Thursday, October 25, 2007

Berkshire Hathaway vs Sears Holdings: The Early Years

The comparisons have been rampant about Warren Buffett's Berkshire Hathaway (BRK.A) and Eddie Lampert's Sears Holdings (SHLD). Let's look and rather than comparing the 42 year old Berkshire with the 2 year old Sears in both their current states, let's look at Berkshire's beginnings and take an apples to apples approach when making the comparison.

First things first. This is not a "who is better" look between Buffett and Lampert but a look at the beginning of both businesses and the investment by both owners. Most people do not know about Berkshire's beginnings and if we are going to make the comparison, we need to look back at Warren early experiences so that we can look at Lampert's and draw honest conclusions. One cannot look at the finished product of Berkshire and then look at Sears Holdings, still in its infancy and draw any meaningful comparison. Doing that is a bit like one neighbor with a kid in kindergarten contrasting their child to the neighbors child, a 27 year old doctor and making an effort to discern their own child's future from that. Can't be done.

Given the recent stock slide of Sears Holdings from $190 to $130, many people have jumped ship on Lampert and given up on Sears and their Chairman. Gone now are the Buffett comparisons and the doubters have surfaced. However, if one looks at the history of Berkshire one also sees dramatic price drops. In 1973-74 the stock dropped from $90 to $40 a share. After the '87 stock crash it fell from $4,000 to $3,000. In 1990-91 it fell from $8,900 to $5,500 and from mid-1998 to 2000 the stock slid from $80,000 to $40,800. A drop in the share price of the has very little to do with the ability of either Buffett or Lampert to do what they so best. As a matter of fact at the turn of the century, Buffett was deluged with doubters who said he was "out of touch" and did not understand the "new paradigm" of business. I think we all know how that turned out.

If we look closer at the beginnings, Berkshire was bought by Warren is 1965 for about $16 a share and, according to Buffett "had no net cash". In fact, according to Buffett in the previous 10 years, the business had earned "less than nothing". After two years of ownership (the same time period Lampert has owned Sears) shares fetched between $17 and $21 in 1967, virtually flat. Sears, shares conversely have gone from $50 when the deal was announced to the $130 they sit at today. At the end of the 4th year Buffett owned Berkshire it traded between $32 and $39 a share.

In 1965 and 1966 Berkshire was profitable but in 1967 saw a dramatic downturn in earnings and at that point Buffett used Berkshire cash and acquired National Indemnity Insurance in the spring of 1967. It was an attempt by him to level out the cyclical earnings of the textile industry and Buffett thought the insurance float would provide a buffer for the erratic textile operations. Soon after that was See's Candy, Wesco, Illinois National Bank ans Sun Newspapers.

When Lampert acquired Sears it had lost almost $5 billion the previous 4 years and since he took over it has earned about $3.7 billion in just two and a half years and more importantly produces near $2 billion a year in cash for Lampert to invest in the business (that number will clearly be down this year due to the retail environment).

Lampert doubters will point to this years profit decline as their proof what he is doing at Sears is not working. However, if one looks at Berkshire in the last decade, one will see earnings large declines in 1999, 2001 and 2004 due to a challenging insurance environment. With retailers like Target (TGT), Home Depot (HD), Lowes (LOW), Macy's (M) and JC Penney (JCP)all lowering expectations recently, 2007 has
shaped up to be a similar environment for retailers. An earnings decline is not proof what he is not doing is not working nor is the Berkshire declines in those years meant to absolve any issues at Sears but it is meant to illustrate that not all earning go up in perpetuity and a bad year does not mean disaster. What Berkshire fans always point to is the cash available for Buffett to use for investment in years that earnings suffer. Lampert devotees point to the same metric and how it is being used. Sears is so young compared to Berkshire that Lampert followers currently are focused on his use of that cash within Sears (repurchases, debt reduction, IT investment) and how those actions will maximize its production later on.

Like Buffett in his early Berkshire years Lampert is using weakness to buy more shares. Buffett began buying Berkshire shares in 1962 and took control in 1965. He kept buying in 1965 until he had 70% of Berkshire shares and did not become chairman until 1970. Lampert first bough Sears in 2004 and 2005 and has kept buying and estimates are that he control almost 60% of Sears shares after the current buyback is done. Sound familiar?

The business:
Buffett was very judicious in his use of Berkshire's cash in the early years just as Lampert has been with Sears. Unlike Berkshire, Sears is in a business that will continue to earn Lampert money and produce large amount of cash and will not eventually be forced to close like Berkshire was in 1985 (the textile mill). That being said Lampert, also unlike Buffett is sitting on a fortune in real estate in Sears Holdings and also billions of dollars in licensing fees from the valuable Craftsman and Kenmore should he opt to monetize them. Just because he has not, doesn't mean he won't, that is where the "value" lies.

Track Record:
Both Buffett and Lampert ran private investment operations before the big acquisition. Both had track records that trounced the markets as a whole and made themselves and investor very wealthy. Both were long term value investors who kept their thoughts close to the vest and invested with a time frame unlike their peers. Both experienced difficulties in the early years of their ownership of the business and used that difficulty to increase their ownership in that business.

In short, Sears is a better "business" than Berkshire was in 1965, what remains to be seen is what Lampert's next move will be with that business. I do not think anyone has ever got very rich betting against either Buffett or Lampert.

Why start trying now?


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