Can Re­struc­tur­ing Sears Fix a Cat­a­log of Prob­lems?


LAST WEEK, BAY HAR­BOR Is­lands, Fla.-based hedge fund ESL In­vest­ments un­veiled a plan to res­cue one of the icons of Amer­i­can re­tail: Sears Hold­ings Corp., which owns the Sears and Kmart brands. How­ever, ex­perts warn that ESL likely stands to gain more from the re­struc­tur­ing than Sears Hold­ings, and they note there is a po­ten­tially large con­flict of in­ter­est, be­cause Sears CEO and chair­man Ed­ward Lam­pert also owns the hedge fund, which is the re­tailer’s largest share­holder.

ESL’s plan for Sears’ re­struc­tur­ing called for the re­tailer to sell real es­tate as­sets to ex­tin­guish re­lated debt of $1.5 bil­lion, as well as re­struc­ture $1.1 bil­lion in debt, ac­cord­ing to a fil­ing with the Se­cu­ri­ties and Ex­change Com­mis­sion. The plan is ex­pected to cut debt by 78% to $1.2 bil­lion and lower annual in­ter­est ex­pense by 80% to $88 mil­lion. Ear­lier this month, Sears posted a net loss of $508 mil­lion ($4.68 per share) for its fis­cal se­cond quar­ter, which was more than dou­ble the $250 mil­lion ($2.33 per share) in losses in­curred in the same quar­ter last year. Rev­enues plunged from $4.3 bil­lion to $3.2 bil­lion dur­ing the same pe­riod.

Sears — which traces its sto­ried his­tory to 1886 when sta­tion agent Richard Sears sold a batch of watches to other agents to earn ex­tra in­come — be­came Sears Hold­ings in an $11.5 bil­lion merger with Kmart in 2005. Lam­pert steered that merger after buy­ing Kmart in 2003, and be­came Sears CEO in 2013. The com­pany had 3,500 stores in the U.S. at the time of the merger, but as­set sales over the years have re­duced its store count to 820 cur­rently. ESL stressed the ur­gency of its re­vival plan for Sears, point­ing to a $134 mil­lion debt re­pay­ment that is due by Oct. 15. It pushed to im­ple­ment its plan while Sears is “a go­ing con­cern, rather than al­ter­na­tives that would

