Sunday, February 27, 2011

Buffett vs. Lampert: A Tale of Two Letters


Two significant shareholder letters were released this week.

The first was from Sears Holdings’ Chairman Eddie Lampert; the second from Berkshire Hathaway Chairman Warren Buffett.

And while it is certainly easier, and a lot more fun, to write about good news—as Buffett has been accustomed to doing over the years at Berkshire, in contrast to the kind of bad news that has issued forth from Lampert’s fading retail giant of late—there is, even so, a remarkable difference in both the substance and style of letters by two men who actually have a great deal in common.

For one thing, both started out as hedge fund managers. For another, both are without peer in their fields, and fabulously wealthy as a result. For a third, they each got into the position of writing annual shareholder letters as a result of taking control of a fading, once-giant, public company. Finally, they each spent years personally wrestling with how to turn the original business around.

In the end, of course, one (Buffett) decided the rational thing was to disinvest in the original business and re-create the company to his liking, while the other (Lampert) is still wrestling with Sears even as he extracts cash from “hidden” assets like real estate and minority-controlled subsidiaries.

Still, differences between the two men are legion (Midwest publicity-magnet versus East Coast recluse, for starters) and do not end with how they played the hand they were dealt: differences in how to hire, invest, manage and incentivize people are revealed in almost every sentence of the respective shareholder letters they have penned.

Indeed, so remarkably different are the letters that we here at NotMakingThisUp couldn’t help but compare the two, by topic.


On Investing Excess Cash:

“As we have done since we took control of Kmart in 2003, we will continue to evaluate alternative uses of the company’s cash flow and capital resources to generate long-term value for all shareholders. Each year brings with it different circumstances, and we expect to have a variety of opportunities to invest our cash in the years to come. Our discipline in evaluating opportunities leaves us prepared to weather difficult times as well as to prosper when economic conditions improve.”
—Edward S. Lampert

“Our elephant gun has been reloaded, and my trigger finger is itchy.”

—Warren E. Buffett


On Management:

“We continue to make changes in our broader leadership team, as we allocate more responsibility to leaders who have delivered results and seek to attract leaders who are capable of improving performance in areas that have lagged. In particular, we want leaders who are capable of transforming key aspects of our business, as retail is increasingly impacted by new technologies and social interaction.”
—ESL

“Our trust is in people rather than process. A 'hire well, manage little' code suits both them and me.”

—WEB


On Investing for the Long-Term

“We will continue to make long-term investments in key areas that may adversely impact short-term results when we believe they will generate attractive long-term returns. In particular, we have significantly grown our Shop Your Way Rewards program, improved our online and mobile platforms, and re-examined our overall technology infrastructure. We believe these investments are an important part of transforming Sears Holdings into a truly integrated retail company, focusing on customers first.”
—ESL

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well…. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

—WEB


On Making a Key Hire

“Lou knows what it is like to be the 800-pound gorilla from his days at IBM, and he knows what it is like to compete against 800-pound gorillas from his days at Avaya. He also understands how technology can shape and change companies and industries. The profound changes that many industries, including retail, are currently experiencing require new thinking, new leadership and new business models. Information and technology have always been an important part of the supply chain in retail, but more and more it is becoming critical that we use information and technology in a much more profound way to deliver great customer experiences. Lou is a proven winner, and I am excited to have him as the leader of our company.”
—ESL

“It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of—and sensitivity to—risk…. In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed. Finally, we wanted someone who would regard working for Berkshire as far more than a job.

“When Charlie and I met Todd Combs, we knew he fit our requirements.”

—WEB


On How to Deal with a Cyclical Business:

“Given the large proportion of the Sears Domestic business which is in 'big ticket' categories and linked to housing and consumer credit, Sears is much more susceptible to the macro-economic environment than Kmart. But I don’t accept this as an excuse: our results at Sears in 2010 were completely unacceptable. The profit erosion at Sears Domestic occurred primarily in appliance-related businesses and in the Full-line Store apparel and consumer electronics businesses….

“When industry margins are shrinking, an organization must respond by adding new innovative products and bundling them with services and solutions that meet customers’ evolving needs….

