Bruce Berkowitz Still Riding Sears Down
I've been a bad son. That thought occurred to me after reading Mark Gottlieb's interview with Fairholme Fund (FAIRX) manager Bruce Berkowitz on Wednesday. Eleven years ago, my mother had some cash in a retirement account, and I suggested she put it in the Fairholme Fund (This was long before I decided to forget about value investing; at the time I was a believer in it.).
The part of Mark Gottlieb's interview that gave me that bad son feeling was his discussion of Sears Holdings (SHLD). To Mark's credit, he expressed skepticism about Berkowitz's answers. I found myself nodding along with this part, in particular:
[T]hey are operating in the toughest retail environment I have seen in my lifetime and Eddie Lampert is a financial guy running a retailer that has been in decline for years.
That reminded me of a point I made about Sears 6 years ago ("A Warning Sign That Might Help You Avoid The Next Sears"). The title of that article referred to a broadly-applicable warning sign; more on that below. But I led off that article with a warning specific to Eddie Lampert, one from way back in 2006:
Perhaps one of the earliest warning flags for Sears Holdings might have been the disdainful attitude its chairman Edward Lampert displayed toward the upkeep of his company's retail stores in a Fortune article from early 2006 ("Edward Lampert: The Best Investor of His Generation"). That article described a strategy session Lampert held with two dozen senior Sears executives in 2005:
"What's the benefit of that?" he [Lampert] asked again and again. "What's the value?" He shot down a modest $2 million proposal to improve lighting in the stores. "Why invest in that?" He skewered a plan to sell DVDs at a discounted price to better compete with Target (TGT) and Wal-Mart (WMT). "It doesn't matter what Target and Wal-Mart do," he declared.
The article went on to note that when the Sears executives asked Lampert to share his future vision for the retailer, he didn't answer.
I was reminded of that Fortune article every time I drove by a certain Sears warehouse on a highway near my home (Route 17 in Bergen County, NJ, for those who know the area): the lighting on the "R" in the "SEARS" sign was broken, so the sign read "SEAPS" instead. It was "SEAPS" for years, until the warehouse was finally demolished.
Although I raised that concern about Eddie Lampert here 6 years ago, a quick Internet search tells me I was making similar points years earlier. Here's a comment of mine from 2008, for example:
When I wrote that, shares of Sears were trading at $66.81. They're down 89% since.
But What About The Real Estate?
I think we can agree now that Eddie Lampert isn't a great business jockey. And, frankly, it reflects poorly on Bruce Berkowitz that he's ridden Sears down this far (my promise to Bulletproof Investing subscribers is to never blow a Sears-sized hole in your portfolio, because each position is strictly hedged). Yeah, yeah, I know: the real estate. Berkowitz loves real estate. When I read the part of Mark's interview drilling down on Sears's real estate, two thoughts came to mind.
First, I was reminded of an offhand comment Berkowitz made six years ago at the Manhattan chapter of the American Association of Individual Investors, on why he bought a big stake in the St. Joe Company (JOE), which owns swaths of Florida Panhandle land:
I grew up in an apartment and never had a backyard, so I thought 600k acres would be a lot of fun.
St. Joe closed at $21 per share that day, incidentally, so 6 years later it's down about 15% -- a relative winner compared to Sears.
The second thought that came to mind when Berkowitz kvelled about Sears's real estate in Mark Gottlieb's interview was how retail space in even prime parts of Manhattan is going vacant, thanks to the Amazon (AMZN) effect. I mentioned that in April (Amazon: Threatened By Kroger?):
Our acquaintance Dr. Emanuel Derman, the renowned financial engineer and Amazon author, has, in his spare time, been documenting the vacant retail spaces in his neighborhood, the Upper West Side of Manhattan.
In response to one of his tweets of bricks and mortar retail despair, Joe Zhou shared a chart that ought to be more concerning to shareholders of Wal-Mart, Kroger, and Costco than to Amazon shareholders. The U.S. would appear to have a surfeit of bricks and mortar retail.
If only Bruce Berkowitz had grown up with a backyard.
The Broadly-Applicable Warning Sign
In the same 2011 article where I warned about Eddie Lampert's disdain for the operational details of Sears, I also noted that the high cost of hedging, or insuring shares of SHLD against decline, had been a warning sign:
In a Seeking Alpha article published on December 18th ("Hedging Bruce Berkowitz's Top Fairholme Fund Holdings"), we include this paragraph noting that the high cost of hedging one holding in particular, SHLD:
At the time, the cost of hedging Sears Holdings against a greater-than-27% decline, using optimal puts, was 24.2% of position value -- by far the most expensive of Berkowitz's top holdings to hedge. As of Tuesday's close, it was too expensive to hedge Sears Holdings using a decline threshold of only 27%.Regarding the stock below with the highest hedging costs, Sears Holdings Corporation , recall a previous article ("High Optimal Hedging Costs: A Red Flag?") where we speculated that high hedging costs could presage future underperformance.
That was before I had developed the security selection method that picked stocks such as Amazon and Nvidia (NVDA) (What Happens When We're Right), but you can see the wheels turning there: the "wisdom of crowds" in the option market was telling anyone who cared to listen that Sears was a dog with fleas.
Bruce Berkowitz didn't care to listen. Will you, next time?
