WHAT WENT WRONG
Sears Canada’s largest shareholder explains the retailer’s financial collapse,
Sears Canada Inc. is closed but the court case continues.
The question of whether the company should have paid out more than $3 billion in dividends to shareholders between 2005 and 2013 has become a central issue in the insolvency still making its way through Ontario Superior Court.
Dividends issued in 2012 and 2013 are under review and former employees are seeking the appointment of a special litigation trustee to look at whether selling off the company’s prime assets and paying dividends to shareholders contributed to the insolvency.
Pensioners have been at the forefront of the challenge for years, asking why shareholders were being rewarded even as the company was failing and the employee pension fund was running a deficit.
Today, retirees are facing the prospect of reduced pension payments and they are blaming the largest shareholder, U.S. hedge fund manager Eddie Lampert, chairman and chief executive officer of Sears Holdings Inc. and founder, chairman and CEO of ESL Investments.
In a Q&A with the Star, Lampert said he believes differently.
What went wrong at Sears Canada, in your opinion — and not simply at the end, when executive chairman Brandon Stranzl launched what you have described as a risky turnaround strategy, but over the course of your ownership?
Sears Canada was affected by the same changes in the retail landscape that have made it extraordinarily difficult to run traditional brick-andmortar retailers in the last decade or more. Walmart and other discount chains cut deeply into the customer base and imposed extraordinary pricing pressure, while the advent of Amazon and online retailing compounded the competitive pressures with a much lower cost structure than the traditional retail store operating model. So, while the profitability of Sears Canada improved in the first few years after the merger, different management teams and a variety of strategies were unable to evolve the company to a sustainable, successful level.
In your blog, you refer to the 2008 financial crisis as a trigger in the decline of the company’s fortunes. Competing retailers are still standing. Why was Sears Canada unable to recover?
Any implication that Sears Canada alone was unable to recover after the 2008 recession couldn’t be further from the truth. While some competing retailers in Canada are still standing, many of them are not — some have failed (Target, Future Shop con- trolled by Best Buy, Radio Shack, etc.), some have been deliberately liquidated (Zellers), and some have been merged into bigger companies (Shoppers Drug Mart, Saks Fifth Avenue). In addition, major U.S. retailers such as Macy’s, J.C. Penney and Kohl’s have so far chosen to avoid opening operations in Canada, due to the challenging retail environment in both Canada and the United States.
It is also important to be clear that neither I nor ESL were operating the company or making the capital expenditure decisions of Sears Canada, and different management teams had various views on the amounts and the focus of the company’s capital investments over time. While Sears Holdings and ESL did occasionally express their opinions to members of Sears Canada’s board and management, our input was always focused on improving the competitiveness of the business, to the benefit of customers, associates and shareholders.
The argument has been made that Sears Canada maintained a meaningful amount of cash in the business. But capital expenditures were reduced significantly beginning in 2005 and the business has failed. Former CEOs have said they didn’t have access to the money they needed to effect enough change at a time when the marketplace was changing rapidly and becoming more competitive. What do you think?
In my judgment, there were always sufficient financial resources to invest in the business. More to the point, while the level of spending was higher before 2005, this did not produce more favourable results — a lot of investments were made then, but they earned very low returns. After 2005, many attempts were still made by the different management teams to invest more productively, but ultimately most of those investments also failed to perform particularly well.
In fact, from a broader industry perspective, Target invested over $1.825 billion (Canadian) acquiring most of Zellers’ leases in Canada, spent over $10 million in renovations at each location and finally began operating the stores in 2013, but ultimately lost $5.7 billion (U.S.) when it closed its Canadian operations less than two years later. If simply investing more money in stores was the answer, then Target and others that spent prodigiously would not have suffered such losses and failed.
It is also important to be clear that neither I nor ESL were operating the company or making the capital expenditure decisions of Sears Canada, and different management teams had various views on the amounts and the focus of the company’s capital investments over time. While Sears Holdings and ESL did occasionally express their opinions to members of Sears Canada’s board and management, our input was always focused on improving the competitiveness of the business, to the benefit of customers, associates and shareholders.
This is how Sears pensioners described the situation: “The substance of Sears Canada’s management conduct is asset stripping, and has resulted in a company with negative operating earnings and cash flow and deteriorating key performance measures.” What is your point of view?
The facts are that Sears Canada divested assets when attractive returns were available, which is a normal form of corporate activity, but its management also worked hard to transform the company in the face of an extremely challenging retail environment. I would also expect that the Sears Canada board of directors appropriately sought to balance the interests of the company’s many stakeholders, of whom the pensioners are an extremely important, but not the sole, constituent.
Pensioners have argued that the company should not have been paying rich dividends to investors at a time when the company was performing poorly on a variety of fronts and the pension was underfunded. How do you respond to that?