sub­stan­tially re­duce, if not elim­i­nate, value for stake­hold­ers.” Missed Tar­gets? ESL’s re­struc­tur­ing plan for Sears does not ad­dress the com­pany’s core busi­ness is­sues, ac­cord­ing to Mark A. Co­hen, di­rec­tor of re­tail stud­ies at Columbia Busi­ness School. Co­hen is a for­mer chair­man and CEO of Sears Canada, Lazarus De­part­ment Stores and Bradlees. “This is the can­dle fi­nally burn­ing it­self down and soon to be out,” he said. “This is a 13-year-long sham that’s run its course, and is about to run its course to the very end.” In 2004, Sears Canada ter­mi­nated Co­hen’s con­tract “over ‘strate­gic dif­fer­ences’ in the fu­ture di­rec­tion of the busi­ness,” ac­cord­ing to CBC. Bar­bara Kahn, a Whar­ton mar­ket­ing pro­fes­sor and au­thor of the book, The ! "Suc­cess­ful Re­tail­ers Win Customers in an Era of End­less Dis­rup­tion, agreed. “This is a debt-re­duc­tion move, and it has noth­ing to do with try­ing to cor­rect the un­der­ly­ing prob­lem, which is that Sears is a ter­ri­ble re­tailer right now.” Co­hen and Kahn dis­cussed the Sears re­vival plan and the com­pany’s fu­ture on the Knowl­edge@Whar­ton. To say that Sears is bad at re­tail­ing “is a harsh com­ment, but un­for­tu­nately it is true,” said San­ti­ago Gallino, Whar­ton pro­fes­sor of op­er­a­tions, in­for­ma­tion and de­ci­sions. Gallino’s re­search spe­cial­ties in­clude op­er­a­tions man­age­ment chal­lenges in the re­tail in­dus­try. “At this time, re­tail­ers need to re­think their busi­ness mod­els and in­vest in a strat­egy that fo­cuses on customers. I don’t think this is the best time to cut costs. That will only ex­tend the agony.” Sears share price cur­rently is hov­er­ing around 76 cents — “that’s al­most a penny stock,” noted Thomas S. Robert­son, Whar­ton mar­ket­ing pro­fes­sor and di­rec­tor of the school’s Baker Re­tail­ing Cen­ter. “I don’t know how much time [Lam­pert’s re­struc­tur­ing plan] can buy with a share price of 76 cents. It might buy some time, but it’s not go­ing to be very much. At some point, Sears is go­ing to go out of busi­ness and no­body’s go­ing to no­tice.” Robert­son pointed out that the op­ti­mal time to mount a turn­around plan for Sears was 20 or 25 years ago, when the 125 year-old brand still had the ca­chet of be­ing a “great Amer­i­can com­pany.” “The world changed and they con­tin­ued to build stores and ap­peal to Amer­i­cans mov­ing to sub­ur­bia,” he said. “That worked very well for a long time, but it hasn’t worked for [the past] 20 years and they haven’t adapted.” Gallino did not see on­line re­tail gi­ant Ama­zon as the prime cause of the de­cline of Sears or any other re­tailer. “Re­tail­ers that are strug­gling or that have gone bank­rupt have been vic­tims of their own in­abil­ity to un­der­stand their cus­tomer’s needs, and the changes in the land­scape. Blam­ing Ama­zon is a way to avoid re­spon­si­bil­ity for lack of ini­tia­tive and cre­ativ­ity from the man­age­ment team.” For any re­tailer, en­sur­ing that sup­pli­ers con­tinue to send their prod­ucts is crit­i­cal, be­cause with­out them they would have empty stores. Ac­cord­ing to Kahn and Co­hen, one of the key ob­jec­tives of Lam­pert’s lat­est plan is to main­tain sup­plier re­la­tion­ships. “The only cash the com­pany has been able to put on its bal­ance sheet over the past five, six or seven years is through as­set sales and loans that Lam­pert and ESL have made, se­cu­ri­tized against real es­tate as­sets,” said Co­hen. “In fact, Sears, which op­er­ated rent-free, now pays rent into a real es­tate trust,” Co­hen con­tin­ued. “So this has all been about putting cash on the bal­ance sheet, to con­tinue to ap­pear to be sol­vent so as to con­vince ven­dors to con­tinue to ship.” To demon­strate liq­uid­ity is es­pe­cially im­por­tant for Sears to have sup­pli­ers ship­ping prod­ucts to it ahead of the com­ing hol­i­day sea­son, he noted. Co­hen de­scribed Lam­pert tap­ping an in­de­pen­dent com­mit­tee of the com­pany’s board seek­ing ap­proval for the re­struc­tur­ing plan as “a sham.” The Sears board “is noth­ing more than a group of rub­ber stamp artists,” he said. “What in­de­pen­dent board would al­low a com­pany to be run this way?” As Co­hen saw it, Lam­pert’s plan is to use the pro­posed as­set sales to bring cash onto the bal­ance sheet to keep the day sea­son. That plan would tide the com­pany over may# # $%&'( but not for much longer. “Even­tu­ally it’s go­ing to have )# *(+ pre­dicted. “But since [Lam­pert is] the prin­ci­pal cred­i­tor, he’ll con­trol the bank­ruptcy process and he’ll bring it back out to strip what­ever as­sets re­main that he hasn’t been able to en­cum­ber yet.” Con­flict of In­ter­est? For Sears watch­ers who ques­tion the mer­its of the plan, one big is­sue is “re­lated-party trans­ac­tions,” or busi­ness trans­ac­tions be­tween Sears and its ma­jor­ity owner ESL. ESL would be the big­gest ben­e­fi­ciary of the debt-re­struc­tur­ing plan, re­coup­ing $1 bil­lion of the $2.5 bil­lion in Sears debt it owns, ac­cord­ing to a Bloomberg re­port. Sears has also sold its prop­er­ties to a real es­tate in­vest­ment trust called Ser­itage Growth Prop­er­ties, in which ESL is the big­gest unit holder, the re­port added. Ser­itage has leased the prop­er­ties back to Sears. When Sears sold its Land’s End cloth­ing line four years ago, Lam­pert ended up as its big­gest owner, ac­cord­ing to Bloomberg. “From