The Outsiders, Part II: Edward Lampert & Sears Holdings

This second post related to William Thorndike’s splendid book, The Outsiders, will address commonalities amongst the CEOs highlighted in the book and Sears Holdings’ CEO & chairman, Edward Lampert. As I read The Outsiders (twice), I was continually struck by parallels amongst the book’s subjects and Lampert.

As a starting point, there is a common set of tactics and attributes Thorndike ascribes to his illustrious set of CEOs:

• Significant share repurchases
• No dividends
• No Wall Street guidance
• “Same combination of derision, wonder, and skepticism from their peers and the business press.”
• Remarkable performance over very long terms (20+ years on average)

Each of these bullet points is manifested in Lampert:

• Share repurchases –  during the period of Lampert’s involvement with and investment in AutoZone, the share count has been reduced via repurchases by over 75%.  Over the same time period, the share price has appreciated roughly 1,075%, an IRR of around 18% versus the S&P 500’s IRR of approximately 2% (exclusive of dividends).  This AutoZone track record is analogous to Henry Singleton repurchasing 90% of Teledyne shares between 1972 and 1984.  Similarly, since orchestrating the 2005 Sears-Kmart merger, Sears Holdings has reduced the outstanding share count by over 35%.  While Lampert has taken much public flak for significant Sears Holdings repurchases above $130/share during 2006 and 2007, the final verdict on Sears Holdings repurchases should be withheld until the company’s values are ultimately determined.
• No dividends – enough said.
• No Wall Street guidance – Sears Holdings offers no guidance, and Lampert’s skeptical views concerning Wall Street and financial commentary are relatively clear.  Lampert offers no SHLD sales pitch – necessary information is disclosed and not much more.  These are not the actions of the average CEO who courts and coddles both the press, Wall Street and buyside analysts.
• Peer and business press derision and skepticism – read any article concerning Sears Holdings, and this Lampert-Outsider CEO analogy is made clear.
• Remarkable long-term performance – although not a precise comparison as Lampert has managed a private investment partnership rather than steered a publicly-traded company for the vast majority of his career, Lampert has compounded ESL capital at over 20% since its 1998 formation.

Beyond these common attributes, there are other aspects of the Outsider CEOs that conjure Lampert:

• Decentralization driving accountability – as Thorndike describes Teledyne: the company had a “wafer-thin corporate staff at headquarters and operational responsibility and authority concentrated in the general managers of the business units.”   Singleton “[e]mphasized extreme diversification, breaking the company into its smallest component parts and driving accountability and managerial responsibility as far down into the organization as possible.”  While Lampert inherited a bloated corporate organization, his efforts to divide Sears Holdings into five business units (brands, real estate, online, operating and support)  and the spinning off of businesses to drive increased accountability echo Singleton – in Lampert’s words: “The idea behind the reorganization is to drive decision-making down into the organization and to harness free-market forces to convert a centrally planned company into a more decentralized company.”
• Focusing on return on investment rather than sales or growth –  counter to the tendency of many CEOs to prize growth, often without appropriate focus on associated profitability or ROIC, the Outsider CEOs were of a different mindset.  In the words of General Dynamics Bill Anders who shrank the business dramatically – “Most CEOs grade themselves on size and growth . . . very few really focus on shareholder returns.”  Likewise, Thorndike’s own words on Berkshire Hathaway: “A critical part of capital allocation, one that receives less attention than more glamorous activities like acquisitions, is deciding which businesses are no longer deserving of future investment due to low returns.”  While the Sears Holdings story has yet to play out, Lampert has received an inordinate amount of negative commentary concerning SHLD’s “underinvestment” in its stores as the primary driver of same-store sales declines and overall poor operating performance.  In the face of such criticism, Lampert has consistently – from 2006 to 2013 – re-framed the issue as one of return on investment rather than top-line fixation.  Clearly, the company’s operating performance has been poor but is it also clear that heightened investment in poorly-positioned large format department stores would have been anything other than “throwing good money after bad”?  Whether – in the long run – Lampert’s capital allocation decisions prove correct is yet to be determined; however, what is clear is that contrary to most managers his focus is on return on incremental capital even if that means shrinking the enterprise.
• Optionality – the last aspect of the Outsider CEOs I want to discuss is a bit more amorphous – channeling optionality.  Many corporations have grandiose long-term plans that set their course well into the future.  While prudent planning is a necessity, plans should not be so rigid as to suffocate the ability and freedom to capture the optionality offered by Lady Fortuna – in Taleb’s vernacular, remaining antifragile.  As Thorndike quotes Henry Singleton: “I know a lot of people have very strong and definite plans that they’ve worked out on all kinds of things, but we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.”  Similarly from Singleton, “[m]y only plan is to keep coming to work. . . . I like to steer the boat each day rather than plan ahead way into the future.”  Likewise – with SHLD – Lampert is dealing with a diverse, mixed  bag of assets.  It appears the company is tinkering with many different strategies and means of monetizing these various assets.  While many of these efforts will fail, the associated investment is low and the potential payoffs are high – intelligent tinkering is the womb of optionality.

To wrap, Thorndike’s The Outsiders does a tremendous job conveying common traits and strategies amongst a group of CEOs who generated vast amounts of shareholder value while marching to a different beat than their peers.  Upon reflection, many of these same traits appear in SHLD’s Edward Lampert, one of the most currently reviled corporate executives.  While only time will offer the ultimate verdict on Lampert’s helming of SHLD, it is worth noting he stands in good company in terms of his mindset and methodologies.