Thursday, December 29, 2011

More Blues at Sears

Back in February, in a post about the dubious benefits of shareholder control, we noted Sears as an example:

"The recent case of Sears comes to mind. Much was made, rightly so, of the fact that the management simply couldn't run or merchandise stores very well. Shareholders voted with their feet and sold the stock. The story then became the value of the underlying prime real estate that Sears owned or controlled. Meanwhile, another terrible cast of executives were busy fiddling while Kmart burned slowly. Enter hedge fund manager Ed Lampert who took control of Sear merged it with Kmart, while confusing both sets of customers, who were distinct segments of consumers. Years later, Sears' repeated experiments with soft goods have failed miserably, but we didn't need to a change of control to know they couldn't execute. The appliance and home and garden segments are still the reason most people enter the store. An iconic brand of American retailing seems on the precipice of going the way of Woolworth, W.T. Grant and Montgomery Ward. Last year ended with Sears comps down 6% for December and 3.8% for the year. The environment in Sears stores is positively funereal. Most of the analysts have downgraded to neutral or under perform, with a few sells. Has shareholder control been beneficial in this case? I don't believe so."

Recent results, along with a relatively small number of store closings, raise more questions than answers for me.  It seems clear to me that Ed Lampert has no real interest in turning Sears around, which will require investment in systems, store remodels, and a savvy, motivated management, which means more lousy quarters until a turnaround could take effect.  By the way, CBS MarketWatch "Lump of Coal" winner Bruce Berkowitz initated his large purchase of Sears for Fairholme Fund because of the investment by Lampert.

Here's what Berkowitz had to say about Sears back in 2008:
"I (Berkowitz)  think that he's (Lampert)  going to do it. And it's very reminiscent of what happened with Warren Buffett and Berkshire Hathaway in the early days (a laughable analogy!). If you play back the tape, Warren Buffett bought into Berkshire Hathaway, a textile mill, and he took many years to try and turn it around. He had deep respect for the employees; he really gave it his best shot. And then when he realized it wouldn't work, he then started to redeploy the assets and the free cash that was coming out of this industry that was destined to die. And that's how Berkshire Hathaway started.

Sears is the same situation. Sears has a great real-estate portfolio, and people are behaving as if it can only be used as retail space. And they have brands; some of them are quite good. The company has over $50 billion of revenue and is making money, and people are acting as if it's a company that's bleeding to death. People aren't looking at it in the right way. They are measuring it based as a retailer, and they are measuring it based on short-term net income profitability. But there are many more dimensions to Sears. Real estate can have a higher and best use. Today's anchor to a mall can be tomorrow's multipurpose, multiuse building where you can have office buildings, retail, and residential spaces."

Of course, the best thing that could happen would be that he turns around Sears and Kmart and it's a grand-slam home run. The worst thing that happens is he gives it his best shot and starts to find higher and better uses for all of the assets, from land to trademarks to online. If you can see three or four different ways where you can make an awful lot of money with a guy who has a record of making an awful lot of money, it's not such a bad thing."

What's the end game here? As a retailing story it has the familiar feel of Mervyn's or Monkey Ward's before they succumbed to liquidation.  I can't help but feel, without doing the analysis, that it has to be a vulture real estate transaction at the end game.  Right now, for example, we are just beginning to hear about rising demand for non-hospital medical real estate, for all sorts of specialty clinics and diagnostic centers.  There is also some suggestion that demand for non-conventional educational space may spill over into traditional shopping centers.  Sears still has lots of visible, high traffic anchor locations with good parking facilities. 

If traditional institutional shareholders throw in the towel and become apathetic, that's the perfect environment to prepare for a series of maneuvers that creates value for those who bought the stock right and who are willing to wait. 

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