Unseen Value in Sears' Brands

When Sears Holdings (SHLD) announced its restructuring of operations, the most discussed point was if this was the beginning of Lampert's own "Berkshire Hathaway". Rarely discussed is the fact that Sears has much more going for it compared to a dying/failing manufacturer of commodity textiles . The ignorant and impatient regularly call for a fire sale of assets as if they have no on-going value. This couldn't be further from the truth. In the most recent Annual Letter, Mr. Lampert discusses the unseen value held by Sears brands alone.

One of our most important resources is the great brands we own, in particular DieHard, Craftsman, Kenmore, and Lands’ End. All four of these brands have significant equity with customers and provide tremendous opportunity for value creation. To illustrate, let me discuss one of them, DieHard, in more detail. Based on brand recognition studies, DieHard leads in customer recognition among car battery brands by a wide margin, but it lags dramatically in market share. Why? We believe it is due to fewer points of distribution. As a proprietary brand, DieHard is only available in 900 Sears Auto Centers and 1,400 Kmart stores. Yet it is competing with other batteries that are available in thousands of locations across the country. Further, a car battery purchase is a duress purchase event, in which the customer is looking for the nearest, most convenient solution. Unfortunately, it is not always us, but there is an opportunity for us to rethink our brand distribution strategy to create value.

This point, that DieHard is the most recognized battery brand, is rarely discussed. I honestly can't figure out why. There is a very obvious* avenue for growing DieHard sales - AutoZone (AZO). Currently, DieHard is sold at 2,300 SHLD locations. AZO has about 4,000 North American locations. Not only does this double the points of sale, but it's easy to see more battery sales occurring at a ubiquitous auto parts store than at 1,400 weak big box retailers. I won't attempt to guesstimate the number of possible sales but it is easy to see a massive, perpetual flow of cash into Sears Holdings.

The same licensing scenario can easily apply to Kennmore and Craftsmen. As ESL/RBS builds its stake in Home Depot (HD), they are presented with another chance to benefit on both ends of their licensed products. Craftsman is a great product but tool-buyers spend retail time in hardware stores and rarely make special trips to Sears/Kmart just for an American wrench or tool box.

An interesting twist on this brand-story is the fact that Sears Holding has securitized these three brands. Sears wrote $1.8 billion dollars worth of bonds backed entirely with these brands. The bonds are currently held in an offshore insurance subsidy owned by Sears. These bonds can sit and appreciate while acting like a potential $2 billion dollar insurance policy for the company. This portfolio of brands presents SHLD with strong potential future cash flow. Add the potential of real estate leasing, credit cards, continuing operations, buybacks and you have a holding company with far more potential than a useless textile factory. Somehow, Buffett did alright and Lampert should too.

*Buffett always mentions that he prefers doing business with people he likes. Maybe Lampert could take that a step further; only do business with himself. Mr. Lampert's investment groups own a controlling +34% stake in AutoZone.

Disclosure: Author has a long position in SHLD

Comments

[Iditarod:]

Yes yes, SHLD will be saved by battery sales...

How about quantifying the vaunted real-estate value if it's so great? Why do I doubt it, given the attention Lampert has received?

As a substantial FAIRX holder, Berkowitz's recent comments sound disturbingly un-Buffett-like. Paraphrasing his SHLD analysis: "Hey, there are so many ways to make money on this deal. It's either great or really great. I don't see any risk here." That's ridiculous. Why doesn't he display some balanced acumen (which, a-la-Buffett, creates long term confidence, not a just short-term hoped-for price movement via chatter) with points about risk or where his thesis has failed thus far? Don't other retail operations have valuable real estate? Come on. The "DieHard" brand? Get real. What a commodity. And as far as appliance brands, "Kenmore"? Seriously? Maytag had a wonderful brand name and recently went belly up. I don't see anyone clamoring to pay anything significant for that "brand equity". Brands ain't cash flow, friends. FAO Schwartz, anyone? PanAm? A million others... FYI, examples of actual brand value: GEICO. Coke. American Express. Hmmmmmm....

Further synopsis of Berkowitz: "Hey, Buffett bought a dying business and that was the start of his greatness..." Wow, that's illogical. No, Buffett dodged a bullet, and through skill and luck turned his holding company around with other investments. That's what he says anyway. Looking back, he never would have bought Hathaway; he'd have begun with the subsequent investments, no doubt. Banging your head on a rock and then finding a quarter on the ground doesn't mean you should go around banging your head on rocks.

Another Lampert-Buffett comparison point: Buffett never ran businesses. Lampert is trying to be a retail guy. Good luck with that vs. Wal-Mart, Target, Sears, Penneys, Lowes, Kohls, etc. etc. Also, Lampert is a young billionaire with a massive appetite for the high life, while at a similar age Buffett was just getting started with Hathaway, wearing rumpled suits and polyester-blend shirts in Omaha and eating gelatinous processed turkey sandwiches on white bread for his working lunches - very symbolic of a celebrity investor vs. a worker.

