Wednesday, December 28, 2011

Sears Holdings liquidation sale

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.


*(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.


Kid Dynamite said...

You've hit on a topic here that has been vivid in my brain many times over the last several years. I call it "spreadsheet math"

during the bubble, people were saying the same thing about the Vegas companies: MGM was worth $140 a share or something because of the Vegas Strip land it owned, alone. I argued at length with an analyst, explaining "ummm - the land only has value because it's on the Vegas Strip, where you can put a casino, but MGM also already HAS casinos on their land! You can't RE-put another casino on the land, and you also can't sell it to someone who will do something else with it - SOMEONE has to pay the rent."

same story with Bill Ackman's TGT thesis - spreadsheet math based on "real estate"...

John Hempton said...

Target at least has a well run store sitting on that land. But yes - "spreadsheet math" is an apt description.

It takes more than a spreadsheet to fire 200 thousand people.

As for Target - they appear well run and I think they had the common-sense to largely ignore Ackman. Tesco alas sold some of its property during the boom. We own both (but prefer Tesco).


Michael Goode said...

At least judging by the price of its stock, Syms (SYMSQ) is going to be one of the few retail liquidation success stories.

Anonymous said...

Many years ago the township I lived in had a lawsuit with the local Sears/mall over property taxes - whether the proper rate was the "bricks/mortar" value of the property or the value based on things like sales traffic (which was much higher). Sales based valuations won. Guess the taxes are way down now :)

J said...

Real estate value for an operating business is best thought of as a floor...Ackman's proposal would have made sense if TGT were trading below the value of some other income-producing use of the a parking lot?

Nemo Incognito said...

Spreadsheet math: math that does not have recursion or dynamics. Ie, if a business is sucking because the biz sucks and it has a lot of biz specific assets (like strip mall property) then spreadsheet math doesn't iterate to: hmm, maybe those biz specific but fungible assets are impaired too?

Unfavorable odds said...

This is not a liberal/conservative issue. I am a diehard conservative and agree with what you said.

It is an arrogance issue. Certain people have expertise in certain subjects or areas. To think that you can take that expertise in one area and apply it to something else is pure arrogance. Knowing how to invest and spot hidden value in a company is quite different than knowing how to operate two retailing giants.

Lambert may have been right about Sears having hidden real estate value. But he obviously had no workable plan for extracting that value. His arrogance blinded him of this reality.

Anonymous said...

While it's no question that the stores have not has exploded and continues to grow at a double-digit pace. In fact, it was rated the best in terms of mobile experience which is where everything is going. You also have to look at other assets and brands. Sears conducted over 15 million in home service calls last year! That's a very profit-rich source of income. Reduce the costly stores, grow the web presence and service portion of the business and you have a real winner. A winner which gives the consumer a more personal experience than Amazon with the option to deal with human beings in a store.

MovingEast said...

Such a pity for Sears. It still has a good name for whitegoods - most people I speak to who have bought new washing machines, fridges or similar go to Sears. It is such a pleasure to shop there too compared with the aggresive "do you want an extended warranty" alternative at BestBuy. (Anecdotal information for sure, but I feel there is some truth in this). As for K-mart (at least the US version of it) - never shopped there and never intend to.

I would think Sears would have a better shot at survival concentrating on its whitegoods, hardware and landsend brands, while reducing some of the other lines. Perhaps if they took an approach like Harvey Norman in Australia with the individual departments operating independently and required to be profitable on their own, Sears would do better.

But that is retailing rather than a property play...

josh said...

brilliant as always, great post - this is an topic that not many consider amidst all the dealmaking and "rightsizing"

najdorf said...

Anon - Any hope to transform Sears into a web-driven business is a ludicrous pipe dream. As John discussed, they own millions of SF of mall real estate and employ hundreds of thousands of people. They couldn't be further from an asset-light approach like Amazon, and they face enormous competition in the hybrid retail-B&M category from HD, Lowe's, Best Buy, etc for half of their products and Target, WalMart, JC Penney for the other half. Anyone can drive online sales with promotions, but the margins are horrible and can't possible generate the kind of EBITDA necessary to justify the amount of capital tied up in Sears.

MovingEast: In white goods, Sears is more or less a warehouse for Whirlpool and the days of expert salesmen are gone. Customers come in knowing what machine they want and the best you're going to do is sell them a moderately overpriced warranty or installation. How much profitability is there?

