I Hope Eddie Lampert Is Mulling a Deal

What could be worse than trying to turn around Kmart and Sears? The only thing I can think of is trying to do that when the low end consumer is being squeezed from all angles and the housing market is weak. Today’s earnings warnings from Home Depot (HD) and Sears (SHLD) aren’t that surprising when we look at the macro view of the economy domestically, but even still, the Sears number was pretty bad and Home Depot only escaped a wrath of selling because of their enormous buyback. Sears announced a $1 billion buyback, but that is just a drop in the bucket for them (4% of shares outstanding).

Home Depot got lucky. They timed the sale of their supply business well enough that they can just use that money to buyback shares above the market price and keep their stock up even when earnings are declining. Sears has a problem, though, in that it hasn’t diversified yet like everyone thought it would. The Kmart/Sears merger was supposed to be about real estate, excess cash flow, making more acquisitions, becoming the next Berkshire, etc. What happened?

Well, Eddie Lampert decided to try and fix the retail business as best he could. That’s a perfectly fine idea (just look at what JC Penney has been able to do over the last five years and you’ll see retail turnarounds like this do happen) but given we have the low end consumer getting squeezed and a weak housing market (which just happen to be the two core focuses for Kmart and Sears), the fact that Lampert hasn’t diversified Sears Holdings yet is a problem right now.

Long term investors (myself included) likely aren’t overly concerned because they know the retail weakness won’t last forever, and they know Lampert has other ideas for excess cash. But, given the stock price weakness lately, he really needs to do something to get the shares moving again, a la Home Depot. So what should he do?

Quite simply, a deal, any deal. I don’t mean just any deal that happens to be available (it has to make sense), but it also does not have to be an outright buyout of another company. Surely Wall Street would applaud the purchase of something at a bargain basement price, preferably outside of retail completely, but even an internal deal could boost shareholder morale.

The most logical would be a large real estate deal like many investors have been hoping for since Lampert bought Kmart out of bankruptcy and leveraged that stake to takeover Sears. Eddie hasn’t sold underperforming locations as fast as many people thought he might. It is clear he wants to try things before giving up on certain locations. However, a deal to monetize some real estate would accomplish two things that would help the stock price.

First, it would show to investors that the real estate actually does have meaningful value. It has been debated exactly how much the Sears real estate is worth. Everybody has their own forecasts, but in reality, something is only worth what someone else is willing to pay. Selling stores would give investors a way to value that real estate (which is likely understated in most valuation models focused mostly on retail profits) and also show them that Lampert is willing to cut his losses on more stores.

The second thing it would do would be to help the bottom line. Selling underperforming stores not only gives you money to diversify with, but it also boosts your earnings, which are already under pressure due to the economic environment. Surely there are stores that aren’t making any money, even after many have been closed. Closing those underperforming locations will help boost retail margins, which would also boost investors’ perception of what the company’s retail business is worth.

All in all, Sears is in the unenviable situation of trying to turn around a retailer during tough times. Since this makes it harder than usual, if they want to continue down the retail road, it is imperative for the company to make some moves to diversify away from low-end retail and housing. The only way to do that is to free up some cash, or use cash you already have on hand, and do a deal. Either sell some real estate and reallocate that money, or use the money you have now and buy something unrelated to Kmart and Sears.

If Lampert does something like that sometime this year, Sears stock can get moving again. As long as he waits it out, the odds are good that the stock is dead money for a while. I’m confident he will make the right moves, which is why I’ve owned the stock for years and will continue to hold it, but after Tuesday’s earnings warning, I think it is important for him to do something sooner rather than later. If not, he will eventually lose some of his loyal supporters.

Full Disclosure: Long shares of Sears Holdings

Enjoy this post? Subscribe and never miss another one: RSS | Email | Twitter

6 Thoughts on “I Hope Eddie Lampert Is Mulling a Deal

  1. Anonymous on July 11, 2007 at 10:39 AM said:

    I think you’re off base here. this is a “hope stock” that will never deliver. This Eddie will be viewed as a big bust a few years down the road. All the Eddie razzle dazzle isn’t going to save this one. This was one of the best variant perception trades out there, and w/ guys like you “hoping” it still is. I’ve been short the past year or so, which hasn’t been easy — until yesterday of course when I scored big. But I earned it because 1) I went against the crowd, 2) I didn’t buckle under this Eddie media driven nonsense, 3) and I stayed committed to the facts in front of me. The primary fact being that Sears is a fourth rate retail operation up against super intense competition. Eddie’s derivative trading acumen is more smoke and mirrors. Is this what you want your CEO doing? Sooner or later he’ll lose big. This guy is way overrated. Then I asked myself, what kind of a moog would join sears and k-mart? Think Buffett would merge Sears and K-mart?
    Would you? It’s that simple.

