Monday, October 15, 2018

Schadenfreude: reposting a 2011 post on Sears

I posted on Sears in 2011

They finally filed bankruptcy.

I am surprised it took that long.

Here though is the post again. It reads okay.

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We have been short Sears Holdings, publicly, albeit in small quantity. Being summer in Australia I did not even look at the market for the last couple of days - but got into work for some congratulatory emails as Sears stock is off very hard on an announcement of truly awful sales, the closure of 100 to 120 stores and $1.6 to $2.4 billion of non-cash charges. (More about the charges later on.)

I look pretty smart putting a Sears short on in November - and kudos is gratefully accepted but undeserved. I was short Sears at my old firm when the Eddie Lambert controlled K-Mart took them out for considerably more than they were worth. It was not the only time that happened to me - but multiple stabs don't dull the pain. I would gladly swap kudos for a refund of my then clients' money.*

The premise for owning Sears was property liquidation. The company owned many of its sites - sometimes on book at low historic values reflecting the company's long and once glorious history. Eddie Lambert and his merry-men were going to extract that value through selective store closures and super-profitable liquidation. Sears was an awful retailer (there was little doubt about that) but it was - they thought - a good property play.

My view: owning Sears as a property play is a demonstration of the arrogance and breathtaking naivete of much that passes on Wall Street. Sears Holdings has over 300 thousand employees. I don't know how you successfully liquidate a business integrated with that many lives. I don't know of anyone who has ever successfully liquidated a business with that many employees.** I am not sure it can be done and it certainly can't be done by someone with my skill-set (highly analytical, ability to spy value or value traps but no people management skill and not much tact).

The idea that Sears was going to be managed/liquidated by a bunch of hedge fund guys (people like me) well - that was comical.

Just to stress the point for my fund manager friends who read accounts and have my skills (but like me are often disconnected from the businesses they invest in) I will state the obvious. The employees are living breathing people and as you pull the business apart the way you treat those people and how they think about you (and behave towards you) are critical to any value you extract in liquidation. Someone has to look these people in the eye and tell them they don't have a job. And someone has to pick-and-choose which people to fire and which to retain. And they have to do this without destroying much of the value extracted along the way. They have to liquidate the firm in such a way that the value accrues to the liquidators and not to the people who are being screwed.

I don't care what you think of the morality of that. The reality of that is that it was always going to be hard - possibly very hard.***

We are about to find out how hard. Sears is going to close 100 to 120 stores (it is vague about the number) and fire many employees. But they have not worked out which employees or even which stores. Not to sound ghoulish - but my guess is that this is going to be considerably harder than the "Sears spokesman" makes it sound. And if they can't do 120 stores without trouble then the original Sears liquidation premise was insane. This is a case of Wall Street fantasy meeting reality: eventually reality wins.

The charges and reality

The large (non-cash!) charges deserve mention. This is from the Sears release:
[We Sears] expect that we will record in the fourth quarter a non-cash charge related to a valuation allowance on certain deferred tax assets of $1.6 to $1.8 billion
You know what that means. It means that you should not expect to earn that profit in the future. It is the admission from the Eddie Lambert controlled Sears that the fantasy is over.

The reality is unchanged: when you think of the 1950s you think of Sears. Sears was (in Main Street reality) irrelevant a decade ago. The Wall Street fantasy took a little longer to end.


John



*(A note about Schadenfreude.) The take-over of the old Sears by the Eddie Lambert controlled K-Mart was the second worst day of my career. The worst day was when Fred Goodwin's Royal Bank of Scotland purchased Charter One Financial. When I started the blog one of the main goals was to spell out just how atrocious Sir Fred Goodwin (the then CEO of Royal Bank of Scotland) was. The fourth post on this blog was the beginning of my "Sir Fred Goodwin death watch". I enjoyed watching him and his bank come apart. But I should not have enjoyed it. Schadenfreude is not an attractive personality characteristic and the collapse of RBS has caused real pain to a lot of innocent parties. And a Schadenfreudegasm - well that just strikes me as unreasonably indulgent. After all my clients lost money - and I should and would but cannot swap any pleasure I had for a refund of their losses.

This time though I am just accepting the Schadenfreude. My client are making money and I have no reason to feel guilty about that. Moreover I don't have to fire those employees. Unlike Royal Bank of Scotland (which Sir Fred destroyed) Sears employees were doomed anyway.

**. It is worth mentioning the GM example. GM was salvaged through bankruptcy with a couple of hundred thousand employees. But those employees were particularly trapped, the shareholders were wiped out and the Government contributed considerable money. That is what a "successful" transition for a business with that many employees looks like.

***. (Politics, employees and realism). I am a bleeding heart left-winger and naturally feel a little paternalistic to the employees being fired. However you don't need to be a bleeding heart lefty to agree with my analysis. A realist will tell that when you have 300 thousand employees your relation to them is going to be critical in running your business. Employees are "stakeholders" even if your only (moral) criteria is "shareholder value". Realism over politics is a better basis for investment.

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