Lastly, look at Lampert's language; alternatively defensive, aggressive, frustrated, self-righteous...very, very un-Buffett-like. Despite his phenomenal track record, Berkowitz too is starting to sound more like Lampert than Buffett. Advice to Berkowitz: Re-read a few Buffett shareholder letters and balance out the commentary so your shareholders can learn something. Thanks then. Oh, and remember to thank your shareholders every time you deposit a paycheck, not the other way around. You are in a privileged position through skill and luck. Keep that ego strictly in check, or your investment results will falter.

Berkowitz, I daresay you owe your shareholders a detalied explanantion of your SHLD analysis, your new "core holding", given the eroding value, rather than a Lampert cheerleading session. Lampert has indisputably destroyed shareholder value recently with now deep-under-water share buybacks alone, and you're doing the same, no?

2008 Mar 13 11:27 AM

[Will Morris...:]

1- No one ever said that DieHard would save anything. Its a potential cash flow.

2- No attempt has been made to quantify this cash flow or the possible cashflow from real estae operations. The potential lies in how inexpensive the leases are and what potential lies in each individual property. Good luck 'quantifying' so many unknowable variables.

3- DieHard is a branded commodity like Hienze ketchup or GEICO insurance. All of these brands represent strong future cashflow.

4- Comparing SHLD to early BRK is the opposite of what this article said. Sears has strong assets that represent future cash flow if managed corectly. It is this potential cash that will allow for investments in the future.

5- Being Buffett-like has nothing to do with words on paper or quotes from interviews. It's action based. Lampert could write children's stories for all I care. And, his personal choices of clothing also have no bearing on the future of this company. Maybe, you could start and ETF of companies run by guys in wrinkled suits.

6- Also, you do realize that this isn't a FAIRX sounding board? Berkowitz doesn't care about your analysis of annual letters and Business Week articles.

7- Notes: Buffett actually ran several floundering businesess including Saloman Brothers. Maytag was aquired by Whirlpool. You have done no actual analysis of Sears. I ate a PBJ for lunch today; am I going to be rich? Thanks for the comments Idiotrod.

2008 Mar 13 01:13 PM

[User 163468:]

While Diehard may be a well recognized brand name, it doesn't explain why battery sales at Sears are half of what they used to be just a few years back. Besides, it is just another brand manufactured by JCI.

The same can be said about Kenmore. Whirlpool manufacturers the Kenmore brand along with many others, including Maytag, Ammana as well as the Whirlpool brand itself. On top of that, Sears has lost market share to competitors like Home Depot and Lowe's in metropolitan areas. That is why they are desperately trying to set up dealer stores in adjacent areas to stop the "bleeding".

Certainly the Craftman's brand is well recognized in the marketplace. But there is strong competition and Sears has chipped away at the brand value by curtailing the life time warranty in a number of areas. If you don't it, try taking a Craftman's product back to a store some time.

The bright light is Lands' End, but unfortunately, this may end up being a case of guilt by association. Instead of bring the rest of Sears apparel up to the lands' End standard, they are at risk of pulling Lands' End down to the lowest common denominator.

And don't place the real estate on such a pedestal. Look where the Kmart stores are located. Changing demographics left them behind long ago. On top of that, they are so old, many of them have asbestos issues to deal with should a potential buyer wish to redevelop the premises.

2008 Mar 13 01:42 PM

[BULRUN100:]

Boy some of these responders just don't GET IT! Maybe they never took economics.Nice blog well written . It sound like they don't know much about Shld but also the rest of retail as a whole.Most retailers don't own property out right or at all,most big retailers are swimming it debt(DO YOUR RESEARCH).Not to mention none of them OWN iconic product lines with Billions of dollars in value and sales............PERIO...

2008 Mar 13 05:00 PM

[valueinvest...:]

A few comments. In terms of real estate, it is only worth something if you can sell it and right now no one is buying the real estate that SHLD would be selling. I also love how people always talk about real estate value with SHLD, but not HD and LOW despite the fact that HD owns 87% of their stores and Lowe's own 86% of their stores. In fact, HD and LOW's real estate is much more valuable than SHLD's. Secondly, Eddie is not going to turn SHLD into Berkshire because at his hedge fund Eddie gets to charge something like 2 and 25 (I am just guessing, it may be lower or higher) whereas he does not get a similar fee when he invests the cash for Sears so he will never have a holding company like Berkshire where he makes investments and buys companies because he will just invest in other stocks through his hedge fund and collect the fees. I think there are lots of great values in the retail sector that offer more upside than SHLD.

