By guest authors By Suzanne Kapner, Rachael Levy and Juliet Chung from Wall Street Journal
He made billions for investors in his ESL Investments fund by bucking naysayers. At the storied American retailer, his instincts proved wrong.
A day after Sears Holdings Corp. filed for bankruptcy protection, the hedge-fund manager who bet his career on the retailer addressed nearly 1,000 employees gathered at its somber headquarters.
Edward Lampert told the crowd it was the second most difficult speech of his life. “The first was having to speak at my father’s funeral” at age 14, he said.
Mr. Lampert made billions of dollars for investors and himself as a financier famous for his contrarian bent, taking risks despite a chorus of naysayers. This time, his instincts ran headlong into the unforgiving economics of the modern retailing business.
Marked Down
Edward Lampert, who has been Chairman of Sears Holdings since 2005 and CEO since 2013, has overseen the storied retail brand’s steady decline.
Instead of stuffing stores with goods, he cut back inventory to avoid markdowns. Rather than offering big discounts, he raised prices slightly. He scrapped newspaper circulars and television ads in favour of email marketing. And, rather than fixing up stores, some former executives said, he let many get run down.
Sales fell and empty shelves sometimes gave consumers the impression Sears was going out of business.
Last year, Sears booked its seventh straight year of losses. Its total sales fell to USD 16.7 billion, compared with USD 53 billion in 2006, the first full year after Mr. Lampert became chairman.
Sears will now go down as one of the worst bets by a hedge-fund manager, shattering Mr. Lampert’s reputation after risking billions of dollars through his fund, ESL Investments, and more than a decade of his life.
Mr. Lampert, 56 years old, said in an interview last month that Sears’s collapse has taken a toll on him professionally and personally. “People have been trying to figure out why I haven’t given up or what’s in it for me,” he said. “I really believed this could be something special.”
His biggest disappointment, he said, was that Sears was unable to capitalize on his early insight that e-commerce would be a game-changer: “If we could play that game and play it well, we had a chance.”
Mr. Lampert still thinks he was right about where the retail world was headed and what Sears needed to do. In the interview, he said he did everything he could to keep the company afloat, even though some of his ideas backfired. He took on risk in lending the company money when others wouldn’t, he said. Hamstrung by years of losses and onerous pension obligations, he said, Sears simply lacked the funds to compete against Walmart Inc. and Amazon.com Inc.
“The world of retailing turned out as I had expected,” Mr. Lampert said. “If you had predicted the future relatively correctly and you still didn’t produce the outcome you wanted, that is different than not predicting correctly.”
He knew some things he was trying would not work and had warned his executive team, “If we’re going to be a leader, we’re doing things others aren’t doing. There is a feeling of loneliness.” He said he invested in stores that performed well but wanted the company to focus on its most loyal customers and selling online. “I was thinking about a future where things were much more on demand.”
Mr. Lampert, who resigned Monday as CEO and will remain chairman, is Sears’s largest shareholder and one of its biggest lenders.
Although he has been criticized for selling Sears assets, spending on stock buybacks and collecting interest on loans to Sears, he said it is unlikely he will come out ahead financially on his long-running Sears bet. “I’ve never sold a share,” he said.
A spokesman for Mr. Lampert on October 16 said he wasn’t available for further comment. After the bankruptcy filing, Sears and Mr. Lampert said the restructuring would let Sears reduce debt and emerge a smaller, stronger retailer. It plans to close 142 of its roughly 700 stores and sell other assets. Mr. Lampert’s fund is exploring a bid to buy 400 stores, Sears said.
Hedge-fund hubris
“He bet his entire career on one stock. What on earth does he know about running a retailer?” said Whitney Tilson, a former hedge-fund manager who closed his own fund in 2017 after poor returns. “It’s exhibit A of hedge-fund hubris. This is a case study I will teach in my seminars for years.”
Near his peak, before the financial crisis, Mr. Lampert managed more than USD 15 billion in addition to billions of his personal wealth invested in his fund.
At the end of 2017, ESL managed USD 1.3 billion, according to a recent filing with the Securities and Exchange Commission.
As his Sears bet soured, investors abandoned him. Most of what is left is Mr. Lampert’s own money.
Mr. Lampert rose through Goldman Sachs’s risk-arbitrage department in the 1980s before leaving to run the hedge fund he launched in April 1988. He quickly made hundreds of millions of dollars for himself and early backers.
He started his hedge fund with about USD 29 million and notched a 31.4 % return in its first year, according to a client letter and marketing documents reviewed by The Wall Street Journal.
He made a winning bet on an ATM company, to the surprise of investors who had questioned the wager, said people familiar with the matter. In 1989, a year after the influential money manager Richard Rainwater and others had staked the money to start ESL, Mr. Lampert and Mr. Rainwater launched a successful proxy fight against defence contractor Honeywell International Inc.
Other bets followed on companies including International Business Machines Corp. , AutoZone Inc. and AutoNation Inc. Before and after investments, Mr. Lampert and his team would visit stores, talk to managers, check backrooms for inventory levels and, before the internet, request hard copies of 10-Ks. “They would outwork everyone,” said a person familiar with ESL.
By 2007, ESL had generated an annualized net return of 23.7%, according to the marketing documents.
The big bet
Mr. Lampert had taken control of Kmart in bankruptcy and had been acquiring Sears stock. In 2005, he merged the two in an $11.5 billion deal, installing himself as chairman and taking an active role in management. Two years later, the new company, Sears Holdings Corp. SHLD -15.63% , represented his ESL Investments fund’s largest investment.
