Risky Side of Sears: Retailer Is Recast As a Hedge Fund

By David Cho
Washington Post Staff Writer
Sunday, March 11, 2007

Over its 121-year history, Sears has been a watch seller, a giant mail-order business, a home builder and the nation's favorite retailer. And now, in 2007, it is becoming . . . a hedge fund?

As strange as it sounds, this transformation of Sears is now in force. Its retail sales have dropped for five straight years, and managers complain about deteriorating stores. Meanwhile, Sears is pouring its money into risky, esoteric investments to generate huge returns for shareholders.

The man orchestrating this makeover is Edward S. Lampert, 44, who by many accounts is a brilliant and controversial hedge fund trader. As chairman of Sears Holdings, which includes Kmart and Sears Canada, Lampert is a startling example of the new avant-garde of Wall Street -- alternative investors who have the power and money to acquire and radically transform large traditional businesses.

Lampert's management of Sears Holdings, the nation's third-largest retailer, has been a departure from long-established industry practices -- using extra cash to improve stores or earn a small amount of interest. That has stirred anxiety among former executives who fear the iconic brand could be dying. Their concerns are being heightened by retail analysts who predict the company will shed hundreds of stores.

"I do think the company is in a spiral which, if it doesn't pull itself out of, is likely to face at minimum an uncertain future," said Arthur C. Martinez, who led Sears in the 1990s.

But, if Sears the Retailer is ailing, Sears the Hedge Fund has never been healthier. Hedge funds are massive unregulated investment pools typically open to only institutional investors and wealthy individuals. The company's stock soared 45 percent in 2006, driven by high-risk trades that produced $101 million, or a third, of Sears Holding's pretax income in the third quarter. These investments did not perform well in the fourth quarter, and the firm had to sell off properties to cover its losses, according to a Morgan Stanley report.

"It's clearly not your traditional retail business," said William Dreher, a Deutsche Bank retail analyst who dubs the firm the "working man's hedge fund."

Dreher said: "The classically trained retailer focuses on same-store growth, market share, store spending. These are the keys to traditional merchants. They are not the keys for Lampert."

More than a few Wall Street analysts label Lampert as "the next Warren Buffett," the billionaire investor, for having the insight to buy two troubled retailers, Kmart and Sears, on the cheap and then use their cash flows to fund his investments. In 2003, Lampert gained control over Kmart and helped it out of bankruptcy protection by cutting costs and selling off poor-performing stores. He announced an $11 billion buyout of Sears in 2004.

But some who have crossed Lampert in his dealings say he is ruthless. Traditional retailers add that they doubt whether Lampert's singular focus on profit can work in the long run -- he may cut spending so drastically that stores will stop attracting shoppers.

Lampert's detractors point to a worrisome trend: Overall same-store sales for Sears Holdings have dropped for five years, with the Sears component performing particularly poorly. In 2006, sales at Sears stores dropped 6.1 percent, while Kmart sales were down 0.6 percent.

"As those comparable-store sales decline it means you are losing customers and they are finding solutions to their needs elsewhere," said Martinez, the former chief executive who is credited with leading a revival at Sears in the 1990s and retired in 2000. "And it is unlikely once they find those solutions they will ever return."

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