What has two thumbs, a billion-dollar hedge fund, and is bailing on Sears Holdings Corporation (SHLDQ)?
Bruce Berkowitz, the investor who's been Sears' biggest supporter for much of the last decade. The Founder and Chief Investment Officer of Fairholme Capital Management, a $3.1 billion hedge fund that is Sears' second-biggest shareholder after Sears' own CEO Eddie Lampert, said he would step down from Sears' board of directors at the end of the month.
Sears shares crumbled on the news, falling as much as 15% yesterday as the market seemed to think that one of the retailer's biggest backers has lost faith.
The reasoning behind Berkowitz's departure wasn't immediately clear. In a filing, Sears simply stated that Berkowitz's decision "was not the result of any disagreement with the Company on matters related to the Company's operations, policies or practices."
In a statement, Berkowitz said, "I wish the company and its associates all the best as Sears Holdings continues to execute on its strategic priorities."
In addition to serving on the retailer's board and controlling a fund that holds 27% of Sears's outstanding shares, Berkowitz had been one of the stock's biggest boosters in recent months.
Back in June, the stock rallied as Berkowitz said Sears' real estate was worth between $90 and $100 a share, arguing that Amazon's acquisition demonstrated the value of brick-and-mortar retailers like Sears. However, his decision to relinquish is board seat seems to indicate he no longer sees that kind of value in the stock. Berkowitz's fund, however, has not yet reduced its stake.
Image source: Sears.
The Grim Reaper lurks
Sears shares approached an eight-month low on the news, which confirmed ongoing doubts about the company's future. In its annual report issued in March, management said, "Our historical operating results indicate substantial doubt exists related to the company's ability to continue as a going concern." The retailer hasn't posted an annual operating profit since 2010, and revenue has been fallen by half since then. Last year, it posted an operating loss of $2 billion. Its Canadian franchise, Sears Canada, declared bankruptcy in June and said it would liquidate earlier this month as it couldn't find a buyer for its assets. Sears Holdings itself, which also owns Kmart, will close at least 350 stores this year from a total of about 1,400 at the beginning of the year.
Sears has done backflips in recent years to stay afloat, including selling or spinning off brands like Craftsman and Lands' End, borrowing from Lampert's own hedge fund, and converting a portion of its real estate into Seritage Growth Properties (SRG 2.26%), but the company continues to bleed cash; it lost $1.5 billion in free cash flow last year. The climate in the department sector also does the company little help as even profitable peers like Macy's (M 1.60%) are seeing their share prices plunge as they struggle to adjust to changing consumer habits.
By continuing to downsize and sell off real estate, Sears is delaying its seemingly inevitable demise, but vendors are already getting nervous. The retailer has lost some smaller suppliers who fear they won't get paid by the company and can't afford the high price of insurance that covers Sears' debt in the case it goes bankrupt. In June, Sears sued two suppliers to ensure they would continue shipping Craftsman tools to the company, and Lampert railed against vendors in a blog post in May, accusing them of using negative media attention to get better terms.
That lack of supplier confidence leads to a vicious cycle of empty shelves and shabby stores, which inevitably drive even more customers away. This sort of supplier squeeze often precipitates retail bankruptcies, as the retailer has trouble stocking merchandise and meeting terms such as cash paid upfront for their orders.
With the holiday season around the corner, Sears will survive to see 2018, but Berkowitz's move casts even more doubt on the retailer's prospects. As a board member and one of its biggest investors, Berkowitz has special insight into the company. If even Sears' biggest cheerleader is turning in his pom-poms, it could soon be game over for the retail dinosaur.