“The new management in our appliance business has already taken actions to rebuild leadership in this area and to further reinvigorate the Kenmore brand….

“In parallel to the efforts that we are making to increase the productivity of our Sears stores, we are also looking at adding world class third-party retailers to our space. Earlier this year we announced that Forever 21 will be taking over 43,000 square feet of Sears space at South Coast Plaza in Costa Mesa, CA…”

—ESL

[Editor’s Note: We are not making this last part up; the author also discusses leasing out space to Whole Foods].


“Our businesses related to home construction, however, continue to struggle…. A housing recovery will probably begin within a year or so. In any event, it is certain occur at some point. Consequently: (1) At MiTeck, we have made, or committed to, five bolt-on acquisitions during the past eleven months; (2) At Acme, we just recently acquired the leading manufacturer of brick in Alabama for $50 million; (3) Johns Manville is building a $55 million roofing membrane plant in Ohio…; and (4) Shaw will spend $200 million in 2011 on plant and equipment, all of it situated in America. These businesses entered the recession strong and will exit it stronger. At Berkshire, our time horizon is forever.”

—WEB


On Wonderful Businesses vs. the Wonder of Financial Legerdemain

“I wouldn’t be surprised to see our share of Coke’s annual earnings to exceed 100% of what we paid for the investment. Time is the friend of the wonderful business.”
—WEB

“In April, we had the opportunity to purchase an additional 17% of Sears Canada for $560 million, increasing our ownership from 73% to 90%. In 2010, Sears Canada has paid two dividends, which returned $639 million of cash to Sears Holdings. Of course, of the cash we received in dividends, we would have received $518 million without the additional shares purchased (because we already owned 73% of Sears Canada), so in effect we received $121 million in dividends on behalf of the additional shares purchased in 2010.”

—ESL


On Reinvesting in the Business, or Not

"Furthermore, not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month."
--WEB

"We invested more than $400 million in capital expenditures in 2010, including significant investments in stores in important markets, and contributed over $300 million to our pension and post-retirement plans. We invested just under $400 million in Sears Holdings share repurchases in 2010, a slight reduction from 2009....

"Share repurchases are not a panacea, nor are they a singular strategy. Yet they are more than just the return of capital to shareholders... As a form of discipline on alternative capital allocation strategies, share repurchases can magnify returns."
--ESL


Did He Really Say That?

“At Sears Holdings, we seek to create long-term value for our shareholders. Like Apple, we seek to do so by improving our operating performance, innovating, and delighting customers…”
—ESL

[Editor's Note: The first and last time you will see 'Apple' and 'Sears' in the same sentence, at least for some time to come.]

“As one investor said in 2009: ‘This is worse than divorce. I’ve lost half my net worth—and I still have my wife.’”

—WEB

[Editor’s Note: Buffett’s letters have always been suffused with a 1950’s-era Hugh Hefner-style male/female sensibility, but it never ceases to amaze us that he continues with the nagging-wife jokes]


On ‘Painting the Bull’s-Eye’ of Performance

“Charlie and I believe that those entrusted with handling the funds of others should establish performance goals at the onset of their stewardship. Lacking such standards, managements are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands…. To eliminate subjectivity, we therefore use an understated proxy for intrinsic value—book value—when measuring our performance.”
—WEB

“Despite our challenging performance over the past several years, the difficult economic environment, and the dramatically changing retail environment, we have generated very attractive returns for shareholders since May 2003, when we assisted Kmart in its emergence from bankruptcy.”

—ESL

[Editor’s Note: While SHLD stock has more than quadrupled from the aforementioned May 2003 "bull's-eye," it is in fact down more than 50% from its 2007 peak.]


What Happens to the Wrong Managers

“This requires us to part ways with some who have given great effort, but who have fallen short of the performance required for us to be competitive.”
—ESL

“Our compensation programs, our annual meeting and even our annual reports are all designed with an eye to reinforcing the Berkshire culture, and making it one that will repel and expel managers of a different bent.”

