Sears as a private equity morality tale

Today’s NYT, in a news story tellingly written and co-reported by its agenda-heavy columnist Gretchen Morgenson, tells a tale of a grand old store being driven down by private equity. In Morgenson's version it’s all about Eddie Lampert’s misguided attempt to seek profit by cutting spending:

Since combining the two retailers, Mr. Lampert, 45, has raised prices even as he has cut capital spending and marketing budgets. The dearth of investment shows up in stores, many of which look shabby next to those of rivals like Target and J. C. Penney. Mr. Lampert’s major use of cash has been to buy back Sears Holdings’ shares.* * *

[T]he question remains. Would the performance of Sears have improved if Mr. Lampert had not cut the company’s capital investment? In 2004, before the merger, Sears and Kmart managers spent a combined $1.1 billion on investments like new-store openings and renovations. In 2005, Mr. Lampert took that number down to $546 million, and in 2006, capital investment at Sears Holdings fell to $513 million.. . . .

So it seems to be all about private equity trying for a quick buck by plundering a grand old company.  While this is a consistent theme in private equity journalistm, it's an unconvincing one.  Private equity managers live or die on the value they're able to deliver, including by reselling its restructured properties.  What's missing from the standard criticism of private equity is how these gurus think they can fetch high prices for plundered properties.

In this case, the typical line on private equity is even less apt than usual. The real story is about private equity being too ambitious in an attempt to prop up a fading star.

I called this shot a couple of years ago. At that time I asked:

Why leave the real estate portfolio in the combined corporate entity -- i.e., why not spin it off into a tax-advantaged REIT or a limited partnership, and chuck the double corporate tax? * * * Jesse Eisinger, writing about the deal in today’s W$J, persists in seeing Sears as a retailer. * * * Where are all these new Sears shoppers coming from? Nostalgia freaks? Dawn of the Dead zombies? * * * Why not just become a real estate portfolio right now?

Last November I updated this with a discussion of a WSJ story noting that "Sears shares have plunged nearly 50% from the April high. . .. Apart from the general malaise affecting the sector, Sears lacks a compelling strategy to attract more customers to its stores."

Morgenson’s story repeats this tale of woe:

Customers are avoiding Sears stores in droves. Indeed, at many Sears stores, clerks at times seem to outnumber shoppers. * * *

Sears Essentials flopped. It was not because Kmart shoppers rejected Sears products, but because the experiment seemed to consist only of tossing Kenmore stoves and Craftsman hammers into an old Kmart store, rather than creating a vibrant new shopping experience * * *

Meanwhile, it's getting clearer that the real estate play was the best move:

[DB analyst Bill] Dreher added that the Sears chairman could be moving to take the company private and use the cash generated by Sears Holdings’ retail operation to finance ESL Investments. Mr. Dreher estimates the liquidation value of Sears Holdings to be about $150 a share, after tax, including the value of its stores and leases and its well-known consumer brands. Craig Schmidt, an analyst at Merrill Lynch, and Gregory Melich, an analyst at Morgan Stanley, value Sears real estate at around $16 billion. The company’s market capitalization is $14 billion, as of Friday’s close. One investor who has bet against Sears said he believes the real estate may be worth just $10 billion.

Alas, as Morgenson's article points out, the decline in the commercial real estate market probably defeats that strategy now. So Morgenson concludes: "If Mr. Lampert finds it difficult to sell in an anemic real estate market, he will have to improve the retail operations to generate shareholder value."

In other words, the real story here is that Lampert’s best strategy from the beginning probably would have been to just shutter Sears. Think about what the storyline would have been then from all the private equity haters. Instead, Lampert tried to make the retail story work, always a dubious proposition, in my view.

But to complicate things further, it is worth adding the point that Ted Frank made in commenting on my November post: "that 50% decline [in Sears stock] is still a 600% increase since your original post."

Funny that Morgenson, who is always complaining about the failure of today’s corporate management to deliver value to shareholders, chooses to complain as well about a private equity guy who tried mightily to do just that, while in the process trying to save an important symbol of America’s corporate past, and a lot of jobs as well.

While I’ve written many posts on Morgenson’s particular failings as a business journalist, this particular failure to get the story straight on private equity is unfortunately one that’s shared widely in the business press.

Comments

[Ted]

My original comment was imprecise. The SHLD IPO was in 2003, not 2005, and most of the run-up was between 2003 and 2005.

[save_the_rustbelt]

Sears has been wandering the wilderness for at least 30 years, trying to find a niche and strategy to revive the company, and nothing has worked.

Buying the crippled K-Mart, with a similar history of wandering, was a really bad idea.

This is a 30 year story, which I imagine is hard to write, but current events are just the last throes of a long painful death.

[Gritsforbreakfast]

Hmmmm ... you say "What's missing from the standard criticism of private equity is how these gurus think they can fetch high prices for plundered properties."

But then with Sears' example you show us how - by shuttering the business and selling off the real estate.

Perhaps (probably) it was just Sears time to go, but I don't think the case study disputes the problems with private equity looking for a "quick buck" - you just appear to be arguing they should have gone for the quick bucks quicker.