There have been few investments that have promised so much yet achieved so little as Sears Holdings Corp. (SHLD, Financial).
The Sears story began nearly two decades ago. In 2002, hedge fund manager Edward Lampert (Trades, Portfolio), out to make a name for himself, masterminded the merger of Kmart Holding Corp. and Sears, Roebuck & Co.
Lampert bought a controlling stake in Kmart and rescued the bankrupt retailer. He observed the real estate blocks under the 1,500 stores were precious. After stabilizing the company, he sold 68 of the company’s stores to Home Depot Inc. (HD, Financial) and Sears. This transaction earned him $850 million, which was almost equal to the amount he paid for all the real estate blocks. Finally, he closed down 300 stores and laid off 34,000 workers to cut costs. The value of Kmart’s shares increased from $15 in March 2002 to $150 by mid-2005. In 2004, Sears and Kmart merged, making Sears Holdings the country’s third-largest retailer.
“Alan, Alwin and I believe these changes will achieve greater clarity in our operating management and align this corporate structure with our vision of Sears Holdings," Lampert said. "Our goal is to build one company with multiple ways of connecting with our customers, including our various store formats, online offerings, service relations and credit products.” Â
The new wunderkind
Lampert’s initial success with Sears and Kmart paid off handsomely for the financier. His hedge fund, ESL Investments, returned 29% per annum from inception to 2012, growing the initial $28 million seed investment into a $9 billion fund.
In recent years, Sears has caved in on itself, and Lampert’s reputation has faded from Wall Street star to Wall Street pariah. In an attempt to keep the lights on, the company has shed its most attractive assets, including its Craftsman brand to Stanley Black & Decker Inc. (SWK, Financial), Lands’ End Inc. (LE, Financial), a retail brand that once perfromed strongly, and a portfolio of its most attractive real estate assets.
While these sales have been taking place, the company has neglected its core store portfolio, so customers are flocking to other retailers.
Finding value
Is there any value left in Sears? There could be, but this is not a trade for the faint of heart.
One of the company’s largest shareholders is Bruce Berkowitz (Trades, Portfolio). Named mutual fund manager of the decade in 2010, Berkowitz’s fund reached $20 billion in assets under management in 2011. Since the Fairholme Fund (Trades, Portfolio) was started in 1999, it has delivered an annualized total return of about 10% versus about 5% for the Standard & Poor's 500 according to Morningstar – that is not a bad record considering the market peaks and troughs during this period.
Earlier this year, Berkowitz told the Wall Street Journal he is still positive on the outlook for Sears because “The deaths of today’s malls and other enclosed spaces is greatly exaggerated."
The article continued:
"He believes restaurants are returning to malls but in the form of outdoor eateries. Mr. Berkowitz said traditional clothing chains may die, but their space will be replaced by movie theaters and auto showrooms. As online retailers reshape shopping, he says the parking lots and properties traditional retailers occupied will be redeveloped and used for new services or homes."
As malls rebuild their offering, Berkowitz believes Sears’ anchor properties will regain their value, given their footprint and location. The doubters might question whether or not malls are relevant in today’s world where Amazon (AMZN, Financial) dominates, but the former star fund manager believes the value lies in the parking lots.
“No one thinks about the parking lots. Those already have infrastructure, highways, secondary roads, sewers, water systems,” he said.
Closing down sale
Of course, this thesis makes little sense if Sears goes out of business, which at this point seems likely. The company’s annual report for the fiscal year ended January 2016 contained a concerning statement: “Our historical operating results indicate substantial doubt exists related to the company's ability to continue as a going concern." That is a warning no investor ever wants to see in a report.
Nevertheless, for the time being Lampert has been willing to bankroll the retailer. He has lent Sears $100 million at 11% to fund it for the holiday season and $1.7 billion in total.
There is still some value here. At the end of June, the company’s debt-asset ratio was around 50%, although total shareholder equity is negative. Still, in the first two months of the fiscal year, the group produced around $2 billion of gross profit.
Sears is not a total basket case. The chances of it making a turnaround are slim, however. Even though Lampert has saved a company before, it is unlikely he will be able to repeat his trick twice. I will be happy to be proven wrong.
Disclosure: The author owns no stocks mentioned.
