The Sears Stock Trap
Sears Holdings Corporation (NASDAQ: SHLD) reported earnings yesterday. And they were terrible...
As I write this (on Thursday), the stock has already fallen about 10%. But by the time you’re reading this, the stock could be rallying.
That’s the thing with Sears. Even though the company’s stock price is down over 90% in the past five years, investors still think there’s turnaround potential.
If you haven’t heard it from anyone else, let me be the first to tell you: There’s no hope for Sears.
Revenues and income are falling and show no signs of recovering. The only profitable line the company still owns is Kenmore. Everything else has been sold off.
The stores are all owned by a real estate investment trust. The company is drowning in debt it can’t ever hope to pay off. Interest rates are rising so it can’t even take out loans to roll that debt over.
But the thing is, there hasn’t been any hope for a long time.
Revenues have been falling steadily for the past decade. Income has been negative since 2012.
And although it’s taken five years to pound in, Sears put the final nail in the coffin in 2013. That’s when the company put its current CEO, president, top shareholder, and dirtbag extraordinaire in charge.
Well, that’s a little harsh. Eddie Lampert isn’t really a dirtbag. He’s an activist hedge fund manager. And he’s a really good one. That’s exactly why giving him the top spot at Sears was the biggest mistake the company ever made.
At least it was the biggest one the shareholders ever approved.
The Incredible Mr. Lampert
Eddie Lampert got his start as an intern at Goldman Sachs back in 1984. He worked his way up into the firm’s risk arbitrage department within a couple years and stayed there until 1988.
It was then that he left the bank to form his own hedge fund, ESL Investments. He got $28 million in seed money from a friend and got some introductions to potential clients from friends and family as well.
His investing style has been compared to that of Warren Buffett. He typically holds investments in between three and 15 companies. And he usually holds onto them for several years. But he’s an activist investor, so he’s not afraid to force a company to change if he feels it’ll help him profit.
By 2004, Mr. Lampert was the most successful hedge fund manager in the world. It was that year he became the first Wall Street financial manager to exceed an income of $1 billion in a single year. He made $1.02 billion in 2004.
By 2006, he was the richest person in Connecticut (home of hedge funds) with a net worth of $3.8 billion.
In 2006, he was also featured as one of Time magazine’s top 100 most influential people for being one of the “brightest minds on Wall Street” and leading a new class of activist hedge funds.
In May 2013, he took over as CEO of Sears. By July 2016, he owned 28% of the outstanding shares of the company, making him the top shareholder. And last year, he provided a $500 million loan to the company with letters of credit for up to an additional half-billion more.
On a personal note, he’s a big follower of Ayn Rand and uses elements of her philosophy to guide his business decisions. And he’s got a 288-foot motor yacht named Fountainhead after one of her more famous works.
So, let's recap...
We’ve got a billionaire activist hedge fund manager who’s an avid Ayn Rand reader.
Not that there’s anything wrong with reading Ayn Rand — I love her work. We’ve just got to keep in mind the general themes and philosophy. Spoiler alert: They’re not really all about providing for others.
Combine the two, and you’ve got a guy with tons of capital to throw around who doesn’t mind going in and tearing a company apart if it’ll make him a buck.
And that’s exactly what he’s been doing since he took over: making sure he comes out on top.
Vindication Ain’t That Sweet
Back in 2013, when the company announced Lampert was taking the top spot, I said this was a bad move if Sears hoped to survive. Lampert’s not exactly a vulture capitalist, but he’s not far from it.
I even had a buddy who was working for an ad firm Sears had hired to revamp the company. He and I talked about the new boss over there, and both of us agreed the best strategy for the management team was to make the company look like it was getting stronger by improving margins.
We figured Lampert was in to make a buck. And the best and fastest way for him to squeeze Sears dry was to make operating margins look better so investors would buy stock and bonds.
Then he could sell off the valuable assets to boost margins even more and make another quick buck there.
We figured eventually the company would go bankrupt, with one or two valuable assets still in hand and a lot of money owed to Eddie and his hedge fund.
