He could be building a superpower of retailing to wage war with
. Or he could be following in the footsteps of Warren Buffett, building a publicly traded, cash-generating investment vehicle like
Maybe Ed Lampert is just trying to maximize returns for his hedge fund, ESL Investments.
Whatever thesis best describes the motives behind Lampert's plan to merge
, one thing is certain: Wall Street is mesmerized by the investment guru and is awaiting his next move.
Traders have bid up Sears over 16% since Lampert announced his intentions to make it Kmart's acquiree. Meanwhile, bucking the usual pattern for the acquirer, Kmart remains up too, having now gained 0.5% since the announcement after initially adding 7.7%.
Elsewhere, the merger has shaken up the retail world, starting a downtrend for Wal-Mart and
, among others. A postmerger pop in department store chains including
has since dissipated as rumors of more consolidation have given way to concerns about holiday spending.
While Wall Street waits for the merger to become official, more immediate attention has turned to Lampert's other holdings. Besides Sears and Kmart, ESL's two biggest publicly traded equity stakes are in
. As Lampert's cash pile grows, investors have to wonder whether these companies will become acquisition targets as well.
ESL has recently raised its stake in both companies, scooping up about 2 million shares of AutoZone and AutoNation over the summer. The fund owns roughly 35% of each, having purchased the bulk of the shares in the late 1990s and early 2000s.
Both companies have adopted similar strategies to the one Lampert used to take Kmart from bankruptcy to profitability in less than a year. The prescription calls for a focus on profitability through cost-cutting and return on investment, often at the expense of sales growth. For instance, AutoZone increased its store count only 10% from fiscal 2000 to 2003 and 6% in 2004, after expanding 18%, on average, from 1993 through 2000.
"Lampert's modus operandi is to look for a company that's been dumping too much cash flow into growth or other forms of capital expenditures and competition that don't really yield that much," said Phil Guziec, an analyst with Morningstar. "He pulls in the growth, reins back that extra spending, and he focuses on operating earnings. Once he gets those under control and maximizes the free cash flow, he then pursues whatever reasonable, limited growth makes sense."
Guziec also pointed out another strategy that is fast becoming a Lampert trademark.
"He likes companies that are real estate plays to the extent that even if he's not divesting the real estate, the real estate isn't fully valued," he said. "And the businesses he likes tend to be location-based businesses. By that I mean that with AutoZone, for instance, you're not likely to go to a
if there's an AutoZone nearby."
One of the major synergies talked about between Kmart and Sears is location. Aside from speculation that both companies own undervalued real estate assets that has driven up their stock prices of late, management has unveiled a strategy that would involve the Sears business model and product mix moving into Kmart's off-mall locations, where recent trends show consumers are now shopping more frequently.
Nick Pantazis, an analyst with Monness, Crespi Hardt & Co., said any synergies between AutoNation and the new Sears Holdings would have to exist in real estate.
"Maybe there's some grand plan to bring these all under one umbrella, but I don't see where Sears and Kmart's businesses overlap with AutoNation's business of selling cars," Pantazis said. (He does not own shares in AutoNation, and his firm has no banking relationship with the company.) "AutoNation is somewhat unique in the auto retail industry in that they own outright the vast majority of the real estate where the dealerships sit. So there's definitely the potential for some untapped real estate value there, which is similar with some of the arguments made now about Kmart."
Guziec said a merger with AutoNation could be complicated due to franchise agreements and requirements. Furthermore, he thinks Lampert is probably content with his stake in the company.
AutoNation is just a nice profitable portfolio of little monopolies that are just going to keep throwing off cash, and I doubt he's going to want to change that business model at all," Guziec said. "He bought it at the right price, and he's just making sure that it's run for maximum free cash flow."
AutoZone, however, could be another story.
"The growth in the auto parts sector is really in the commercial side of the business, and with the Sears Auto Care centers, that could be a good outlet for AutoZone's commercial business," said Kevin Tynan, an analyst with Argus Research. "I think AutoZone fits better. There's more synergies there. The logic makes more sense."
AutoZone boasts an attractive real estate portfolio as well.
"Of all the auto parts retailers that are out there, AutoZone has the highest percentage of ownership of their stores in the sector," said Cid Wilson, an analyst with Monarch Research LLC (he does not own shares in AutoZone, and his firm has no investment banking relationship with the company). "So when you look at them from a real estate perspective, there could be some value in AutoZone that may not be realized by the Street."
In sharp contrast to Kmart, AutoZone's management has used a large amount of cash extracted from operations to repurchase shares, which has been to the benefit of Lampert's ESL Investments as well as other shareholders.
A move to acquire either of these holdings through Sears could potentially benefit ESL as well, as it would allow the hedge fund to cash out but still retain ownership through its stake in Sears Holding. Kmart and Sears have a combined $5 billion of cash on their balance sheets.
Guziec stressed that any talk of mergers and acquisitions between Sears Holdings and AutoNation or AutoZone are pure speculation and certainly not a "slam dunk." For now, investors can only look at Lampert's record and try to predict where it will lead him.
"He's not a manager that's trying to build an empire or save an empire," said Guziec. "He's just trying to wind down the empire and extract value out of it over time."