"How great would it be if you could see what appliances your friends have?"
-- Eddie Lampert, CEO, Sears Holdings
Two weeks ago I flew to Chicago to attend the Sears Holdings (SHLD) annual shareholders meeting. Unlike most of these corporate gatherings, Sears CEO Eddie Lampert takes questions from the audience. Considering that he does not host regular quarterly earnings conference calls or make media appearances, the annual meeting offers attendees a rare glimpse into his thinking as he continues to make the transition from billionaire hedge fund manager to underdog retail executive. While I was not expecting Lampert to divulge many details about his plans to get Sears and Kmart (a merger he orchestrated a decade ago) back to profitability, I did think it would be a chance to try and read between the lines of his comments and determine for myself if he really believes in Sears and Kmart as retailers, or if he simply talks up their prospects because anything else would be un-CEO-like.
The problem I have with Sears Holdings stock, despite the fact that the CEO is the largest shareholder and a self-made billionaire, is that everything that Eddie has done and said over the last decade makes it clear that he believes that he can help turn Kmart and Sears into the relevant retailers they were 20 or 30 years ago. Despite no significant experience in retail, Lampert continues to insist he can "transform" (he likes to make clear that this is not a "turnaround" because the company is changing the way it does business) the company and have it thrive in the most competitive retail environment we have ever seen in the U.S. And this is after a decade of failure in that regard, with sales declining year after year and profit margins negative.
Before taking questions at the annual meeting, Eddie gave a PowerPoint presentation detailing why he is trying to transform Sears and Kmart and how he is going to do it. This is what I was afraid he was going to convey to those of us in attendance; that he is laser-focused on Sears and Kmart as future winners in retail. The plan revolves around four core pillars; incentivizing consumers to shop at Sears and Kmart by offering them Shop Your Way membership points (a rewards card program), offering a Shop Your Way marketplace with millions of items from third party sellers to give members a massive selection of products (think: eBay and Amazon), a social media platform at ShopYourWay.com where members can share advice, research products, and read reviews, and a fast, free shipping program (a cheaper version of Amazon Prime without streaming video).
Lampert's presentation included a video showing exactly how some of the Shop Your Way products and services are being designed. Among the highlights were e-receipts emailed directly to shoppers, the option to buy online and pick-up in store, curb-side store pick-up where an employee will bring your items out to your car so you don't have to come inside, employees with tablets helping shoppers in-store, radio frequency identification (RFID) inventory management to ensure stores are stocked appropriately, and digital signs in the store that allow for instantaneous pricing changes and the ability for shoppers to read online reviews as they are looking at the product on the shelf.
He also gave examples of transformation attempts by three other companies; Apple (cost cuts plus successful new products), General Dynamics (divestitures followed by new products), and Kodak (unsuccessful acquisitions that led to bankruptcy). He was quick to state that he was not saying that Sears is like any of those three companies (I would hope not... none of them are retailers). Instead he wanted to point out the sometimes R&D makes sense (Apple), sometimes spin-offs and refocusing on new areas make sense (General Dynamics), and sometimes going on a massive acquisition spending spree because your core product is dying (Kodak, with film) is not the right strategy.
Interestingly, my reaction was somewhat different. I think everybody can point to cases where a certain strategy worked or didn't work. There are always two sides to every coin and no assurances that a certain path will be successful. The thing I found strange was that he didn't use any examples in the retail industry. Why not explain why Caldor and Woolworth are no longer in business? Why not talk about how Dayton Hudson was transformed into Target and was a massive success?
Instead, Lampert tried to convince us that he has a vision for where retail is going and Sears is going to lead the industry in getting there. Oddly, this came shortly after he admitted that the reason for the Kmart/Sears merger was to take Sears' brands off-mall (into Kmart stores as well as new Sears store formats like Sears Grand and Sears Essentials, both of which failed) where retailers like Target and Wal-Mart were expanding. He admitted that was a huge failure and is now actually closing off-mall Kmart stores and renovating Sears stores in the best mall locations they have across the country. His vision was dead wrong back then, but this time around he is going to be right? Why?
He also admitted that all of his retail advisers told him to shut down hundreds more stores after the merger, but he refused and wanted to give them time to get into the black. Now that they are still not making money, he is finally closing them at a faster pace (more than 100 store closures this year are likely, by my math). It just proves that he does not have successful retail experiences to draw from, and as a result is unlikely to turn this ship around.
You may have the same reaction to all of this that I did while sitting through Lampert's presentation. I couldn't help but wonder what was different about this shopping experience that Sears was moving towards. Other retailers are already doing these things. In order for Sears and Kmart to really stop the market share losses they have been sustaining for years now, and get back to profitability, they need to be unique. They need to give shoppers a reason to decide that Kmart and Sears really are relevant now, like they were in 1980. Is a rewards card really the answer? What about a third party marketplace just like eBay and Amazon? A social media platform of their own that will compete with other retailers' presence on Facebook, Twitter, and Pinterest... why will that be successful? Buy online, pick-up in store is not new... and while I don't know of other retailers who are offering to deliver your items to your car, couldn't competitors offer that service in a matter of months if they decided to?
