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Sears-Kmart strategy still murky a year later

Twelve months after the Kmart-Sears merger, industry experts are still trying to figure out just what Chairman Edward Lampert has in mind for the famously struggling store brands.
Customers head up and down in this downtown Chicago Sears store. Observers are unsure which direction the company is headed.
Customers head up and down in this downtown Chicago Sears store. Observers are unsure which direction the company is headed.Nam Y Huh / AP
/ Source: The Associated Press

Minutes after securing final approval for the Kmart-Sears merger last year, Edward Lampert pledged in a rare appearance before reporters to transform the two faded retail icons into “a great company.” But he didn’t offer any blueprint for how he’d do it.

Twelve months later, approaching next Friday’s anniversary of the unlikely pairing that created Sears Holdings Corp., industry experts are still trying to figure out just what the billionaire chairman has in mind for the famously struggling store brands.

On the surface, retail results are shakier than ever.

Same-store sales fell 5.3 percent in 2005 — 8.4 percent at its namesake department stores, where an attempt to introduce more fashionable clothing fell flat, and 1.2 percent at Kmart. A new brand for a Kmart-Sears store hybrid, Sears Essentials, was abandoned amid poor results and will be incorporated into the existing Sears Grand. Service levels were reduced in some stores.

Competitors, meanwhile, are taking more market share and expanding while Sears holds down spending on stores and promotions.

For the quarter, its stock shot up 18 percent in two days. Shares are now up modestly since the merger despite short term, cutting costs to improve profitability works for Wall Street. After Sears reported results on Wednesday, including an increase in profit margins and operating income in the fourth weaker sales.

But prospects for shoppers, and the 120-year-old retail legacy of Sears, Roebuck and Co., remain highly uncertain. The strategy of reducing assortments, curtailing sales promotions and cutting service is not sustainable, industry observers say.

“Eddie Lampert is shrinking in the face of an explosion by Target, Wal-Mart, Home Depot, Lowe’s, Best Buy and Penney’s,” said Howard Davidowitz, chairman of Davidowitz & Associates, a New York-based retail consulting and investment banking firm. “The proposition he’s put together doesn’t work as a retail entity. As a retail entity, he’s disappearing.”

Lampert, who oversaw Kmart’s turnaround before engineering the $11.9 billion acquisition of Sears, says he’s not concerned.

In a nearly 6,000-word letter posted on the Sears Holdings Web site, he said he views the Hoffman Estates, Ill.-based company as “a $55 billion revenue, 350,000-person startup” and doesn’t fret about same-store sales sinking lower and lower. He said he wants to make it “a great company whose greatness is sustainable for generations to come” and invoked the names of General Electric and another well-known billionaire investor whom he acknowledged over a decade ago as one of his investing heroes.

“Warren Buffett makes clear that his goal is to increase the per-share value of Berkshire Hathaway,” he wrote. “Similarly, our goal is to increase the per-share value of Sears Holdings.”

The reclusive chairman avoids contact with analysts and reporters and declined to be interviewed for this story. But Lampert-watchers think there’s more evidence than ever that the hedge-fund operator and investing whiz wants to turn the company into an investment empire along the lines of Berkshire Hathaway, taking it far beyond retail — and maybe even out of retail altogether.

“When he names Warren Buffett as a model, you’ve got to believe there are things he has in mind with the cash that he has and the stock price that he has,” said George Rosenbaum, chairman of Leo J. Shapiro and Associates, a Chicago-based retail consulting firm. “I would think it’s acquisitions. But I can’t imagine what he might acquire. It may not be a retail business at all.”

Lampert promised last March 24 that there would not be wholesale store closings, and there haven’t been. But Rosenbaum speculated that more closings will occur in the already pruned-down Kmart chain, resulting in a smaller but more profitable group of Sears and Kmart stores.

“It’s the Lampert style,” Rosenbaum said. “Keep the stock high, cut spending to the bone, let sales down to levels where you’re running pretty profitable stores without a lot of investments in renewing the store or improving the offering. And then take the stock price and use it in businesses that are more interesting than Sears or Kmart.”

Davidowitz believes similarly. “There’s got to be another act to this because I think Eddie Lampert knows that what he’s doing is unsustainable,” he said.

Lampert used cost cuts and real-estate transactions to help Troy, Mich.-based Kmart Holding Corp. turn a $1.1 billion profit in 2004, a year after taking control when it emerged from bankruptcy.

That contrasts with the strategy employed at rival Penney’s, where then-CEO Allen Questrom launched a turnaround by and opening new off-mall stores.

Some analysts say Lampert is treading dangerously with his opposite approach.

“To claim that same-store sales is a ’vastly overrated metric’ ignores every retailer’s primary performance target, expense leverage tool and definition of success, and his reasoning rests more on mathematics than merchandising,” said Carol Levenson, of the corporate bond research firm Gimme Credit, in a research note.

Lampert, whose personal wealth was ranked by Forbes magazine this month at $2.5 billion, could use his Greenwich, Conn.-based ESL Investments to fund acquisitions as he did with Kmart. So far, little of the money being saved through margin management and cost controls is being plowed back into the stores.

Sears Holdings had $4.4 billion in cash as of Jan. 28 when its fiscal year ended, $1 billion more than a year earlier.

“The cash arsenal is starting to build up again, just like it did at Kmart in 2003 and 2004,” said Richard Hastings, retail analyst for Bernard Sands LLC.

That cash was used in the Sears deal, which caught everyone by surprise when it was announced in November 2004.

Lampert isn’t any more likely to tip his hand about the next acquisition. But shareholders may hear more about his thinking at Sears’ April 12 annual meeting in Hoffman Estates.

Regardless, Wall Street couldn’t be more curious about Lampert’s next move after watching his unorthodox strategy in retailing over the last three years.

“This remains one of the most interesting major retailing case studies in the past 20 years,” said Hastings.