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Wall Street was certainly relieved with Sears, Roebuck & Co.'s disclosure on Mar. 26 that it's exploring the sale of all or a portion of its weakened credit-card business. Sears shares rallied on the news, rising 13%, to close at $24.14. But is selling the business, which accounts for 60% of corporate profits, in investors' long-term interests?
Unquestionably, concerns about credit quality have weighed down Sears' stock price (S
) since the retailer warned of rising charge-offs last October (see BW Online, 10/2/02, "How Plastic Put Sears in a Pickle"). But a good case can be made that Sears' credit-card operations are so integral to its retail business that it can't afford to lose direct control of the card unit. "This will diminish Sears' ability to drive sales long-term," warns Richard Church, managing director at hedge fund Shumway Capital Partners.
What's surprising is that CEO Alan Lacy had argued that Sears retail and credit businesses were inseparable since he took the reigns in 2000. But in a conference call with analysts on Mar. 26, he said the sale would "create significant value for investors...and create a more profitable and focused retail company."
PRICE PRESSURE. Sears declined further elaboration, and a spokeswoman didn't return a call seeking comment. But Joseph Grabowski, a retail analyst with Strong Capital Management and a former Sears employee, says he suspects that the decision reflects Lacy's frustration with how credit was penalizing Sears' stock price. Church adds: "What I think is big shareholders and the board are putting a lot of pressure on management to get the stock price up."
The credit-card portfolio, with $30 billion in receivables, has certainly had a rough go. Last October, Sears spooked investors when it announced a sharp increase to reserves for potential bad credit-card debts, hurting earnings growth for the year.
Most of the increase was for rising charge-offs Sears expected on its new MasterCard product, which accounts for $12 billion of receivables. The balance of those receivables are on Sears' proprietary stores cards. However, Grabowski and some other analysts say investor concerns about credit are overblown.
UNPROVEN PORTFOLIO. Lacy indicated as much in the conference call, saying charge-offs and credit profits are tracking on plan and that the business "would be highly attractive to leading credit-card providers."
How much they would pay for the portfolio is hard to calculate, analysts who follow the credit industry say. Acquirers generally pay a premium of 20% over total receivables, which would place a value of $6 billion on Sears' portfolio. But that premium is for a well-proven MasterCard or Visa portfolio, which for Sears MasterCard is debatable.
Analysts say more interest could be seen for the more mature proprietary card portfolio, where the potential increase in charge-offs is less. Saks (SKS
), for instance, sold its card to Household Finance in July. Another likely interested party is General Electric's (GE
) G.E. Capital unit.
FOCUS ON RETAIL. In the conference call, Lacy wouldn't estimate what premium Sears expected to receive. He also declined to detail how the money would be used, other than that paying down debt, buying back Sears shares, and paying a special dividend would be priority considerations.
Lacy also said the divestiture would allow Sears to "sharpen our focus" on core retail and home-service business. He cited the strides Sears has made in turning around retail operations, which last year posted $1.16 billion in operating profits, up 29% from $901 million in 2001.
Virtually all that increase came from cost-cutting and none from top-line growth, however. In fact, Sears sales at stores open at least a year have fallen virtually every month since early 2001. Lacy's $1.9 billion acquisition of Lands' End last year has yet to prove it will significantly boost apparel sales. And Sears is losing market share in appliances, its most important retail category, to home-improvement retailers Lowe's (LOW
) and Home Depot (HD
).
CAKE QUANDRY. Sears' credit-card operations are critical to selling its goods, particularly appliances, which account for nearly 40% of receivables, former employees say. Sears has been able to drive sales by how generously it grants credit to consumers.
It would lose much of that control with the sale of its credit business to an outside credit-card company, however. "The problem with going to third-party credit providers is that they're going to operate it for profit, which means they'll be far more discriminating who they open up credit lines to," says Shumway's Church.
The more control over its cards Sears tries to keep in the negotiations with an acquirer, Church adds, the lower price it'll receive. "You can't have your cake and eat it to," he says.
SUPERFICIAL REMEDY? History provides a clear warning of the danger. Montgomery Ward, the longtime Sears rival, sold its credit-card portfolio to G.E. Capital in the late 1980s, losing that substantial source of profit as well as control over that business. Montgomery Ward liquidated its retail operations in 2000.
Over the long-term, investors reward companies for generating profits through sales growth. Lacy is far from proving that Sears can do that. And selling all or part of the credit business may fix a short-term headache, but it won't likely help with the long-term problem.
Berner covers Sears from BusinessWeek's Chicago bureau Edited by Douglas Harbrecht
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