The problem with this strategy is that it is not differentiated. If you are a retailer that is not losing market share, you don't really have to stand out any more than you already do. Your brand is already strong and you have a loyal customer base, so merely matching your competitors in terms of service is good enough to maintain your position. But in the case of Kmart and Sears, they are losing customers because they are seen as old and past their prime. There is no reason to go to Kmart when there is a Wal-Mart down the street, or Sears when there is a Target close by. E-receipts are not going to change this. A rewards card isn't going to either.
So when the Q&A session began I got up to ask Eddie Lampert that very question; "What are you doing that is different from any other retailer? Why would someone use the Shop Your Way marketplace instead of eBay or Amazon?" I wasn't a jerk about it, but I honestly wanted to understand why he thought they could start gaining (or at least keeping) their fair share of customers when they have been losing market share to these other stores for years.
Lampert was very reasonable and detailed in his reply. He acknowledged that the things he had discussed were not different or unique on the surface. His explained that his goal is to focus on building relationships with shoppers and do so better than other retailers. While he knows other stores are doing similar things, he doesn't think it is a focus for them. If he can do the same things but do them more intensely he thinks he can build a group of loyal Shop Your Way members and return the company to profitability. It is more about keeping the customers he already has ($30 billion of sales in the U.S. in 2013) than it is about getting people to switch from Amazon, eBay, Wal-Mart, or Target.
While answering another person's question later on, he circled back to my inquiry and simply said "We believe we can build a better mouse trap." And so that is the strategy going forward; making Sears and Kmart (and the Shop Your Way membership program) a better way to shop by connecting with your customers on a deeper and more helpful level. And that is where his quote about the appliances came in.
"How great would it be if you could see what appliances your friends have?"
Eddie Lampert's vision is that you will associate appliances with Sears because of the store'sheritage. When you need to buy a new dishwasher you will login to the Shop Your Way web site and use the social platform to see what makes and models your friends have purchased in the past. You will read reviews. You will decide which one you want and buy it online. You will schedule delivery or if you have a truck you can come to the store and pick-it up the same day. You won't even have to leave your truck, because once you arrive you'll pull up your Shop Your Way app and tell them you are parked in the dedicated parking space out front. Within five minutes your item will be loaded onto your truck by a Sears employee and you will be on your way back home. Since the item was fairly expensive you'll earn a bunch of rewards points, which will entice you to shop at Sears or Kmart again soon. The fact that Best Buy, Home Depot, Lowe's, and HHGregg also sell dishwashers won't even dawn on you.
In a bubble that all might sound like a great strategic vision with a high likelihood of success. In reality though, I don't think it is going to work. Kmart competes on the low end with Wal-Mart, Dollar Tree, and Family Dollar. But since they can't match the prices of those other companies there is really no reason to shop there. The stores are dirty, disorganized, and less stocked. And the online initiatives are easily copied by these other companies (buy online/pickup in store is already a big part of Wal-Mart's business). On my way to the Sears annual meeting I passed a Kmart with about a dozen cars in the parking lot and about a mile down the street there was a Wal-Mart that was nearly full of cars. Shop Your Way is not going to change that.
Sears has a better chance because they are known for certain categories like tools and appliances. There are a lot of older, loyal customers who have been shopping at Sears for decades. However, the demographics of the U.S. are not moving in Sears' direction. Younger shoppers aren't going to be caught dead in a Sears store. They'll go to Home Depot or Lowe's instead. And that's a big part of the problem. The technology that Eddie Lampert is infusing into his retail stores is more attractive to younger shoppers. Many older customers who like Sears today don't want to use their smartphone to shop (or have one at all). That mismatch is yet another challenge for this "integrated retail" strategy. Going on ShopYourWay.com to see what appliances your friends have bought only works if you are an engaged Shop Your Way member and your friends are also avid users of the Shop Your Way web site. If you are 50 or 60 years old you are not going to find your friends on that site. And you aren't likely to have the Shop Your Way app downloaded on your phone.
As I left the Sears annual meeting, I realized that nothing I had heard or seen had changed my mind about the likely future success of Sears and Kmart as retailing operations. That said, I was glad I made the trip (it's not everyday you can ask a billionaire and brilliant stock picker a question and have them take 5 minutes to answer it in depth). It is obvious that Eddie Lampert has moved on to focus on new things in his life. After 25 years as a wildly successful hedge fund manager, he is now interested in running companies more than simply investing passively in them. That explains why he has not used Sears' cash to invest in or buy other businesses that are not shrinking with each passing day like Kmart and Sears. He is looking to build a new business, not his net worth (which he has already done).
While I hope he succeeds, I don't like his odds, for all of the reasons explained here. As long as his focus is on Kmart and Sears as retailers, investors are better off allocating their capital to Sears debt (the company is not in financial trouble, despite many media headlines to the contrary) and/or watching from the sidelines for any signs that Eddie is finally admitting defeat and shifting strategies. As long as the bulk of Sears Holdings' financial performance is linked to Sears and Kmart's ability to sell products and services to customers at a profit, I would not be bullish.
Stay tuned later this week when I will publish a follow-up post explaining why the very fact that another very good stock picker owns a large chunk of Sears Holdings stock (Bruce Berkowitz of Fairholme Capital) is not a good enough reason on its own to invest in the company, even though Lampert and Berkowitz together control about two-thirds of the company.
Full Disclosure: Long Sears debt at the time of writing but positions may change at any time. Also, I still own the very small number of shares of Sears stock I bought for the sole purpose of being allowed to attend the annual shareholders meeting, but you should not mistake that for a bullish call on the stock.