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Is Sears the Next Berkshire Hathaway?

January 10, 2013 | About:


A well-respected value investor buys an old American company in decline, promising to restore its fortunes. Alas, the recovery never comes. The economics of the industry have changed, and the company cannot compete with younger, nimbler rivals. The company ceases operations, but the value investor holds onto the shell to use as an investment vehicle.

Could this be the future of Sears Holdings (SHLD) under Eddie Lampert? Maybe; maybe not. But it was certainly the case for Warren Buffett’s Berkshire Hathaway (BRK-A).

Unless you’re a history buff or a dedicated Buffett disciple, you might not have known that Berkshire Hathaway was not always an insurance and investment conglomerate. It was a textile mill, and not a particularly profitable one. It was, however, a cash cow. And after buying the company in 1964, Buffett used the cash that the declining textile business threw off to make many of the investments he is now famous for, starting with insurance company Geico.

So, when hedge fund superstar Eddie Lampert first brought Kmart out of bankruptcy in 2003, the parallels were obvious. With its debts discharged, the retailer would throw off plenty of cash to fund Lampert’s future investments. And even if the retail business continued to struggle, Lampert could—and did—sell off some of the company’s prime real estate to retailers in a better position to use it. Lampert sold 18 stores to the Home Depot (HD) for a combined $271 million in the first year.

That Lampert would use Kmart’s pristine balance sheet to purchase Sears, Roebuck, & Co.—itself a struggling retailer—seemed somewhat odd, but his management decisions after the merger seemed to confirm that his strategy was cash cow milking. Lampert continued to talk up the combined retailer’s prospects, of course. But his emphasis was on relentless cost cutting, and he invested only the absolute bare minimum to keep the doors open. Sears Holdings didn’t have to compete with the likes of Home Depot or Wal-Mart (WMT). It just had to stay in business long enough for Lampert to wring out every dollar he could before selling off the company’s assets.

The strategy might have played out just fine were it not for the bursting of the housing bubble—which killed demand for the company’s Kenmore appliances and Craftsman tools—and the onset of the worst recession in decades. With retail sales in the toilet (and looking to stay there for a while), there was little demand among competing retailers for the company’s real estate assets.

It’s fair to blame Lampert for making what was, in effect, a major real estate investment near the peak of the biggest real estate bubble in American history. But investors frustrated by watching the share price fall by more than 80 percent from its 2007 highs have no one to blame but themselves. Anyone who bought Sears when it traded for nearly $200 per share clearly didn’t do their homework. They instead were hoping to ride Lampert’s coattails while somehow ignoring the value investor’s core principle of maintaining safety by not overpaying for assets.

Lampert is a great investor with a great long-term track record, and there is nothing wrong with paying a modest “Lampert premium” for shares of Sears Holdings. If you like Lampert’s investment style but lack the means to invest in his hedge fund, Sears may be the closest you can get. But at $200 per share—or even $100—the Lampert premium had been blown completely out of proportion. The same is true of Buffett, of course, or of any great investor. As the Sage of Omaha would no doubt agree, there is a price at which Berkshire Hathaway is no longer attractive either.

This brings us back to the title of this piece—is Sears the Next Berkshire Hathaway?

I would answer “yes,” but not necessarily for the reasons you think.

Everyone assumes that Buffett’s decision to buy Berkshire Hathaway was a typical Buffett stroke of genius. Nothing could be further from the truth. In fact, Buffett revealed in an interview last year that Berkshire Hathaway was the worst trade of his career.



If you cannot view the video above, please follow this link: “Buffett’s Worst Trade
We like to think of Warren Buffett as the wise, elder statesman of the investment profession, but Buffett too was young once and prone to the rash behavior of youth. He had been trading Berkshire Hathaway’s stock in his hedge fund; he noticed that when the company would sell off an underperforming mill, it would use the proceeds to buy back stock. Buffett intended to sell Berkshire Hathaway its own stock back for a small, tidy profit.

Warren-Buffett-300x210.jpgWe’ve all been there, Warren.

But due to a tender offer that Buffett took as a personal insult, he essentially bought a controlling interest in the company so that he could have the pleasure of firing its CEO. And though it might have given him satisfaction at the time, Buffett called the move a “200-billion-dollar mistake.”

Why? Because Buffett wasted precious time and capital on a textile mill in terminal decline rather than allocate his funds in something more profitable—in his case, insurance. Berkshire Hathaway will still go down in history as one of the greatest investment success stories in history. But by Buffett’s own admission, he would have had far greater returns over his career had he never touched it.

So, in a word, “yes.” Sears probably is the next Berkshire Hathaway. And investors who buy Sears at a reasonable price will most likely enjoy enviable long-term returns as Lampert’s plans are eventually realized. But Mr. Lampert himself will almost certainly come to regret buying the company—if he doesn’t already.

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About the author:

Charles Sizemore
Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management. Please contact our offices today for a portfolio consultation.

Mr. Sizemore has been a repeat guest on Fox Business News, has been quoted in Barron’s Magazine and the Wall Street Journal, and has been published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures, and Options Magazine and The Daily Reckoning.

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Rating: 2.9/5 (12 votes)

Comments

ramands123
Ramands123 - 1 year ago


For the price it is selling now, you are getting the entire real estate , brands and future of Eddie Lampart for free.Thanks Bruce Berkowitch for this great find.

