On Tuesday, March 21, Sears Holdings Corp. (SHLD), the owner of Sears and Kmart, warned investors that "substantial doubt exists related to the company's ability to continue as a going concern." Earlier in the month Sears reported a loss of over $2.2 billion for 2016. It was the sixth year of a streak that has seen the company lose $10.4 billion and erase 84% of its shares' value.
In a few decades, Sears went from being unstoppable to publicly admitting that it may not survive. What happened?
A Tale of Retail Hubris
It started by selling a single product, but when it became clear that a sleepy, over-priced retail sector would crumple before it, there was nothing to stop the firm from selling everything. You could order from the comfort of your own home. You could pay a fair price. They would ship the goods right to you. Sales exploded, and if you'd picked up a big enough chunk of stock when the company went public, you'd never have to work again.
That description once applied to Sears, Roebuck and Co., but now it better describes the company that's blamed for (or credited with) its looming demise, Amazon.com Inc. (AMZN). Having played the role of upstart retail juggernaut in the 1890s, Sears now finds itself in the same position as the rural general stores it used to drive out of business en masse. (See also, Why Retail Layoffs Are on the Rise.)
On the other hand, Sears' demise is not all Amazon's fault, nor is it a simple circle-of-life parable. Sears has made its share of mistakes.
In its most recent annual report, the company named Wal-Mart Stores Inc. (WMT), Target Corp. (TGT), Kohl's Corp. (KSS), J.C. Penney Co. Inc. (JCP), Macy's Inc. (M), Home Depot Inc. (HD), Lowe's Companies Inc. (LOW), Best Buy Co. Inc. (BBY) and Amazon as its main competitors. As of February 9, Sears was the worst-performing of them all: it had lost 51.1% of its value since it began trading under its current ticker in May 2003 (it has pared that loss to 30.4% as of March 22 at 10:50 a.m. EST). J.C. Penney did almost as badly during the same period, falling 50.5%. But Lowe's, Best Buy, Home Depot and Macy's all saw their share prices at least double. Amazon's were up nearly 29-fold. Even for a brick-and-mortar retailer in the digital era, Sears is struggling. (See also, Macy's vs. Sears: Two Beleaguered Retailers.)
Sears' Rise: The First 90 Years
In the mid-1880s, Richard Sears worked as a station agent for the Minneapolis and St. Louis Railway in North Redwood, Minnesota. He would sell lumber and coal on the side, giving him experience that came in handy when, in 1886, a local jeweler rejected a shipment of gold-filled watches from Chicago. Sears bought them himself, sold them at a profit and ordered more. He founded the R.W. Sears Watch Company in Minneapolis, then moved to Chicago in 1887 and partnered with Alvah C. Roebuck, a watchmaker from Indiana. Both were in their twenties.
They launched a catalog of watches and jewelry the following year and incorporated Sears, Roebuck and Co. in 1893. Two years later a couple of Chicago businessmen bought Roebuck's 50% stake for $75,000 (around $2.2 million in 2016 terms). By that time the company had branched out from watches. Sales reached $750,000, and Sears' iconic catalog ballooned to 532 pages (Americans had a complicated relationship with the volume: often called the "consumer Bible," it also served as toilet paper). Farmers, fed up with understocked and overpriced general stores, flocked to Sears.
The company sold stock in 1906 in the first initial public offering (IPO) for an American retail firm and the first to be handled by Goldman Sachs. The same year it opened a 40-acre logistics center in Chicago. According to Sears' corporate archives site, Henry Ford made a pilgrimage to this "'seventh wonder' of the business world" to learn about the company's storied efficiency. (See also, Top 10 Largest Global IPOs of All Time.)
Ford would throw a wrench in Sears' business model, as cars made chain stores more appealing and mail-order catalogs less crucial for rural customers. Sears adapted, opening retail stores in the 1920s that outsold the catalog by 1931. Revenues totaled $180 million that year (around $2.8 billion 2016 terms). The company began to introduce its own brands, including Crafstman, DieHard and Kenmore. It began selling insurance through its Allstate subsidiary.