2008 Mar 13 07:39 PM

[Will Morris...:]

Sears shouldn't sell any real estate. They can become landlords. That's another stream of perpetual cashflow. You've said, "In terms of real estate, it is only worth something if you can sell it." Then what the hell is the point of a REIT? Cashflow.
Real estate isn't real if you sell it. They can become landlords of companies like Target, Lowes, Kroger, and so on. So, obviously, real estate is worth something even when you don't sell. If you actually read the article, I mentioned you in paragraph one, "The ignorant and impatient regularly call for a fire sale of assets as if they have no on-going value." Pure selling of assets is no way to create permanent wealth.

As for the 2 and 25 charges, if Sears grows, Mr. Lampert's stake grows along side; so why wouldn't it be in his best interest to improve Sears through various investments and acquisitions? 2 and 25 means his fees equal 2% of assets and 25% of returns. How is that a disincentive to invest in a controlled Holding Company? Think about it. SHLD goes up in value, he makes more money.

2008 Mar 13 08:09 PM

[valueinvest...:]

I can only hope this leads to a good back and forth on this discussion. Let's first take a look at SHLD's real estate. You may recall that a few years back when they were selling stores that some of the stores they had orginally sold to tenants like HD were later rejected. My guess is that the stores were rejected because upon closer inspection HD realized what was known by many then which was that Kmart had underinvested in their stores and therefore they were in bad condition. Therefore, for other tenants to even want to lease the stores, I hope that the stores have been greatly improved. I also believe, but can't prove that what Eddie did was sell only A locations to HD and I believe the other tenant was Toys R US. This means that those stores sold for much more per square foot than what the average Kmart store would sell for. Lets assume for a moment that the stores have been improved so they are avaliable to everyone. Now they could certainly lease the stores, but who is looking to lease stores today in a declining economy. I am not going to get into semantics on whether we are in a recession or not, I just hope we could both agree that at best growth is anemic. This anemic growth certainly creates less people looking to grow. However, lets assume we come out of this recession rather quickly (something I do not expect), very few tennats can occupy a free standing Kmart or Sears store because of the size. So SHLD has to hope that the potential tenants do not already have a store in the same area or that the store is in a better location say an "A" location vs say maybe HD has a "C" location in that area so they want to trade up location wise. My guess is that given the scope of HD, TGT, LOW, COST, BJ etc they already have a store in a similar location as SHLD so the only way they would want the SHLD store is if its in a better location. I am just guessing again, but I doubt many Kmart or Sears locations would be upgrades from what the companies I mentioned above already have. That is because Kmart and SHLD were not known to have the best real estate locations. Therefore, my guess is they would find the stores hard to lease.

In terms of investing through SHLD with SHLD's cash position, I still contend Eddie would be buying a stock through his hedge fund and not through SHLD. The reason I have this assumption is because Eddie was out not to long ago trying to raise more capital. I believe he was using GS to help. He must of looked at the math and said I would rather use GS to help me raise $ and then charge my fee rather than make those investments through the cash I have in SHLD. Eddie is a very smart guy and someone I respect tremendously so I assume he ran the math both ways to figure out what benefits him the most and in the end the decision was to retain GS to raise more capital.

Since you made a disclosure it is only fair I do the same. I have no position in this name so I am not bashing it as a short.

2008 Mar 13 09:07 PM

[Will Morris...:]

If you're an investor, the current economic environment is inconsequential. If anything, it provides a buying opportunity. Also, I don't disagree that their are issues in Sears Holding but if everything was perfect, we would have a $200 dollar stock.

On the landlord issue, I think you are over estimating the market saturation of some retailers. Lowe's has 1/2 the HD locations; Target has 1/5 the WalMart locations; Costco has 534 stores; Bj's 172. This doesn't even scratch the surface of grocers, including low-end (Super Valu, Food Lion) to high-end (Whole Foods, Fresh Market). And, the idea a big box can only be a big box lacks creativity. Off the top of my head, what about bowling alleys, car dealerships, furniture stores, or warehousing?

Those are options for the K-Mart stores, but the on-mall Sears locations have even more options: Macy's, Dillard's, Neman Marcus, JC Penny, Kohls, movie theaters, anything you can imagine. I don't spend enough time in malls to be more creative.

Through triple-net-leases these properties can offer some cashflow, free capital improvements, and less tax and utility expenses for Sears Holdings.

In regards to stock purchases, their is no mutually exclusive relationship between making investments via SHLD and raising more money for RBS/ESL funds. For example, this winter Sears made an effort to buy Restoration Hardware while RBS built its HD stake.

This isn't a rhetorical question: Where did the idea that 'K-Mart has poor locations' come from? I understand the upkeep has been minimal/poor but every K-Mart I see is on a main road in a urban/suburban area.

