Michael Santoli

20 Years of Sears: Forlorn Stores, Happy Investors. Thank Spinoffs

File photo of a Sears store in Schaumburg, Illinois near Chicago
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A Sears store is seen in Schaumburg, Illinois near Chicago, in this September 23, 2013, file photo. Sears Holdings Corp SHLD.O is considering splitting off its Lands' End clothing and Sears Auto Center businesses, after another quarter of declining same-store sales. REUTERS/Jim Young/Files (UNITED STATES - Tags: BUSINESS LOGO)

Imagine, for a moment, an investor who bought stock in Sears, Roebuck & Co. in the middle of 1993 the last year the company produced its signature Big Book catalog and then forgot about it until now.

At that moment a bit more than two decades ago, Sears had just recently lost its status as largest U.S. retailer to Wal-Mart Stores Inc. (WMT), but was still a dominant mall anchor and one-stop Main Street department store. The company had also built a “financial supermarket” of insurance, lending and investment businesses. The stock by then had been in the Dow Jones Industrial Average for seven decades. It was close to the definition of a conservative, blue-chip stock.

As every shopper and all investors know well, the subsequent two decades have been a steady, steep decline for Sears, which, along with Kmart, forms the present-day Sears Holdings Inc. (SHLD). The core retail operations have been marginalized by Home Depot Inc. (HD), Target Corp. (TGT) and other, younger big-box chains, resulting in years of declining sales and bottom-line losses under the current chairman and controlling shareholder Edward Lampert.

It is, in many respects, the country’s most-hated retailer, reduced to hiving off its best real estate holdings and perhaps separating out crown jewels such as Lands' End and its auto-service centers.

Outperforming the market

And yet, counter-intuitively, it turns out the buy-it-and-forget-it investor from 1993 has done just fine. In fact, Sears Holdings, combined with the collection of spun-off financial companies and other divisions the company distributed to shareholders, has handily outperformed the broad market over the past 20-plus years, measured from just before the former Dean Witter Discover & Co. was spun off to investors June 30, 1993.

According to an analysis performed upon request by Frank Bifulco, private investor and portfolio manager at www.PortfolioChannel.com, 100 shares of the old Sears acquired on June 1, 1993, has by now become the following “portfolio” after subsequent mergers and distributions: 50 shares of Sears Holdings; 156 shares of Morgan Stanley (MS) (which acquired Dean Witter); 21 shares of Sears Canada Inc. (SEARF); 184 shares of Allstate Corp. (ALL) and 78 shares of Discover Financial Services (DFS).

Toting up their combined value, this group of stocks – which investors received automatically – has delivered an annualized return since June ’93 of 10.3% with dividends reinvested, compared to just under 9% per year for the Standard & Poor’s 500 index.

This surprising record points up the impressive tendency of corporate spinoffs to boost shareholder value over time – an anomaly of markets that has remained remarkably consistent over the years.

While, on the surface, breaking off one division and handing it to investors as a separate entity would seem a purely cosmetic exercise, in reality it allows the market to properly value sometimes-obscured value, gives the management team focus and incentives to grow efficiently, and results in an initially “orphaned” stock that is usually then discovered by analysts and professional investors months later. Some of the best-performing stocks of the past couple of years were spinoffs, including TripAdvisor Inc. (TRIP), Madison Square Garden Co. (MSG) and Philips 66 (PSX).

This is the reason so many activist investors press the CEOs and boards of diversified companies to use the spinoff as a tool to raise the value of the sum of their parts. Dan Loeb tried to prod Sony Corp. (SNE) to set free its entertainment division. Barington Capital is asking Darden Restaurants Inc. (DRI) to separate Olive Garden and Red Lobster from its faster-growing chains. Microsoft Corp. (MSFT), where ValueAct Capital sought a board seat, parted ways with longtime CEO Steve Ballmer and is widely seen as a good candidate for a breakup.

The spinoff strategy

The $9 billion asset manager Horizon Kinetics, an early advocate of buying spun-off companies, has run an actively managed spinoff strategy for institutional investors since 1997, and over that span it has produced double the total return of the broad market, outperforming the S&P easily over virtually every time span within that period. Because a spinoff is the only sort of stock an investor owns without having decided to buy, index funds and other institutions often are automatic sellers of the new shares, depressing their value only to have it spring higher as new investors pour in.

There is an exchange-traded fund that tracks the sector, too, the $340 million Guggenheim Spin-Off ETF (CSD), and it’s having a fine year, up 44% versus 21% for the S&P 500. Yet it has some structural shortcomings, waiting a full six months after a spin to buy the new stock (it holds 40 individual stocks at one time), leaving some potential upside on the table.

The above Sears analysis also has relevance for Sears Holdings today, given that its legions of critics like to carp that it is merely shuffling assets around, parting out the good stuff while allowing its 2,000-store network to wither. It’s true that Lampert has vastly underinvested in the stores and ceded tremendous market share. But in separating out the valuable from the “broken” parts of the company, he is doing a commendable – if still risky - salvage operation.

There is no guarantee that Sears will be able to sell and redevelop its real estate, carve away its strong divisions, and exploit its strong appliance-and-tool brands in time to offset a precipitous decline in the physical retail business. A New York Times column last weekend struck a typically skeptical tone in this regard.

And, for sure, the Sears of 20 years ago had the rare advantage of having used its former dominance to amass some truly lucrative financial assets it managed to spin off into a huge credit-and-investing boom.

But the way the stock jumped 9% a week ago upon revealing it was considering options for Lands' End and the auto business along with weak same-store sales suggests the market understands there is good value now trapped within the company. And Lampert, a billionaire former hedge fund manager who owns 55% of Sears stock, is surely determined to liberate it.

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