently—lousy sales, shuttered stores, and uncharacteristically dour reports by Wall Street’s Finest—and;
b) Called out the use of one-time “special charges” and reliance on “Adjusted EBITDA”—a notoriously misleading measure of business health in a capital-intensive business like department store retailing—as a performance metric, and;
c) Speculated that Lampert and his investors are “backed into a blind alley” with “no escape,” thanks to cost-cutting that “has been so extreme,” according to Barron’s, “that it can no longer generate the cash flow to mount a turnaround”—a legitimate concern given that the balance sheet was cleared of $5 billion in cash spent on share buybacks from 2005 to 2008 at stock prices well above the current price—and;
d) Predicted “Sears stock could fall by as much as 50% as the problems drag on,” and;
3) Declared that “The agonies of Sears are of vital importance to the investors in Lampert's hedge fund,” suggesting gruesome consequences for the hedge fund king.
So how did that hedge fund king respond to Barron’s?
Quite lamely, we think.
While first admitting “the performance of the company is not where I would like it to be,” Lampert writes:
“The executive team and associates of Sears have all been hard at work in attempting to change this performance in an environment that has been less than friendly to the entire retail industry. At the same time, contrary to the theme of the article, we have made some important progress in 2009.”
Let’s ignore Lampert’s nobody-else-did-well-either kick-off and focus on exactly what those signs of “important progress” might be.
The first sign of progress, according to Lampert, is an amended credit facility. We do not make this up.
To healthy retailers, of course, an amended credit facility is not so much a sign of “progress” as a sign the company won’t be filing Chapter 11 any time soon. We think it should be dismissed out of hand as filler.
The second sign of progress, Lampert says, was an increase in “adjusted Ebitda” of 9% in the first six months of 2009, when “most of our major competitors saw a decrease in their Ebitda performance.”
Unfortunately, this assertion that Sears outperformed peers in one measure of its fundamentals is hard to refute without exact knowledge of a) who Lampert considers to be Sears’ “major competitors,” and b) what goes into Lampert’s own calculations of “Adjusted Ebitda.”
According to our Bloomberg, for example, Sears’ EBITDA in the first half of the current year did not grow: it declined, to $465 million from $636 million the previous year.
Furthermore, Wal-Mart, which has been taking market share from Sears almost since the day Sam Walton opened his first store, and certainly has to be Lampert’s company’s single most important “major competitor,” did not show an EBITDA decrease during the first half of the current year—it showed a slight increase.
Worse, for Lampert anyway, is that while Sears was bleeding $162 million of negative cash flow from operations in that same period, and spending a bit under $200 million on top of that for capital spending, Wal-Mart was gushing $13.469 billion in positive cash flow, and spending $9 billion—yes, $9 billion—of that money on new stores, new fixtures, and new technology...i.e. the very stuff that has made Wal-Mart what it is today: Eddie Lampert’s worst nightmare.
Moving on to the third of Lampert’s “signs of progress”—and we aren’t making this one up, either—the Sears Chairman points out that Sears stock jumped 70% year-to-date, “outperforming all of our large competitors.”
Besides being absolutely meaningless—short-term stock price moves tell an outsider precisely nothing about the long-term health of a business—this data point, like Lampert’s EBITDA calculation, looks far less impressive when you move the goalposts back to the end zone, where they were before he shifted them to a better-looking spot on the field.
Lampert surely knows—he does run one of the most successful hedge funds in America—that in almost any stock market rally of the type we’ve enjoyed thus far in 2009 (i.e. the sharp, short-covering-off-a-panic-low variety), the lowest quality stocks always move up the furthest, for the simple reason that they already moved down the furthest.
Just ask the short-sellers in AIG.
More telling to the underlying business than a short-term dead-cat stock bounce, of course, is a time-frame that encompasses the entire financial crisis. Had Lampert chosen to brag about the last twelve months, in that case, the comparison wouldn’t look so perky: Wal-Mart, Target and Costco shares were recently down 15 to 20% over that timeframe.
Sears was down 31%.
“Okay, wise-guy,” the discriminating reader might say (and we have very discriminating readers here at NotMakingThisUp), “what would you do with Sears that the great Eddie Lampert is not?”
The answer to that is easier said than done, but the turnaround of any institution as large and storied as Sears has nothing to do with short-term moves in stock price, “adjusted EBITDA” or amended credit facilities.
Rather, it is about something Lampert did not address in his letter—not even once. It is about one person.
The person who runs the business.
And by way of explaining what we mean by that, we harken back to a simpler but more dangerous time, just 22 years before the 1886 founding of the R.W. Sears Watch Company in Minneapolis: the American Civil War.
During that Civil War (or the War Between the States, if you prefer), the North had suffered a series of overcautious generals, most of them with political ambitions, who could not bring themselves to fight until pushed into battle by the inexperienced Commander in Chief (Abraham Lincoln) and his incompetent General-in-Chief (Henry Halleck).
The end result was, in all cases but Antietam (or Sharpsburg, if you prefer that), disaster for the Northern Army of the Potomac.
It wasn’t until Lincoln finally selected Ulysses S. Grant—a fighter without political ambitions who had captured Vicksburg following one of the riskiest and most underrated maneuvers of the war—as his General-in-Chief, and gave Grant complete control over all Northern armies in the field, that the tide shifted to such an extent that Confederate General Robert E. Lee—the best general the U.S. ever produced—was eventually forced to concede to Grant at Appomattox.
And in much the same way that Lincoln and Halleck tinkered aimlessly until that war had almost been lost (or won, if you prefer that) before turning everything over to General Grant, Eddie Lampert, in all his years as Chairman of Sears Holdings, seems to have avoided making any single individual responsible for the retail battles being fought every day in the real world—i.e. in the communities where shoppers right now are making up their minds whether to go to a Sears, or a Wal-Mart, or a Costco.
But that’s exactly what Sears Holdings needs: it needs a General Grant.
And it needs one sooner, not later.
I Am Not Making This Up
© 2009 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.
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