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 to Home 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.
Lampert is a great investor with a proven long-term track record, and there’s nothing wrong with paying a modest “Lampert premium” for shares of Sears Holdings. If you like Lampert’s investment style but lack the means to invest in his hedge fund, Sears may be the closest you can get.
However, at $200 per share — or even $100 — the Lampert premium had been blown completely out of proportion. The same is true of Buffett, of course, or of any great investor. As the Sage of Omaha would no doubt agree, at some price Berkshire Hathaway is no longer attractive either.
This brings us back to the title of this piece: Is Sears the Next Berkshire Hathaway?
I would answer “yes,” but not necessarily for the reasons you think.
Everyone assumes that Buffett’s decision to buy Berkshire Hathaway was one of his typical strokes of genius. Nothing could be further from the truth. In fact, Buffett revealed in a video interview last year that Berkshire Hathaway was the worst trade of his career.
We like to think of Warren Buffett as the wise, elder statesman of the investment profession. But Buffett, too, was young once and prone to the rash behavior of youth. He had been trading Berkshire Hathaway’s stock in his hedge fund. He noticed that when the company would sell an underperforming mill, it would use the proceeds to buy back stock. Buffett intended to sell Berkshire Hathaway its own stock back for a small but tidy profit.
However, due to a tender offer that Buffett took as a personal insult, he essentially bought a controlling interest in the company so that he could have the pleasure of firing its CEO. And though it might have given him satisfaction at the time, Buffett called the move a “$200 billion mistake.”
Why? Because Buffett wasted precious time and capital on a textile mill in terminal decline rather than allocate his funds in something more profitable — in his case, insurance. Berkshire Hathaway will still go down as one of the greatest investment success stories in history. But by Buffett’s own admission, he would have had far greater returns over his career had he never touched it.
So, in a word, “yes.” Sears probably is the next Berkshire Hathaway. And investors who buy Sears at a reasonable price will most likely enjoy enviable long-term returns as Lampert eventually realizes his plans. But Lampert himself will almost certainly come to regret buying the company — if he doesn’t already.