    The stock should work into the 130s – 145 area. I will continue to short on rallies. What did Graham say 70 years ago? The market in the short run is a voting machine and in the long run is a weighing machine. It took awhile, but the market is finally weighing in. You’re voting for a losing candidate. Go back to the drawing board and rethink your position. Study and analyze the pure facts minus the hype.You don’t even realize that you’ve been had.

    Good blog and good luck. peace.

    Phil C.

  2. Chad Brand on July 11, 2007 at 11:10 AM said:

    Thanks for the opposing viewpoint, Phil. Although we are on opposite sides of the trade, your points are valid. Obviously, how it turns out is just our opinion, since we can’t predict the future, but there is “hope” in this stock.

    If we just look at SHLD on the surface, at what we know for sure, we have a poor retail operation trading at or above a market multiple. Why is that?

    For exactly the reasons you state, because people believe there is reason to value it above what a normal retailer sells for. If we simply assume the retail operation will peak at about $10 in earnings power and stagnate with nothing else going on, this is probably a $125-$140 stock.

    Why then has it traded between $150 and $200 over the last year? Because some people think there is a good chance Lampert can either turn around the retail operations, use its cash flow to diversify away from retail and add other sources of income, or both.

    As it stands today, there is not much evidence that this will happen. He has not yet diversified away from retail. The retail operations have improved, but now have hit a wall. You have to give him some credit though. He did bring Kmart from bankruptcy to profitability. That is one reason people are willing to “believe” in him, or at least give him a chance.

    So, if the retail operation doesn’t improve from here, and nothing else comes along, then I think you will be right. I’ve been in it for a while, and made a bunch from his work at Kmart, so I’ll give him a little longer rope to work with. That said, I do think he needs to do something soon to show that this is more than just, as you put it, a fourth rate retail operation. Because that is what investors are banking on.

    Thanks for the comment.

  3. sagacious on July 11, 2007 at 2:18 PM said:

    I think a shorting this stock is a mistake despite periods of “being right,” such as yesterday. The reason is that the company can still grow in per-share business value. Sears throws off solid free cash flow and continues to buy in shares opportunistically. For any company, what matters should not be size or market share for their own sake but profitability in the markets in which it operates. Lampert is keenly aware of this and is managing for profitability. I would compare this to Buffett not growing insurance premium volume just for the sake of having a larger policy base. There have been 10-year periods for Berkshire where premium volume shrank in every single year, but profitability on those in-force policies remained solid. And Lampert is a Buffett disciple, so there is ample reason to believe he looks at Sears in a similar way. I think he’s willing to shrink the total size of the “empire” as long as he, per-share, grows wealthier.

    So let’s say the Sears business as a whole shrinks, but the stores that are still around will be more profitable in their individual markets. What remains of a smaller, more profitable company will have low reinvestment requirements (since it’s just maintaining what it already has). With solid free cash flow (and proceeds from real estate sales), opportunistic buybacks can increase per share business value at a steady clip even while decreasing aggregate sales and net income.

    Look at what he’s helped orchestrate at AutoZone. Since 1997, sales and profits at the company have risen 9.2% and 12.7% annually, but 18% and 22%, respectively, on a per-share basis. They’ve done this by focusing on profitability (net profit margin has gone from an average of around 7% to nearly 10% over that time period) and have used increasing free cash flow to buy back heaps of shares. And the stock has followed, up nearly 20% annually over that time.

  4. javasoy on July 11, 2007 at 7:11 PM said:


    I think you are not the only getting restless. Eddie might have something in his mind, I don’t know. I am not very please with the large Citibank investment he made. True, if C is split into smaller parts, there is a lot of value going to be unlocked. But C is too large to play the activist investment. Phil was kinda right that SHLD is an investment of Eddie himself, apparently, he didn’t have a whole lot of respect for him. He probably should be forgiven for his apparent cockiness. For at least a short period, he’s earned the right to crow.

  5. Chad Brand on July 11, 2007 at 7:37 PM said:

    sagacious – you articulated the bull case well, I guess I would just like to see him be a little quicker with paring the company down in size. I know there have been store closings, but I think it could be even more drastic. I hope that happens eventually.

    javasoy – don’t forget, Lampert bought Citi in his hedge fund, ESL, not with SHLD funds, so it doesn’t affect SHLD holders directly. Personally, C trading at a 10 P/E and yielding 4% seems like a pretty good purchase. It won’t make him rich, but the risk-reward is pretty appealing at the very least.

  6. It’s not that I don’t respect Eddie — I just think he’s very overrated — that’s all. In essence I shorted the Eddie premium. I will not put my hard earned money on Eddie magic. But then again, I learned these lessons the old fashioned way. Trust me, when the next Eddie comes along you won’t be so fast to buy into the hype and future financial wizardry. Remember that the markets are just as tough for him as they are for us. And you’d better pray that he’s as smart as they say he is.

    For the record, my short position was closed out this afternoon and (believe it or not) I plan on getting long for the reflexive bounce (probably a good 10 points). After that I’m done with this one for good.

Post Navigation