Deal Professor: Sears Clings to Catalog Thinking in an Online World

2017-01-18 03:24:09

 

Deal Professor: Sears Clings to Catalog Thinking in an Online World

The Sears Holdings Corporation, which is projected to lose more than $2 billion this year, is in the retailing dead pool. As its prospects for a turnaround appear to grow dimmer, it may seem to be another morality tale for bricks-and-mortar retailers in the age of Amazon.

Yet it is a lesson that even Sears recognizes. Like other retailers, the company is scrambling to adapt to today’s internet market. The question is whether it can do so before its cash runs out and the deal-making of its hedge fund chief executive, Edward S. Lampert is not enough to create more.

Everyone knows Sears, which has been around for over 130 years. It started as a catalog business, the Amazon of a century ago, where you could buy just about anything. And I mean anything. I lived for several years in a Sears catalog home, shipped to my town by Sears at the turn of the 20th century.

But in recent years, Sears has struggled. The company has lost over $9 billion in the last five years. Since 2011, it has shut more than 150 of its big Sears stores and over 350 Kmart stores, and it has just announced the closing of another 150 stores. Its revenue has fallen to a projected $25 billion in 2016, from $42.6 billion in 2011, according to Standard & Poor’s Global Market Intelligence.

The outlook is grim for Sears. This month, the company said that comparable sales had declined by 12 to 13 percent over the holiday shopping season. Its stock price has fallen to $8.75, from a high of over $190.

Amazon, in the meantime, has soared. Its revenue is on track to reach $136 billion in revenue this year, according to S.&P. Global Market Intelligence, up over 30 percent from the previous year. Amazon has a market value of $395 billion as it dominates internet retail. And Amazon is on a roll, not just with sales but also with new products like the Echo that are must-haves, at least if you want your children to be screaming for Alexa to play Disney tunes all day.

Other bricks-and-mortar retailers are struggling as well because of the Amazon juggernaut. Macy’s has announced store closures and a revenue decline. J. C. Penney has reported disappointing sales.

Still, Sears is a special case. Since 2008, it has been directly run and at times aided by Mr. Lampert.

Despite a decade of decline, Mr. Lampert — who is after all a person who can read numbers even if he seldom leaves his compound in Florida — still seems to believe in a future for Sears, whose headquarters is in the Chicago suburbs. What is he up to?

Mr. Lampert’s hedge fund acquired Kmart out of bankruptcy and combined it with Sears. At first, it looked like a miracle as the stock and sales rose. But the financial crisis was grim for Sears.

Over the years, Mr. Lampert has managed the company directly — some say micromanaged — by dividing managers into segments and pitting them against one another. In addition, he has tried to refocus Sears onto the internet. This has involved the Shop Your Way strategy, in which Sears is to become an “asset light” company with “members” who can shop online and at more streamlined stores.

Mr. Lampert has been pushing this idea for a while. In his annual letter last year, he wrote glowingly about Uber and its ability to have almost “unlimited capital” despite large losses. Sears and other older companies were held to a higher standard, he noted. “Because of Sears and Kmart’s longstanding history and cultural impact, we are targeted for criticism when our results are poor,” he wrote. Mr. Lampert seemed to be saying that internet companies get a free pass, while Sears is subject to criticism.

Despite the conventional wisdom, though, it is not Amazon that is primarily to blame for Sears’s plight. Sears is being squeezed by changing economies and technology. Shoppers go to Walmart for discount items or to Target for discount items with a touch of style. The high end stays at stores like Nordstrom. The middle is smaller and increasingly shops online.

(Sears, when asked to comment, referred to recent news releases.)

People love to hate hedge fund guys, and perhaps the biggest criticism of Mr. Lampert is that he acts like a hedge fund manager, slicing and dicing Sears to meet its fire hose cash-flow needs. And so Sears has been split up into multiple companies to create more value, but also to raise cash for Sears itself, like Seritage (Sears real estate), Orchard Supply Hardware. In the most recent example, Sears sold the Craftsman brand to Black & Decker.

Lots of financing transactions have included a rights offering and letters of credit and loans from Mr. Lampert’s own hedge fund. The financial engineering has been extreme, while the turnaround has been slow to realize.

In all of this, Sears itself has declined in value while Mr. Lampert’s net worth has fallen to $2 billion from about $3 billion.

So why doesn’t he just try to liquidate the company instead?

After all, Sears has $5 billion in inventory alone, lots of real estate still to monetize and beloved brands like Kenmore and DieHard that it has yet to sell. This is a classic 1980s play; the breakup value is much more than that of the existing company.

One explanation is that it would be expensive to liquidate Sears. Shutting down 1,600 stores would be chaotic, and selling $5 billion worth of inventory at liquidation value would yield much less. Seritage, which mostly holds Sears property, would be significantly affected.

But another explanation is that whatever you think of the execution, Sears is onto something. Bricks-and-mortar retail is not going away— it still dominates online sales and most likely always will. But retail is fragmenting and shifting into branded stores.

Sears was once the Amazon of its day through its catalogs, and it successfully migrated to stores. Companies like Allstate, Dean Witter and Discover were spun out of Sears. Back then the company was everything to all consumers. Now, at a time when Amazon is everything to all customers, $24 billion in sales is still nothing to sneeze at, and surely some Sears stores are still profitable.

This is ultimately Mr. Lampert’s strategy — leverage a huge ground footprint to extend into the internet. A ground footprint is valuable not just because people still mostly shop by ground but also as a delivery vehicle. Amazon itself is opening up some physical stores.

Here, Mr. Lampert is betting that Sears can transform itself by leveraging its ground footprint and streamlining it. It has invested in a newer, more streamlined store format selling appliances. The first of these opened in Fort Collins, Colo.

But that belies the question of whom Sears is marketing to: discount shoppers or a more upmarket crowd? In today’s day and age it is impossible to be everything for everyone in a physical store when the internet is simply much better at it.

All of this must be done when Amazon or Walmart could buy the retailer for pocket change at this point. If Sears intended to dominate the internet, it should have started 15 years ago when it had the brand recognition to do so.

In the end, the problem with Sears may be that while Mr. Lampert may be sure of Sears’s value, the public just isn’t sure of where it stands in the hierarchy of retailers when a ground store selling everything just isn’t what it used to be. No amount of Wall Street alchemy and deal-making can fix this problem.

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