Last week, Bay Harbor Islands, Fla.-based hedge fund ESL Investments unveiled a plan to rescue one of the icons of American retail: Sears Holdings Corp., which owns the Sears and Kmart brands. However, experts warn that ESL likely stands to gain more from the restructuring than Sears Holdings, and they note there is a potentially large conflict of interest, because Sears CEO and chairman Edward Lampert also owns the hedge fund, which is the retailer’s largest shareholder.
ESL’s plan for Sears’ restructuring called for the retailer to sell real estate assets to extinguish related debt of $1.5 billion, as well as restructure $1.1 billion in debt, according to a filing with the Securities and Exchange Commission. The plan is expected to cut debt by 78% to $1.2 billion and lower annual interest expense by 80% to $88 million. Earlier this month, Sears posted a net loss of $508 million ($4.68 per share) for its fiscal second quarter, which was more than double the $250 million ($2.33 per share) in losses incurred in the same quarter last year. Revenues plunged from $4.3 billion to $3.2 billion during the same period.
Sears — which traces its storied history to 1886 when station agent Richard Sears sold a batch of watches to other agents to earn extra income — became Sears Holdings in an $11.5 billion merger with Kmart in 2005. Lampert steered that merger after buying Kmart in 2003, and became Sears CEO in 2013. The company had 3,500 stores in the U.S. at the time of the merger, but asset sales over the years have reduced its store count to 820 currently. ESL stressed the urgency of its revival plan for Sears, pointing to a $134 million debt repayment that is due by Oct. 15. It pushed to implement its plan while Sears is “a going concern, rather than alternatives that would substantially reduce, if not eliminate, value for stakeholders.”
Missed Targets?
ESL’s restructuring plan for Sears does not address the company’s core business issues, according to Mark A. Cohen, director of retail studies at Columbia Business School. Cohen is a former chairman and CEO of Sears Canada, Lazarus Department Stores and Bradlees. “This is the candle finally burning itself down and soon to be out,” he said. “This is a 13-year-long sham that’s run its course, and is about to run its course to the very end.” In 2004, Sears Canada terminated Cohen’s contract “over ‘strategic differences’ in the future direction of the business,” according to CBC.
Barbara Kahn, a Wharton marketing professor and author of the book, The Shopping Revolution: How Successful Retailers Win Customers in an Era of Endless Disruption, agreed. “This is a debt-reduction move, and it has nothing to do with trying to correct the underlying problem, which is that Sears is a terrible retailer right now.”
Cohen and Kahn discussed the Sears revival plan and the company’s future on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)
“This is a 13-year-long sham that’s run its course, and is about to run its course to the very end.”–Mark Cohen
To say that Sears is bad at retailing “is a harsh comment, but unfortunately it is true,” said Santiago Gallino, Wharton professor of operations, information and decisions. Gallino’s research specialties include operations management challenges in the retail industry. “At this time, retailers need to rethink their business models and invest in a strategy that focuses on customers. I don’t think this is the best time to cut costs. That will only extend the agony.”
Sears share price currently is hovering around 76 cents — “that’s almost a penny stock,” noted Thomas S. Robertson, Wharton marketing professor and director of the school’s Baker Retailing Center. “I don’t know how much time [Lampert’s restructuring plan] can buy with a share price of 76 cents. It might buy some time, but it’s not going to be very much. At some point, Sears is going to go out of business and nobody’s going to notice.”
Robertson pointed out that the optimal time to mount a turnaround plan for Sears was 20 or 25 years ago, when the 125 year-old brand still had the cachet of being a “great American company.” “The world changed and they continued to build stores and appeal to Americans moving to suburbia,” he said. “That worked very well for a long time, but it hasn’t worked for [the past] 20 years and they haven’t adapted.”
Gallino did not see online retail giant Amazon as the prime cause of the decline of Sears or any other retailer. “Retailers that are struggling or that have gone bankrupt have been victims of their own inability to understand their customer’s needs, and the changes in the landscape. Blaming Amazon is a way to avoid responsibility for lack of initiative and creativity from the management team.”
For any retailer, ensuring that suppliers continue to send their products is critical, because without them they would have empty stores. According to Kahn and Cohen, one of the key objectives of Lampert’s latest plan is to maintain supplier relationships. “The only cash the company has been able to put on its balance sheet over the past five, six or seven years is through asset sales and loans that Lampert and ESL have made, securitized against real estate assets,” said Cohen.
“In fact, Sears, which operated rent-free, now pays rent into a real estate trust,” Cohen continued. “So this has all been about putting cash on the balance sheet, to continue to appear to be solvent so as to convince vendors to continue to ship.” To demonstrate liquidity is especially important for Sears to have suppliers shipping products to it ahead of the coming holiday season, he noted.
Cohen described Lampert tapping an independent committee of the company’s board seeking approval for the restructuring plan as “a sham.” The Sears board “is nothing more than a group of rubber stamp artists,” he said. “What independent board would allow a company to be run this way?”
As Cohen saw it, Lampert’s plan is to use the proposed asset sales to bring cash onto the balance sheet to keep the firm going through the holiday season. That plan would tide the company over maybe into the first half of 2019, but not for much longer. “Eventually it’s going to have to file [for bankruptcy],” he predicted. “But since [Lampert is] the principal creditor, he’ll control the bankruptcy process and he’ll bring it back out to strip whatever assets remain that he hasn’t been able to encumber yet.”
