So what business is Sears in? I don’t think anyone knows any more. But it is certain that without a direction, Sears will burn through its cash and leave shareholders with nothing soon enough.
After months of whipping Sears management in this blog for extending its Lock-in to failing retailing practices, in my last Sears post I recognized that I finally could see the management team was milking Sears and KMart of cash. They weren’t trying to actually compete with Target, JC Penneys, Kohl’s and WalMart. They are interested in pulling as much cash out of Sears and KMart as possible. Recently the Chicago Tribune reported (see article here) that Sears was in fact using its "excess cash" to invest in derivatives. Buying into the equities of other companies in a fashion so that no one, not even Sears’ investors, would know what Mr. Lampert and his team is buying.
What’s wrong with this picture? Well, to start with, businesses no longer have some extended lifetime where they can sit back and "clip the coupons" as they rake in the cash. Sure that was possible in the less dynamic era from the 1940’s through the 1970s when competition was dominated by huge players (like Sears) who grabbed market share and then simply held onto it by erecting barriers to competition. But today the flow of products, money and information is so fast that no barrier actually holds back the tide of competition. Sears and KMart have to contend with all the old competitors, all the emerging new traditional retailers, and all the on-line retailers. And they are doing so without the benefit of a powerful supply chain like WalMart. When you go to "milk" the business, the poor cow finds itself malnourished and no longer producing a lot faster than most people predict. WalMart is too busy cutting prices to feed its machine, while Target and Kohls are out finding the latest new products and fashion goods. There isn’t much of a storehouse of value in a brand when everyone can see the number of stores declining, the costs and prices rising, and the employees less satisfied than at competitors. "Milking" the business was a strategy for the 1980’s and before – not really applicable today.
And is Mr. Lampert’s team using this cash flow to invest in something where they can achieve competitive advantage? Well, we simply don’t know. All we know is he’s investing in lots of derivatives – and hiding his investments from anyone to see. What’s wrong with this picture? Well, firstly, do investors have a right to know how their money is invested? I seem to recall investor information being a bedrock of importance to publicly traded companies.
"But what about Warren Buffett and Berkshire Hathaway?" you may ask. Alas, we know that the go-go era of Berkshire Hathaway was at a time when Mr. Buffett and his cash stockpiles could be used to rescue situations where management was somewhat desperate. He offered a White Knight approach to helping those with cash needs to rebuild their business. But today, with the flourishing of Private Equity and Hedge Funds the marketplace is awash in dealmakers with lower capital costs hunting for the kinds of opportunities that were delivered to Mr. Buffett for most of the 1980s and 1990s. The value of such opportunities has shrunk so low that even Mr. Buffett himself, in the Berkshire annual reports, has stated that there are insufficient opportunities for him to keep Berkshire’s capital effectively employed for investors.
Beyond deals, Berkshire Hathaway has made almost all its money in insurance. Berkshire is a primary player in the sophisticated, and highly analytical, world of insurance underwriting and re-insurance (that’s insuring the insurers). Several times Mr. Buffett has explained that the primary profit generator for Berkshire comes from understanding risk and insurance products and knowing how to be the low-cost player in the insurance business. Something Berkshire has mastered and maintained for over 20 years. His investments in other companies, such as Pier One, have done no better than the overall marketplace – and at times far worse. In the end, his whole acquisitions of companies such as Dairy Queen have produced cash for investing into insurance – a target business where Berkshire Hathaway is not only low cost but also the most innovative company in the industry.
So where does that leave Sears? Their plans to "milk" the Kmart and Sears stores for cash I don’t buy into at all. As every quarter has demonstrated, revenues are falling and costs are rising faster than management can predict. Opportunities to sell the real estate into a REIT or other cash producer have not developed, and the real estate market has long ago peaked. Its plan to be a public "hedge fund" holds little promise of long-term above average returns or growth in an ever increasingly competitive world for "deals" where they are no better than any other sharp team of MBAs with a lot of cash from a pension fund or elsewhere. And there is no business, like Buffett’s insurance, where Sears management team claims to have any leadership or innovation.
