By Jonathan Yates
Not even the first Wall Street investment manager to make more than $1 billion in a year could hope to challenge Wal Mart and come out on top.
Speaking at the shareholders meeting for Sears Holdings, Eddie Lampert, founder of ESL Investments, offered “no excuses” for the first quarter of 2011 that saw losses of $195 million and same store sales declines of 3.6 percent. Merging Sears and K Mart in 2005 was expected to generate efficiencies, synergy and economies of scale to allow the new retail behemoth to compete with Wal Mart and others, while serving as a cash cow to finance other acquisitions for ESL Investments.
Many have speculated that the merger of Sears and K Mart was more a real estate play rather than business reorganization. The properties owned by the combined Sears/K mart were thought to be a valuable asset. With the real estate boom underway for several years heading into 2005, these stores could be sold into the rising tide of commercial real estate investing. At the bankruptcy proceedings for Kmart, the real estate was considered to be worth $879 million, with 1,513 stores, 16 distribution centers, and the assorted fixtures in each.
But micro and macro factors rapidly came into play. Upon closer examination, many of the Sears/K Mart properties were not that attractive. Some were in malls that were substandard, sited when Sears and Kmart were premier retailers. Stores were not of the size and layout that modern shoppers wanted. It turned out that the real estate assets of Sears Holdings were not as valuable as hoped.
Hope was all that was left, and not much of it, after The Great Recession decimated the commercial real sector. The properties of Sears Holdings, like those everywhere, declined greatly in value. In addition, as most were not in premier retail sites, there was even less of an interest from what few buyers remained.
Compounding the effects of The Great Recession was the impact of brutal competition. Wal Mart dominated the sector that had traditionally been the customer base for Sears and K mart. Retailers such as Target and Costco carved deeper into the pool of customers. Outlet shopping centers emerged in greater numbers. All merchants joined in the assault with Internet sales. And EBay and Craig’s List allowed for bargain hunters and savvy consumers to more effectively deploy their discretionary income, further reducing revenues for Sears and K mart.
This does not mean that this will turn out badly for the long term for ESL Investments. Founded in1988 by Lampert with $28 million in seed capital, ESL Investments now has around $10 billion under management. An article in Fortune magazine in February 2006, “Eddie Lampert: the Best of His Generation,” stated that ESL Investment had returned about 30 percent annually. Lampert began his career at Goldman Sachs, working in the risk arbitrage department, a protégé of Robert Rubin, who later became Chairman of the firm and later served Secretary of the Treasury under President Bill Clinton.
While Lampert’s investment style can best be described as “concentrated value” and draws comparisons to Warren Buffet’s, there are substantial differences. Buffet prefers to leave the top management in place, pointing out that is why they acquired the entity. Lampert, by contrast, takes over the running of the company.
Buffet has acquired a diverse set of companies in a variety of businesses for Berkshire Hathaway, ranging from reinsurance. (Gen Re) to railroads (Santé Fe Pacific) to petroleum additives (Lubrizol Corp) to consumer staples (Coca Cola) to finance (Wells Fargo). Most of ESL Investments is in the retail sector, with Sears Holdings constituting 53.9 percent of the portfolio. ESL Investments has also owned Auto Nation and Auto Zone. Lampert recently plowed $800 million in Gap, Inc. It is also invested heavily in the financial sector with Citi Group, CIT Group, Glenworth Financial and Capital One.
Both Buffet and Lampert prefer companies that generate a healthy cash flow. These funds are used to finance other acquisitions. But this extracting of money from Sears Holdings is considered to have resulted in the poor performance of the companies. The stores are considered to be thinly staffed, poorly furnished, need updating and are woefully lacking in customer amenities.
This is a crucial difference between Buffet and other investors. Buffet seeks to buy great companies with great management that will be profitable forever, as he says that is his ideal holding period. A great company is much, much different than a great investment. About Lubrizol Corporation, a recent acquisition, Buffet declared: “Lubrizol is exactly the sort of company with which we love to partner…the global leader in several market applications, run by a talented CEO, James Hambrick. Our only instruction to James…just keep doing for us what you have done so successfully for your shareholders.”
This is unlike the modus operandi of many other investment firms, who after acquiring a company replace much of the staff to extract management fees and salaries from the firm. All the senior management at Lubrizol Corporation will remain, as the headquarters will too stay in Wickliffe. According to one article, Lampert, in comparison, who bought K mart while in bankruptcy, “…played rough at AutoZone, where he started amassing shares in 1997. After his stake reached 15.7% he got a board seat in 1999. The management tried to crimp his power, but Lampert ran rings around them. CEO John C. Adams Jr. left shortly afterward. Adams says he voluntarily retired.”
Lampert, like many others and unlike Buffet, selects companies that can be sold in the future for the profit. Until that time, the maximum capital is pulled from the company through dividend payments and other transactions. Top management is also replaced, costs slashed and payrolls reduced as far as possible to generate as much cash as possible to fund other acquisitions and enrich the new owners.
This was the basis for the Kmart acquisition. Lampert acquired Kmart for less than $1 billion in bankruptcy court, hardly the sign of a thriving company with great management that would attract Buffet. Kmart had $3.8 billion in accumulated tax credits, which can offset taxes on future income. By cramping down on capital spending, Kmart has generated billions in excess capital for ESL Investments. Some have claimed that this will be the Berkshire Hathaway for Lampert: the foundation for his future investments, throwing off billions in annual acquisition funding for future activities. Lampert is considered one of the best at visualizing the “deal within the deal,” how the present transaction will fit with the rest of ESL Investment’s holdings and play out in the future.
Lampert typically holds his acquisitions for several years and usually has between three and fifteen stocks in his portfolio. His forming and merging Kmart and Sears into Sears Holdings in 2004 took his compensation that year to $1.02 billion, the highest ever for a financial manager at that time. Lampert has been called the richest person in Connecticut with a net worth of $3.8 billion (which resulted in his being kidnapped in 2003).