“If you're unwilling to try new things and to fail and learn, you don't have a shot. That doesn't mean you are going to be successful, but you have to try to change.” --Edward Lampert
For some 20 years, Edward Lampert (Trades, Portfolio), also known as Eddie, was a hedge fund power player, with returns averaging more than 20% a year.
Over the past decade, though, his name has become synonymous with Sears, which has not been a good thing. The retailer has struggled, bringing Lampert’s ESL Investments down with it.
But is that all there is to Lampert? And, is it a certainty that Sears must fail?
Who is Lampert?
According to Value Walk, Lampert became an intern at Goldman Sachs right after graduating from Yale. After completing his internship, he worked in the bank's risk arbitrage department.
But he did not stay long. In 1988, at age 26, he left to start his own firm, ESL Investments (named after his initials). Over the firm's first 20 years, he produced average annual returns of more than 20% (gross/net not specified), making him a superstar in the first decade of this century.
Lampert's name has become deeply intertwined with the Sears brand over the past 15 years. According to Business Insider, in 2002, he bought a controlling interest in another troubled retail chain: Kmart. His buy was motivated by the real estate assets of the company. He doubled down on retail two years later by investing enough to bring Sears into the fold. Following the merger, the combined company was called Sears Holdings Corp. (SHLD, Financial).
His leadership tenure at Sears has been controversial. Soon after setting up Sears Holdings and becoming its chairman, Lampert and the company began a share buyback campaign that lasted five years. Lampert defends the practice, saying it was the most efficient use of capital because further investment in stores was no longer necessary. Critics say the buybacks starved the company of capital it would need, forcing it to sell off assets to stay afloat.
The critics have an important point: while Lampert was engaged in buybacks, Amazon.com Inc. (AMZN, Financial) was reinvesting everything it could into its new platform.
What is ESL Investments?
ESL describes itself as an asset manager offering private investment funds. The firm is free to invest in a “broad” range of investment products, including equity and debt securities, fixed-income securities, convertibles, derivatives, swaps, options and other products.
Its clients are limited partnerships and limited liability companies formed in the U.S. and international jurisdictions. Specifically, they serve ultra-high-net-worth individuals and family offices as well as institutional investors. Clients may need to agree to a five-year lock-in period.
In its latest Form ADV, filed March 31, 2017, the firm listed just over $2 billion in discretionary assets under management. GuruFocus put its equity assets at $512 million on Nov. 14.
In 2012, Lampert moved ESL from the New York City area to Miami. The New York Post notes one of the consequences of that move appears to have been the loss of William Crowley, who had been president and chief operating officer for 13 years, while the positives included better tax treatment.
Strategy
Lampert says he is value-driven and bases his investment decisions on disciplined, extensive fundamental analysis and field research.
- The firm looks for good companies with strong fundamentals that are selling at a discount to their intrinsic value.
- It takes a bottom-up perspective. It focuses on the business models of individual companies, rather than sectors or industries.
- They like to stick with what they understand, eschewing macroeconomic factors or industries which they do not fully understand. Typically, most of its investments have been American companies through American markets.
- Lampert places a good deal of importance on management teams, looking for those that have shown their business skills, and focus on shareholder value.
A concentrated portfolio is the consequence of investments in a limited number of companies. When the firm finds opportunities, it makes a substantial investment. It does not aim for a diversified portfolio.
As for activism, ESL takes both passive and active positions. In cases of the former, they engage with management and the board to increase shareholder value, especially on capital allocation. Lampert says they prefer to work constructively with management and do not like to publicly air grievances. He serves on several boards and is chairman of Sears Holdings.
A long-term perspective comes with investment, as they look at a minimum of five years for a holding. This allows them to invest in companies that have temporarily fallen out of favor.