Otherwise, Sears is a great company. The fact is, management has not really stepped up to any of the Challenges which faces the company in retailing, or in hedge fund investing or in identifying a new business which can grow and return above average profits for years into the future. There is no White Space at Sears, no effort to find a new business with advantage. Right now, Sears is just a vainglorious story of a CEO who wants to spend other people’s money. As Cramer says on Mad Money "You buy Sears to buy into my friend Eddie Lampert." With a below market average Return on Equity of 10.7%, a low Return on Assets of 3.9% and an above average Price/Earnings multiple of 22 – that’s a very risky buy.
I remember the Blue-Light Special growing up. KMart’s reputation has slipped heavily since the mid 1990’s. Why go slumming at KMart, when you can have a pleasant shopping experience with low prices and a touch of class at Target, which seems 9 out of 10 times can be found right down the street from Target. I view KMart in a similar light as that of WalMart. Personal experiences at these two retailers have been close to miserable, especially the chains in the city. Stores are disheveled, products are often times missing from the store shelves, supplies are out, and it seems like utter chaos. Trying to find assistance at these stores can be challenging at best. WalMart, perhaps not as bad as KMart, has greater customer loyalty . As stated in your blog, retailers like Kohls, Target, even JC Penney’s are finding ways to innovate and move forward in the retail business. KMart seems to be in a slump, confused of which strategic route to take. What once was a low cost, practically one-stop shop at KMart has turned in to a ‘why would I stop at KMart when I have my choice of a Target of WalMart a few blocks away?’ It seems that KMart has struggled and is inable to implement any sort of goals at this point.
Well, with Martha getting ready to pull out of K-mart/Sears the writing is on the wall. Risky investment, yes. Just going to the store makes me want to shop else where. K-mart looks and acts out of date. However I do think Sears stands a chance. I questioned why Sears and K-mart merged together.
Well some things I would agree. Yes, Sears and Kmart don’t really fit into one picture. I used to look at Sears from a little different angle than on Kmart. I was never big fan of Kmart, because I believed they don’t know how to present themselves and compete with Wal-Mart. They are not attractive and here are the consequences. I was really shocked seeing Kmart going through Chapter 11, and few months after buying Sears. WHY????
If your “milking” theory is right, I feel bad for Sears; because I still believe they could do something good. As of Sears not having “white space” I would disagree. Few years ago, Sears created chain of stores called The Great Indoors. This is a Sear’s chain of stores created for the upscale customers. Moreover, Sears also owns: Sears Auto Centers, Hometown Dealers (Locally owned and operated stores in small communities), Sears Appliance Outlet Stores (Discontinued or slightly blemished appliances at reduced prices). What Wal-Mart did with its Sam’s Club, Sears did exactly the same thing but the “upper” way, for more demanding customers. Like I said, Sears has potential but being part of Kmart may have terrible consequences.
Someone needs to explain to Sears the difference between “”white space” and “black hole.” They aren’t creative. They aren’t increasing their share in the consumer market. They aren’t innovative in any way except, perhaps, in ways to “milk” the company’s cash cow as described in Mr. Hartung’s article.
So far, the combined efforts of Kmart & Sears to merge into one corporation to compete with Target, Kohl’s and Walmart are, to paraphrase Martha Stewart, “not a good thing.” I believe Target is a true leader in the white space approach. They’ve done their homework and drastically improved their image so well that they’ve managed to increase their customer base without losing anything. There are huge demographic ranges in the Target customer base. It’s working! Kohl’s, while a very good, solid organization, is now chasing Target’s marketing team in an effort to be more hip & trendy. It’s too soon to tell how well that will produce or last.
But what has Sears done? Can you identify a Sears holiday commercial before you see the name? In fact – have you even SEEN a Sears or KMart holiday commercial? I am not promoting more commercialism for Christmas, but from a business standpoint – this is the time to make a difference in the bottom line.
It’s arguable as how to much effect Ms. Stewart’s presence has within KMart, but regardless of her pending decision – it is not a positive sign. KMart and Sears suffered individually with their reputations. The combined result is no answer, either. If they’re going to survive, they need to pull themselves out of the black hole and hurl themselves into some “white space” NOW!