Since engineering the combination of Sears and Kmart last year, billionaire Edward Lampert has tried to convince investors that he intends to run the new company as a retailer.
Wall Street, for the most part, has turned a deaf ear, betting that Lampert will turn Sears Holdings Corp.’s massive real estate holdings into cash.
Perhaps he will, eventually. But one prominent real estate investor isn’t waiting around to find out.
Michael H. Winer, portfolio manager of Third Avenue Real Estate Value Fund, cut his fund’s Sears stake roughly by half in the quarter ended April 30 and expects to liquidate the rest of the holdings in January, according to Third Avenue’s second-quarter letter to shareholders mailed in June. He sold 250,000 shares worth roughly $35 million.
The reason: a combination of an “attractive price”–about $140 a share; a fourteenfold increase from what the fund paid for them–and “our view that the company should be valued as a going concern, as opposed to the theoretical liquidation value,” Winer wrote.
Sears investors watch Third Avenue’s actions closely. The New York-based fund teamed with Lampert to gain control of Kmart Holding Corp. when it was in Chapter 11 bankruptcy in 2002, purchasing debt that converted into stock in the reorganized Kmart.
Third Avenue’s flagship value fund, run by value investor Martin J. Whitman, sold the bulk of its Sears stake, 2.25 million shares, last year when the stock was trading between $134 and $163 a share. Mr. Whitman, in a letter at the time to his shareholders, noted that Sears’ success as a retailer was “far from assured.”
The belief that Sears would liquidate its real estate grew out of Lampert’s dealings at Kmart. As chairman of the ailing discount retailer, Lampert raised more than $1 billion in cash by selling Kmart stores to retailers including Home Depot Inc. and the old Sears, Roebuck and Co. Some analysts estimate Sears’ portfolio of stores to be worth as much as $10 billion.
Although Lampert has said that he would operate Sears as a retailer, the belief that he would sell off real estate has persisted.
“It seems Eddie Lampert may have been shooting straight,” says Biff Ruttenberg, president of Atlas Partners LLC, a Chicago-based real estate firm and turnaround consultant. “He won’t turn it into a real estate play. That’s Plan B. Plan A is, let’s run a retail business. If he can’t run it profitably, he’s got a back door.”
In his most recent letter to shareholders on March 15, Lampert wrote his goal is to “strive to return Sears and Kmart to the position of prominence that both brands and companies held in American retailing.”
But both Sears and Kmart have been losing market share for years and sales have continued to slip on Lampert’s watch.
Sales at stores open at least one year, a key measure of a retailer’s health, fell 8.4 percent at Sears and less than 1 percent at Kmart in the first quarter, while profits benefited from payroll and selling expense cuts.
Mohnish Pabrai, managing partner at Irvine, Calif.-based Pabrai Investment Funds, who follows Lampert but doesn’t own Sears, said he is skeptical Lampert can turn around the ailing Sears-Kmart stores.
“And if you don’t buy into the story that Sears can turn around, you’re betting on real estate or on Eddie’s abilities as a master capital allocator,” Pabrai said. “I think the real estate values for Lampert give him a huge margin of safety.”
Philip Zahn, a Chicago-based credit analyst at Fitch Ratings, agreed. “Real estate is something they can fall back on if the company deteriorates to the point where operations aren’t working.”
Sears spokesman Chris Brathwaite declined to comment. Winer referred calls to a spokeswoman who also declined to comment.
Winer’s real estate fund originally paid $10 per share in May 2003 for Kmart shares that converted into Sears shares in March 2005 when Troy, Mich.-based Kmart purchased Sears for $12.3 billion. Winer hedged his investment by using options to lock in a floor and ceiling on about half of the 500,000 shares held. Those options expire in January and “it is likely that the entire position will be liquidated at that time,” he wrote.
After the second-quarter sale, the real estate fund held 272,951 Sears shares and 2,443 options. The real estate fund boasts an annual average return of 19.5 percent from its inception in 1998 through June 30, according to Third Avenue. Whitman’s flagship fund has returned an annual average of 16.7 percent since it was founded in 1990.
Scott Rothbort, president of Lakeview Asset Management in Millburn, N.J., who counts Sears as one of his top holdings, said, “A lot of people were saying it was just a real estate play, but that was a story spun by bears and shorts and naysayers. The real estate is a factor, but only one of many.”
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