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The Liquid Side Of Sears

Sears store seen against a cloudy sky
photo by Mike Kalasnik

The cliche “the bigger they are, the harder the fall” seems destined to come true for one more giant as Sears Holdings Corp. faces down its lenders.

In late 2017, S&P Global Ratings downgraded Sears’ debt due to concerns over its ability to pay or refinance $1 billion of loans due in 2018. Those concerns turned out to be well-founded. The company prepared to file for bankruptcy as $134 million of that sum came due Oct. 15. The question then became whether bankruptcy would mark the end of Sears’ glory days – or the end of Sears.

The Wall Street Journal reported on Oct. 11 that some of Sears’ biggest lenders, including Bank of America Corp. and Wells Fargo & Co., were pushing for the company to liquidate rather than continue operation in some stripped-down form. Edward Lampert, Sears’ chief executive and largest shareholder, was instead promoting a plan that would restructure the company but keep the chain in business, closing hundreds of individual stores in an attempt to shrink the retailer back to profitability. Sears’ retail footprint is already down to about 700 stores from nearly 4,000 in 2008.

Early on Oct. 15, Sears filed for bankruptcy protection under Chapter 11, which will allow the retailer to keep some of its stores open – at least for now. Sears announced that Lampert would step down as CEO, but remain chairman. Sears will also shutter nearly 200 of its remaining stores by the end of the year.

Even though Sears managed to negotiate a bankruptcy plan that allowed it to continue as a functioning business, I suspect an eventual conversion to liquidation is inevitable. It is hard to see how a scaled-down chain that lacks buying power, internal distribution efficiencies and a strong internet presence could succeed where a once-giant national chain failed. Sears has not earned a profit since 2010, and Lampert has repeatedly bailed the company out with short-term loans. His hedge fund may provide a $300 million junior bankruptcy loan, pumping even more cash into the restructured business. A post-bankruptcy Sears would have one advantage – greatly scaled back debt – so its chances of success would not be zero. But they would be small.

To illustrate Sears’ diminished fortunes, consider: On reports of a potential Chapter 11 filing, rather than a Chapter 7 liquidation, company stock soared 18.09 percent – to a whopping 40 cents a share. The bankruptcy filing showed that Sears had between $1 billion and $10 billion in assets and more than $10 billion in liabilities.

Around the same time, three vendors told Reuters that Sears had failed to make scheduled payments, a problem that could disrupt its supply chain ahead of the holiday season. Other vendors have demanded that Sears pay upfront, worsening its already dire financial situation. Even in the absence of liquidation, the inability to stock shelves in time for the holidays may have already eliminated any hope of Sears using the fourth quarter to kick-start its fortunes. A disastrous holiday season proved to be the end of Toys R Us following its Chapter 11 filing last year.

Sarah Halzack observed in an opinion column for Bloomberg that the biggest problem with the idea of restructuring is that it “would only truly mark the beginning of a healing process if Sears’s underlying business had untapped potential.” Even weighed down by less debt, it is doubtful that Sears is up to the challenge of competing with the retail juggernauts of today. Its lenders must know that as well as anyone.

It is sad to see a 125-year-old institution wind down, and it is worth considering whether such a result was inevitable. Imagine if, decades ago, Sears had pushed itself as a buy-anything-anywhere sort of business, using the rise of toll-free phone lines and overnight delivery as its principal selling points rather than building such a vast store network and scaling back its catalog business. In this scenario, Sears could have avoided picking up the fixed costs of all those stores, instead taking on the variable costs of a mail-order house. Sears could have moved into online shopping as it first took off – and it would have had a far bigger product line to offer than Amazon could have matched in its early days. Sears might have maintained its position as the Amazon before Amazon, and the online shopping revolution could have been a boon rather than a fatal stumbling block.

Fixed costs are the double-edged sword of business. Amazon certainly understands this. When your costs are fixed and your sales are growing, your margins improve and you become exponentially more profitable. But when your costs are fixed and your sales shrink, the reverse happens. It becomes imperative in that situation for managers to get ahead of the curve by cutting costs to maintain margins and cash flow. Managers in some industries, like airlines and auto manufacturing, have learned to do this (often from painful experience). But many retailers failed to make the adjustment quickly enough. Sears and Toys R Us are destined to be the business school case studies on that.

If this ignominious end can happen to Sears, it can happen to anybody. No business can afford to remain complacent or to be too stuck in the past in the face of a changing world. Businesses, like living things, need to adapt and grow – or else they wither and, eventually, die off.

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