Winter 2005 Newsletter, we asked whether the Sears/Kmart Merger was a “Happy Marriage or a Double Suicide?”
Summer 2008 Newsletter, we answered the question: It was a double suicide. It has been a slow death but the end is near. It is a sad, sad story.
Sears and Kmart are two of the most iconic names in U.S. retailing. Richard Sears and Alvah Roebuck founded Sears, Roebuck and Company in 1886 as a mail order catalog. It began opening stores in 1925 and ultimately became the largest retailer in the country.
Kmart was the successor company to S. S. Kresge Company, which was founded in 1899 by Sabastian S. Kresge. Kmart started up in 1962, the same year as Wal-Mart. Kmart grew much faster than Wal-Mart initially and eventually passed Sears in the late 1980s only to be eclipsed by Wal-Mart in 1990. At its peak, Kmart operated 2,171 stores.
By the time the two merged in March 2005, both were ailing but many thought Eddie Lampert, who had engineered the merger, would somehow stitch the two together and achieve a stronger company. The stock price rose from $124 at the time of the merger to $195 in short order. It did not last.
Lampert failed to reinvest in the company, and instead milked it and stripped it of its assets over time. We pointed out in our 2008 paper that Sears had the lowest rate of capital investment to sales of any major U.S. retailer. The biggest use of this diverted cash was to buy back shares. Capex-starved stores look old and tired, and both Sears and Kmart have fit that bill for many years. Post-merger Capex is detailed in Chart 1.
Interestingly, prior to Kmart’s bankruptcy in 2002, Kmart had 2001 Capex of $1.385 billion and Sears had Capex of $1.126 billion, or $2.511 billion between the two of them. Post-merger, that number had dropped to $513 million, one-fifth of the 2001 amount. From there, Capex dropped to $142 million in 2016. Meanwhile, as would be expected, depreciation declined in line with the decrease in Capex, from $1.142 billion in 2006 to $375 million in 2016. See Chart 2.
It did not take long for the lack of reinvestment to show up as declining sales, assets, and net worth.
Sears Holdings revenues slipped from $53 billion in the first full year after the merger to $22 billion in its most recent fiscal year. See Chart 3.
Similarly, the company’s Total Assets declined from $30 billion to $9 billion over the same time. See Chart 4.
Likewise, the company’s net worth declined from $13 billion to negative $4 billion over that same time frame. See Chart 5.
And, not surprisingly, Sears Holdings stock price plummeted from a post-merger high of $195 to less than $10 today. See Chart 6. In 2016, TheStreet.com listed Sears Holdings as the “worst stock in the world.”
All of these performance metrics are pointing to the same end—ZERO. The game is nearly over and the vultures are circling.
When he took over leadership of the company, Sears Holding Corporation Chairman Eddie Lampert promised to reinvigorate the faded retail icons and “transform them into a great company.” Instead, he has led the organization to ruin with a disastrous strategy. He is the only constant in the post-merger company, which has run through several CEOs and other senior officers. Lampert has been CEO since 2013, as well as chairman of the board. He has presided over the greatest destruction of retail value in history
Sears Holdings’ website provides the chairman’s letter written by Lampert each year as part of the annual report to shareholders. The letters provide insight into the ideas behind the creation and evolution of Sears Holdings’ disastrous strategy.
Beginning with the combination of Sears and Kmart in 2005, Lampert expressed his view that he hoped to combine Sears’ operations with Kmart’s store network and a Kmart balance sheet wiped clean of debt through the bankruptcy in 2002–2003. Lampert provided four principles for strategy:
- Build an ownership culture. However, unlike other retailers who aim to have the team act as owners, Lampert explicitly stated that he meant having the Board of Directors own more than 40 percent of the stock, with himself holding the largest share.
- Expense and capital spending control. Lampert noted that he was able to cut capital spending from $143 million to $106 million in the first quarter of Sears Holdings control.
- Generate cash flow, with the measure of success being growth in EBITDA.
- Divest Orchard Supply, and convert Kmart to a new “Sears Essentials” format.