Sears' Downfall: The Past 50 Years
In 1969 Sears, the largest retailer in the world, began construction on the world's tallest skyscraper. The Sears' Tower's completion four years later may not mark the company's exact peak, but its retail dominance began to fade around that time. In the 1980s it adopted a "socks and stocks" strategy, expanding into financial services beyond its existing insurance business. In 1981 it purchased Dean Witter Reynolds Organization Inc., a stock broker, and Coldwell, Banker & Co., a real estate broker. It launched Discover Card through Dean Witter in 1985.
In 1984, together with International Business Machines Corp. (IBM) and (for a time) CBS Inc., the company created what would become Prodigy, a pre-Web online portal. Built on a private network, it was distinct from the Internet, but presaged it in many ways, offering email, games, news, weather, sports and shopping.
In 1992, when Sears' revenues reached $59 billion, the company announced plans to simplify its structure. It took parts of Dean Witter and Allstate public, then distributed the remaining shares to investors. It discontinued its famous catalog in 1993 and sold Prodigy in 1996. Having sunk over $1 billion into the project between them, Sears and IBM received less than $200 million from the sale. Sears also sold Coldwell Banker, along with other financial services subsidiaries.
By 1999, Sears' archives site says, the company "had returned to its retailing roots." (In fact it retained a significant consumer credit division, with U.S. borrowers accounting for 61% of the company's $2.5 billion in operating income in 2002. Investors began to worry that the early-2000s recession had made credit card issuance too risky, and Sears sold the business to Citigroup Inc. (C) in 2003.)
At the turn of the century, Sears turned to the web in earnest. A July 2000 press release boasted that sears.com sold home electronics, computers, office equipment, appliances, cookware, baby products, school uniforms, gifts, toys and sports memorabilia. Amazon, meanwhile, had only just begun branching out from books, offering software, video games and home improvement products in November 1999.
At that time, however, Sears' problem was not so much Amazon as Wal-Mart, which had become the nation's largest retailer in the 1990s. Barbara Kahn, a professor of marketing at the Wharton School, told CNN in 2004 that when the Arkansas-based company "came along with its great service and low-prices, other retailers started to innovate more with products and service. Sears and Kmart simply trudged along and thought that was good enough."
Kahn mentioned Kmart because it had just announced, on November 17 of that year, that it would buy Sears for $11 billion. The combined companies to be headquartered in Chicago and called Sears Holdings would operate around 3,500 locations. Analysts expressed excitement at combining the fading giants' mainstays, cross-selling brands such as Sears' Craftsman and Kmart's Martha Stewart Everyday. Management promised to save $500 million a year by 2007, partly through jobs cuts and store closings.
The mastermind of the deal was Kmart chairman Edward Lampert, a Goldman Sachs Group Inc. (GS) alumnus and one-time roommate of Treasury Secretary Steven Mnuchin at Yale. Lampert had left Goldman to start a hedge fund in 1988, aged 25, and bought up Kmart's debt when the retailer declared bankruptcy in 2002. He gained a 53% stake in the company for less than $1 billion. A week after the merger with Sears was announced, Bloomberg reported that Kmart's market capitalization was $8.6 billion.
As chairman of the combined company – he took on the CEO role as well in 2013 – Lampert initially attracted breathless praise from the media. A Businessweek cover story called him "the next Warren Buffett." Just as Buffett turned a failing textile company into a vehicle for superhuman returns, the line went, Lampert would use Kmart as a cash cow for savvy acquisitions. His hedge fund's average annual return of 29% from its inception to 2003 boded well. (See also, Eddie Lampert's Success Story.)
A little over 12 years later, such comparisons seem ridiculous. Sears Holdings' sales rose in 2006, its first full year as a combined company, but then fell in each of the following nine years. For a while Sears' stock rose anyway, but the financial crisis wiped 85% off its value between its April 2007 high and its November 2008 low. The recovery was tepid and short-lived. The Chicago Tribune reported in March 2010 that Sears was losing market share. Shares peaked again that April at less than two-thirds their pre-crisis high. They have not recovered since.
