Sears’ CEO and billionaire hedge fund manager Eddie Lampert: “I’d like to go faster. I’d like to go bigger. We’re just not making money, which makes it much, much harder to fund the transformation.”

November 2, 2013

At Sears, Those Big Losses Get in the Way

By GRETCHEN MORGENSON

“I’d like to go faster. I’d like to go bigger. We’re just not making money, which makes it much, much harder to fund the transformation.” That’s Edward S. Lampert, the chairman and chief executive of Sears Holdings, speaking last Friday about what lies ahead for this embattled retailing giant, which he put together in 2005 and now oversees. Earlier in the week, the company had announced a possible spin-off of a prized asset — the trusted online retailer Lands’ End. Together with another spin-off, of Sears Auto Centers, the company could “accelerate our transformation into a leading integrated retailer,” it said.But wasn’t spinning off high-performing assets and businesses like Lands’ End a sign of weakness at the company’s core, I asked Mr. Lampert? And what about that transformation? Given the company’s financial performance — it has lost more than $4.5 billion over the last two and a half years — does it have the resources and the time to make it to the other side?

It has been eight years since Mr. Lampert, hedge fund manager and former Goldman Sachs executive, merged Kmart and Sears with the goal of creating a world-class retailer. For many of those years, especially after the recent deep recession, it’s been a bumpy ride.

And during many of those years, Mr. Lampert has bristled at criticism that he was a financial operator, not a merchant, and that in the interests of cutting costs, he had failed to invest in his stores, leaving them outdated and in some cases a mess. In 2012, for instance, Sears Holdings spent $1.46 per square foot, on average, on its stores. Four of its peers — J.C. Penney, Target, Lowe’s, Walmart and Home Depot — spent an average of $9.45 a square foot.

Mr. Lampert now seems to accept responsibility for not executing well on the capital the company did invest in its properties. “For sure there is more money we could be investing in our stores, but when we did invest in our stores, we didn’t see a return,” he said. “If I can’t invest in 100 stores and do well, doing that across 1,000 stores doesn’t make sense.”

What some observers may be missing, Mr. Lampert said, is how much money Sears Holdings has poured into technology, to turn the company into an online shopping powerhouse. “It’s not fair to say we haven’t invested in the future of the company and transformation of the company,” he said. “Store investment may be necessary, but it’s not sufficient in helping to transform a traditional retailer to a retailer that’s more competitive in the 21st century.”

Gary Balter, a retail analyst at Credit Suisse, is negative on Sears Holdings’ stock but is impressed with the online presence Mr. Lampert has created. “The irony of Eddie is he’s one of the retailers who did see the Internet coming,” Mr. Balter said. “I have so many retailers who were so blind to the impact. Eddie saw it and he made significant investments. His website is better than just about any other retailer I cover.”

Mr. Lampert argues that retailing, like other businesses, is in the throes of a technological upheaval that demands a comprehensive overhaul. Yet his company’s extensive real estate obligations, pension liabilities — Sears Holdings has poured $1.7 billion into its pension since 2009 — and other fixed costs are holding it back.

“The role of the store is changing,” Mr. Lampert said. “It’s got to be both experiential, but also utilitarian. We want to be on the right side of behavioral change. But the business model has to support the experiential model and vice versa.”

The company’s financial situation remains a concern to some analysts. So are the asset spin-offs. “They’ve got talent, they did good things with Lands’ End and Sears Canada is still worth something,” said Burt P. Flickinger III, managing director of the Strategic Resource Group, a retail consulting firm. “But without them the company just doesn’t appear to have the balance sheet and working capital to compete against far more capable competitors at a time when bricks-and-mortar retail is contracting at an unprecedented rate.”

Investors don’t seem fazed. They bid up shares of Sears Holdings almost 12 percent on the Lands’ End news, perhaps thinking the sale of various parts would unlock a greater value for the company. By the end of the week, the stock had fallen back a bit, but it is still up 41 percent this year.

Among the biggest beneficiaries of this stock move are Mr. Lampert and his hedge fund, ESL Investments. It owns approximately 55 percent of Sears Holdings’ shares.

At last count, Sears Holdings had 2,036 Kmart and Sears stores in the United States and 451 in Canada, down from a total of almost 3,500 in 2004. A year ago, it spun off 45 percent of its interest in Sears Canada, which generated 11 percent of the company’s $40 billion in revenue in 2012. Main brands include Kenmore appliances and Craftsman tools as well as clothing manufactured under the Kardashian Kollection, Jaclyn Smith and Joe Boxer labels.

The online and mobile shopping platform with which Mr. Lampert hopes to transform the company is known as Shop Your Way. A membership program that rewards shoppers with discount offers and points they can redeem, the system also lets the company analyze data generated by customers to build loyalty and increase sales.

“If you go through history, you’ll see many successful transformations have involved a shift in a business model from a perspective traditionally associated with a company to something that leverages what the company was to become,” Mr. Lampert said. “The motivation I’ve had is to transform Sears Holdings from a company focused on running stores and selling products to a company more focused on serving members.”

Mr. Lampert is well aware that the fixed idea that many shoppers have of Sears and Kmart is neither innovative nor exciting. But the flip side of that, he says, is the trust the company still enjoys among consumers.

“Everyone knows what Sears was and what Kmart was,” he said “The challenge is, will people be open to seeing us in a new light and experiencing us in a new light?”

The progress, he said, was encouraging. Although the company does not break out participation in the program, the number of members and active members is in the tens of millions, a spokesman said.

“We have seen a big uptick in the number of people shopping with us both in-store and online,” Mr. Lampert said. “It’s very easy to obscure the progress we’ve made because of the financial results.”

Mr. Lampert knows what he’s up against: Amazon, Target, Walmart and the rest. How the company puts his words into action — that is the test.