This is Why Hedge Fund Managers Shouldn't Meddle With Retailers
James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Considering they collectively manage billions of dollars' worth of OPM (other people's money), you'd think hedge fund managers - even the top performing ones - would at the very least learn from one another's mistakes. It doesn't look like it's happening though, which could be a little troubling for folks with money being run by Pershing Square Management LP.
It's not a bad group of funds. Founder and CEO Bill Ackman has steered the flagship fund to an average return of about 24% per year between 2004 and 2010, though last year all three funds finished up with near-breakeven performances. Still, making money is a marathon - not a sprint. One year shouldn't wave red flags. On the other hand....
There's a not so fine line between having faith and being stubborn. Ackman's adherence to his optimism on J.C. Penney (NYSE: JCP) may have just reached the 'stubborn' stage.
Pershing owns just a tad under 18% of the struggling retailer - a position Ackman has been adding to since the initial purchase in October of 2010. The stake is worth about $1.39 billion.
So what? All too often, hedge fund managers want to tweak and manage the business back into its glory days. It's not a sin, and it's certainly their prerogative as a majority shareholder. That doesn't mean it's the right thing to do though. And so far, Pershing's involved ownership hasn't helped J.C. Penney...
...not that the retailer wasn't struggling to begin with -- last (fiscal) year's per-share income of $1.25 was down from $1.59 a year earlier. Most retailers were able to make some semblance of progress during that time. The reason it hurts a little more in this case is that Ackman billed his changes (and his insertion of a new CEO) as the magic bullet designed to do quite the opposite of what actually happened in 2011. Indeed, the deterioration has accelerated, so much so that Standard & Poor's cut J.C. Penney's rating to BB-. The stock made a historic plunge on the bad news.
If all of this retail/hedge fund chatter seems vaguely familiar, it may be because the manager of ESL Investments - a $6.5 billion fund - is taking a similar hands-on approach with the fund's 60% stake in the $6.0 billion retailer (about $3.6 billion) Sears Holdings (NASDAQ: SHLD).
To be fair, the comparison to Ackman's goal with Penney's and Eddie Lampert's goal with Sears isn't exactly an apples-to-apples comparison. On the flipside, it's not an apples-to-oranges scenario either.
Eddie Lampert initially wanted ESL Investments' Sears position to facilitate the purchase of, and then liquidation (for a nice profit) of several Kmart Stores' real estate. The strategy has worked well too, but it doesn't change the fact that Eddie Lampert still owns the bulk of Sears, and as chairman, still wants to revitalize it. That's where the Ackman and Lampert stories merge again - both hedge fund managers have taken active roles in both stores' day-to-day operation in the effort to get each back on track.
For J.C. Penney, part of those changes have included overhauling the pricing and promotional efforts. Some of the specific ideas have included keeping stores closed at normally-weak sales hours, and ramping up the 'store within a store' feel.
For Lampert, Sears' revamps have been less obvious, but it is pretty clear there's a strong digital aspect to the vision. Lampert has worked diligently to build Sears as an online-shopping brand, and has added an in-store experience allowing consumers to use tablets to enhance the shopping experience. It hasn't helped one iota; Sears' same-store sales have fallen every year since 2005, when Lampert took over.
The failing revitalization efforts aren't even the coup d'etat of bad decisions, however. That honor belongs to the person each of these hedge fund managers chose to execute the turnaround stories for each of their respective retailers. Last February, Lampert chose former IBM executive and Avaya CEO Lou D'Ambrosio to steer the ship at Sears. Ackman ended up asking former Apple VP Ron Johnson to take over J.C. Penney in January.
It's not that either choice is a guaranteed train wreck for his respective company. But, D'Ambrosio has no retail experience to speak of. Johnson's 16 years with Target and experience heading Apple's retail stores may have some value, though he's been out of the department store loop since 2000. And, performance concerns are already mounting.
The choices and lackluster results they've achieved may underscore the bigger problem with managing department stores that Lampert and Ackman just weren't counting on. And what's that? From the outside looking in, retailing looks easy. From the inside though, retailing is a @!%$#.
From some perspectives, it seems as if both Lampert and Ackman have adopted an "If you build it, they will come" mentality. But, that's not all a retailer needs to do to draw a crowd. It's far more complex than that. For example, merchandise is bought up to a year in advance. Some merchandise is deliberately sold at or below cost for a reason. Stores are kept open even at unproductive times in order to train customers and/or get other work done. And, as cliche as it seems, customer service does eventually matter. Both hedge fund managers are running their retailing organizations as if they were technology companies, up to and including turning the keys over to former technology executives. It's not a great fit.
As for what it all means to current shareholders of either company, seven years of declining sales for Sears speaks volumes. Considering it's on the same path, J.C. Penney isn't likely to escape the same fate, though Johnson has a small shot at getting the company back in shape... if he can just keep Ackman out of the way. Indeed, it's going to take a veteran retailer's special care (and a lot of time) for either outfit to become investment-worthy again. D'Ambrosio isn't that guy, and Johnson is still a question mark, at best.
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