Thus, from the beginning Sears Holdings was overwhelmingly driven by a narrow set of financial metrics—not surprising, perhaps, given Lampert’s career as a hedge fund owner and investor.
The March 2006 letter focused on increasing EBITDA from $2,524 million to $2,969 million, driven in part by the company’s decision to consolidate store operations, merchandising, and supply chain for both companies, thereby reducing meaningful differentiation—but saving overhead in the short term. The company also reported that customers did not understand the “Sears Essentials” format, so it would be renamed “Sears Grand.”
A year later, the March 2007 letter proudly noted that 2006 EBITDA had risen to $3,657 million. This result was cited as proof that the strategy was working. Nevertheless, same stores sales were declining, and profits were being driven solely by cost cutting. Sears Holdings also announced that the Sears Grand strategy had failed. The 2006 results would prove to be the high water mark of the financial strategy set out by Lampert.
The February 2008 letter reported a huge reversal in Lampert’s preferred metric of performance. EBITDA fell to $2,056 million—a stunning 44 percent decrease. Despite this decline, the company repurchased $2.9 billion in stock. Organizationally, Sears Holdings was restructured into five stand-alone businesses (store operations, merchandising, brands, real estate, and services) which would foreshadow the future actions of the company in selling off pieces of each business to generate cash.
The 2008 results, discussed in Lampert’s February 2009 letter, justifiably discussed the financial crisis and recession. In this context, Sears Holdings’ EBITDA fell to $1.6 billion—less than half the amount just two years earlier. Lampert announced the departure of Alwyn Lewis as CEO and the beginning of a search for a successor that would last more than two years. The letter also announced a new strategy with five pillars:
- Build lasting relationships with customers
- Best in class productivity
- Building our brands
- Reinvent the company
- Reinforce “The Sears Holdings Way”
However, the discussion of these pillars was vague and unfocused; it is hard to see how they might translate into execution and practice—let alone better performance.
The 2009 results note that EBITDA had stabilized at $1.8 billion. By 2010, the slide had resumed—EBITDA had fallen to $1.4 billion. The company announced the appointment of a permanent CEO, Lou D’Ambrosio, who had no prior retail experience. Sears Holdings also announced the purchase of an additional 17 percent of Sears Canada, taking its stake to 90 percent.
The 2011 results, discussed in Lampert’s February 2012 letter, represented the first steps in the dismantling of Sears Holdings. The company announced that it would spin off the Sears Hardware, Sears Hometown, and Sears Outlet small format stores to generate cash. It also announced it would sell half of Sears Canada—a complete reversal of the actions a year earlier.
By 2012, the decline accelerated as Lampert took over the role as CEO as well as chairman. He announced that Sears Holding would focus on becoming a “member company” through the “Shop Your Way” loyalty program with partnerships with other businesses. EBITDA fell to $536 million, and more store closures were announced.
By 2013, EBITDA had fallen to -$337 million, which then plummeted to -$718 million in 2014, -$836 million in 2015, and -$808 million in 2016. By Lampert’s own metric, Sears Holdings was collapsing, leading to fire sales of assets. Lands’ End was sold in 2015, as was the last bit of Sears Canada. Real estate was spun off into a separate REIT to raise cash. Sears stores were converted to other uses as fast as possible, as subleases added Primark, Forever 21, and other retailers in prime Sears locations. In early 2017, the venerable Craftsman tool brand—arguably the most valuable asset that Sears had ever created—was sold to Stanley Black & Decker. The company also announced it was seeking alternative means to generate cash from the sale or spinoff of Sears Home Services, Sears Auto Centers, and even its two remaining iconic brands, Kenmore and DieHard.
In his 2007 letter, Lampert had noted that the old way “you can’t cut your way to success” was being proven wrong at Sears Holdings—that the cost and capital reductions were prerequisites for long-term success. In a dozen years, Sears Holdings strategy was predominantly focused on generating gross cash flow, which was largely accomplished by reducing costs, cutting capital spending, then resorting to store closures and asset sales. Throughout the period, there was never a clear, consistent plan for growth. Eddie Lampert directed the destruction of Sears Holdings and its iconic brands, Sears and Kmart.
What a sad, sad story.