Look Toward the Insiders at Lands' End

Insider activity in spinoff situations such as Lands' End provide a treasure of information for investors to utilize.

Jun 27, 2014 at 1:02PM

The Lands' End (NASDAQ:LE) spinoff from Sears Holdings Corporation (NASDAQ:SHLD) has created uncertainty for Foolish investors with Lands' End's inability to rebound from the recession. Given this, it is difficult to know if Sear's intention to spin off Lands' End was to unlock shareholder value or divest from a struggling business. While time will eventually sort out the truth, taking note of insider activity provides inference to what's to come.

Executive compensation significance
Management's compensation is very important in spinoff situations. As hedge fund legend Joel Greenblatt adroitly pointed out in his book You Can Be a Stock Market Genius, it is vital that management's incentives are aligned with shareholders. If management is given the option to purchase shares, and they do purchase them, it signifies that insiders are optimistic about the company's future.

Currently, the Lands' End executive team is not invested in the companies stock. The lack of insider ownership is not preferable, but it is not yet a deal-breaker because the stock was recently spun off, and it makes sense to diversify career salary from investment income. With that said, if the insiders remain on the sidelines, Foolish investors should beg the question: if the people who have an array of information and experience on the company and the industry are not investing, why should I?

Sears' compensation
Prior to the spinoff, the Sears compensation committee developed the Lands' End compensation packages. The incentive opportunities included annual and long-term performance-based programs. Annual compensation consisted of a base salary and an annual incentive based on hitting certain financial performance goals.

The Sears "2006 Stock Plan" did not provide Lands' End executives the potential for stock options. The more recent Sears "2013 Stock Plan" does contain provisions allowing stock options; however, no such stock options were granted to Lands' End executives. Instead, the Lands' End executives were paid in cash based primarily on hitting certain EBITDA goals. Oddly enough, under the 2013 plan, 25% of the award was based on achieving Sears' EBITDA and 75% on specific business unit goals.

The fact that Lands' End executives were primarily compensated in cash is valuable information due to how a spinoff works. Sears shareholders were given approximately three shares of Lands' End for every 10 shares held. Since it was Sears shareholders that received Lands' End shares, and Lands' End executives were not compensated in Sears shares, it is logical that current insider ownership would be low. The question could be raised as why executives would not just buy Sears stock themselves prior to the spinoff? The answer is that they may not have wanted an exposure to all the Sears' business lines, and/or expected a short-term sell-off that usually occurs in spinoff situations.

Spinoff umbrella program
In connection with the spinoff, an "umbrella incentive program" created the following incentives for Lands' End executives:

  1. Annual Incentive Plan
  2. Long-Term Incentive Program
  3. Cash Long-Term Incentive Plan
  4. 2014 Stock Plan

Under the annual and long-term incentive plans, executives can receive cash and/or stock. For each performance period (whether it be a fiscal year or a fiscal quarter), the compensation committee will establish in writing the financial performance goals and the annual incentive opportunity to be awarded for each participant. The stock plan allows for the grant of restricted stock, options, stock appreciation rights, stock units and other stock-based awards. Currently, there are 1,000,000 shares of the company's common stock reserved for the stock plan.

The ultimate value of this information is that insiders, who understand the Lands' End business model and industry very well, are given the option to choose between stock and/or cash. If many or all the executives choose the stock, then it shows that the insiders believe it will likely appreciate in value. Foolish investors should stay alert for what executives choose once their incentive plans are eligible for payout.

Recent amendments
An 8K filed on May 20, 2014, showed that the compensation committee amended the Long-Term Incentive Program. The change states that the committee can establish a performance period other than a fiscal year. This amendment is good information because it potentially shortens the option time that executives get paid. Essentially, Foolish investors may be able to see if insiders choose stock over cash much sooner than previously expected.

Foolish takeaway
Foolish investors without a crystal ball should utilize information such as insider buying to assist in forming expectations. The lack of insider exposure raises flags, but is understandable given the stock compensation plan when the company was apart of Sears. Foolish investors should continue to watch insider buying and specifically what form of compensation -- cash or stock -- is chosen in the umbrella program.

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