—WEB


What Happens to the Right Managers

“We will continue to provide great opportunities for talented individuals to run businesses, while holding them accountable for performance.”
—ESL

“Many of our CEOs are independently wealthy and work only because they love what they do. They are volunteers, not mercenaries. Because no one can offer them a job they would enjoy more, they can’t be lured away.”

—WEB


On Throwing Good Money after Bad

“At Berkshire we face no institutional restraints when we deploy capital… When I took control of Berkshire in 1965…the dumbest thing I could have done was to pursue 'opportunities' to improve and expand the existing textile operation—so for years that’s exactly what I did. And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh! Eventually I came to my senses, heading first into insurance and then into other businesses.”
—WEB

“We have a need to manage the scale of our operations at the same time as we transform them. The activities required for transformation are vast and time-consuming. As the retail industry is reinvented, we intend and expect Sears Holdings to be a significant player in this reinvention.”

—ESL


Sentences We Didn’t Want to Read

“By aligning our associates with our customers, not with our stores or products, we believe this reinvention will play out in our favor.”
—ESL

[Editor’s Note: That was perhaps the most astonishing sentence we have ever seen in a Chairman’s Letter—the runner-up being the one that follows.]

“To update Aesop, a girl in a convertible is worth five in the phone book.”

—WEB


Jeff Matthews
I Am Not Making This Up

© 2011 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


19 comments:

Anonymous said...

I'd rather bet on Eddie vs Warren. Warren is nearly done with his career. It's been a great ride but risk reward is skewed to Eddie vs Warren. How much will BRK drop when Warren retires? Eddie has potential to take Sears private and still has HUGE opportunity to transform a business. Perhaps Eddie's day is still ahead. One thing that is clear. These guys are polar opposites. One is liberal and one is conservative. One is aweshucks in public and ruthless in private. One is reclusive in public and couldn't be nicer in private. As you can tell I am a friend of Eddie's and have a bias. He's one of the stronger thinkers I've ever been around.

Anonymous said...

Jeff:
Have you considered that your analysis of Buffett v Lampert is clouded by the halo effect? Buffett is a legend and is sitting on top of the world and it tends to have a strong impact of how people perceive what he's doing. Lampert has hit a rought spot and I think that likewise colors people's assessment of him. It reminds me of Cisco where pre bubble people though that everything they did was perfect and then post bubble people thought that everything they did was poor and then later everything they did was pretty good - people have trouble make judgments of elements of a person or business independent of their overall assessment. Like first anonymous, I wonder if three years from now your article might be one you regret. Keep up the good work.
- American Bandersnatch

Jeff Matthews said...

AB: Thanks for your thoughtful input.

I say right up front that it's easier to write about good news than bad news, and Sears hasn't had much good news for many years.

And, yes, if Lampert were writing about Autozone, which has been one of the all-time great retail investments of anybody's career (and why I call him 'without peer'), the letter would be more fun reading.

But the letter is about Sears, and much of what Lampert writes struck me as, frankly, delusional and bizarre. The comparisons with Apple were just one example. More importantly, the operational stuff seemed to have very little substance.

As for the comparison to Cisco (which I think might apply more to Apple, where nobody thinks anything can ever go wrong), it's been 7 years since the K-Mart merger. That's a long time, and yet Sears Holdings continues to lose customers, market share and relevance.

Will this change? I don't believe so. Sears spent $400 million last year on its stores: Wal-mart spent $12 billion. That's a losing battle.

So I'll wager that 3 or 5 years from now, Lampert will have continued to extract cash from Sears, and the investment may look good on a per-share basis (post buybacks)...but that Sears will be smaller than it is today and even less relevant.

But your comments are worthwhile and appreciated.

Best,

JM

Anonymous said...

Jeff:

"Will this change? I don't believe so. Sears spent $400 million last year on its stores: Wal-mart spent $12 billion. That's a losing battle."

This statement somehow assumes that Eddie is trying to fight this battle. I don't think that's the case. He's clearly not investing in the stores. He's more interested in per share return than in taking on Walmart. I do agree that some of his letter was a bit bizarre and lacking substance. His use of his letter as a political soapbox was rather odd as well.

Wilber said...

