It has been a long time since I took a serious look at Sears (SHLD, Financial) and was a little shocked by how far the share price had fallen. As I tried to re-familiarize myself with the current state of affairs with the company I came across an interesting section in the most recent Sears letter to shareholders.
Of course Lampert’s policy has been to aggressively buy back shares virtually non-stop. Far different that what Buffett did with Berkshire Hathaway and certainly different than what most of us expected when he took over the company.
His discussion uses references to Apple (cash retention) and Microsoft (Buybacks and dividends) to make his point.
Shareholder Value
In 2010, Apple (AAPL, Financial) surpassed Microsoft (MSFT, Financial) in total market capitalization, making it the most valuable technology company in the world and the second most valuable company overall after Exxon Mobil (XOM).
In Apple’s case, its market capitalization increase has been driven by two factors. First, Apple has delivered incredible improvements in operating performance resulting from a decade of innovation, both in product design and in business model. The creation of iTunes and the App Store coupled with the creation of the iPod and the iPhone defied the conventional wisdom that success required open systems. At a time of increasing openness and interoperability of software and hardware, Apple promoted its own proprietary systems, keeping tight control over the design and integration of its products and the applications that make them useful. It developed a system for protecting the intellectual property of music companies and a system for promoting the properties of independent application developers based upon a combination of ratings and micropayments.
Second, Apple has neither repurchased shares nor paid a dividend since 2003. Currently, Apple sits on about $60 billion of cash and investments, while generating almost $20 billion in cash (after-tax) over the last year. It is the combination of spectacular operating performance and cash retention that has led to a market capitalization that eclipses all but Exxon Mobil.
In contrast, over the past four years, Microsoft has repurchased around $40 billion of its own shares, in addition to paying out almost $18 billion of dividends, for a total of almost $60 billion or about the same amount of cash that Apple currently carries on its balance sheet. Despite this, Microsoft still carries almost $50 billion in cash and investments. Had Microsoft set a goal to have its overall market value be higher than other companies, there are many things it could have done to make this happen, including not repurchasing shares or paying dividends.
Suppose, for example, that Microsoft had not returned $60 billion in cash to shareholders over the past four years. In that case, its market capitalization would have been $60 billion higher than it is today. Meanwhile, suppose that Apple returned to shareholders the $60 billion in cash and investments currently on its balance sheet. Then Microsoft’s market capitalization would currently be higher than Apple’s. The point is that the attention some have placed on overall market value rather than per share value is misplaced from the vantage point of an investor in a company. Sheer size may make for interesting headlines, but it may distract from doing the optimal things for the shareholders of a business. (Apple’s per share performance, by the way, has also been spectacular.)
If one owns 10% of a company, or 1% of a company or .0000001% of a company, what matters is how that investment fares over time. A company worth $1 billion that doubles in value to $2 billion only doubles an owner’s investment if the number of shares outstanding remains constant. Merging with another company with a $1 billion market capitalization and issuing shares to effect that merger would leave the 10% owner of a $1 billion company with a 5% stake in a $2 billion market value company. In both cases, the value of that investment is $100 million. Taking that logic down to the lowest possible unit, 1 share, serves to demonstrate and emphasize the logic of focusing on per share value as the key measure for shareholders.
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. In this area, we have fallen far short of our goals and what we aspire to do in the future. On the second dimension of capital allocation, I believe that our behavior and focus has served our shareholders well over the past eight years and will magnify the value creation when our operating performance improves. We built cash when we felt that it was the right decision for our shareholders, and we delivered cash to those who elected to sell their shares when we felt that it was the right thing to do.
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.
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.
In order for us to fulfill the potential of the company, we need to improve. We will continue to provide great opportunities for talented individuals to run businesses, while holding them accountable for performance. 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. By aligning our associates with our customers, not with our stores or products, we believe this reinvention will play out in our favor.
Of course Lampert’s policy has been to aggressively buy back shares virtually non-stop. Far different that what Buffett did with Berkshire Hathaway and certainly different than what most of us expected when he took over the company.
His discussion uses references to Apple (cash retention) and Microsoft (Buybacks and dividends) to make his point.
Shareholder Value
In 2010, Apple (AAPL, Financial) surpassed Microsoft (MSFT, Financial) in total market capitalization, making it the most valuable technology company in the world and the second most valuable company overall after Exxon Mobil (XOM).
In Apple’s case, its market capitalization increase has been driven by two factors. First, Apple has delivered incredible improvements in operating performance resulting from a decade of innovation, both in product design and in business model. The creation of iTunes and the App Store coupled with the creation of the iPod and the iPhone defied the conventional wisdom that success required open systems. At a time of increasing openness and interoperability of software and hardware, Apple promoted its own proprietary systems, keeping tight control over the design and integration of its products and the applications that make them useful. It developed a system for protecting the intellectual property of music companies and a system for promoting the properties of independent application developers based upon a combination of ratings and micropayments.
Second, Apple has neither repurchased shares nor paid a dividend since 2003. Currently, Apple sits on about $60 billion of cash and investments, while generating almost $20 billion in cash (after-tax) over the last year. It is the combination of spectacular operating performance and cash retention that has led to a market capitalization that eclipses all but Exxon Mobil.
In contrast, over the past four years, Microsoft has repurchased around $40 billion of its own shares, in addition to paying out almost $18 billion of dividends, for a total of almost $60 billion or about the same amount of cash that Apple currently carries on its balance sheet. Despite this, Microsoft still carries almost $50 billion in cash and investments. Had Microsoft set a goal to have its overall market value be higher than other companies, there are many things it could have done to make this happen, including not repurchasing shares or paying dividends.
Suppose, for example, that Microsoft had not returned $60 billion in cash to shareholders over the past four years. In that case, its market capitalization would have been $60 billion higher than it is today. Meanwhile, suppose that Apple returned to shareholders the $60 billion in cash and investments currently on its balance sheet. Then Microsoft’s market capitalization would currently be higher than Apple’s. The point is that the attention some have placed on overall market value rather than per share value is misplaced from the vantage point of an investor in a company. Sheer size may make for interesting headlines, but it may distract from doing the optimal things for the shareholders of a business. (Apple’s per share performance, by the way, has also been spectacular.)
If one owns 10% of a company, or 1% of a company or .0000001% of a company, what matters is how that investment fares over time. A company worth $1 billion that doubles in value to $2 billion only doubles an owner’s investment if the number of shares outstanding remains constant. Merging with another company with a $1 billion market capitalization and issuing shares to effect that merger would leave the 10% owner of a $1 billion company with a 5% stake in a $2 billion market value company. In both cases, the value of that investment is $100 million. Taking that logic down to the lowest possible unit, 1 share, serves to demonstrate and emphasize the logic of focusing on per share value as the key measure for shareholders.
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. In this area, we have fallen far short of our goals and what we aspire to do in the future. On the second dimension of capital allocation, I believe that our behavior and focus has served our shareholders well over the past eight years and will magnify the value creation when our operating performance improves. We built cash when we felt that it was the right decision for our shareholders, and we delivered cash to those who elected to sell their shares when we felt that it was the right thing to do.
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.
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.
In order for us to fulfill the potential of the company, we need to improve. We will continue to provide great opportunities for talented individuals to run businesses, while holding them accountable for performance. 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. By aligning our associates with our customers, not with our stores or products, we believe this reinvention will play out in our favor.