Unknown said...

Re: "MovingEast's comment. Sear's share of the white goods market in the US is also declining. Home Depot and Lowes are gaining market share at Sear's expense. See

Anonymous said...

Not to be snarky but It's "Lampert", not "Lambert"

Anonymous said...

Can someone please show me where Lampert is on record saying Sears is a real estate play? I don't believe this happened. I think that part was a media/analyst construct. If we are going to criticize someone lets be fair and accurate.

Thank you,

Anonymous said...

Great post. From an economic standpoint, does anybody think that of its 2000+ stores, only 120 are underperforming? And in an overmalled/overstored time and place, who will take over the space or acquire suboptimal locations? As mentioned, the nature of malls has changed over the last 50 years and the underinvestment in many of Sears locations makes the value extraction dynamic a difficult one. In fact, some locations may be worth less as they are than they would be as raw land. And as a few homebuilders know, raw land is not worth nearly what many paid for a few years ago and banks are still reluctant to write C&D loans.

Anonymous said...

I bet you were the same guy who was hyping Eddie when the stock was at $170 a few years ago.

Anonymous said...

It's appropriate to juxtapose Ackman's TGT thesis w/Sears/KMT in this regard- from a real estate perspective, despite the tenant's credit, there is questionable residual value in true Big Box Retail- that is 80-150,000 SF buildings. The retail landscape has changed. The Jr. box retailers who could fill these buildings has diminished, and the retailers that are still around have reduced their footprints. And the single tenant who turn-keys a vacant Kmart is few and far between. Point being, there is more risk, less value (not no value, less) in the real estate in what I believe is a new retail landscape forever more.

Anonymous said...

not to mention Lambert putting Lou D'Ambrosio in place as CEO. Smart guy no doubt, but his entire career in sales and marketing roles for Avaya? no retail experience, no real estate exper. that was MY signal to short....

Mark Holder said...

Short SHLD is a very crowded trade now. It's ignorant to not focus on the real estate and to focus on the retail operations. That property has plenty of other uses.

Jordan Waxman said...

John - great post about investor skillsets and arrogance. I'm familiar w/ the concept of a real estate/asset liquidation play, but a bit ignorant on the details. Speaking purely about the economics, if the assumption is that the assets are worth more liquidated than as a going concern, why can't you just shut down all the 2000+ stores, lay the 300k people off, sell the real estate, and profit on the deal? This thought experminet is of course ignoring political, social, and moral concerns, but if I understood correctly you are saying that even on an economic basis this doesn't work, but I didn't see how you reached that conclusion. If anything it sounds like you are saying the poor business decision was not to shut down the 120 stores but to keep the other 1880+ open.

Anonymous said...

Re: Sears white goods. I've bought my last Sears clothes washer and dryer. They both are unreliable, not well made like they used to be.

Josh said...

I will defend Ackman on his thesis for TGT. He had two main ideas, place the real estate assets in a REIT and sell the credit card business.

TGT did not sell the credit card receivables, which turns out at the time was the top of the market. Banks were fighting and paying top dollar for these assets. I believe (and I think the street does as well) that Ackman was clearly right at the time.

On separating the real estate and putting those assets into a REIT, the 'spreadsheet math' there are two scenarios. One is that the market will pay more for yield, making two assets separate worth more. In this specific case, the real estate could have been turned into a REIT generating perhaps 4 or 5% in yield. (I believe that yield is still bought aggressively today and this could still be undertaken)

Look at companies that have converted to REIT like structures and/or have announced that they will.

The other argument is that if the REIT had control of the real estate as a separate entity, the REIT could say location x is paying $12 per square foot. On renewal, the rate needs to rise to $14 as we think another retailer would be willing to pay that.

By keeping the allocated cost of rent low, this could keep a marginally profitable store open vs closing that store and receiving higher profits by renting.

Josh said...

SHLD is turning around slowly moving stores and/or downsizing. If you look at SHLD they are opening up new smaller stores (less overhead) and investing in them. They realized some time ago that their stores are too big.

Unfortunately, they have not moved fast enough as profits are dropping faster then they can cut expenses.