Kmart was Lampert's first majority stake, and he proved to be a better speculator than manager. A 2013 Bloomberg article excoriates his Ayn Rand-inspired approach: in 2008 he split the company into 30 divisions – which swelled to 40 a year later – each of which reported profits separately and had to compete with the others for resources. Lambert was both strict with money and distant, seldom leaving his home in South Florida.
Divisions found themselves acting like separate companies, even drawing up contracts with each other. Compensation costs rose as each division hired its own senior management. These executives in turn had to form their own boards, and their pay was determined according to an in-house profit metric that led to cannibalization as some divisions cut jobs, forcing others to step in. The appliances unit found itself being gouged by the Kenmore unit, so it bought wares from LG, a South Korean conglomerate, instead.
The combined company's profits peaked at $1.5 billion in 2006, then dwindled to nearly nothing by 2010. From 2011 to 2016 the company lost $10.4 billion. In 2014 its total debt ($4.2 billion at the end of January 2017) surpassed its market cap ($974.1 million as of March 21).
In November 2016, 24/7 Wall Street reported that Lampert was "the most hated CEO in America" based on their review of Glassdoor ratings.
While Lambert experimented with new management techniques, Amazon – itself no stranger to intense competition – built a retail empire. Its total sales were a mere 17% of Sears' in 2005, the first full year after the Kmart merger. But whereas Sears' revenues fell by 14% over the following five years, Amazon's nearly quadrupled. In 2011 the tech giant surpassed Sears, then lapped it in 2013. In 2016 it made $136 billion in sales to Sears' $22 billion. (See also, Amazon Filing Reveals Prime Numbers for First Time.)
When Kmart's acquisition of Sears was announced in 2004, Lampert commented, "I don't think any retailer should aspire to have its real estate be worth more than its operating business." As Sears' prospects fade, however, investors are increasingly eyeing its real estate. Sears spun off around 200 properties into a real estate investment trust (REIT) that began trading as Seritage Growth Properties (SRG) in July 2015. Previous spinoffs include Lands' End and Sears Canada. Stanley Black & Decker Inc. (SWK) agreed to buy Craftsman in January.
Sears has cut the hours, pay and headcount of retail staff to save cash, causing stores and customer experience to deteriorate. "We have a 17-year-old running the office and cash office," one employee wrote to Business Insider in August 2016. "He has no experience in either, but he is a warm body to fill the job. The end is coming soon, get out while you can." (See also, The Bad News Keeps Piling Up for Sears.)
An affiliate of Lampert's hedge fund agreed to loan Sears up to $500 million in January, bringing the total amount Lampert has plowed back into the business since September 2014 to around $1 billion.
On February 10, Sears announced a 10.3% decline in fourth-quarter same-store sales and unveiled a turnaround plan promising $1 billion in cost cuts. It reiterated a previous plan to close 108 Kmart and 42 Sears locations. Shares closed up 25.6% on the news and continued to rise, but at a closing price of $7.10 on February 14, they remained less than half as valuable as they had been 12 months prior.
Susquehanna analyst Bill Dreher reiterated his negative rating on Sears following the announcement. In a note initiating coverage of the company on February 9, Dreher brought up the possibility of bankruptcy, writing that Sears had been "spinning off assets to survive."
Who Killed Sears?
It would be easy to read this story as a triumph of e-commerce, or to reflect on the irony that Sears was a first-mover when it came to online shopping, with its proto-internet joint venture Prodigy. But even recently, Sears has been ahead of the curve in that area. According to Bloomberg, Lampert "showered" the online division with resources while the rest meleed over a shrinking pie.
Nor did competition with Amazon alone precipitate Sears' decline. When sales and profits began to fade, in the mid-2000s, other big box retailers – particularly Wal-Mart – were thriving. In 2011, the year Sears lost over $3.1 billion, Wal-Mart made $17.1 billion.
Perhaps the might-have-been next Warren Buffett should have listened to the original, who told University of Kansas students in 2005, "Eddie is a very smart guy, but putting Kmart and Sears together is a tough hand. Turning around a retailer that has been slipping for a long time would be very difficult. Can you think of an example of a retailer that was successfully turned around?" (See also, Buffett's Berkshire Reduces Stake in Wal-Mart.)