Institutional Investor's Alpha Magazine - February 2008 - (Page 12)

UPDATE Edward Lampert hings have gone from bad to worse for Edward Lampert, chairman of Greenwich, Connecticut–based hedge fund ESL Investments. Since October, when Alpha questioned whether the ailing stock of Sears Holdings Corp. was a sign that the billionaire hedge fund manager had lost his touch, its shares have fallen further, by nearly 30 percent, to about $102 in early February. (ESL holds a 48 percent stake in Sears.) But this is actually up from about $86 on January 15, the day after Lampert issued a profit warning and then swung into action. He broke the company into five business units with the goal of streamlining management and allowing greater autonomy and accountability for the unit leaders, who no longer report to the hedge fund manager. A few days later Lampert fired Aylwin Lewis, the president and chief executive officer, replacing him on an interim basis with W. Bruce Johnson, an executive vice president. All this raises questions about whether Lampert, 45, will ever dig himself out of the Sears hole. Things got so drastic that the fund manager, who rarely speaks to the press or the investment community, gave an interview to the Wall Street Journal, in which he stated, T “What we’re trying to do is not for the faint of heart.” Lampert, whose fund was down 27 percent last year largely because of losses at Sears, which accounts for about t wo thirds of ESL’s $13.6 billion in equity assets, defended his record, noting that instead of Sears stock being up 20-fold since he took Kmart out of bankruptcy in May 2003 (and later used it to buy Sears), shares are up ten times. But many investors who bought the stock looking for a turnaround at Sears and Kmart stores, as well as an asset play on the retailer’s real estate, are now losing their conviction. “You can make an argument that there is a lot of value, but unless Eddie does something with it, it is all theoretical,” says one hedge fund manager who has bought and sold Sears shares many times and is currently out of the stock. “Sears is a trapped-value play with deteriorating operations.” Indeed, even Lampert — who discounts the use of same-store sales as an important measure of performance — has publicly conceded that the company is failing to meet his goal of 10 percent operating margins as measured by earnings before interest, taxes, depreciation and amortization. “The operating improvements were short-lived, and the environ- Edward Lampert’s Sears Holdings has faltered. ment for monetizing the assets has gotten worse,” says Deutsche Bank Securities analyst William Dreher Jr., who currently has a sell recommendation on the stock. “The values for the real estate are not as strong as they were a year or two ago.” Some investors cling to the underlying values. Dreher estimates that Sears is worth $152 per share after taxes. He figures the company’s real estate alone is worth $102 per share after taxes; the furniture, ﬁ xtures and equipment add $5 per share in value; and Sears’ proprietary brands — Kenmore, Craftsman, Diehard and Lands’ End — are worth an additional $45. However, given the soft real estate market, Dreher says it may be hard for Lampert to realize Sears’ maximum value anytime soon. “The asset story is not as good now,” concedes a longtime ESL investor, who says critics don’t give Lampert enough credit for buying Kmart “for a song” and then using its shares to buy Sears, which had better assets. “Turning around the culture takes a long time,” says the investor. “He may have taken the portfolio concentration to the nth degree. But he is still young and has all of his money in the fund.” — S.T. Winthrop Shaw Pittman, have recently established units devoted to subprime-related hedge fund lawsuits. “For hedge funds in general, there is a received notion that they’re deep-pocketed, and a lot of law ﬁrms are now getting involved,” he says. “The idea of misrepresentation could come across in the various investment strategies hedge fund managers do.” Kaye advises hedge funds to customize their coverage. He believes, for example, that a fund with signiﬁcant emerging-markets exposure or unusually aggressive trading should have a specialized policy. “Every hedge fund has its own comfort level,” he says. Jay Gould, head of Pillsbury’s subprime unit, reports “more activity, more interest, more negotiations” in potential hedge-fund-related litigation, though he says lawsuits so far have been “not so much threatened as implied.” 12 • INSTITUTIONAL INVESTOR’S ALPHA • FEBRUARY 2008 Kaye says he has seen hedge fund interest in insurance grow steadily since about 2003, as traditionally conservative investment managers have begun to branch out and diversify into hedge funds and other alternative forms of investing: “With more regulatory scrutiny and more institutional investors and pensions invested in hedge funds, they have a much stronger threshold to need to know what is going on.” The well-publicized collapses of certain hedge funds — like Amaranth Advisors, which lost more than $6 billion almost overnight in September 2006 because of bad bets on natural-gas futures — have also helped spur interest in broader coverage. Kaye says that fund managers and general partners should consider beeﬁ ng up their personal coverage as well. Divorce insurance, for example, might not be a bad idea. — Christopher O’Leary MARK H. MILSTEIN/ZUMA PRESS

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2008

Institutional Investor's Alpha Magazine - February 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Alternative Perspective The Good Guys: A Simple Plan Cover Story: Energy and Commodities: Fueling Opportunity Regulation: Energy Trading: The Brawl on the Hill Interview: Master of Values Regulation: Hedge Fund Registration: Way Out West Research Center: Top Hedge Fund Analysts Alpha Bytes: Rocket Man Unhedged: Commentary: Structured for Success

Institutional Investor's Alpha Magazine - February 2008

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