The idea got axed by my buddy’s boss, and they went with some idiotic idea like “Sears Prime” or something like that.
But my point is, we were right on the money. That’s exactly what Lampert’s been doing the past five years. And now Sears is left with Kenmore as its only really profitable asset.
Do I feel good to be right? Not really. Shareholders that got excited at the prospect of fresh blood at the top and bought back in 2013 have lost nearly everything. If they keep holding on much longer, they’ll lose what little they have left.
I’d feel good if people had picked up the story and run with it. If other analysts spread the warning, I’d feel great. Because I’d have been right and I’d have helped folks avoid that elevator ride down from $40 to $3.
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You Lose, Eddie Wins
And maybe I’d feel good if Eddie was going down with the ship. Or at least maybe I’d feel better. But that’s not going to happen, either.
I’ve read some articles recently that are finally noting that Lampert’s killed Sears. But they’re saying he’ll make out without a loss.
Really, guys? He’s going to break even? He’s been there for five years, invested billions of his own dollars, and his plan all along was to break even?
That may be the dumbest thing I’ve ever read. Well, not the absolute dumbest, but darned close.
Guys like Eddie Lampert don’t spend billions of dollars and thousands of hours to break even. They do it to make billions more.
And trust me, Eddie is going to be A-OK when all this is over.
You remember when I told you how all of Sears’ stores are owned by an investment trust? Well, guess who owns said trust. You got it! Eddie Lampert himself.
And all those shares of Sears stock? That’s his hedge fund. And it’s been able to trade those shares through drops and bounces the past five years to make a tidy profit.
But what about the loans he’s made to the company? If it goes under, he won’t get his money back. Right?
Not exactly. He’ll likely get less than he loaned. But when you add up the interest payments he’ll be collecting until bankruptcy, he’ll actually come out on top there, too.
And then there’s Kenmore, the one remaining valuable asset Sears actually owns...
I’m predicting that gets spun off either just before or during a bankruptcy. And I’m guessing ESL Investments would be happy to buy it and provide the company with some extra cash to pay back more of Mr. Lampert’s loans.
When all is said and done, if Eddie’s not sitting on twice what he’s put in so far, I’ll be extremely surprised.
I bet you’re wondering what my point is here.
Well, one is not to buy shares in Sears thinking it’ll rally and that since it’s cheap, it’s valuable. But I think that’s pretty clear.
My real point is that we all should have seen this coming five years back when Sears brought in a corporate raider to right its sinking ship.
And while the Sears story is pretty much over, there are other companies out there in need of fixing. And there are other activist/vulture investors out there. Heck, Eddie’s going to be looking for a new gig pretty soon.
So, we’ve got to keep our eyes out and really research who’s in charge before we start investing. In fact, even if everything at a company is textbook perfect, I won’t invest if I don’t like the management team.
You shouldn’t, either. Have a problem with Kevin Plank? Don’t buy Under Armour. Don’t like Darren Woods? Stay away from ExxonMobil.
See a corporate raider moving up the chain of command at one of your investments? It might just be time to cut bait and get the heck out of there.
It’s not just fundamentals, business plans, or improving margins that make a good company. It’s a top-notch management team that cares about maximizing value for all stakeholders — from suppliers to shareholders and from employees to customers.
That’s it from me for this week. But keep an eye out because I’ve got some very exciting new investment opportunities coming in my premium advisory service, The Wealth Advisory.
My active subscribers will get first access, however. So, if you want to get a head start, just click here to join The Wealth Advisory nation.
Trust me when I say you won’t want to miss out on any of these opportunities.
To your wealth,
After graduating Cum Laude in finance and economics, Jason analyzed complex projects and budgets for the U.S. Army. Then, at Morgan Stanley, he led the assistants' team for the North American repo sales desk, responsible for hundreds of multibillion-dollar trades every day. Jason is the assistant editor for The Wealth Advisory income stock newsletter. He also contributes regularly to Wealth Daily. To learn more about Jason, click here.
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