Saturday, November 19, 2011

Funny money

My contrarian nature makes me suspicious of movements, grass roots and otherwise. The current Occupy Wall Street movement is no exception, my feeling is this; throughout history, the few that are rich have always controlled most of the wealth, our time is no different. As the wise Mr. Bernstein said in Citizen Kane: "It's not a trick to make a lot of money if all you want, is to make a lot of money." Since I haven't devoted my life to the pursuit of personal fortune, I don't have a problem with other people having more money than I do.

On the other hand, there's always been a part of me that believes that people who have more money than they know what to do with, ("stupid money" as a friend calls it), could do a little better sharing it with those who have little or none. I also make a distinction between people who earn a lot of money, justly being compensated for building, creating and doing things that benefit society, (including those who invest responsibly), from those who make a great deal of money in any way they see fit, regardless of the consequences. It's an age old battle, but the following is just one case where the hard work and struggle of generations of Americans, rich and otherwise is being undermined by a few who may be about to bring down a couple of national institutions, along with thousands of livelihoods.

An article in the October issue of Esquire explores the sorry state of retail giants Sears and Kmart. The sub title of the piece;  The End, Old Friendby investment writer Ken Kurson spells it out:

The only value left at Sears and Kmart is the bet against them.

Sears played an integral role in Chicago's history. Richard Sears moved his watch business to Chicago where he met his future partner Alvah C. Roebuck who would help diversify the operation. Together they created the mail order business that would bring a whole new world to Americans, especially rural Americans, via the catalog. Sears was a man with vision but little practical sense. It was his penchant for example, to advertise impossibly attractive deals in his catalog regardless of whether or not he was able to deliver them. He had to rely on his suppliers several times to save his skin. The stress of the business made Roebuck resign in 1895.

Sears needed an infusion of capital to keep the business going and he got it from one of those suppliers who came to his rescue. Julius Rosenwald from the discount clothing trade, as was his nature, seized upon a good opportunity and bought into the company in 1895. As vice president, Rosenwald organized and further diversified the business, turning a successful operation into a national icon. Rosenwald was instrumental in taking Sears Roebuck public in 1906, which resulted in a windfall for both him and the company. He assumed the presidency of the company in 1908 upon Richard Sears' retirement.

Julius Rosenwald was a remarkable man who today is more remembered for his philanthropic work than his formidable business acumen. Feeling personally uncomfortable with the inequity of his immense wealth compared to those who were in his employ, Mr. Rosenwald sought and received ethical direction from the teachings of Judaism. He was deeply moved by these words of a rabbi from a Yom Kippur address:

As long as the weakest in humanity has not his own, civilization is only a sham and a pretender, and as long as civilization is a pretender, Judaism must stand alone as a historic protest against injustice. 

Rosenwald took those words to heart and put his business skill, progressive ideals, much of his personal treasure, and most important of all, his time, to support initiatives that helped disadvantaged people learn the skills that would enable them to help themselves. He became associated with Booker T. Washington and his Tuskegee Institute in Alabama, as well as many efforts to establish schools for African American children in the South. He became a staunch supporter of racial justice and was equally swayed by Washington's ideological adversary, W.E.B. DuBois, who eulogized Rosenwald this way:

He was a great man. But he was no mere philanthropist. He was, rather, the subtle stinging critic of our racial democracy.

Rosenwald disliked perpetual foundations, seeing them as an attempt for their benefactors to achieve a kind of immortality. Instead he believed in giving his money away while he was alive. The foundation that bore his name was established in 1917 and lasted until its funds were purposely exhausted in 1948. In the words of Mr. Rosenwald:

I am opposed to the principle of storing up large sums of money for philanthropic uses centuries hence…. The generation which has contributed to the making of a millionaire should also be the one to profit by his generosity. 

Not only is his foundation a memory, but you won't find Rosenwald's name on the company he helped build, or many of the institutions he founded such as the Museum of Science and Industry in Chicago, simply because he wanted it that way. 

Kmart is another American institution whose company's origins date back almost as far as Sears'. Sebastian S. Kresge developed his business philosophy of hard work, thrift, and a disdain for credit, early in his career. As a clerk in a hardware store in Scranton, PA. he noticed that the store was falling behind on its bills because the customers were falling behind on their credit payments. He was diligent in keeping the place tidy, choosing to clean and polish up the store during his idle moments rather than just stand around. This attitude did not go unnoticed and his employer promoted him to the position of traveling salesman, where he remained for several years. One of his customers was Frank Woolworth of dime store fame. With $8,000 that he saved up while in that position, Kresge with a partner opened up his own five and ten cent store, first in Memphis, then another, later in Detroit. All transactions were cash only. In 1899 Kresge bought out his partner and by 1912, Kresge owned 85 dime stores under his name across the U.S. He took a close personal interest in his stores that extended to knowing all his managers by name, and hanging a picture of his mother in each store.

