How Greedy Investors Looted Sears Into Bankruptcy
Stores were in shambles and workers laid off while investors made billions. Now, former Sears CEO and directors, including Steve Mnuchin, are being sued.
Eddie Lampert, once described by TIME as a wunderkind of Wall Street, reasoned that because of his success at passive investing - and although he had not one hour of retail experience – he could take on America’s 128-year-old iconic retailer, Sears, and make it “great again“ (yes, his actual words).
Now angry Sears’ creditors are causing Sears’ Trustee in bankruptcy to sue Lambert, Treasury Secretary Steve Mnuchin, and other former directors of Sears for allegedly stripping $2 billion in assets out of the corporation for their personal benefit. It will be an uphill battle. What Lampert and co did is standard operating procedure that hedge funds use to strip companies. I outlined these tactics in my first article on hedge funds.
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Here’s how the story played out. Lampert got control of Sears in 2003. From 2006 to 2010, Sears’ sales slipped into sharp decline as shown in the graph below. Notwithstanding this downturn and the 2008 crisis, he had Sears spend $5.8 billion in share buybacks while its income was only $3.8 billion in that period.
To see how SEC regulations permit executives, even though they are the ultimate insiders, to sell their shares secretly to the corporation on a buy-back, read more here.
From then on, Sears had to borrow to meet its operational costs. Guess who it often borrowed the money from? Yep, you got that right. Lampert and his hedge fund, ESL Investments, have lent Sears around $2.66 billion.
Lampert planned to move Sears to more of an online shopping model through “Shop Your Way”, a program designed to incentivize customers to move to internet shopping. Sears customers, however, were older and not interested. At the same time, because he thought the brick-and-mortar stores were not so important, he stopped funding store maintenance. Soon the stores were in/a shambles. Business Insider reported leaking ceilings, cracked floors, rat infestations, stores operating with about half of the needed staff so customers could not even check out and were leaving empty-handed. Sears denied all allegations.
By 2013, sales continued to decline so Lampert had himself appointed CEO. Afterward, share prices went into a tailspin. By 2016 media reported sales had halved. Sears lost $8.2 billion in 2016 alone.
Back in 2015, when it had become clear that Sears’ days were numbered, Lampert’s hedge fund created a real estate investment trust called Seritage Growth Properties. Lampert owned 43% of Seritage and was Chairman of its Board of Trustees. At this time he controlled 54% of Sears’s shares.
All these positions made him Sears CEO, lender, vendor, largest shareholder holder and, now, landlord.
In a classic move out of the corporate raiders’ playbook, Lampert caused Sears to sell 253 of its prime location stores to Seritage. Sears got the cash, but from then on had to pay rent.
Next, according to the playbook, Sears started closing Seritage owned stores. Seritage could redevelop these prime sites for more profitable ventures, for example, The New York Times reported, in Santa Monica, CA, it converted closed Sears stores into office spaces suitable for the area’s burgeoning high tech sector. On Long Island, NY, it is redeveloping the Sears site into a 600 unit apartment complex. In Aventura, FL, it has begun construction of a luxury shopping center.
Then put it into Chapter 11 bankruptcy and buy the assets at fire-sale prices free and clear of debts - especially pensions for the workers. Note as Bill Black, a professor of economics and law, stresses, executives get generous severance pay. It is the workers’ pensions that are underfunded in bankruptcies - Sears and Toys-R-Us are two recent examples.
Defenders of the right of hedge funds to scuttle worker pension funds like to point out that’s why the federal Pension Benefit Guaranty Corp. (PBGC) exists. It will keep the pension cheques flowing for the 90,000 workers affected. No problem.
Yes, problem - big problem. the sears pension plan is $1.5 billion underfunded. The PGCB is continually raising premiums to cover these increasing defaults - and it also depends on rising market conditions for returns on its investments. That means responsible corporations, that have adequately funded their pensions, will be paying more to subsidize Lampert’s gambit.
All of Lampert’s planning got approved by the bankruptcy court over creditor objections that this was an audacious engineered bankruptcy. But what could the judge do? Lampert’s proposal was the only one that promised to save 45,000 jobs.
A Modern American Tragedy
During the longest period of economic expansion of recent history (since 2009), Lampert managed to destroy Americas’ once largest retailer. After Lampert’s takeover, Sears shuttered more than 3,000 stores and slashed its workforce from 350,000 to roughly 68,000 fair paying jobs and put the public pension insurance schemes under strain.
How has Lampert fared? Retail tech analyst Pula Rosenblum writing in Forbes believes, ” This exercise in job destruction has made Lampert even richer.” The New York Times reported in 2018 more sources of profit, “Mr. Lampert’s stake in this business [Seritage] is now worth approximately $1.1 billion.” He has pocketed another $1.4 billion from his investment in the retailer, Institutional Investor recently calculated. Most of those profits came from performance fees ESL investors paid to Lampert on his Sears and Kmart investments.
Business Insider adds: “[Lampert’s ]home, located in the wealthy Indian Creek community off Miami’s coast, is a sprawling estate worth $38 million. Lampert also owns a $26 million property in Connecticut, a $14.5 million home in Colorado, and a 288-foot yacht called Fountainhead.”
This is the second in the series on how hedge funds loot corporations. The first can be read here.
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