I was surprised that no one noticed (or at least I did not see analysts or seeking alpha etc) that SHLD basically stopped buying back stock in the previous quarter. I thought this was a hint that there might be a cash squeeze coming. Granted I thought it would be early next year with the 4Q being very profitable. I only had a small short position on.

I'm interested in shorting again at higher levels but the current risk/reward is not favorable in my view.

John Hempton said...

There are a few difficult things about selling 2000 plus stores. You have (memory here) 7 billions of dollars in trading stock which you are on the hock for (you have purchased it).

A flat "closing down sale" will cost you 2 billion plus. Imagine trying to sell it fast. So you need to close it piece meal - and keep it functioning as you do so.

Also if you close stores when they are mid lease you get costs - so you want to close as leases expire etc. The thought experiment makes it clear how hard it is to do and extract value.


Geoff Ponty said...

John, lets be clear.

Selling the property of many stores, particularly at the same time is difficult because:

1) Its hard to move that much product (property)and find one or more buyers

2) That type of commercial real estate cyclically is is a bad place

3) Leases, legacy and other costs/legal restrictions are messy.

But, this has absolutely nothing to do with closing the businesses on those sites, or the number of employees.

John, there is no analysis here mate. Liquidating value has nothing to do with employee issues. In fact, liquidation value could well be higher in practice if the land will be reused productively to create local jobs. Business closure is a tough thing to go through. Witness Ansett folding and taking over 10 years to end for workers etc. But it ain't going to make a dime of difference to land sales.

Its hard John yes. But its got nothing to do with your read on it- unless I have missed something?


Anonymous said...

To merge your RBS and Sears threads -- in 2006 RBS (via Greenwich Capital) offered to monetize over $1 billion of Sears stores assets as a "test case" at incredibly attractive rates via a CMBS transaction, only to be rebuffed by an ESL finance group which felt that those assets would only increase in value, while believing that continued robust store operations would ensure that Sears did not need cash in any event. The "spreadsheet math" would have become reality but for the hubris of ESL/Sears.

The only thing worse than not creating value is actually having value handed to one who ultimately destroys it.

Anonymous said...

For someone "without these skills", you definitely understand that stuff well. Better then most people actually doing it, naturally.

Very few businesses are not, in the end, about employees. And there is absolutely no known way to motivate them to care while pulling the usual "anticrisis downsizing" stuff.

That's why coomebacks are so rare in big businesses: once stuff goes south, people's morale follows. Then normally, instead of clinging to people (because in the end, the only real way business can come back is be pulled by them) and keeping their spirits, managers dig themselves deeper by crashing on them with poorly-organized "tremble and despair"-style layoffs, pay cuts and stuff.

It all looks smart on paper, but in reality it just assures that stuff is busy sending out their CVs, not working and caring. THerefore business loses whatever remains of functional abilities there were.

Then, naturally, you liquidate assets :)

But on the long horizon, you can place bear bets on companies on first signs of this "employee base erosion" process and be right way more often then not.


Amit Chokshi said...

I discussed why Ackman's Target move would fail.

SHLD is a good short, BBY is and I would imagine a lot of mall retailers in middle america that have big box retailers would be good shorts as well. SPG could be a good long as a hedge.

Anonymous said...

great articulated post and threaded comments.

there was another hedge fund guy who bought a crummy business for too much money in the sixties out of an egomaniacal crusade. It was a textile mill. He also bought a department store retailer and slowly closed it down as returns were unacceptable to his internal spreadsheet. (it was the sixties, but he was a smart guy.)

at this point the short bet says Sears is going bankrupt pretty fast.
Any other scenario for a short has some serious downside risk in my opinion.
It will be interesting to see where orchard supply trades.
Also interesting will be if the share buybacks stopped because there was no money, or because the price was pinned for the first quarter of 2012 between 30 and 60 where some meaningful buybacks could take place.

I have a hard time imagining that Lampert, even if he is as stupid and evil as many bashers say, would let Sears go bankrupt.
Maybe I'm wrong.
Of course, the buyout was made in what everyone called the "goldilocks economy"
remember that?

Anonymous said...

Before writing a post about the arrongance of Eddie, you should have learned how to spell his name.

Anonymous said...

sears will go to the drain and
get some driano it it's funeral.,
it is rumored that sears will
brintany spears to get free buy
out the company with justin
beaver to offer beaver pie's.,
how about that!

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