Kresge was notoriously stingy in providing for himself and his family. Despite being a millionaire many times over, he wore threadbare suits and refused to play golf because he lost too many balls. The penny-pinching did not however extend to his employees who were some of the first in his industry to receive paid sick leave and holidays, profit-sharing bonuses, and pensions. Nor did his parsimoniousness extend to charity. In 1924, Kresge with an initial gift of 1.6 million, established the Kresge Foundation; “to help  human progress through benefactions of whatever name or nature.” Unlike Julius Rosenwald's foundation, the Kresge Foundation is alive and well today. It ranks as the 28th richest charitable organization in the world with an endowment of 3.3 billion dollars. Kresge lived to see much of the work of his charity as he died in 1966 at the ripe old age of 99.

The Kresge Foundation casts a wide net to provide grant money to a wide variety of causes, but one specific area that is near and dear to the heart of the Foundation is the city of Detroit which was the home of the Kresge Corporation and continues to be the home of the Foundation. From its mission statement:

We aspire to change the city of Detroit’s trajectory to one of long-term economic opportunity that advances social equity, promotes cultural expression, and re-establishes our hometown as the center of a vibrant region.

The corporation no longer resides in the Motor City but Kresge's name continues to be prominently displayed in Downtown Detroit at the top of the building that was at one time its corporate headquarters. Built in 1914 the Kales Building was designed by Detroit's preeminent architect Albert Kahn. Like Cass Gilbert's Woolworth Building in New York City, the Kales Building continues to be one of the most prominent buildings in its city's distinguished skyline. To think, both magnificent buildings were built out of nickels and dimes, lots and lots of them.

Times changed and nickels and dimes didn't go as far as they once did. Dime stores eventually became known as "variety stores" and they would hang around urban commercial districts for most of the twentieth century. It was not uncommon for Woolworth and Kresge stores to coexist next to one another in downtowns throughout much of America. By mid-century the Kresge company began to change direction recognizing that the future of retail meant following the customers and their automobiles, to the suburbs. The old fashioned urban Kresge variety stores became suburban Kmart discount centers. Kmart may not have been the first "big box" store but it was the quintessential one that set the tone for what was to follow. It was the paradigm for competitors such as Shopper's World, Community, Zayre, Venture, Walmart and Target. It survived all but the last two.

Here is a blog devoted entirely to Kmart.

Unlike K(resge)mart, Sears transformed itself many times over in the twentieth century. In 1906, the year the company went public, Richard Sears wrote: "We do comparatively very little business in cities, and we assume the cities are not at all our field - maybe they are not - but I think it is our duty to prove they are not ." Shortly after that, retail stores began to open up in small towns all over the country, cutting into the mail order business and the company knew it had to adapt. In 1925, Sears opened up its first retail store located on the campus of its enormous headquarters on the west side of Chicago. Their "brick and mortar" stores quickly became successful, during one period in the twenties, a new Sears store opened somewhere in America on an average of one every other day. New stores kept opening despite the Depression and only the outbreak of World War II could stop the growth, temporarily. Sears pioneered the concept of one stop shopping, you could drive to Sears, get your car serviced, have your eyes checked, purchase insurance, get some investment advice, and put your house on the market, while your family browsed through the store which sold pretty much anything they needed. Sears also was the first company to feature in house brands such as Kenmore appliances, Die Hard car batteries, and Craftsman tools, all of whom were renowned for their quality and reliability.

Sears came the closest of any retailer in the United States to being all things to all people. In small towns they had catalog stores, limited retail establishments where you could order what they couldn't stock. In the suburbs, Sears stores were the anchors of shopping malls, and in urban centers, they coexisted comfortably along with their competitors, the other great department stores. For half of my life, the Sears department store on State Street between Congress and Van Buren was the largest and most comprehensive of all the great stores on that street.

Then there was the catalog which itself was an institution. Quoting myself; at one time all across America the arrival of the Sears catalog was anticipated with as much gusto as birthdays and Christmas. For many years the company's slogan was; "Where America shops." That was not hyperbole, Sears was so strong and powerful in the early seventies, it built as its corporate headquarters what would be at the time, and for many years to come, the world's tallest building. If any other retailer could legitimately claim to be the icon of Middle America, I certainly can't think if it.

Things began to change in the late seventies and that old bugaboo reared its ugly head, Sears and especially Kmart, didn't go along with the times. Kmart during the last part of the last century was pleagued with extremely incompetent management. The company found itself caught in between its two chief rivals. On one side was Walmart with its efficient technologically driven distribution system, and its aggressively low overhead, high discount strategy. On the other side was Target which emphasized design while maintaining low prices. Kmart did not stray from its original template and as a result, could not compete with Walmart's prices, or Target's sense of style. Consequently it became irrelevant. 

