Sears

The year 2018 turned into an unlucky “13” for Sears Holdings Corp., representing the number of years following the 2005 merger of Kmart Holding Corp. and Sears, Roebuck & Co. by Edward S. Lampert before the combined entity entered bankruptcy proceedings.

After operating for 125 years, Sears Holdings and 49 affiliates on Oct. 15 filed its voluntary petition for Chapter 11 bankruptcy court protection, listing total assets of $6.94 billion and total liabilities of $11.34 billion. The filing made the company the third-largest retail bankruptcy, behind Kmart Corp.’s 2002 Chapter 11 filing at $17 billion in assets and Federated Department Store Inc.’s 1990 filing that listed $7.9 billion in assets. Rounding out the top five retail bankruptcies are Toys ‘R’ Us in 2017, with $6.6 billion in assets, and Montgomery Ward Holding Corp. in 1997, listing $4.9 billion in assets.

The filing wasn’t exactly unexpected. Sears Holdings was under enormous financial stress because of the $134 million debt payment due on the day it filed. But the groundwork for the company’s long road to ruin began years ago.

Lampert, through his hedge fund ESL Investments, bailed out bankrupt Kmart Corp. in 2003 after acquiring a controlling stake in the discounter for $1 billion. A year later, he masterminded the $11 billion merger of Kmart Holding Corp. and Sears, Roebuck & Co., which was finalized in 2005. Lampert’s now chairman of both ESL and Sears Holdings. Thirteen years ago, the combined entity had projected annual revenues of $55 billion and more than 3,500 stores. Some thought Lampert was an investment genius, with many hailing him as the next Warren Buffett.

Lampert clearly isn’t Warren Buffett. But he still might be in the running for investment genius of a different kind — that of great liquidator — if the qualification is based solely on the ability to extract value, something that he has done with his Sears investment many times over. And that has served as the basis for some key criticisms of Lampert and the turn of events at Sears Holdings. Critics have said he’s not a merchant, doesn’t care about retail and is interested only in the real estate. And because he has no experience running a retailer, Lampert is often panned for not making the right retail investments in people, store environment, marketing and inventory.

Many retail and real estate executives, including those in parts of the retail supply chain, believe the scuttlebutt that Lampert’s core interest was always about the real estate holdings. It didn’t help when some service providers added fuel to the fire through whispers over the years about what they saw and heard from their limited engagements that seemed to support those rumblings. Some even groused that advice on how to improve Sears’ retail operations went unheeded.

And while it hasn’t been clear how much he’s made from his investment in Sears, Lampert has already made back his initial $1 billion investment in Kmart in spades. His magic wand in putting together deals at Sears has netted him and ESL stakes in spin-offs and in assets not included in the bankruptcy filing, secured debt, and interest payments over the years.

Financial maneuvers over the past five to six years to keep Sears in operation have given Lampert time to cut one more deal, and then another and another after that. Those transactions have included the spin-off of Lands’ End, which netted Sears $500 million and the creation of real estate investment trust Seritage Growth Properties, which gave the bankrupt retailer $2.7 billion on the transfer of 266 of its top doors to the REIT. There was also a rights offering for Sears Canada to raise $380 million. That’s on top of the loans — $2.4 billion in total — from ESL. Those loans in turn created a flow of interest and debt payments — estimated at hundreds of millions — to the hedge fund over the last several years. Lampert’s ESL also has retained a majority interest in both Lands’ End and Seritage.

But if one had known to watch Lampert more closely, a hint of the game plan might have been discerned back in 2006. That’s because one of Lampert’s first moves after the merger was to take Sears’ three crown jewels — the intellectual property of Craftsman tools, Kenmore appliances and DieHard automotive batteries brands — and move ownership to a bankrupt-remote, special purpose entity called KCD IP LLC through a $1.8 billion securitization bond. KCD now charges Sears a royalty fee for the licensing of the brands. While Craftsman was sold to Stanley Black & Decker in 2017 for $900 million, Lampert still controls the Kenmore and DieHard IP.