“This is a debt-reduction move, and it has nothing to do with trying to correct the underlying problem, which is that Sears is a terrible retailer right now.”–Barbara Kahn
Conflict of Interest?
For Sears watchers who question the merits of the plan, one big issue is “related-party transactions,” or business transactions between Sears and its majority owner ESL. ESL would be the biggest beneficiary of the debt-restructuring plan, recouping $1 billion of the $2.5 billion in Sears debt it owns, according to a Bloomberg report. Sears has also sold its properties to a real estate investment trust called Seritage Growth Properties, in which ESL is the biggest unit holder, the report added. Seritage has leased the properties back to Sears. When Sears sold its Land’s End clothing line four years ago, Lampert ended up as its biggest owner, according to Bloomberg.
“From what [Lampert] is doing, it is unclear that the idea is to save the company,” said Gallino. “The plan seems more focused on getting a good return on the investment on some of [Lampert’s] other interests.”
One controversial proposal is to sell Sears’ Kenmore brand. Lampert on behalf of ESL has offered $400 million to buy the once-popular brand of home appliances, although a special committee would vet the proposed deal for potential conflicts of interest. According to Cohen, Kahn and Gallino, Kenmore is the last remaining big brand of Sears. “It is the last leg on the stool of any consequence,” said Cohen; the company’s collection of real estate properties make up the other significant assets. “Selling off the company’s principal assets leaves the company with nothing.” That is precisely “what’s been happening literally for over the last decade,” he added, referring to sales of other assets including real estate and brands like Land’s End.
Leadership Issues
Kahn wondered if Lampert had “a chance” to revive Sears over years. “There’s been no chance, and there’s been no intent,” Cohen responded. “It is an absolute travesty that there is still some conversation coming out of Lampert and his organization about a turnaround. There never was a turnaround; there never could be a turnaround. This is all about stripping an asset down to the bare walls.”
Cohen traced the retailer’s recent decline to the period after Alan Lacy became CEO of Sears, following the retirement of Arthur Martinez in 2000. “Lacy spent five years making believe he knew what he was doing, and the company went into a slow decline,” he said. “The stock price came down. Gross margins came down, volumes fell off. He bumbled his way through a catastrophic sale of the company’s credit portfolio — it was, in fact, a fire sale.”
After Lampert gained control of Sears following its merger with Kmart, the decline continued, according to Cohen. “Lampert had all sorts of theories about how to run the business, largely by withdrawing all conventional investment in capital expense,” he said. “For about two years, the company looked heroic in its performance in that free cash flow exploded. (Free cash flow is the cash left over after operating costs and capital expenditure.) That fantasy went on for about a year-and-a-half or two years, and then the business started to decline.”
“The plan seems more focused on getting a good return on the investment on some of [Lampert’s] other interests.”–Santiago Gallino
Cohen noted that Lampert invested the free cash flow that came from cutbacks in derivatives, instead of in improving the company’s stores and product offerings or in human resources. “The lifeblood of retail is obviously product, and the energy and engine that supports product is an organization of merchants supported by store operators and logisticians. So this company has not had a viable operating strategy in 18 years — certainly in the 13 years that Lampert has been in possession of it.”
If Sears as we know it collapsed, could the brand be brought back in a different form? “At one time, when Pan Am went out of business — and it was a brilliant brand at one time — the brand was purchased and someone tried an airline with the Pan Am name from New York to Miami. It failed,” said Robertson, noting that the same group of hedge funds that pulled the plug on Toys R Us earlier this year now hope to revive the business on the strength of the brand name. “I don’t know how much the Sears brand is worth. I don’t know that it’s worth very much at all.”
Losing the Initiative
To be sure, Sears was an innovator in its industry in many respects, but lost the plot somewhere along the way. Cohen listed its firsts: Sears Roebuck was the first national catalog retailer. After World War II, it developed shopping malls through a subsidiary, and in fact, it was “the prime mover in many of the major malls throughout the U.S.” The company also was the first to create a credit card. “That enabled newly formed households and returning servicemen to buy a refrigerator which otherwise would have been impossible for them,” he recalled. Added Kahn: “These are all ideas before their time.”
Sears closed its catalog business in the early 1990s after trying to revive it, but returned to the direct-to-consumer business in the late 1990s with Sears.com, its online channel. Cohen lamented that Sears missed the bus there as well. “There is no reason in the world why Sears could not have become much of what Amazon is today,” he said. “It didn’t have the fulfillment structures [that Amazon has] because it had closed them, but it had the DNA, and it had most importantly the reputation and relationship with customers. Sears should have been a marketplace of consequence in an omni-channel sense, and it just didn’t go there.”
The Fallout for Malls
As Sears closes more and more stores, it will accelerate the secular decline of malls across the country. Cohen said between 800 and 1,000 malls are “at risk” across the country. “The majority of them are in trouble and aren’t going to extract themselves because they don’t have enough economic energy to warrant the reinvestment that would be required.”
Kahn predicted that those dying malls would find other uses. “We’re going to see a repurposing; it’s going to be multi-use malls moving into hotel space, apartment space, gym space [and so forth].”