Sears also was beginning to show its age as well, its image as the store your parents and grandparents shopped at probably didn't help. The company let its stores become tired looking and run down. Here is a picture of the great Sears store at the Six Corners shopping district of Chicago as it looks today:

Sears department store at Cicero and Irving Park Avenues, Chicago, 2011

The building was built during the Great Depression at a cost of one million dollars. 100,000 people attended its opening in 1938. From the photo above you can just barely detect hints of the building's beautiful Art Deco facade. Compare it the photograph below of the same building from around the time of its opening. Amazingly, they covered up the building's most distinctive feature, its great display window, the largest in Chicago. Long ago they removed the stunning neon sign, replacing it with pedestrian illuminated plastic signs featuring the corporate logo du jour.

Same Sears store, c. 1938

Of course the last forty years have been challenging for all retailers, many of whom have closed up shop entirely. In a way it's a small miracle that Sears and Kmart exist at all today. In 2002, Kmart filed for bankruptcy protection.

Enter hedge fund manager Edward Lampert. Lampert's strategy is to buy up old school, struggling retailers, shake up the management, then use their cash flow to buy up other retailers. In 2003, Lampert bought Kmart along with all its debt. Struggling as it was, Kmart was still taking in $30 billion per year in sales. In addition, Kmart also had plenty of real estate. Lampert closed several stores and sold off the property, further improving his cash flow.

In what seemed to the general public a case of the blind leading the blind, the Kmart Corporation under Lampert, bought Sears Roebuck. From an investors' standpoint, it was a brilliant move as Sears was even more real estate rich than Kmart, and as long as they could keep selling off property, the price of the stock kept going up. Lampert's group promised to revitalize both Sears and Kmart and did make a few token moves attempting to improve sales at Sears and Kmart, but little of the money earned from the sale of assets was reinvested into either store. Sales remained flat while stock in the combined companies gained in value. Given this it shouldn't come as a surprise to anyone that the corporation that controls Sears and Kmart today is known as "Sears Holdings."

All was well with this arrangement, at least as far as stock value went, until the collapse of the real estate market six years ago. According to Ken Kurson's Esquire piece, since then the income of the company has decreased 84 percent. Sears for the first time has dropped to the tenth largest retailer and unlike every other retailer in its class, its profits have dropped consistently in that time. Kmart has dropped to a very distant fourth place among its big box competitors, Walmart, Target and Costco. Yet for the past six years, the price of the stock of Sears Holdings has remained fairly constant, quite an accomplishment for the current climate.

That is until now.

Kurson closes his Esquire piece with this: "The smart money didn't care if the retailers recovered. They liked the real estate."

This is not in any way illegal, it's business as usual in corporate America. But I think a good argument could be made about the lack of ethics in Lampert's actions.  He acquired two companies, pledging in good faith to the employees, the general public and the shareholders to do everything in his power to return them to profitability. It's clear I think to everyone like me who has visited a Sears or Kmart lately to find two businesses that appear to only be going through the motions. 

Then there's the issue of morality. Lampert's chief responsibility in his mind is to his clients, the stockholders, whose interest is the bottom line. As for Sears and Kmart, and the people who work there, well they're expendable in the eyes of the "smart money." Lampert's clients, who probably don't shop at Sears Holdings stores and definitely don't work in them, will just move on to other investment opportunities. Moving on will not be so easy for the folks whose livelihood depends on the stores.

One of the options to investors, as Kurson suggests, would be to short sell Sears Holdings stock, thereby profiting off the company's collapse. 

Eddie Lampert may not be a bad guy. In the end he may like his mentor Warren Buffet, decide to donate all of his billions to charity upon his death. He's still a relatively young man so it's not at all fair to compare his legacy in terms of charity and good works to that of Kresge's or Rosenwald's.

But he does have a substantial track record in business, so I do think it's fair to compare Lampert's business legacy up to this point, with the men who created Kmart and Sears. Richard Sears, Alvah Roebuck, Sebastian Kresge and Julius Rosenwald, at great financial risk to themselves, built companies out of nothing but their own hard work and inspiration. Their companies which have been around for well over 100 years, have provided gainful employment to countless people over that time and both Kresge and Rosenwald at least, expressed deep concern for the well being of their workers. The companies in their own right served as engines that helped drive the U.S. economy for many years, as well as provided a very good return to their investors. 

By buying and selling off the assets of Kmart and Sears, Lampert may very well have sealed the fate of the companies built by Sears, Roebuck, Kresge and Rosenwald. If that happens, he will be responsible for tens of thousands of workers losing their jobs, the loss of two American institutions, and the vacuum in the economy that their loss would entail. On the upside, he made himself and his clients richer.

As far as legacy goes, you can judge for yourself but in my book, it's not much of a contest. 

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