By and
with contributions from Kellie Ell, Evan Clark
 on October 16, 2018
Forty additional Sears stores are set to close in February 2019.

Sears Holdings Corp. finally came tumbling down.

The question now is who gets caught in the wreckage and who gains as the 126-year-old retailer winds through the torturous process of bankruptcy.

Sears’ Chapter 11 filing in the wee hours of Monday morning was very much expected and came years after it was clear that Edward S. Lampert’s grand 2005 experiment to merge Sears and Kmart was headed for eventual failure — but not before making the hedge fund honcho millions in profits on his financial engineering.

If there is one person responsible for the state of Sears it’s Lampert, who in addition to being architect of the company’s modern iteration is also chairman as well as its largest shareholder and creditor. He was also chief executive officer, but ceded that role when the company went into bankruptcy.

“It’s an American tragedy,” said Arthur Martinez, who was chairman and ceo of the Sears Merchandise Group from 1992 to 1995, and chairman, ceo and president of the parent company from 1995 to 2000. “This didn’t have to happen. I’m heartbroken.

“Edward Lampert had a complete disregard for investment needs — store environments, marketing, inventory, people and significantly, in the online commerce platform,” Martinez said. “Retail is intensely capital-needy. He ignored that. His capital spend over the years was dramatically less than the Macy’s and the Penney’s of the world. I think the likelihood of the company emerging from Chapter 11 as a sustainable, profitable entity is very low, given the path the company has been on for the past 13 years.”

Kmart chairman Edward Lampert listens during a news conference to announce the merger of Kmart and Sears in New York . Kmart is acquiring Sears, one of the most venerable names in U.S. retailing, in a surprise $11 billion deal that will create the nation's third-largest retailerKMART SEARS MERGER, NEW YORK, USA

Edward Lampert in 2004, when the deal to merge Kmart and Sears was revealed.  GREGORY BULL/AP/REX/Shutterstock

“It’s a sad story,” added Allen Questrom, the former J.C. Penney, Macy’s, Barneys New York and Federated Department Stores ceo. “Sears served America so well for so many years. It sold everything from tombstones and houses to major appliances. It was the dominant place to shop till the Seventies. But they lost touch. You’ve got to be able to satisfy customers based on what they want now, not 20 years ago. You have to stay on top of your customers — all of the time.”

Asked if he believed Sears could survive post-bankruptcy, Questrom replied, “I don’t know what the reason for being is today. Frankly, I’m surprised Sears has lasted as long as it has,” particularly with Macy’s, Walmart and Amazon, among other major retailers, investing and transforming for the future.

Sears is going to make a go of it in retail for at least a little while longer, closing some stores immediately and plans to try to reject additional leases during the bankruptcy process to get down to a core store base that would work. The company secured $300 million in financing for the bankruptcy process and is in the process of trying to borrow another $300 million from Lampert’s fund.

But it might be too late.

Neil Saunders, managing director of GlobalData Retail, said: “Too much rot has set in at Sears to make it a viable business. The brand is now tarnished just as the economics of its model are firmly stacked against its future success.

“That said, trading through the holidays is a reasonable tactic, not least because it will allow Sears to clear down some inventory and ensure that at least some staff can keep their jobs, even if only temporarily. Even so, Sears will still be running up a down escalator. This is all the more so as many consumers will now be nervous about buying bigger ticket items from the retailer for fear that it may not be around to back guarantees or fix problems come the New Year,” he added.

Sources said vendors will continue to ship to Sears, at least through mid-November for the holiday season, provided they are prepaid or paid on a C-O-D basis, or given a bank guarantee.

“A lot of vendors have required cash before delivery, some have not,” said one retail expert. “But for the most part, established brands and suppliers have scrutinized all of their orders and shipments to Sears. Many have created reserves on their balance sheets so with the Chapter 11, they would have as little liability as possible. Reserves would cover the forfeiture of payments. This is not a surprise attack, this situation has been brewing, not for months, but for years.”

The straw that finally broke Sears’ balance sheet was a $134 million debt payment due Monday — but the pressure at the department store chain has been building for decades.

The once undisputed retail leader limped into bankruptcy with just $6.94 billion in assets and $11.34 billion in liabilities.

