Act Fast, Eddie Lampert

As his Sears deal loses luster, shareholders are starting to doubt the prince of retail

by Bob Reed

When Eddie Lampert took over Sears (SHLD) in 2005, the hedge fund financier was crowned the new prince of the investment world. Now, with his department-store chain sinking, he will soon have to make some tough choices or lose his vaunted position.

The financial trends at Sears Holdings are no longer Lampert's friends. The company's stock price, trading around $135 per share, is down nearly a third from its 52-week high of $195 last April. In the second quarter, profits at the Hoffman Estates company fell 40%, to $176 million, from $295 million a year earlier. That's its lowest net in nearly two years. Meanwhile, revenue dipped 4%, to $12.24 billion, and Sears' cash position shrank to $2.6 billion from $4 billion in February.

The only major number that was up was one that smart companies keep down—inventories, which rose to $10.2 billion. Optimists may argue that Christmas is coming, and holiday sales will save the day for the parent of Kmart and Sears, Roebuck by easing that backlog. But in this slowing economy, nervous shoppers are apt to act more like Scrooge than Santa.

So what's the billionaire-turned-shopkeeper to do? Lampert's turnaround options are narrowing to a precious few. None are especially attractive, and all of them are costly.

First, consider this possibility: Lampert makes good on his word that he is going to transform Sears Holdings into a dynamic, successful retailer. He pours cash—lots of it—into operations, stores, and marketing. More important, he hires a top-notch merchant, a superstar executive to spotlight the five, six, or seven core retail strengths that Sears still possesses, and then embarks on a 5- to 10-year rebuilding effort.

The chances of Lampert signing on for this action? Slim to none. Spending tons of money for a far-off and uncertain payback are not part of his hedge fund manager DNA.

So let's weigh another strategy: Lampert pulls the plug. He sells off part or all of the company's assets in search of a big payday. This is a favorite theory of institutional investors and speculators, who've always doubted Lampert's proclamations about wanting to be a retailer. They expect Lampert to liquidate the place and cash in on a bonanza of commercial real estate that sits underneath all those Sears and Kmart stores.

to buy or not to buy?

But hold on a second. Just who is going to buy these sites, especially those big, beige Sears boxes that anchor regional shopping malls throughout the country? While some locations have their unique appeal, many of them are real dogs. Moreover, does anyone think the housing meltdown and related credit crunch won't be a significant drag on retail property and an impediment to obtaining deal financing? Howard Davidowitz, a retail consultant and investment banker in New York, conjectures that an all-out liquidation would take at least 15 years. The odds of a partial or outright sale of Sears? Less than 50-50.

That leaves one other option: Lampert goes out and buys another big retailer. We know he's raking in money to do something. This summer, Lampert's ESL Investments, which has a 40% stake in Sears, hired Goldman Sachs to raise up to $5 billion. ESL already has $18 billion in assets.

There are rumors that Lampert will make a run at Macy's, Office Depot, or maybe even Home Depot. Merging another chain into Sears Holdings would buy Lampert some time to continue the cost-cutting, asset-leveraging, and periodic stock repurchases that placate investors—all while furthering his image as a brilliant dealmaker. The chances of such a big deal? Let's say better than 70%.

But no matter what he does, one thing is certain: Lampert's retail empire is in trouble, and he needs to find a way out—quick.

Reed is a monthly columnist for BW Chicago.