ESL had a long list of reasons for the big bet on Sears. The retailer was a “ubiquitous brand name” with “valuable real estate” and “a loyal customer base,” the hedge fund said in the marketing documents. ESL made money by reducing “corporate overhead,” limiting capital expenditures “primarily to projects that are expected to generate attractive returns” and focusing on “management accountability and shareholder return.”
The rationale for the deal was to sell Sears brands in Kmart’s off-mall locations and to a combined customer base online.
Around that time, a wealthy investor in Mr. Lampert’s fund warned him he might be in over his head. “Just because you’re a smart investor,” the investor recalled telling Mr. Lampert, “doesn’t mean you’ll be a good operator of a department store.”
The recession was a big test. Major-appliance sales, a large driver of Sears’s profits, dropped during the home-building collapse. Amazon.com, Home Depot Inc. and Best Buy Co. ate into Sears’s market share.
Many of his ideas at Sears were first put into practice at Kmart, which he rescued from bankruptcy. Although Kmart sales declined, profits increased, said Alan Lacy, the CEO of Sears from 2000 to 2005. “That emboldened him to think he could do things differently,” Mr. Lacy said. “If he thought something was right, he didn’t care if people said it wouldn’t work.”
At Sears, Mr. Lampert scaled back television advertising and newspaper circulars in favor of email marketing, which was cheaper, former executives said. But emails didn’t generate as much store traffic, they said. While other retailers did this, too, it was the degree of the shift at Sears that made it extreme, they added.
During last year’s holiday season, Sears stopped buying national TV ads. Sales, excluding stores that closed, fell 18.1 % at Sears and 12.2 % at Kmart in the holiday quarter.
Mr. Lampert also restricted the amount of goods Sears bought in hopes of not having to mark down as many items at season’s end, the former executives said. Many departments were left with empty shelves, giving consumers the impression Sears was going out of business, they said.
The number-crunching chairman was also parsimonious about store investments. Soon after the merger, he converted about 100 Kmarts to a format called Sears Essentials that competed more directly with big-box chains like Walmart. The converted stores didn’t deliver the expected sales bump, and the renovations were discontinued, said a person familiar with the situation.
It was a lesson Mr. Lampert took to heart. While Sears occasionally updated lighting and carpeting, it shied away from large-scale store remodels. “People say we didn’t invest in our stores, we invested a lot but didn’t see a return,” he said in the interview. “You can criticize us for not having better ideas. But it doesn’t make sense to invest more when we didn’t see a return.”
Facing pushback
Mr. Lampert said he faced pushback from managers wedded to a more-traditional view of retailing. “People said, ‘This guy doesn’t get it. He’s focused online. He doesn’t care about the stores,’ ” he said. “The idea of how important online was going to be and knowing your customers, not just your products, was sort of a foreign concept.”
In early 2013, after rolling through three CEOs, Mr. Lampert assumed the job. “Serving as CEO will not require significant additional time but it will allow for certain economies in decision making and action,” he wrote in a client letter dated Jan. 8, 2013. “I believe that this focus will pay off for Sears and for ESL.” He expected to remain CEO for only a few months, said a person familiar with his thinking.
He pushed to turn Sears into the next Amazon by adopting dynamic pricing—in which algorithms frequently adjust online prices based on demand—and collecting data on shopper preferences. That led to some success, including a jump in snowblower sales in 2013, after the lawn-and-garden team used data to reach customers who had relocated to the Northern U.S., one of the former executives said.
The efforts did not overcome sharp declines in customer traffic. Sears lost USD 1.4 billion that year, as revenue decreased USD 3.7 billion from the prior year.
The company spent USD 6.7 billion buying back stock from 2005 to 2013, according to FactSet, leaving it with less of a war chest to survive the difficult years following the recession.
Mr. Lampert’s management style did not help, some former executives said. He visited the Hoffman Estates, Ill., headquarters a few times a year, preferring to beam in via conference calls from ESL’s Florida offices, they said. While most retail executives visit stores weekly, Mr. Lampert urged Sears executives to hold video chats with store managers, arguing that they could collect more data, more quickly.
Some former executives said Mr. Lampert was out of touch with Sears’s middle-class shoppers. During one meeting, the billionaire spoke at length about the French luxury house Hermès, where he had bought shoes, as an example of how Sears could provide better service, said a person who was in the meeting.
Mr. Lampert declined to comment on the Hermès example but said he has tried to impart a “deeper notion of what it is to serve people.”
Supporters say Mr. Lampert kept the brand alive and thousands employed. They point to reduced vendor liabilities and billions put into the pension.
“In many areas, Eddie was well ahead of the competition,” said Tarun Koshy, an investor who was Mr. Lampert’s chief of staff in 2013. “He predicted the rapid growth of e-commerce before almost anyone else.”
Others wonder whether he simply took on too much. ESL employed perhaps 35 people at its peak, said a former employee. Soon after the merger, Sears and Kmart employed some 300000.
Five years after Mr. Lampert became CEO, Sears is a tarnished brand that has closed hundreds of stores and is burning through USD 125 million monthly. “He could have gotten out at any time,” said Kunal Kamlani, ESL’s president. “But he had and still has conviction that there is a chance to create tremendous value.”
Mr. Lampert is still betting on Sears. At the employee gathering at Sears headquarters this week, Mr. Lampert told employees, “I don’t view today as a funeral, but as a new beginning.”
“He had a lot of success at basically seeing things other people don’t see,” said a longtime friend. With Sears, “that probably made him feel he had a better chance of turning it around than others.”