what [Lam­pert] is do­ing, it is un­clear that the idea is to save the com­pany,” said Gallino. “The plan seems more fo­cused on get­ting a good re­turn on the in­vest­ment on some of [Lam­pert’s] other in­ter­ests.” One con­tro­ver­sial pro­posal is to sell Sears’ Ken­more brand. Lam­pert on be­half of ESL has of­fered $400 mil­lion to buy the once-pop­u­lar brand of home ap­pli­ances, al­though a spe­cial com­mit­tee would vet the pro­posed deal for po­ten­tial con­flicts of in­ter­est. Ac­cord­ing to Co­hen, Kahn and Gallino, Ken­more is the last re­main­ing big brand of Sears. “It is the last leg on the stool of any con­se­quence,” said Co­hen; the com­pany’s col­lec­tion of real es­tate prop­er­ties make up “Sell­ing off the com­pany’s prin­ci­pal as­sets leaves the com­pany with noth­ing.” That is pre­cisely “what’s been hap­pen­ing lit­er­ally for over the last decade,” he added, re­fer­ring to sales of other as­sets in­clud­ing real es­tate and brands like Land’s End. Lead­er­ship Is­sues Kahn won­dered if Lam­pert had “a chance” to re­vive Sears over years. “There’s been no chance, and there’s been no in­tent,” Co­hen re­sponded. “It is an ab­so­lute trav­esty that there is still some con­ver­sa­tion com­ing out of Lam­pert and his or­ga­ni­za­tion about a turn­around. There never was a turn­around; there never could be a turn­around. This is all about strip­ping an as­set down to the bare walls.” Co­hen traced the re­tailer’s re­cent de­cline to the pe­riod after Alan Lacy be­came CEO of Sears, fol­low­ing the re­tire­ment of Arthur Martinez in $%%% : ! mak­ing be­lieve he knew what he was do­ing, and the com­pany went into a slow de­cline,” he said. “The stock price came down. Gross mar­gins came down, vol­umes # ## "through a cat­a­strophic sale of the com­pany’s credit port# < ( # ( sale.” After Lam­pert gained con­trol of Sears fol­low­ing its merger with Kmart, the de­cline con­tin­ued, ac­cord­ing to Co­hen. “Lam­pert had all sorts of the­o­ries about how to run the busi­ness, largely by with­draw­ing all con­ven­tional in­vest­ment in cap­i­tal ex­pense,” he said. “For about two years, the com­pany looked heroic in its per­for­mance in that free cash flow ex­ploded. (Free > # ! after op­er­at­ing costs and cap­i­tal ex­pen­di­ture.) That fan­tasy went on for about a year-and-a-half or two years, and then the busi­ness started to de­cline.” Co­hen noted that Lam­pert in­vested the free cash > # in de­riv­a­tives, in­stead of in im­prov­ing the com­pany’s stores and prod­uct of­fer­ings or in hu­man re­sources. “The lifeblood of re­tail is ob­vi­ously prod­uct, and the en­ergy and engine that sup­ports prod­uct is an or­ga­ni­za­tion of mer- chants sup­ported by store op­er­a­tors and lo­gis­ti­cians. So this com­pany has not had a vi­able op­er­at­ing strat­egy in 18 years — cer­tainly in the 13 years that Lam­pert has been in pos­ses­sion of it.” If Sears as we know it col­lapsed, could the brand be brought back in a dif­fer­ent form? “At one time, when Pan Am went out of busi­ness — and it was a bril­liant brand at one time — the brand was pur­chased and some­one tried an air­line with the Pan Am name from New York to Mi­ami. It failed,” said Robert­son, not­ing that the same group of hedge funds that pulled the plug on Toys R Us ear­lier this year now hope to re­vive the busi­ness on the strength of the brand name. “I don’t know how much the Sears brand is worth. I don’t know that it’s worth very much at all.” Los­ing the Ini­tia­tive To be sure, Sears was an in­no­va­tor in its in­dus­try in many re­spects, but lost the plot some­where along the na­tional cat­a­log re­tailer. After World War II, it de­vel­oped shop­ping malls through a sub­sidiary, and in fact, it was “the prime mover in many of the ma­jor malls through­out the U.S.” The com­pany also card. “That en­abled newly formed house­holds and re­turn­ing ser­vice­men to buy a re­frig­er­a­tor which oth­er­wise would have been im­pos­si­ble for them,” he re­called. Added be­fore their time.” Sears closed its cat­a­log busi­ness in the early 1990s after try­ing to re­vive it, but re­turned to the di­rect-to­con­sumer busi­ness in the late 1990s with, its on­line chan­nel. Co­hen lamented that Sears missed the bus there as well. “There is no rea­son in the world why Sears could not have be­come much of what Ama­zon is to­day,” he said. “It didn’t have the ful­fill­ment struc­tures [that Ama­zon has] be­cause it had closed them, but it had the DNA, and it had most im­por­tantly the rep­u­ta­tion and re­la­tion­ship with customers. Sears should have been a mar­ket­place of con­se­quence in an omni-chan­nel sense, and it just didn’t go there.” The Fall­out for Malls As Sears closes more and more stores, it will ac­cel­er­ate the sec­u­lar de­cline of malls across the coun­try. Co­hen said be­tween 800 and 1,000 malls are “at risk” across the coun­try. “The ma­jor­ity of them are in trou­ble and aren’t go­ing to ex­tract them­selves be­cause they don’t have enough eco­nomic en­ergy to war­rant the rein­vest­ment that would be re­quired.” Kahn pre­dicted that those uses. “We’re go­ing to see a re­pur­pos­ing; it’s go­ing to be multi-use malls mov­ing into ho­tel space, apart­ment space, gym space [and so forth].”

This is a 13-year-long sham that’s run its course, and is about to run its course to the very end

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