That makes Sears the third-largest retail bankruptcy — behind Kmart’s 2002 trip to court and Federated Department Store Inc.’s 1990 filing. Along with Sears, 49 affiliates also filed, including its Kmart Holding Corp. division.

Kmart was where it all started for Lampert, who gained control of the discounter after it filed bankruptcy and later combined it with Sears, building a retailer with more than $53 billion in sales and more than 3,500 stores.

That move had some on Wall Street hailing him as a latter-day Warren Buffett and expecting him to use cash flow from Sears to fund other acquisitions. But Sears Holdings never really gelled and the company ultimately started shedding operations instead of funding other deals.

Lampert held back on store investments, arguing against critics who said he was starving the business. Instead he claimed he was cutting in the name of transformation, pushing his Shop Your Way membership program over and setting up what was widely seen as a slow-motion liquidation.

Asset sales included the spin-off of Lands’ End, netting Sears $500 million, and the sale of real estate and joint venture deals creating Seritage Growth Properties, which gave the company a $2 billion cash infusion — and Lampert a big stake in the REIT, a major Sears landlord.

Lampert, who was already Sears’ largest stockholder, also grew to be its biggest creditor, with his ESL Investments extending loans to the company — and pocketing the interest payments.

The businesses that have been spun out of Sears recently have been careful to keep their distance.

Seritage president and ceo Benjamin Schall said Monday: “All of our capital investment, leasing and development activity over the last three years is unlocking substantial value, and has significantly diversified our income stream with approximately 70 percent of our signed leased income now coming from diversified non-Sears tenants.” The company secured a $2 billion term loan facility from an affiliate of Warren Buffett’s Berkshire Hathaway in August, providing some extra cushion.

As part of the bankruptcy process, Sears is working with Abacus Advisors to liquidate a total of 142 Sears and Kmart doors by the end of the year, raising $42 million in funding for the rest of the company. Those closures come on top of the 46 stores slated to go dark next month. And the company will seek to reject another 220 leases during the bankruptcy process.

That would leave Sears with about 300 stores to carry on with — if it gets the chance. That compares with the roughly 3,770 stores Sears had when it hit its peak sales of $53 billion in 2006.

“This time, [Lampert] cannot be the de facto ceo,” said Craig Johnson, president of Customer Growth Partners. “They need to get a true ceo, not just an ‘office of the ceo.’”

Johnson said that had Lampert right-sized the fleet, invested in the stores and embraced the Internet sooner, the company would “be in better shape today, with a market cap far above the penny-stock level. With the right kind of strategy, and a true retailer at the helm, a smaller and more focused Sears could well survive to play another day.”

If — and it is a big ‘if’ — Sears does survive, it will be as a shadow of its former self.

The ripples of its bankruptcy will be felt immediately as the going-out-of-business sales at the Sears stores set to close start to pressure the market.

“Just on a pricing basis, that could hinder some of the peer groups temporarily,” said Jaime Katz, an equity analyst at Morningstar. “There’s temporary margin pressure because people are going to look for the lowest prices.”

Cowen Research’s shopper overlap analysis indicates Walmart and Target, followed by Penney’s, Kohl’s and Macy’s, are “well-positioned” to benefit from market share gains via Sears Holdings’ store closings. The analysis shows 92 percent of Sears shoppers also shop at Walmart; 75 percent shop Target; 56 percent go to Penney’s; 55 percent go to Kohl’s, and 54 percent shop Macy’s.

But just because Sears is losing, it doesn’t necessarily mean that another retailer is gaining.

“Sears has been declining for a decade and none of these guys have really benefited from it,” said Michael Binetti, an analyst at Credit Suisse. “Some of the sales could just go away. Some of it can go to Amazon. It doesn’t have to go anywhere. Apparel is the one category that people don’t have to buy.”

The company’s failure is seen as only bringing more change to a retail landscape already rapidly transforming.

Melina Cordero, CBRE global head of retail real estate, said, “Sears’ bankruptcy will hasten the evolution of many malls into centers with less retail and more space devoted to apartments, restaurants, hotels, offices, distribution, entertainment and other uses.”

CBRE issued a report noting that mall owners have anticipated Sears’ potential closure for several years, and have made “contingency plans.” The report said the recovery would be a “protracted process” for mall or strip center owners facing an immediate closure. According to CBRE, it takes about 18 to 36 months to “backfill a typical department store, but the complexity of this bankruptcy filing will make this less than typical.”

