Sears Holdings (NASDAQ:SHLD) may be struggling as a department-store operator, but it is proving an astute hedge fund under billionaire investor Edward S. Lampert.
The retailer, controlled by Mr. Lampert, earned more than half its net income in the fiscal third quarter ended Oct. 28 from investments in exotic derivatives designed to mirror the performance of company stocks. Those investments helped triple net income, to $196 million, or $1.27 a share, despite weak sales at its Sears and Kmart stores....
The company turned an investment in derivatives in other companies' shares into a $101 million after-tax profit during the quarter. A spokesman for the Hoffman Estates, Ill., retailer declined to disclose the company or companies whose shares were represented by the derivatives.
In a statement, the company said the investments involve "substantial risks," adding that future results "may be positively or negatively materially affected based on the timing, magnitude and performance of these investments."
The financial derivatives used by Sears, known as "total-return swaps," are agreements that take on the big risks of highly leveraged investments in equities or other assets without actually buying them or assuming debt to purchase them, said David Krein, president of New York structured-investment adviser DTB Capital Group. Total-return swaps also can boost the liquidity of an investment, carry tax benefits, and have the advantage of gains that can be recorded as profit on a balance sheet, whether realized or unrealized.
Note the analysts falling all over themselves to praise the "strategy." But if Lampert loses the formula, and suddenly the whole thing goes gunnybag, those same analysts will be the ones tsk-tsking from their front row seats, rationalizing their sugar coated strong Buy ratings (of course if it gets really ugly they'll just change firms).
By the way, our nearby Kmart is one of the old style versions... and just a horrid shopping experience. A retail ghost town. For the 4 or 5 people shopping there it is a last resort, like when you just need to whip in there real quick to buy a toothbrush or some batteries.