Sears, Kmart stores ailing as CEO’s hedge fund gets millions

When he became CEO of Sears Holdings, Eddie Lampert declared he was on a mission to restore the iconic retailer to its former glory. Since then he’s extended billions of dollars in loans from his hedge fund to Sears and Kmart.

But the difference between what Sears has invested in its stores — and therefore what customers experience when they shop — is stark compared with many of its peers, a USA TODAY review of public filings and analyst research shows. And if the chain ever sinks into bankruptcy, the records show Lampert’s hedge fund will be positioned at the front of the line when loans are repaid.

While Sears has spent less to spruce up stores, competitors have taken the opposite approach. Best Buy, for instance, was left for dead five years ago, Since then, CEO Hubert Joly has plunged hundreds of millions of dollars into store upgrades and critical information technology systems. Today, the electronics retailer is back on its feet, having remade itself as a vibrant physical retailer immersed in the digital age.

Sears stores, on the other hand, have fallen into disrepair. Stained carpeting, broken fixtures and dim lighting are commonplace. Analysts, industry watchers and even shoppers predict the iconic retailer doesn’t have much time left.

“If you go into any Sears, physically they look like 1982,” said Stacey Widlitz, president of SW Retail Advisors. “So as a customer you’re thinking, ‘This is not a place I’m coming back to.’ ”

USA TODAY’s examination of public capital spending data and research compiled by Susquehanna International Group found Sears and Kmart spent 91 cents in capital expenditures per square foot in the fiscal year that ended in February. In contrast, Best Buy invested $15.36 per square foot in its most recent fiscal year.

Lampert declined to be interviewed for this story and a representative for Lampert’s hedge fund, ESL Investments, declined to comment or to make him available.

In an emailed response to questions, Sears told USA TODAY, “we strongly disagree with your assertion” that the company has not used a sufficient percentage of its resources to reinvest in stores. The company pointed out that its recent investments have included several new smaller-format locations, including Sears Appliance & Mattress locations in Texas, Pennsylvania and Hawaii.

While Sears has steadily lowered its investment in store upgrades over the last five years, the company has loaded up on loans due to Lampert himself.

By extending almost exclusively secured loans to the company, Lampert’s hedge fund has racked up more than $2.4 billion in Sears debt, according to a USA TODAY review of public filings and research by Debtwire, which provides news and analysis of corporate and municipal debt.

Lampert-owned investment funds, including ESL and a related fund called JPP, are getting roughly $200 million to $220 million per year in interest payments from Sears, according to separate estimates from Susquehanna and Debtwire.

As the company bleeds cash and puts prized brands up for sale, some industry watchers question whether a greater focus on its stores — or even a declaration of bankruptcy some years ago — could have put it on the path to profitability.

Now, instead, the company’s demise may be inevitable.

“Two or three years ago, in a bankruptcy ... you probably had a chance to execute reorganization,” said Van Conway, CEO of Van Conway & Partners, a financial advisory firm specializing in distressed situations. Now, “I’ve got to believe when they head into a bankruptcy ... you’re going to see a Toys R Us outcome, which will be just a liquidation.” If that happens, Lampert has put the hedge fund in position to snap up some of the company’s prime assets, analysts said. This would come after the CEO orchestrated a series of complex financial deals in which he effectively has played the unusual role of both seller and buyer or lender and borrower.

In the age of the internet, it’s adapt or die for many brick-and-mortar retailers. Sears looks like it’s closer to the latter and here’s why. USA TODAY

Lampert has previously said he does not believe in pouring money into stores that would not provide sufficient return on the investment.

Instead, he has pursued partnerships, including recent deals with Amazon.com and Citi that have earned praise from investors, and made loans to the company that have been personally lucrative.

“My conclusion is he’s trying to take the whole thing for himself,” said Susquehanna International Group analyst Bill Dreher, a retail stock analyst who has tracked Sears for two decades and recently estimated that the retailer needs $1.4 billion in fresh capital to make it through the year. Dreher recommends that investors sell the stock. Susquehanna is a market maker in the stock, meaning it buys and sells shares to help investors execute trades.

Lender, borrower and cost cutter

Under Lampert’s reign, Sears has implemented a relentless cost-cutting campaign — $1.25 billion in 2017 alone, including hundreds of store closures — while making priority payments to Lampert the lender.

Cost cuts and loans have extended the retailer’s lifespan and kept 89,000 employees at work. The loans were authorized by the board of the company, which may have faced difficulty in securing other financing without Lampert’s help.

“He clearly understands the value of the assets that are in the company and is looking to maximize the value of those assets,” said Philip Emma, senior analyst at Debtwire.

Most of Lampert’s loans likely would be paid in full if Sears goes bankrupt, since it’s nearly all secured debt, which typically takes precedent in court over unsecured creditors such as vendors and landlords.

To be sure, Lampert has a lot to lose if he can’t turn Sears around. That includes his 49% equity stake, which was valued at $115 million as of June 4

“He’s been cutting most of the checks,’’ said Noel Hebert, a Bloomberg analyst who noted that a spin-off of outdoor apparel retailer Lands’ End in 2014 was one of the few occasions when Lampert earned equity without paying for it up front. “It’s not like he’s just totally stripping it and just harvesting all of the value for himself. He is paying for it.’’

The question is “whether he’s paying the right value,’’ Hebert said. “If they ever file for bankruptcy, I suspect that will come up in court if he doesn’t by that point own all of everything.’’

Falling into disrepair

Many of the retail sector’s challenges, including declining mall traffic and Amazon’s rise, were already intense by the time Lampert became CEO.

Lampert signaled his reluctance to heavily invest in stores in a letter to shareholders in 2006 — roughly a year after he engineered the merger of Sears and Kmart to create the new parent company, Sears Holdings.

The business would not invest money in “stores simply because we have the capital available to invest or because everyone else does it,” Lampert wrote.

“Rather we are investing in our stores where the investment makes sense — in other words, where it improves the experience for our customers and associates and leads to attractive returns.”