The majority of Kmart stores are in strip centers or stand-alone locations, while the majority of Sears stores are in regional malls. CBRE noted many of Sears’ locations benefited from leases that were signed at below-market rates and now could present an opportunity to sign higher-paying tenants.

“Sears has been struggling for a number of years and, generally speaking, landlords have plans in place to address potential or planned closures,” said Stephanie Cegielski, vice president of public relations for the International Council of Shopping Centers. “This is an opportunity to replace a retailer with declining traffic and low rent with a tenant that drives traffic and pays market rate for rent. The space lends itself to another department store, a fitness center or grocery store, or the opportunity to use the land for redevelopment into multiuse or outdoor space.”

“B, C and D” malls will be more impacted by the Sears closings, since they will have a tougher time repurposing the space compared to the more productive “A” malls.

Landlords and vendors aren’t the only ones watching the Sears bankruptcy closely.

One of the retailer’s largest creditors is The Pension Benefit Guaranty Corp., a federal government agency that holds an unsecured claim of an undetermined amount connected to the retailer’s long-term pension obligations.

Lampert said in a recent blog post that the company has contributed more than $4.5 billion to its pension plan since 2005, citing the obligation as a contributing factor to its financial troubles. Specifically, Lampert said he could have used the funds for Sears’ operations and, in turn, “we would have been in a better position to compete” with other retailers, particularly those that don’t have large pension plan obligations.

If Sears can reorganize and exit bankruptcy proceedings, it can elect to keep the pension plans, which are seen as underfunded. If the company proceeds to a liquidation, it might result in one of the biggest pension defaults in the PBGC’s history, with the government agency then funding the pension obligations of more than 90,000 retirees.

For his part, Lampert will hold a town hall meeting for the company on Tuesday to update everyone on the filing. And, in a typical missive to company employees that placed the blame for the retailer’s failure on everything besides his own mismanagement, Lampert also alluded to the pension plan obligations as a hurdle: He sent an e-mail to company employees that alluded to the pension plan obligations: “As you know, over the last several years, we have worked hard to transform our business. While our plan is delivering for our members, our efforts to become a profitable and more competitive retailer have been affected by a difficult retail environment, unsatisfactory operating performance, and legacy liabilities impacted by historically low interest rates.”

And even as most observers believe Sears is headed for the retail graveyard, Lampert remained defiant, explaining that the company’s goal is to “emerge as a member-centric company, reorganized around a smaller platform of profitable stores, with the capital needed to allow us to prosper in the future. We are eager to move forward quickly and preserve as many jobs as possible.”

In a court affidavit by chief financial officer Robert Riecker, he said that over 68,000 people remain employed by Sears, including 32,000 full-time employees and 36,000 part-timers.

In addition to operating losses driven by significant underperformance, the company’s “liquidity position has been negatively impacted by burdensome legacy liabilities, substantial cash interest expense, and nearly $2 billion in vendor credit contraction,” he said.

He said that as the company has worked to keep itself afloat, Sears has been “cooperating with vendors as they contracted the company’s trade terms,” which in term has reduced the prepetition amounts owed to them.

The company believes it has a viable reorganization path around a smaller store footprint, citing 400 stores that Riecker said are “four-wall EBITDA positive” before any lease concessions. The stores will be sold during a bankruptcy court auction that is expected to save the Sears and Kmart nameplates, as well as the jobs of tens of thousands of employees.

ESL is already in talks with Sears to be the stalking-horse bidder for the stores.

Despite overseeing a grand total of $8.2 billion in net losses at Sears over the last 13-plus years, Lampert is clearly not done with retail.

 

The Missteps

A look at where Sears went wrong during the past few decades.

• A failure to respond to the rise of Amazon, Walmart, Target, Kohl’s, Best Buy, Home Depot and Lowe’s.

• Merging Sears into Kmart in 2004, an $11 billion deal marrying two ailing companies. In this case, one plus one never came close to three.

• Lack of investment in store upgrades, advertising, marketing and social media.

• A revolving door of managers, many of whom were underpaid.

• Hard goods, with Craftsman, Kenmore and DieHard, sold well but not well enough to offset the second-rate apparel business.

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