Sears: The Silent Partner Who's Making Himself Heard

Buybacks and asset sales show the influence of Ed Lampert

When CEO Alan J. Lacy announced the sale of Sears (S ), Roebuck & Co.'s troubled credit-card unit to Citigroup on July 15, he argued that it would unlock the value of the division and allow Sears to focus on its retail business. Yet six months earlier, he declared that the credit business was an inseparable part of the whole.

Why the change of heart? Lacy declined to comment for this story, but many point to the influence of Edward S. Lampert, the low-profile investor who now has a 10% stake in Sears. "The sale completely fits his modus operandi," says a managing director at a hedge fund just down the street from Lampert's Greenwich (Conn.) office.

Lampert isn't talking, but a close look at the strategy he honed at other retailers suggests what he may be up to at Sears. By taking a position in a struggling company, then adopting an activist role, he has forced such underachievers as AutoNation (AN ) Inc. and Kmart (KMRT ) Corp. to focus on core operations, boost cash flow, and control costs. "Eddie is all about unlocking value," says Joseph Grabowski, an analyst at Strong Capital Management.

While Sears insists Lampert has no direct influence on operations, he is now the company's second-largest shareholder -- and its most activist one. While Lampert dumped 1.5 million shares after Sears disclosed its intention to sell the credit unit, he retains a 10% stake that is worth $1.27 billion. And Sears certainly seems to be doing things Lampert is known to support. In the second quarter, for example, the retailer bought back $1 billion worth of shares. What's next? Some investors and analysts speculate that pushing Sears to sell the valuable real estate under its stores may be in the cards.

In the 15 years since he founded his ESL Investments Inc., Lampert, 41, has developed a reputation as a risk-taker with an eye for undervalued assets. That has paid off handsomely: Since 1989, his hedge fund has posted average returns of at least 25%. Kmart has been Lampert's most attention-grabbing play. He and affiliated investors bought most of the discounter's debt after it filed for bankruptcy in 2002. Then, after forcing Kmart to exit bankruptcy earlier than intended, Lampert converted his bonds into a controlling stake and became chairman of the board.

But Lampert's investments in the floundering AutoZone (AZO ) in 1997 and troubled AutoNation three years later may provide a closer parallel to Sears. AutoZone has since focused on generating cash by cutting costs and squeezing suppliers. AutoNation has focused on its core dealership business and freed up cash by jettisoning noncore operations, including a credit business. Both companies bought back large chunks of stock. Improved profit performance, together with the lower number of shares, have sent the stocks soaring; since Lampert's investment, AutoNation's stock is up 80%, while AutoZone's is up 205%.

Lacy, whom Sears says is in regular contact with Lampert, appears to be following a similar strategy. Consider the share buybacks. Analysts can't recall the retailer repurchasing $1 billion worth of shares in a single quarter before. What's more, the board has authorized another $1 billion buyback. And analysts expect Sears to use much of the $4.5 billion in aftertax proceeds from the credit sale to repurchase even more shares. Result: a stronger stock -- and a bigger stake for Lampert.

Lacy also appears to have shifted his cost-cutting goals since Lampert came on the scene. Besides going after headcounts and store expenses, he has reduced capital expenditures, which he cut this year by 15% from earlier projections. Much of that reduction stems from Lacy's pullback on Sears' new home-remodeling store, the Great Indoors. A former Sears official says Lampert made it clear that he didn't think the concept was a wise use of funds.

Given Lampert's zest for unlocking value, it stands to reason, say investors, that he may look to the real estate holdings. Sears owns 519 of its 872 mall stores. Richard C. Moore, an analyst at McDonald Investments Inc. and an expert on mall properties, thinks Sears' properties could fetch $7.6 billion. Whether or not Lampert moves in that direction, he has already made his mark on America's third-largest retailer.

By Robert Berner in Chicago

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