Sears Holdings: What's Lampert Thinking?

I owned a few shares of Sears Holdings (SHLD) a couple years ago, and sold them at more or less the same price they're going for today. I didn't make much money on them, but more or less broke even because I reconsidered my investment thesis in Sears, and decided that I had already missed the Kmart/Sears real-estate fueled run. In retrospect, I missed a nice run over the ensuing year or so before the shares fell back down to their current levels.

That remarkable run of a few years back, when Lampert re-engineered Kmart and monetized its real estate holdings, and used it to merge with Sears, made many people rich. Martin Whitman at Third Avenue famously bet big on the company, and did extremely well.

But over the last year or two, Whitman's various funds started hedging their bets - buying options to lock in their outsize profits, and in some cases gradually paring their holdings of SHLD. I don't know that they had a fundamental reason for doing this, other than the fact that the shares no longer met their "safe and cheap" criteria - I don't think, for example, that they sold because they questioned Sears' ability to merchandise effectively under Lampert.

That last bit was my main concern when I sold as I feared that I had missed the real-estate fueled run, and that any success at Sears was going to have to come from actual performance of the stores. Lampert's focus on profitability and cost cutting was clearly making the stores look lousy, though it might work in the end, and it was severely derailing any progress in the oft-watched "same store sales" metric.

So it was with some interest that I read the excellent Barron's story on Eddie Lampert and Sears over the weekend - they made clear that there is significant potential in Sears for two reasons: A recovery is possible in the stores themselves, and there is still significant unrealized real estate and other breakup value, particularly for the Sears brand.

Now that may or may not be true, but this made me think back to why many people were arguing for an investment in Sears Holdings back in 2004 and 2005: Eddie Lampert was going to be the next Warren Buffett, and Kmart/Sears was going to be his Berkshire Hathaway.

The argument went something like this: Just as Buffett took the cash flow from a failing textile mill to jump start his investment partnership, so Lampert will take the still-prodigious cash flow of a fading retailer, Sears, and use his investing wizardry to build a holding company that will boast outsize returns for generations.

There's a certain logic there. If you were to break up Sears, and sell-off the valuable things the company owns, including real estate, brand names, profitable divisions, and the like, several analysts argue that the sum of the parts is valuable and might even be worth up to $300, according to Barron's.

But as far as I've seen, Lampert is showing no signs of doing that and instead, it looks, at least from the outside, as though he's trying to rebuild Sears stores on the cheap, and restore some of the chains' lost glory. I have no idea whether or not he will succeed, and I'm not particularly a fan of shopping in Sears, except when the occasional need for a refrigerator arises.

That still may be the secret plan, of course, and maybe that's why SHLD is undergoing so many buybacks - maybe Lampert is really planning a big value-creation storm at some point. Whether or not he does manage this, however, I think it's important to note that virtually all of Lampert's focus, and the Sears cash is going into this effort. For those who were hoping that buying shares of Sears would give them access to Lampert's ESL investments, since he has been given broad authority to reinvest Sears' capital, I think there's bound to be some disappointment.

Why? Because reinvesting in Sears is pretty much all Lampert is focusing on right now. Maybe that's a great thing, but for those who thought he would mine this old line retailer for cash, and use that cash to make other brilliant investments and build a conglomerate, you're out of luck so far. Sears has shown through its repeated, massive share buybacks that what Lampert really wants to invest in now is ... more Sears.

So, it might be a smart investment. Barron's makes a pretty good bull case, which is why the shares are up a few percentage points today (though down significantly over the last year or so). But it's not the investment I thought people were looking for three years ago.

I can't be taken seriously when I second guess ESL, I don't have the cash or the investing chops to go against a clearly brilliant investor. But I don't have to believe that he's right all the time, either, and it seems to me that there's at least some possibility here that what Lampert is doing is throwing more good money after a retail chain that I personally believe is destined to fail. Is the contrarian who insists on cutting advertising, sacrificing sales growth, and letting dingy stores fester going to turn the company around?

As I look back at the history of Berkshire Hathaway (BRKA), I'm wondering if this would be like Warren Buffett continuing to invest in his failing textile mill, throwing more and more money at it and not having the cash available, a few years later, to buy the truly transformative GEICO business that really put Berkshire Hathaway on easy street.

Just a thought. I might be wrong, and for those who argue that Lampert will financially engineer great things for Sears in the years to come, through breakups or asset sales, there is something to back up that argument as well: If Lampert really wanted to rebuild the storied Sears name, he might allow the company to invest in its own future, not its own stock.

Full disclosure: I do own shares of Berkshire Hathaway, and have positions in two Third Avenue mutual funds, but do not own any other company mentioned here.