Thanks ValueGuy, this is fun. Sorry if I got mean in that last response. I was still annoyed by that first post by Idiotrod.

2008 Mar 14 07:48 AM

[valueinvest...:]

Let me begin by saying I don't think you are mean at all. As I said before I hope this leads to good conversation. I would also note that I am a long term value investor like yourself, but I see more value in other retailers right now.

If I may I will start with the rhetorical question. It's no so much that Kmart has bad locations (though every retailer has a few they don't like) as it is that for them to get a tenant to lease their store the tenant must either not have a store in that location already or that the location Kmart has must be seen as an upgrade. Let me use an example. A few years back when CC was restructuring part of that restructuring was moving from one location to another. The reason for this was that because in many markets Best Buy had the "A" location and CC had the "B" or "C" location. The reason CC wanted to move as part of their restructuring was because they felt part of the lack of sales came from not having the best location in the area. So in some instances they moved from a "C" location to a "B" location and in other instances they moved from a "B" location to an "A" location. So if Kmart has an "A" location they are willing to part with then supermarkets etc would be interested. However, there is a lack of "A" and even "B" location across the country and most of the potential tenants are already in those locations because when you send you real estate team out to find new stores most companies care much more about location than price per square foot. Of course even if Kmart does have a location you want to move to, if you already have a lease you can't just pick up and move. Therefore, the person who would lease the space must find a new tenant for their space. So I view Kmart as more going after new tennats in the area. You are right in the sense that you could put other things in the space besides a store, but you seem to make an assumption that I also disagree with and have not introduced yet to my own fault which is Kmart locations are not necessarily right for each business. Kmart may have many locations which does not interest say a Supermarket because that location does not bring in a lot of supermarket traffic. When Kmart years ago looked at space they looked for the best locations for them and sometimes what is a good location for kmart would be a bad location for HD, LOW, SVU, SWY etc. This has nothing to do with whether its an "A", "B", or "C" location, but just rather that is not where a supermarket or big box retailer like HD necessarily wants a store.

In terms of malls, Sears may want to leave the mall, but they need to do 2 things first. First they need to find a tenant and second they need to make sure it is ok with the landlord that they leave and the new tenant shows up. Assuming landlord approval, I still contend you will have trouble finding new tennats because not many people are looking to expand right now in this economy.

I agree that you can raise money and invest SHLD's cash. I just think if he was going to turn SHLD into another Berkshire he would not go out and raise cash. Now he could turn SHLD into something similar to Berkshire from the perspective that Eddie also goes out and buys other businesses. However, I would argue that restoration hardware is not the same type of blue chip company Warren buys.

I would conclude that I think most retail even the ones I own are dead money right now. I am buying them for the same reason you are buying SHLD which is you see tremendous value down the road. So I have no problem with a wait and see approach.

2008 Mar 14 09:30 AM

[LTholder:]

To Iditarod.....why bother owning fairx...maybe you should sell your substantial holding and force berkowitz to sell SHLD to fund your redemption...

2008 Mar 14 06:31 PM

[SHC_Holder:]

How much have Die Hard battery sales increased since the last time the number of outlets were doubled (sold in Kmart)? Has increasing outlets made a dent in the market share?

2008 Mar 14 08:15 PM

[Will Morris...:]

SHC_Holder - I have no idea how those stats have changed. But, the most important thing to remember is that K-Mart locations are entirely different from Auto Zone locations. You raise an excellent point that doubling distribution means nothing if customers don't purchase. Although, I have to believe Auto Zone is far more effective at selling batteries than K-Mart.

LTholder- Well put.

Value Guy-Give me a day.

Man,this is fun.

2008 Mar 15 12:02 AM

[MSF:]

The brand plan is a smart strategy for bringing in more profits on top of profits.

At least we seen something productive come out so far.

That is going to be the key revenue stream for Sears.

2008 Mar 18 07:50 AM

[Fighting Yoda:]

Will - are you opinioning that Sears would/should make money by becoming a landlord by sub-letting. If that be the case I would disagree. Sears is a bad reatiler, I don't even consider going inside the stores.
Selling brands, sub-letting, etc are low margin and terminal strategies. From an equity investor stand point I would not think it is a smart idea. There ought to be easier and better ways to make money.

2008 Mar 19 10:25 PM

[MSF:]

Also note,the brand will be a portion of the growth and business.
Businesses outbidding themselves for Sear's products to be sold is great.
Sears is a holding company and not just a retailer.One can see this by Sears dividing up the businesses.
The key here is all the businesses do well including the stores.
In other words,massive,massive profits for Sears.
One more point not too many shares out there to cover short positions easilly.Eddie is buying them all up,,,,,,,another good sign.

2008 Mar 20 11:37 AM