It is Lampert’s long and deep commitment to Sears Holdings that will no doubt define his legacy. Critics look at the competitive landscape as well as these fundamentals, and turn away:
On the other hand, Bruce Berkowitz (Trades, Portfolio) of Fairholme has taken a contrarian position. In his July 2017 letter to Fairholme Fund clients, he said, “From the ashes of failed retailers often come great real estate companies.” He points out the company “owns many valuable assets and there is huge value in optimizing all of them.”
Berkowitz adds that Sears continues to speed up its operational restructuring and should hit $1.25 billion per year in cost savings. Further, Amazon has begun offering Kenmore appliances along with Sears warranty, delivery and installation services and “Shop Your Way,” the company's online platform, already has millions of members.
The market, though, does not share Berkowitz’s optimism. This GuruFocus chart from 2003 through the present shows the share price slide that has occurred since 2008:
Over the past 10 years, investors have bid down the price of Sears from $128.81 to $2.35.
In addition, Berkowitz himself has been selling Sears stock since that expression of confidence in mid-2017. Most recently, TheStreet reported he had sold 8 million shares in January.
Lampert and ESL Investments should have the edge in what, so far, has been a losing tug of war. He is a seasoned value investor who has the knowledge to understand the company, patience and has had a front-row seat to watch Sears’ decline.
Holdings
This sectoral chart shows Lampert’s equity commitment to the retail industry:
It is also a concentrated, or high-conviction, portfolio with just six stocks; at the end of the third quarter of 2017, these were his holdings:
- AutoNation Inc. (AN, Financial): 45.7%
- Sears Holdings Corp. (SHLD, Financial): 29.26%
- Lands' End Inc. (LE, Financial): 16.15%
- Seritage Growth Properties Class A (SRG, Financial): 4.69%
- Sears Hometown and Outlet Stores Inc. (SHOS, Financial): 2.37%
- Sears Holdings Corp. (SHLD.WS, Financial): 1.83%
Although Lampert has six stocks in his equity portfolio, it is even more concentrated than it first appears: Lands’ End, Seritage, Sears Hometown and the Sears warrants were all spun out of or originated with the Sears parent company. Essentially, it is a two-stock portfolio: Sears along with long-time investment AutoNation.
ValueWalk reports Lampert successfully helped AutoNation restructure, which added significantly to the company's value. The following chart shows AutoNation's price chart (with and without Lampert):
Performance
As noted above, Business Insider said Lampert averaged more than 20% per year over his first 20 years, which would have been 1988 to 2008. ValueWalk has a different take: an average of 29% per year between inception and 2012, a 24-year span.
While no charts of his returns over the past several years appear to be available, Bloomberg offers a chart showing the decline in his net worth since March 2014 to the end of January 2018:
In addition, this chart shows how his equity assets under management have shrunk since 2007:
There’s no doubt Lampert was an exceptionally able investor in the first 20 years he operated his own company; unfortunately, there is also a high probability he has been an ineffective one over the past 10.
Conclusion
Still, there is a possibility, however remote, that Lampert will find a winning formula for Sears before all the assets are gone. If that is the case, he will become a hero rather than a goat.
Credit Lampert with one important value investing trait: persistence. There are few other gurus who would stick so long with a losing proposition; Lampert has not run away from a problem he helped create.
He has a vision of where he wants Sears to go, but questions about his ability to steer it there abound. For years, his stores have been run on a shoestring, and the company’s fundamentals show it.
While Lampert may be remembered for Sears, it’s arguably AutoNation that has been his key stock. Not only did his involvement with the company lead to improvements that have driven up the share price, but also provided ongoing cash flow, through sale of stock, to support his commitment to Sears.
Value investors will not find much to emulate or learn from Lampert’s philosophy or execution. He is a value investor, embracing many of Benjamin Graham’s principles, but most of them will already be familiar to investors who have done their homework. In addition, many value investors will question his ongoing involvement with a company like Sears that has so many depressed fundamentals.
Disclosure: I do not own shares in any of the companies listed, and do not expect to buy any in the next 72 hours.
