Sears Struggles Under Ed Lampert

Tuesday's Wall Street Journal's Marketplace section featured an article on hedge fund maven and Sears Holdings owner Ed Lampert entitled "Why Sears Must Engineer Its Own Makeover."

It's a very revealing piece, in my opinion, in terms of being evidence in the perennial debate regarding 'corporate governance.' Specifically, it's been my belief that investors should only buy shares of firms whose performance they already find attractive. It makes little sense to buy something whose performance you don't like, betting that you can fix it, or persuade management to fix it.

While there may be occasional stories of investors who've done that, the simpler approach is that of private equity- simply buy the firm and totally refit and restructure it.

Ed Lampert's Sears-KMart play is the most visible example of the hybrid approach. Lampert took control of both firms, but left the combined firm publicly-held.

The results have been disastrous. According to the Journal article,

"With a potential recession on the horizon, retail experts say it is now clear Chairman Edward S. Lampert must engineer a radical makeover of the 121-year-old retailer to prove it can thrive alongside bigger rivals. To halt the sales and profit declines, the company's Sears and Kmart stores must forge new roles for themselves that will distinguish them in customers' eyes from competitors such as Kohl's Corp., J.C. Penney Co., Target Corp. and Wal-Mart Stores Inc.

"Sears and Kmart can't continue in the format they now do," said Love Goel, chairman of Minnesota retail investment group Growth Ventures Group and a former consultant to the retailer. "The time to fix strategy and execution issues has passed; it's an existential issue now," he said. A Sears spokesman said executives weren't available to comment."

Early on, Mr. Lampert stepped into a direct role in operations, overseeing marketing and strategy, and putting finance, until just recently, under his hedge-fund colleague at ESL Investments, William C. Crowley. Mr. Lampert has top Sears executives fly to Connecticut twice a month to brief him and his ESL colleagues. Messrs. Lampert and Crowley's direct involvement left Aylwin B. Lewis, the company's chief executive, to oversee store operations, focusing on revitalizing a store culture that seemed disillusioned and exhausted amid steady sales declines.

Executives have declined to elaborate on what those actions might be, but keeping Sears and Kmart as separate units will no longer work to carry a turnaround at either, says Growth Ventures' Mr. Goel. Kmart has lost too many customers to Target and Wal-Mart and would be better off converted to Sears's brand, he says. Craftsman tools, Kenmore appliances, and Diehard automotive lines have consumer trust and distinct identities that could make for standalone operations in a future revamping, he says.

Mr. Lampert also must make hard decisions to outsource or exit businesses, such as clothing and home goods, that have little hope of regaining customer favor. Kohl's, Penney's, Target and Wal-Mart distinguish themselves with better selection, a better shopping experience, or better prices.

The retailer's Kenmore brand has dominated the home-appliance market for years, but Sears's share of major U.S. appliance sales dropped. Only recently has Sears tried to stop the losses with a new marketing and services push. Sears blamed increased competition and a crashing housing market that has dogged home products sales for its fourth-quarter sales decline."

The portrait that the Journal piece paints is one of a successful trader who came to believe he could simply step into an operational role of a major retailer, too, and repair its shortcomings.

It hasn't turned out that way. In fact, it seems, according to the article, that Lampert's golden touch may be fading,

"Mr. Lampert and his ESL funds own nearly 48% of Sears shares, according to the most recent securities filings. The retailer's losses were a big reason ESL was down more than 20% last year. But Sears isn't his only big setback lately. ESL has almost 22% of its cash in shares of Autozone Inc., the auto-parts retailer that has dropped more than 13% in the past year, according to FactSet Research Systems Inc. He also invested more than 7% of ESL's portfolio in Citigroup Inc., raising the hedge fund's stake for the past year, even as Citigroup has lost 44% of its value."

Maybe Lampert has been distracted by Sears. Originally, wags touted his acquisition of KMart and Sears as a long-term play for the real estate beneath all the stores. But Lampert's actions have belied that.

In any case, as the nearby two-year price chart for Sears Holdings and the S&P500 Index reveal, the latter has been on a downward slide since May of last year, following a see-sawing of the stock's price throughout the earlier part of the year.

Now, however, we see his troubles extend beyond just Sears. His Citigroup investment has to be among the worst decisions a fund manager could have made.

Perhaps what we are witnessing in Lampert's struggles at Sears Holding, and ESL Investments, is simply good, old-fashioned hubris.

Did Ed Lampert just become too wealthy to remember his own personal limits? Did he think that his own substantial personal wealth would buy him the time for any investment to eventually pay off? And, then, with a little help from the other shareowners, he could sit and bide his time while the turkeys he bought gradually became swans?

It's certainly turning out much differently.

Instead, Lampert's experience with Sears validates one of my long-held beliefs. Mono-line firms in today's world tend to outperform their diversified competitors. The former have only one shot at success, so the successful ones focus intently on winning in their product/market segments. The latter have other business challenges which sap their focus, time, energy and capital. They seem to behave as if they can sustain some setbacks, due to their diverse sources of income. Ultimately, it tends to spell doom for the diversified competitors.

The best examples of this which come to mind were the standalone credit card companies of the 1990s. The best of them handily outperformed their competing divisions of large banks. Eventually, BofA even bought MBNA.

Sadly, one can easily envision the end of Sears and, probably KMart, too, as retail brands, when the agonizing Lampert saga ends. Both chains have now languished under Lampert's hand for nearly three years. That may be too much time for the once-proud Sears to overcome in its quest to reacquire customers to its brands and stores.