A well-respected value investor buys an old American company in decline, promising to restore its fortunes. Alas, the recovery never comes. The industry’s economics have changed, and the company can’t compete with younger, nimbler rivals. It ceases operations, but the value investor holds on to the shell to use as an investment vehicle.
Unless you’re a history buff or a dedicated Buffett disciple, you might not have known that Berkshire Hathaway wasn’t always an insurance and investment conglomerate. It was a textile mill, and not a particularly profitable one. It was, however, a cash cow. And after buying the company in 1964, Buffett used the cash that the declining textile business threw off to make many of the investments he’s now famous for, starting with insurance company Geico.
So, when hedge fund superstar Lampert first brought Kmart out of bankruptcy in 2003, the parallels were obvious. With its debts discharged, the retailer would throw off plenty of cash to fund Lampert’s future investments. And even if the retail business continued to struggle, Lampert could — and did — sell off some of the company’s prime real estate to retailers in a better position to use it. Lampert sold 18 stores toHome Depot (NYSE:HD) for a combined $271 million in the first year.
That Lampert would use Kmart’s pristine balance sheet to purchase Sears, Roebuck & Co. — itself a struggling retailer — seemed somewhat odd, but his management decisions after the merger seemed to confirm that his strategy was cash-cow milking. Lampert continued to talk up the combined retailer’s prospects, of course. But his emphasis was on relentless cost-cutting, and he invested only the absolute bare minimum to keep the doors open.
Sears Holdings didn’t have to compete with the likes of Home Depot or Wal-Mart (NYSE:WMT). It just had to stay in business long enough for Lampert to wring out every dollar before selling off its assets.
The strategy might have played out just fine were it not for the bursting of the housing bubble, which killed demand for Sears’ popular Kenmore appliances and Craftsman tools, and the onset of the worst recession in decades. With retail sales in the toilet (and looking to stay there awhile), competing retailers were hardly clamoring for the company’s real estate assets.
It’s fair to blame Lampert for making what was, in effect, a major real estate investment near the peak of the biggest real estate bubble in American history.
But investors frustrated by watching the share price fall by more than 80% from its 2007 highs have no one to blame but themselves. Anyone who bought Sears when it traded for nearly $200 per share clearly didn’t do their homework. They instead were hoping to ride Lampert’s coattails while somehow ignoring the value investor’s core principle of maintaining safety by not overpaying for assets.