How Hedge funds Profit From Bankruptcy

The Tragedy of Sears

This is the third in the series on how hedge funds loot corporations. The first can be read here, the second here.

As we examine how a hedge fund took over Sears, and the consequences, we will see many of the predatory tactics of the equity/hedge fund playbook in action— as explained in earlier posts—

and a brazen example of how equity/hedge funds make money when their target corporations go bankrupt.

Eddie Lampert, once described by TIME as a wunderkind of Wall Street, reasoned that because of his success at passive investing — and although he had not one hour of retail experience — his hedge fund ESL Investments could take on America’s 128-year-old iconic retailer, Sears, and make it “great again”. — Yes, his actual words.

Lampert got control of Sears in 2003. From 2006 to 2010, Sears’ sales slipped into sharp decline. Notwithstanding this downturn and the 2008 crisis, and while its income was only $3.8 billion in that period, he had Sears spend $5.8 billion in share buybacks.

From then on, Sears had to borrow $2.66 billion from ESL Investments to meet its operational costs.

Lampert planned to move Sears to more of an online shopping model through “Shop Your Way”, a program designed to incentivize customers to move to internet shopping. Sears customers, however, were older and not interested. At the same time, because he thought the brick-and-mortar stores were not so important, he stopped funding store maintenance. Soon the stores were in shambles. Business Insider reported leaking ceilings, cracked floors, rat infestations, stores operating with about half of the needed staff so customers could not even check out and were leaving empty-handed. Sears denied all allegations.

One of many pictures shown by Business Insider of Sears in shambles

By 2013, sales continued to decline so Lampert had himself appointed CEO. By 2016 media reported sales had halved. Sears lost $8.2 billion in 2016 alone.

Back in 2015, when it had become clear that Sears’ days were numbered, Lampert’s hedge fund created a real estate investment trust called Seritage Growth Properties. Lampert owned 43% of Seritage and was Chairman of its Board of Trustees. At this time he also controlled 54% of Sears’s shares.

All these positions made him Sears CEO, lender, vendor, controlling shareholder and now, landlord,

In a classic move out of the corporate raiders’ playbook, Lampert caused Sears to sell 253 of its prime location stores to Seritage. Sears got the cash, but from then on had to pay rent.

Next, according to the playbook, Sears started closing Seritage owned stores. Seritage could then redevelop these prime sites for more profitable ventures. For example, The New York Times reported that in Santa Monica, CA, Seritage converted closed Sears stores into office spaces suitable for the area’s burgeoning high tech sector. On Long Island, NY, it is redeveloping the Sears site into a 600 unit apartment complex. In Aventura, FL, it has begun construction of a luxury shopping center on a former Sears location.

Lampert then put Sears into Chapter 11 bankruptcy to clear the assets  of debts — especially worker severance pay and pensions. Note as Bill Black, professor of economics and law, stresses, in the Sears’ bankruptcy, executives will get generous severance pay while workers get not a cent in severance pay: “Executives of Sears stand to gain up to $1 million in bonuses, should Sears be liquidated, and $500,000 if it’s restructured. Meanwhile, ordinary workers at Sears are being laid off without severance payments''. 

Sears also underfunded workers’ pensions. 

Defenders of the right of hedge funds to scuttle worker pension funds like to point out that’s why the federal Pension Benefit Guaranty Corp. (PBGC) exists. It will keep the pension cheques flowing for the 90,000 workers affected. No problem.

But, a very big problem: The Sears’ pension plan is $1.5 billion underfunded. The PGCB is continually raising premiums to cover these increasing defaults. That means responsible corporations, which have adequately funded their pensions, will be paying more to subsidize Lampert’s gambit.

All of Lampert’s planning got approved by the Bankruptcy Court over creditor objections that this was an audacious engineered bankruptcy. But what could the judge do? Lampert’s proposal was the only one that promised to save 45,000 jobs.

A Modern American Tragedy

During the longest period of economic expansion in recent history since 2009 under Obama-Trump. Lampert managed to destroy Americas’ once largest retailer. After Lampert’s takeover, Sears shuttered more than 3,000 stores and slashed its workforce from 350,000 to roughly 68,000 and put the public pension insurance schemes under strain.

How has Lampert fared? Retail tech analyst Pula Rosenblum writing in Forbes believes, “This exercise in job destruction has made Lampert even richer.” The New York Times reported in 2018 more sources of profit, “Mr. Lampert’s stake in this business [Seritage] is now worth approximately $1.1 billion.” He has pocketed another $1.4 billion from his investment in the retailer, Institutional Investor recently  calculated. Most of those profits came from performance fees ESL investors paid to Lampert for his ability to extract wealth from Sears and Kmart despite those companies losing money.

3000 Sears employees lost their jobs, but the CEO kept his yacht

Business Insider adds: “Lampert’s ]home, located in the wealthy Indian Creek community off Miami’s coast, is a sprawling estate worth $38 million. Lampert also owns a $26 million property in Connecticut, a $14.5 million home in Colorado, and a 288-foot yacht called Fountainhead.”

Lampert failed to improve the company’s performance, failed to meet its obligations to creditors, screwed its workers, and still made a huge profit for his hedge fund members and himself. Is that how capitalism is supposed to work?

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