Sears bankruptcy

January 19, 2019

I’m really interested in the Sears bankruptcy proceedings because I want to know how long exactly I’ll be able to use my points on Shop Your Way. Shop Your Way is a weird rewards program held by Sears holdings, the disastrous trainwreck that is billionaire Eddie Lampert’s brainchild. This rewards program, frankly, makes absolutely no sense. You get $2 in “points” every time you take an Uber (the Uber could be $3, it doesn’t matter). Now, you’ve got to bet that Shop Your Way is on the losing side of this corporate partnership - what private tech company would go around and burn millions of dollars a day?

Honestly, I don’t know how anyone at Sears could have thought that this was a good idea. As long ago as 2014, the program has made up for three quarters of Sears’ sales. Personally, I only buy stuff on Shop Your Way when I have enough points to buy $70 worth of stuff for free with free shipping. I apologize to those in older generations who will miss the novelty of shopping at Sears, where you can actually see and feel the things you’re buying. So you can see how this brilliant scheme to get more people to shop at the dying retailer both succeeded and failed. Succeeded in that more people than would normally shop at Sears shopped at Sears, and failed in that they’re selling stuff for free. (It’s always a winning sales strategy to give away stuff for free, just ask a college student).

So there’s a whole lot out there about the corporate financial trickery that Lampert employed to keep Sears afloat for the past decade or so, while at the same time extracting as much money as possible out of the fading icon as possible for his hedge fund, ESL Investments.

Lampert bought Sears through an acquisition by Kmart for $11 billion in 2005. Before buying the company outright, he was a 15% shareholder in the company. He bought Kmart two years beforehand, and merged the two to form a relic of old time retail. Source

Sears’ sales rose for one year after the acquisition (in 2006) and subsequently declined for the next 9 years. The financial crisis in 2008 was quite close to a nail in the coffin for the fledgling company. The company lost 85% of its market capitalization, but Lampert somehow kept it alive through a corporate restructuring of massive proportions. By splitting the company into dozens of competing subsidiaries, he introduced layers upon layers of bureaucracy. Each of these subsidiaries was individually managed, had its own corporate structure, and vyed for a larger portion of an already scarce pool of resources.

This restructuring did well to drag Sears’ revenues even farther down the hole, as heads of each division would each demand high salaries, and the overhead of maintaining separate organizations weighed down on revenues.

From the late 00s to now, Sears has been on a steady cycle of “streamlining”. Despite pumping hundreds of millions of dollars into the company, Lampert was still able to shave off gains for himself. Some have argued that the way in which Lampert drove Sears into the ground indicates not poor management, but typical Wall Street greed. This is mostly evident in the streamlining cycles that Lampert put the company through in the 2010s.

The picture that comes to mind when thinking of Sears’ restructuring is of a rocket launch gone wrong, with pieces of shrapnel spinning off every ten seconds. First, Lampert spun off over 200 properties into a real estate investment trust. Sears subsequently spun off a number of brands in an effort to build a more streamlined business. Land’s End, Craftsman, and Kenmore were all spun off to shareholders. In this case, however, “shareholders” also refers to Lampert and his hedge fund ESL. So he still owns a 59% stake in Land’s End, on top of a large 43.5% stake of the REIT that holds much of Sears’ old retail space.

Lampert siphoned cash off of these spun-off assets rather sneakily (and definitely without Sears’ best interests in mind). The REIT, called Seritage Growth Properties, was now leasing its properties (formerly Sears retail stores) directly to Sears. Thus, the REIT actually made money off of the company that spun it off. In fact, this maneuver essentially allowed ESL to take cash directly from Sears’ balance sheet.

The money that Lampert lent to Sears will not all be lost to him, either. Sears put up collateral against these loans in the form of its retail property, meaning that Lampert will take control of the property if and when the loans default. So in the event of default, Lampert may even get the better end of the deal (even though he had lent the money through ESL). What’s more, much of what ESL lent Sears is secured, meaning it’s at the very top of the payback pyramid.

For the last decade or so, Lampert has been able to keep Sears alive, simply because it assets to burn in the “streamlining” process.

(As a side note, ESL and Lampert are essentially the same entity, as Lampert “owns all of ESL and makes all of its investment decisions”.)

People overemphasize the role of online shopping and Amazon in killing Sears. Sure, there was certainly a failure to adapt to a new medium of retail. In the end, what really killed Sears is poor management and misaligned incentives. What was in the best interest for the largest shareholder (Lampert) was not in line with the interests of employees (who saw their hours and pay get cut), shareholders (who saw the retailer’s assets dwindle to nothingness), or customers (who saw Sears’ appeal as a retailer drop).

Even since the bankruptcy, my Shop Your Way account still feeds me $2 in points for every Uber ride I take (I’ve heard that they’re getting rid of the free shipping, though).

A lot of weird things have happened with Sears’ debt in the aftermath of the bankruptcy. The way that the debt is settled in these situations is that there is an auction for the debt that is outstanding. This essentially answers the question of “how much do we expect (company) to pay us back for that $X we loaned them?” In default, the company has to pay back as much as it can to its debtors, an auction like this settles it.

Bring credit default swaps into the equation, and suddenly this debt auction isn’t as straightforward anymore. I’m reiterating what Matt Levine very gracefully explained in his fantastic blog, Money Stuff. Sears subsidiaries sold bonds to each other (yes, within the same company) because of Lampert’s super convoluted and unnecessarily complicated corporate structure. The bonds of one subsidiary in particular, Sears Roebuck Acceptance Corp, were supposed to be sold at auction to determine their fair value. Now, the seller of the CDS on those bonds (Cyrus Capital Partners) wants the price at auction to be high, so that they don’t have to pay out as much in CDS. So in order to minimize net losses on the CDS sale, Cyrus can go to the auction and figure out what price they’d have to buy all the bonds to minimize their net payout (CDS payout + bond auction price).

Sears, knowing that this trade existed, set up an auction of its own for the internal debt that it held. Both of the two sides stood to gain from participating in the Sears auction. The CDS holders could buy the notes and bring them to CDS auction, making it harder for Cyrus to push up the price on the debt, thereby increasing the CDS payout. Cyrus, in anticipation of this fudgery, had an incentive to buy the notes, in order to not bring them to auction. Cyrus bought the notes, handing Sears 82.5 million dollars to work with.

Lampert was the only bidder at the bankruptcy auction for Sears itself. Offering 4.4 billion dollars to keep thousands of workers employed, he made a difficult pitch to a number of weary creditors. The only thing stopping him from winning the auction outright is the bankruptcy court’s perception of his ability to bring Sears back to life. Creditors, of course, do not want to see more of the same in management from Lampert. But for many, it could very well be their best option, since if no one else can put in a viable bid for Sears’ assets, the value of their holdings becomes the value of Sears’ assets in a fire sale. Unsecured creditors (not ESL) are the most at risk here. Essentially, Lampert has to give a pitch to creditors that he can provide more value to their holdings than a liquidation could. The courts were originally unsatisfied with Lampert’s bid, given his spotty history as CEO of the company. Eventually, however, Lampert’s bid won, and as of mid-January, he has one more chance to bring Sears back to its feet.

So what happens now? More store closings, more spin-offs, and more consolidation of assets to benefit ESL and Lampert? Or a transformative magical turnaround that somehow brings Sears back to life? I’m just wondering how much longer I can get free stuff from Shop Your Way.

Return to economics