Interesting idea, in a week when many of us have read the two very different letters. Two other parallels struck me:

(1) Hiring: Lampert comes right out and says that you can't just hire people if they won't do any good for the company: Business leaders don’t sit around thinking, “How can we create more jobs?” They think about, “How can we create more value?” or, “How can we create more and better products?” or, “How can we grow our company?” The addition of new jobs in any business is driven by these types of questions and answers to them.

Buffett would never be so cruel as to come out and say that you may have to fire people when you don't have work for them. But then there's this: "Our businesses related to home construction, however, continue to struggle.
Johns Manville, MiTek, Shaw and Acme Brick have maintained their competitive positions, but their profits are
far below the levels of a few years ago. Combined, these operations earned $362 million pre-tax in 2010
compared to $1.3 billion in 2006, and their employment has fallen by about 9,400."

Yes, employment just 'fell'. Not 'we had to cut 9400 people', or anything nasty like that.

(2) Patience with a failing business.
Buffett: The dumbest thing I could have done was to
pursue “opportunities” to improve and expand the existing textile operation – so for years that’s exactly what I
did. And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh!
Eventually I came to my senses, heading first into insurance and then into other industries.

And ESL: Despite our challenging performance over the past several years, the difficult economic environment, and the dramatically changing retail environment, we have generated very attractive returns for shareholders since May 2003, when we assisted Kmart in its emergence from bankruptcy. Others in our industry have grown their revenues since that time, some have grown their profits, but many have been unable to deliver shareholder performance in the past eight years.

I think the story will end up with more similarities than differences, as Sears and Kmart become like Berkshire and Hathaway Mills.

Anonymous said...

Hey Jeff-

I believe your article to be rather simplistic and more of a comparison of apples to oranges. Just as another poster commented, you are comparing Lampert's Sears after seven years to Buffett's Berkshire after forty some years. How about comparing Sears now to Berkshire seven years after Buffett took control. Mr Buffett admitts thats Berkshire Hathaway was one of his worst investments. If you read his early letters you will see how he tried to improve the textile operations much to his and his shareholders disappointment and frustration. I look forward to reading your next article comparing Sears to Berkshire seven years after their current Chairman took over! Rather than just cutting and pasting from their current letters.

Me said...

I would argue the inconsistency here is still one of timing. Both Warren and Lampert are doing the same thing, which is allocating capital to areas where the return exceeds the cost of capital, and away from areas where the return is declining.

We are looking at a Berkshire that has already harvested cash from the textiles and funneled it into higher return opportunities. In this case it can now afford to double down on some of these.

Lampert is doing exactly the same thing, he's just earlier in its development. The priority as an asset manager is the return on capital not the longevity of Sears as an operating entity, and I actually think Lampert would be wasting money to plow it back into Sears without seeking significant change.

The real WEB letter to compare with this would be a Berkshire letter from 65 or 66 when Buffett was still working on what to do with Berkshire, and when he was already allocating any surplus cash from that vehicle elsewhere.

The contrasts are still pretty severe, but i would argue its a function of timing. The 1965 WEB would recognize the fight Lampert is going through right now.

Jeff Matthews said...

Excellent comments and much appreciated.

Timing: Buffett took control of Berkshire in 1965. For a look after 12 years, read the 1977 letter, the earliest available at Berkshire's web site (Try this link http://www.berkshirehathaway.com/letters/1977.html).

You will find plain, straightforward talk, no rambling discourse on "delighting our customers," no comparison of Berkshire's textile operations with the Apple of its day (IBM?): only a sober evaluation of the merits of keeping the textile business versus closing it, before moving on to the vastly more important insurance operations and their investments.

I'd argue that Lampert--smart as he is (Autozone proves it)--isn't close to Buffett even on an apples-to-apples basis.

But, in a few years, we'll see.

JM

P.S. We did not post one or two comments (that happened to be highly complimentary) owing to the fact that they used sloppy Yahoo-message board type language. We will keep those off no matter how nice (or un-nice!) they are.

Anonymous said...

