Daniel Schmerin: Let’s move on, we received the most questions about Sears (SHLD, Financial).
How do you evaluate your investment in Sears today?
Bruce Berkowitz (Trades, Portfolio): Our thesis on Sears cannot be disproven: Sears has a vast real estate empire complemented by unique businesses. Sears also has constraints, and we understand those constraints. As part of our investment process, we developed progress checklists concerning Sears’ fixed obligations, balance sheet strength, footprint, pension fund obligations, the repurposing of real estate, and spinning off companies that would benefit from independence. We thought about all of the possibilities and the potential.
We do understand today that the retail world is morphing, and we understand the challenge of optimizing a huge set of company assets subject to those constraints. On our checklist the two remaining issues are pension fund obligations and retailing losses. The first, the pension fund obligation, should improve over time, especially with higher interest rates. The other remaining issue, the retail losses, is, in our opinion, voluntary, and is expected to stop this year.
Daniel Schmerin: We received several questions about the mistakes that Sears has made over the years, and the impact that those mistakes have had on our investment.
What are you views?
Bruce Berkowitz (Trades, Portfolio): Dan, nobody is perfect, and in hindsight it’s easy. Yes, Sears bought back stock too high. Yes, I was way, way too early in buying Sears stock for our shareholders. Yes, Sears’ pension obligation has been a larger consumer of cash than I anticipated, due in part to the prolonged low interest rate environment. I did not predict that the pension fund would chew up $2 billion of cash in recent years, which as of today is more than the entire market cap of the company.
Yes, these have been unforced errors that have caused a delay of game. It is taking longer than I thought to maximize and monetize the enormous asset base under the Sears umbrella than we would have expected, but it is happening. Last year’s spin-off of 266 properties to a newly formed real estate investment trust called Seritage is proof positive. And the nearly $32 of distributions that shareholders have received from other Sears corporate actions serves as additional proof.
Daniel Schmerin: Is it fathomable that the market is missing the huge gap between Sears’ current stock price and our estimate of intrinsic value, which you published in our Annual Letter last month?
Bruce Berkowitz (Trades, Portfolio): It’s not just fathomable, it’s today’s reality. Our shareholders have to remember Fairholme’s success to date is precisely based on this concept that having a unique viewpoint allows us to buy companies at tremendous discounts. It wasn’t that long ago that AIG was perceived to be dead; Bank of America was perceived to be dead; the entire financial system was about to go over the cliff. We disagreed, and we invested in financial companies and helped stabilize those companies to the benefit of our shareholders, and the country recovered.
We expect the same to be true of all our current investments, including Sears. The facts tell us that we own valuable assets at historic discounts. The facts determine our confidence and willingness to stay the course. Either Sears’ price is going to climb to our assessment of intrinsic value, or we are wrong about that value and it will decline toward the current stock price. Most likely the stock price and our estimate of intrinsic value will meet somewhere in the middle of this large range of possibilities, the same way it has happened for almost every investment at Fairholme.
Daniel Schmerin: We recognize Sears has spent a considerable amount of money trying to stay competitive in a rapidly changing retail environment.
Has it been worthwhile?
Bruce Berkowitz (Trades, Portfolio): I don’t know yet. If Sears is able to return to profitability this year, which is the company’s most important focus during 2016, then yes it has been worthwhile. A considerable portion of the past cash burn is voluntary based on the transformation of the retail businesses. The remaining portion is based upon the pension and rent expenses, which will go down with time. Again, Sears has been going through this metamorphosis, and its technology spending and Shop Your Way marketing spending has been very costly. However, we expect much of the heavy lifting is over, and those expenses should decline.
Daniel Schmerin: Three shareholders asked about the recent Schedule 13D filing, and the perception that you will push for change at Sears.
So what’s the truth?
Bruce Berkowitz (Trades, Portfolio): Fairholme owns over 25% of Sears’ stock as well as various other Sears-related securities. In mid-December we filed a Schedule 13D on our Sears position. We filed on behalf of our shareholders, and it is important that I express my views to the company. In fact, I was invited to express my views to the company just last month in front of their Board of Directors. I took that opportunity to explain Fairholme’s investment perspective on the company as a whole, as well as its various business units.
This included our view regarding the need to preserve the enormous value of its assets and the imperative to promptly return to profitability. I focused on the cash burn, and how the continuation of the cash burn does not build confidence or trust among all of Sears’ constituents – I’m talking about Sears’ customers, vendors, suppliers, employees, creditors, and investors.
I also discussed my belief that eliminating the cash burn will do more to optimize the value of Sears’ assets than any other action. I also shared my view for Sears to help shareholders better understand the company’s assets and strategies by giving them more information. The bottom line is not everyone has the ability to spend as much time studying Sears as we do. Most people only focus on stock price, and while it is wrong, it is human nature. I recognize that much of what Sears’ management has written has proven true. I recognize that most do not understand the vast asset base at Sears, and I recognize that most do not understand the complexity of optimizing all of the assets. More information and a little more hand holding may be helpful – it sure won’t hurt.
I must tell you after I gave my thoughts to the Board and left, I did not sense any disagreement among the Board with any of the points that I raised. I left feeling that we were squarely on the same page. I clearly believe that they know what to do and my views were not revolutionary at all. Also, it is important to note that as I left, there appeared to be an appropriate sense of urgency for these matters.
From Bruce Berkowitz (Trades, Portfolio)'s Feb. 23, 2016, Fairholme Fund (Trades, Portfolio) conference call.