Now he wants the chance for one more bailout. ESL said last week it would bid $4.6 billion to acquire most of the assets of Sears and keep it operating as a going concern. Showing what a dealmaker Lampert is, the $4.6 billion includes very little cash, or up to just $500 million in cash and notes to be issued by NewCo, the reorganized company. That’s because the ESL bid includes a credit bid of $1.8 billion, plus up to $950 million in cash from a new asset-based lending facility for NewCo and the roll over of other assets and the assumption of certain liabilities.

Cynics would say this last bailout will allow Lampert to continue to extract what’s left of the Sears and Kmart retail assets, only this time he would be able to do it out of the glass eye of the Wall Street fishbowl. If there’s no other bid and Lampert gets his way, his offer would still require approval of the bankruptcy court.

So just how bad did the deterioration at Sears get under Lampert’s reign during the 13-year run?

In contrast to the expectation when the Kmart and Sears merger was revealed in 2004 for annual revenues of $55 billion, Sears Holdings ended 2017 with annual revenues of just $16.7 billion. A declining business and store closures over the years contributed to the drop in annual revenues. The company also has posted an estimated loss of more than $11 billion since 2011. Other data points show a slow progression toward oblivion starting around 2007.

The company began 2007 with about 355,000 employees. In the same year, shares of Sears Holdings hit their peak at $195.18. That’s compared with a stock price of just 41 cents prior to the filing of the retailer’s bankruptcy petition in October. The retail industry didn’t know that a financial meltdown was about to begin at the tail end of 2007. As retailers tried to make sense of the new normal, they eventually concluded — Sears included — that a new mind-set incorporating omnichannel was needed as consumers shifted their buying behaviors from brick-and-mortar to more shopping online.

Sears had as many as 4,000 stores in 2012. And while Lampert has emphasized Sears’ costly investments in technological infrastructures and platforms, the company also largely ignored its stores, both in upkeep and in maintaining inventory levels.

Store closures over the years would shrink the base to just 788 doors and 68,000 employees in September, when the company posted second-quarter results. In the last two years alone, more than 725 doors operating under the Sears and Kmart nameplates were shuttered. And the exit plan under Lampert’s ESL bid contemplates just 500 stores in operation. On top of that, there are still about 102 Sears leases in operation under a sale-leaseback structure that’s now owned by Seritage. Those leases, once rent-free, have added to Sears’ overhead with an annual base rent obligation of $61.2 million.

Sears, which began operations as a catalogue company in 1892, opened its first store in February 1925 in Chicago. It began trading publicly in 1906. The stock was a component of the Dow Jones Industrial Average from 1924 to 1999. Sears Holdings in April shuttered its last Chicago store, which was located in the area known as “Six Corners, the intersection of Milwaukee, Cicero and Irving Park Roads.” That store was opened 80 years ago.

Kmart’s roots go back to 1899, when it began operations under the name S.S. Kresge Corp. It was listed on the New York Stock Exchange in 1918. The first store under the Kmart nameplate was opened in 1962 in Garden City, Mich. The company was renamed Kmart Corp. in 1977, and became Kmart Holding Corp. in 2003 when Lampert bailed it out of bankruptcy court protection.

For his part, Lampert has been upfront about transforming Sears Holdings into an asset-light company that is focused on being a technology-driven member-centric Shop Your Way platform as an answer to the shift in consumer buying patterns. That retooling has been under

way for several years, hampered by other constraints such as legacy obligations. One that Lampert has pointed to is funding of the company’s pension plan. He said the funding, in part, has channeled money away from other investments that could have been made in the business.

Despite the naysayers who claim there’s no reason for the company to exist, Lampert still believes in Sears Holdings. He said, through ESL, when the hedge fund submitted its intent to bid on the company: “ESL Investments continues to believe in Sears Holdings’ immense potential to evolve and operate profitably as a going concern with a new capitalization and organizational structure….Our proposed business plan envisages significant strategic initiatives and investments in a right-sized network of large format and small retail stores.”

Sears

Eddie Lampert  Chris Buzelli

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