In 2012 and 2013, Sears Canada’s dividend payments were made out of asset sales proceeds and did not deprive the company of the cash needed to fund operations or to pay pension obligations. In fact, capital expenditures in 2012 and 2013 increased to $102 million (Canadian) and $71 million (Canadian), respectively, and the company had $514 million (Canadian) in cash at the end of 2013.
The dividend payments made in 2012 and 2013 are being reviewed by the monitor overseeing the insolvency. What do you think they will find?
In terms of the review from the monitor, the facts that should be clear are:
Neither Sears Holdings nor ESL directed the payment of the dividends or the amounts of the dividends;
Again, the company retained $514 million (Canadian) in cash after the 2013 payment and there was virtually no funded debt;
The amounts paid were significantly lower than the amounts that could have been paid given the company’s financial position and the significant amount of cash the company retained following each of the dividends;
After the payment of the 2013 dividend, Sears Canada had a market capitalization in excess of $1 billion, indicating that the market continued to view Sears Canada as a valuable and viable company.
It is also important to clarify that neither I nor ESL were the primary — and certainly not the only — recipient of Sears Canada’s dividends over the past several years. ESL’s share of the dividends paid since 2005 was only 5 per cent of the total. And even with respect to the dividends in 2012 and 2013 that have received the most attention, only a minority (less than 28 per cent) of the amount distributed went to ESL.
Sears Holdings received approximately $300 million of the 2012/2013 dividends, but those amounts were used to fund Sears Holdings’ business and were not distributed to ESL or other shareholders of Sears Holdings.
Sears Holdings and ESL never instructed the board of Sears Canada to approve any dividend payments.
Why were there so many different leaders at Sears Canada after 2005 and do you think that affected the business?
The challenge of transforming a traditional retail company in the past decade has been a difficult one. It is a task that many people, at many companies, have not succeeded at. In the case of Sears Canada, several management teams attempted to turn around and transform the company over many years, but the specific strategies pursued did not drive meaningful operational improvements in the changing retail environment.
Did you ever visit Sears Canada headquarters in Toronto?
Yes. However, as I have stated, the idea was to have Sears Canada operate with its own strategy and to translate any success from Canada to the United States and vice versa.
Similar to certain of my investments, such as AutoZone and AutoNation (where I actually served on their boards of directors for a period of time), my goal was that Sears Holdings (and later ESL) would benefit from a talented management team working to improve Sears Canada and its business. I provided advice occasionally as requested, but never sought to control the operating decisions and day-to-day activities of the company, and never attended or participated in any board meetings in Toronto or elsewhere.
How do you feel about the failure of Sears Canada and the 40,000 people who were left jobless by the slow collapse of the business?
ESL always tried to be a constructive shareholder and to support the success of Sears Canada. In 2014, when Sears Holdings decided to sell a sub- stantial amount of its ownership in Sears Canada through a rights offering, ESL invested $200 million (U.S.) to buy stock at $9.50 a share in Sears Canada. We obviously would not have made that investment if we did not believe in the chances of a successful transformation of Sears Canada which would return the company to profitability.
Ultimately, whenever a company fails, it hurts a lot of people, and I sympathize with those employees who lost their jobs and those facing uncertainty surrounding their pension payments. That’s why it was so important for the company to succeed, even if it took finding other parties willing to take over the company, which was tried but unfortunately failed in 2014. In my case, I lost a significant amount of money that I risked betting that Sears Canada could transform successfully.
I deeply regret the failure of Sears Canada and the impact it has had on the lives of its employees.
What do you think of the idea of the appointment of a litigation trustee? Do you oppose it?
My view is there is no legitimate basis to attempt to reclaim dividends which were duly authorized by the board of directors four and five years before the Companies Creditors Arrangement Act (CCAA) filing, and my understanding is that there is no basis under Canadian law to do so. All of the dividends were paid at a time when Sears Canada was clearly solvent — evidenced by its significant market value in excess of $1 billion, minimal debt and $514 million in cash on its balance sheet — after giving effect to the final dividend payment in 2013.
Overall, including the dividends paid and the significant losses you said ESL suffered as a result of the company’s bankruptcy filing, did ESL make or lose money on its investment in Sears Canada? How much?
Like all other shareholders, ESL has suffered significant losses in the bankruptcy — Sears Canada’s shareholders have collectively lost over $1 billion (Canadian) since 2012, even after taking into account dividends received — and ESL’s equity investment in the company was wiped out entirely.
The total dividends received by ESL from Sears Canada since it became a shareholder were approximately $160 million (U.S.) ESL’s aggregate loss on its investment in Sears Canada exceeds $200 million (U.S.)
There is a false narrative that somehow ESL made a lot of money on Sears Canada when, in fact, it has lost a significant amount. That false narrative has been repeated over and over without anyone doing the simple math, which is all a matter of public record.