Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

The Death Spiral

The Strange World of Eddie Lampert

The best way to see the cause of the bizarre and tragic situation at Sears Holdings (NASDAQ: SHLD) is to take a glance into the mind of the company’s CEO, hedge fund guru Eddie Lampert. Such a glance can be found by taking a look at some of Mr. Lampert’s writings, which call both his sanity and grasp on reality into serious question.

In a response to a Seeking Alpha post, contributor Wolf Martin sent me a copy of the Sears Holdings Alumni Newsletter for 2014. The highlight of the publication is “A Letter from Eddie Lampert” that reads more like something from a Middle Eastern dictator’s propaganda ministry than a statement from the CEO of a major American company.

The letter is filled with Orwellian terminology and grandiose statements, yet it says absolutely nothing. Not once does Lampert say anything about the present state of Sears, its sales, its revenues or its financial strength, nor does he make any revelation whatsoever about his thinking or plans for Sears’s future.

Eddie Lampert in a scary pose.
Eddie Lampert in a scary pose.

Instead, the letter seems to reveal a man with no plan and a poor grasp of reality. It also contains a lot of rambling. This statement in particular turns out to be both confusing and verbose:

“Transformations are almost entirely different – they occur when companies adapt their business model to fundamental shifts in technology, competitive landscapes, government policies and regulations, or macro trends to serve their customers (or, in our case, members) in new ways.”

Does anybody have any idea what Mr. Lampert is saying here? What exactly does he mean by transformation, and what is a macro trend? Has Sears suddenly turned into a membership club like Costco Wholesale (NASDAQ: COST)? If it has, I was not aware of it.

Lampert Does Not Get It

This statement reveals the thinking of a man with no plan. It also mentions transformations at other companies, such as General Dynamics (NYSE: GD). General Dynamics is a defense contractor, not a retailer. It builds weapons and vehicles for the military; it does not operate department stores. What does that have to do with Sears?

Lampert noted that General Dynamics adapted to the end of the Cold War. The problem with that analogy is that General Dynamics’ fundamental market—selling stuff to the military—did not change, and its main customer—Uncle Sam—did not go away. Sears has seen the retail market change completely, and it has lost many of its core customers.


Lampert’s assertion is that he can turn Sears around because he once did the same for Kmart. He notes (correctly) that Kmart (now part of Sears) successfully went from bankruptcy in 2002 to a complete turnaround in 2004 under his leadership.

The problem with that claim is the epic decline Sears has experienced under Mr. Lampert’s leadership. Under Eddie’s guidance, Sears’s revenues have essentially collapsed.

How to Lose $5 Billion in Revenue in a Year

Sears and Kmart lost nearly $5 billion ($4.99 billion to be exact) in revenue in 2014. Sears Holdings reported a TTM revenue of $36.19 billion in January 2014 that fell to $31.2 billion by January 2015. Nor was revenue the only dismal figure reported at Sears. Some other sorry figures include:

  • A return on equity of -340.2%.
  • A net income of -$1.682 billion.
  • A diluted earnings per share number of -15.33.

Okay, there was one piece of good news at Sears; it reported a Free Cash Flow of $487 million on Jan. 31, 2015. The only problem with that is the money will not be used to help Sears, ESL Investment Inc.; instead, it will be used to pay off the $400 million loan Lampert’s hedge fund made to Sears in September to get it through the holiday season.

That means Sears’s real free cash flow could be $67 million because the loan had a 5% interest rate. That’s a pretty good deal for Lampert; he made $20 million in a few months. It’s not a very good deal for Sears however.

The loan also shows what Lampert’s transformation really is: Sears is transforming into a cash cow for Lampert. He can milk cash out of it by spinning off assets, selling assets and monetizing real estate.

The Looting of Sears

Lampert has even figured out how to make money out of Sears’s stores that are a drag on malls they are located in. Sears has entered into “joint ventures” with mall operators. In one of those ventures, General Growth Partners (NYSE: GGP) will pay Lampert $165 million in cash; in exchange, Sears will vacate 50% of the 12 stores, which General Growth will be able to redevelop and re-lease.

Get the picture: Lampert has figured out how to make landlords pay him to shut down money-losing stores. News reports indicate that a real estate investment trust Lampert set up to monetize Sears’s properties, Seritage Growth Properties, could make $2.5 billion.

The transformation, like the Lands’ End (NASDAQ: LE) and Sears Hometown & Outlet (NASDAQ: SHOS) spinoffs, is actually the looting of Sears. Like a dictator who has destroyed his nation’s economy, Lampert is now selling its resources off to the highest bidder. Then he pockets the proceeds and flies away in his private jet.

The future of Sears will look a lot like the former Soviet Union. I imagine that it’ll be broken up into various components, but a core company will survive, perhaps as an online retailer— actually does well. I also imagine that other retailers or investors will buy what’s left of Sears and operate it effectively and even profitably.

Yes Folks this is for real, I imagine that certain editors regret this headline today.
Yes Folks this is for real, I imagine that certain editors regret this headline today.

One intriguing possibility is that Warren Buffett might buy some of Sears’s assets. After all, Sears is still a really good brand; was the number five online retailer in the U.S., with 14 million unique visitors a month, according to Thomson Reuters. It also owns some other strong brands, including Craftsman, Kenmore and Diehard, which are protected from the debacle at the brick and mortar stores by legal safeguards.

Somebody will probably buy the Sears and other brand names and operate them profitably, much as Berkshire Hathaway (NYSE: BRK.A) did with Fruit of the Loom. My guess, though, is that a major value investor like Uncle Warren will not touch Sears until Lampert has separated it from its real estate holdings.

The real goal of Mr. Lampert’s plan becomes clear here: it is an exit strategy to get ESL out of Sears, not transformation. No matter what Lampert does, Sears’s brick and mortar retail operations have probably gone too far down the death spiral to be saved.