I think the difference between the two is, largely, that ESL thinks he can and wants to manage the business whereas WEB just wants to allocate capital. ESL would ve better off just allocating the capital, but it doesn't seem his ego will allow that.

JW

Anonymous said...

Mr. Matthews, you mention that Walmart spent 12 Billion in CapEx, but failed to mention that Walmart opened 34 million square feet of new retail space. 550 new stores and 34 Million square feet! Therefore, it's misleading to say that $12 Billion was spent on "reinvesting in their stores."

Jeff Matthews said...

Yes, good point. Not to mention the fact that much of WMT's spending is now outside the US.

So cut WMT's $12 billion total capex in half, and cut that number in half again if you like...it's $3billion versus $400 million at Sears.

Still no comparison.

JM

Anonymous said...

First Lampert, wordy as heck but spot-on correct I'm sure you'll agree:

"Share repurchases are not a panacea, nor are they a singular strategy. Yet, they are more than just the return of capital to shareholders. They represent an investment by the non-selling shareholders in the future of the business and the company. By repurchasing shares from selling shareholders, the remaining shareholders increase their ownership stake, thereby taking the additional risk and additional upside potential based upon future performance. When coupled with outstanding operating performance, share repurchases magnify returns. When the price paid is attractive relative to future performance, share repurchases magnify returns. As a form of discipline on alternative capital allocation strategies, share repurchases can magnify returns. But, at the wrong price, with poor future performance, share repurchases can harm returns."

---

You painted the Buffett v Lampert comparison beautifully -- tough comp as they say. But below is an example where share repurchases are described as pretty much a "singular strategy". I won't give away the Company in case you've not had the 'pleasure' of reading this yourself yet, but I can tell you I got ill reading this:

"Our strategy over recent years has been to use excess cash to buy back stock. We took a break from that in Q4 to reassess our cash needs and the buyback strategy, but plan to return to buying back stock in Q1. The objective of our buyback program is simply to return money to our shareholders, similar to a dividend; consequently, we are neither price sensitive nor market timers."

Ugh.

http://sec.gov/Archives/edgar/data/1065280/000119312511014840/dex991.htm

Jeff Matthews said...

Anon: Agree on Lampert's description of share repurchases.

As for naming the company quoted as being "neither price sensitive nor market-timers": a) it could be a hundred companies...I couldn't guess; b) it is sickening to read; c) it will end badly for them.

I like both Eddie's and Warren's approach much better. (And by the way Buffett has in the past admitted there were times when buying back Berkshire stock would have made sense, but then discusses why it might not have generated better returns over time.)

Thanks,

JM

Anonymous said...

Jeff, it's NETFLIX! Given all the light and heat around an avowed value investor's short, and then covering of short, of said company's common stock, I found it a particularly ironic and horrifying line!

-Ben

Peter said...

Hi Jeff,

I enjoyed your comparison very much in the spirit of what it was. We have all become somewhat numbed to the frantic parsing of Warren Buffett's annual letter in the hours after it is released. So, it was refreshing to see it compared to another substantial letter from another iconic CEO.

I know you mentioned Hugh M. Hefner simply as an aside, but with all this talk about apples and oranges in these posts, I thought that if you ever had some free time perhaps you could turn your thoughts and pen to how these two iconic heads of companies (HMH & WEB) have provided completely different outcomes to shareholders.

Once again, thanks for taking a different tack on these two letters.

PK

gds said...

Jeff - what are you referring to here "minority-controlled subsidiaries"?

Jeff Matthews said...

GDS: Sorry, fast-typing error. Should have been "majority-controlled" and it was referring to Sears Canada.

Thanks,
JM

Bogey said...

This is a great Buffet/Sokol hypothetical.

http://clearandpresent.com/2011/04/04/warren-buffet-and-david-sokol-meet-to-discuss-lubrizol-apple-goldman-sachs-and-other-berkshire-hathaway-matters/

Anonymous said...

ESL defenders seem intent to miss the contrasting philosophies of ESL and WEB, that Jeff went to the trouble of substantiating.

The 'operational' and 'personnel' items are particularly egregious on the part of ESL. It's why he is becoming the Dan Snyder of retailing.