Eddie Lampert Has a Conflict of Fiduciary Interest

In his dual role as Chairman of Sears (SHLD) as well as CEO of ESL Investments, Eddie Lampert finds himself caught in a conflict of fiduciary interest. He is supposed to act in the best interest of his hedge fund investors which causes him problems as the CEO of Sears and vice versa. What used to be a win win has turned into a lose lose. Perhaps the only option he has left is to artificially prop up SHLD through buybacks as he announced yesterday in his $500 million deal. These efforts will only prolong the inevitable that in a struggling economy the weak get eaten alive by the strong, and Sears' retail definitely is weak. With real estate long gone as the backbone of this stock, Sears is finally facing the music of its retail disaster.

When the newly merged company exited bankruptcy, the hope of real estate liquidation served as a nice catalyst to surge to share price from $25 a share up to $180. Sears carved out a real estate niche even though many other retailers could also be viewed as real estate plays. Why did Sears get the nod? Because its retail was so awful that there was no other bullish angle to play and because investors hoped that Lampert would use it as an investment vehicle similar to Warren Buffett's Berkshire Hathaway (BRK.A).

Lampert had a chance to put this plan into effect but his greed got in the way. He wanted to milk every last bit of cash from the retail side in order to buy back every share possible before selling any valuable real estate. This was a great path, but now it appears there won't be enough cash or patience to survive. Mall locations will be flooded with excess inventories for years to come and the size of the old Kmart stand alone stores are no longer appealing to the super sized Walmarts (WMT) and Targets (TGT). I'm afraid this is a classic case of a guy who left his hedge fund area of expertise and got caught up in an illiquid mess.

Don't let yesterday's huge up day in SHLD stock fool you. Sears is trading at a significant premium to its peers and it won't last through this nasty downturn. Even Lampert's buddies are exiting the investment, Bill Ackman of Pershing Square has sold about $550 million in SHLD over the last few months. Credit Suisse analyst Gary Balter recently commented that SHLD is the most expensive stock they cover. All the bargains in the world won't get shoppers back to Sears and even if they did, the anemic margins would further pummel the share price. The moral of this story is that the real estate play is done, gone, capoosh; and that was the only element of intrigue in this stock.

Commercial real estate guru Harvey Green appeared on CNBC yesterday and forecast a bottom in commercial real estate to hit in Q3 of 2009. Let's assume that he is correct, that would infer another 15%-20% drop in value and then how long would it take for Lampert's leases and properties to become attractive again? 2011, maybe 2012. In the short term, he is going to be dealing with continued redemptions from his hedge fund which will force him to sell down SHLD. I don't think the retail cash flow can compensate for the hedge fund outflow. It is a vicious cycle that will take the stock down to single digits. March 2009 $30 puts are looking like a nice trade to average into on a day like this.

Disclosure: Own SHLD puts.

Comments

[Micah:]

Eddie is chairman of the board - not CEO. Next time do your homework.

2008 Dec 03 08:52 AM

[Lost at Sea:]

Eddie's strategy for SHLD has never been in the best interest of the business. There is no clear plan. VP's holding out and protecting turf. He needs a nononsense operational retailer guy to run the company...not his finance team. Time to kick ass and take names or crash and burn!

2008 Dec 03 09:12 AM

[Alex Filonov:]

I think it was Herb Greenberg who said that you can't run retail operation like a hedge fund. Here's the difference with Buffett: unlike Lampert, he know how to hire the right people to manage his properties.

2008 Dec 03 09:54 AM

[Kelley:]

Ackman may have sold out of most of his shares (he still holds 500k shares), but Bruce Berkowitz steadily increased his position - and his Fairholme fund is known for its smart, concentrated investments. The Fairholme fund is very highly rated as well. Oftentimes, I read a negative article about SHLD, and the writer tends to include that Lampert's "buddies" are selling out (who thinks Lampert and Ackman are buddies?). Conveniently, I don't see any mention of other "buddies" like Berkowitz buying more.
The real estate play has most certainly been affected by the current environment. However, this play is not entirely done. The real estate, in my opinion, is not "the only element of intrigue in this stock." Plus, SHLD is producing free cash flow, and their brands are worth something - regardless of what others may think. SHLD also has a 72% stake in Sears Canada. There are a few intriguing things here. Time will tell who is right.

2008 Dec 03 11:10 AM

[fcharlie:]

You say that Lampert's desire to milk the retail ops. for every bit of cash flow is the cause of his problems. This was the intent the whole time. Just because the economy is suffering and the stock is down big doesn't make this a bad idea. The fact is that even if you starve Sears and K Mart of capital the way that he's been doing, it still will take a decade to wind them down. All Lampert needs to do is complete this new buyback and most of the float will be locked up. It's a pure arbitrage play now. Selling inventory to buy back stock at less than 50% of book value seems like the right idea to me. What prudent retailer facing negative 10% comps wouldn't be reducing inventory by 10%? After this stock buyback is complete they can go out and buy back a huge chunk of their debt for 50 cents on the dollar. All the retail operations have to do is live to see another up cycle and Lampert and Berkowitz are going to come out golden.

2008 Dec 03 12:32 PM

[fcharlie:]

Jason Schwarz.

By buying March $30 puts, you are paying 66% annualized to bet against a company whom you seem to not know the C.E.O. and Chairman are not the same person, under the idea that hedge fund redemptions will cause Lampert to sell his shares and force the price to the teens. Know that Lampert locked up billions of dollars last year with a 5 year lockup. If he were worried about redemptions i doubt he'd be putting millions of dollars to work. Check out a 13-F.

Also know that SHLD is selling for a whopping 6 times free cash flow based on this years earnings, 7.5 times next years estimates.... and also selling for less than 1/2 of book value.

2008 Dec 03 11:03 PM