Investor who are looking Sears mainly from income statement standpoint would find out some time in the future what a terrible mistake it was to not focus properly on balance sheet.
GrizzlyRock Capital
GrizzlyRock Capital - 1 year ago
I respectively disagree. Sear's best assets are real estate and brands. And the monetization has "been coming" for 8 years and 4 CEOs. I don't think ESL wants to run this as a public company. He has his HF. I think SHLD ultimately gets broken up and sold
ramands123
Ramands123 - 1 year ago
Ofcourse value is in the real estate which is selling for free at current price...You make money either way ..either Eddy revives it or he sells itin parts ..i love these bets where you win on both sides. Ofcourse institutional investors cannot play such bets because they have fluid capital but individual investors with permanent capital like us can enjoy the volatile but rewarding ride.

jonmonsea
Jonmonsea premium member - 1 year ago
This article was published a year ago. Should G-Focus not have a rule on recycling material?

http://www.gurufocus.com/news/156900/is-sears-the-next-berkshire-hathaway-and-eddie-lampert-the-next-warren-buffett-shld-brka-brkb
Jimbot
Jimbot - 1 year ago
I understand the rationale (company is selling at a low price, real estate free). But tell me: whose going to buy all of this real estate?

I can't think of any big retail chain stores that would want to buy the stand alone stores...Costco seems pretty methodical how they approach placing new stores, and they seem to grow relatively slowly...Some of the more successful retailers might absorb a few (Target, Wal-Mart), but I'm sure just a few, and in select locations.

Ditto the mall anchor locations. Who would want to buy those? I would think the successful department stores (Nordstrom, etc.) aren't in growth mode either and are already pretty much where they want to be (questionable macroeconomic outlook; threat of Internet retail sales, etc.)

So what do you do with with a bunch of empty big box mall anchor stores? What can the mall do with them if they wanted to buy them back and can't find tenants? Turn them into the ultimate mega giant 2 (or 3) story food courts?

I will continue to avoid investing in Sears - even with the free real estate.

sjzhao2003
Sjzhao2003 - 1 year ago
Will Lampert milk the SHLD cow and invest it in other better businesses? So far, he hasn't done that after 8 years.

Then buying SHLD becomes a simple asset play with stagnant asset value, where the return depends on two things: 1) How long will it take to unlock the hidden value by selling off the assets? It's only beginning after 7, 8 years. Remember the longer it takes, the lower your return. 2) What is your opportunity cost? If you can find alternative investments with attractive returns, the opportunity cost will be pretty high. With these two considerations, the investment thesis in SHLD is not that compelling, at least to me.
w1omega
W1omega - 1 year ago
I think it's a mistake to think the RE assets are worthless. How about Zara for mall properties? How about Forever 21? REI? How about Chinese retailer? Old Kmart in my old neighborhood turned into Ranch 99 - an Asian grocery store. Old Mervyn's location turned into a H-Mart - a Korean grocery chain with Asian food court. Comparing RE assets of Sears to Berkshire's mills operation doesn't make sense IMO. Berkowitz seems to be implying more and more that Sears is worth more dead, which I agree with. It's hard to argue Sears is exercising "best use" of the properties it owns.

It seems like a no brainer to me what Mr. Lampert should do. Steal some great execs from Simon Property Group and turn it into a REIT. But then again, 300,000 people that work for Sears retail would lose jobs and Lampert seems serious about transforming retail. Transforming anything must be pretty hard. Still, I don't think he's crazy, so either he succeeds (unlikely) soon or give up eventually. Maybe the question you should ask is whether Lampert is insane or not?
batbeer2
Batbeer2 premium member - 1 year ago
>> 1) How long will it take to unlock the hidden value by selling off the assets?

HUH?

1) If you own a house, do you need to sell it just to prove it's worth something?

2) What does "unlocking the value" mean? Last time I checked, an ounce of gold did not become worth more by taking it out of the vault.

Selling (or spinning off) the RE will allow an accountant to write a higher number on the balance sheet and some earnings on the income statement (that's generally what happens if book value rises).... but it doesn't add value.
sjzhao2003
Sjzhao2003 - 1 year ago
It may not add value but it certainly reduces the discrepancy between the perceived value and actual value.

It means getting people to realize or give full credit to the value of the assets on its balance sheet. If people appropriately value the businesses SHLD spun off, why did the shares go up after spinoff announcements? If an asset sits on the balance and doesn't produce cash or isn't fully recognized, it's dead money until its full value is pointed out.

The point is that all these suggestions about RE assets are POSSIBILITIES that may eventually bring out the true value of the business/assets, but we don't know if and when those possibilities will materialize, and I think people tend to underestimate opportunity costs. I for one would not sacrifice the certainty of getting a decent reward for the mere HOPE of getting perhaps a bigger reward.
batbeer2
Batbeer2 premium member - 1 year ago
>> It may not add value but it certainly reduces the discrepancy between the perceived value and actual value.

Yes.

>> The point is that all these suggestions about RE assets are POSSIBILITIES that may eventually bring out the true value of the business/assets

My point is that the value is either there or it's not. It does not need to be "brought about".

If you have an opportunity to buy a decent family home in a decent neighborhood in Chicago for $5 000, it's a bargain. You do not have to flip it the next day to prove that. Neither do you need to rent it out to someone to produce FCF either. In short, you do not need to know what happens next to conclude it is a bargain.

Investors who pass on any stock only because it has negative earnings, are in effect saying a home without renters is worthless.

Re opportunity cost:

Is there anyone out there that can squeeze something out of US retail property better than Eddy Lampert?

If so, who? If Lampert sells the assets to someone less capable, value is destroyed.


>> If people appropriately value the businesses SHLD spun off, why did the shares go up after spinoff announcements?

Indeed, they (traders) don't. To me, that's good.

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