Circle of Competence Issue #43

Quote of the week: "Not all those who wander are lost." - J.R.R. Tolkien

FOOD FOR THOUGHT

Eddie Lampert

Back in Issue #34 I discussed the slow, painful demise of Sears and Eddie Lampert's fight to save (or suck the life out of?) Sears. I also shared an excellent 2011 short thesis from John Hempton of Bronte Capital

that discussed the incredibly haughty assumption of Lampert that he could actually pull off the feat of liquidating an operating business with many tens of thousands of employees and keep the profits from the tangible property for his fund.

The more I study business and finance, the more I realize that investing and running businesses are akin to an intricate dance. They have rhythms, cadences, actions, and reactions. They are not theoretical complexes that can easily be modeled on paper. Rather, they are living, breathing organisms that grow, plateau, decline, and ultimately die.

And so it has been with Sears.

When Lampert came into the picture in 2005 with the KMart merger, there was little doubt that, as Hempton writes above, Sears was an awful retailer. But the property values looked so darn juicy for the price paid. And now with Sears in bankruptcy proceedings, Lampert is working hard to save his equity position in the property with a last ditch effort to restructure the debt and keep the value of the Sears property from falling into other creditors' hands. By one account, Lampert may have even made a tidy profit while presiding over the desecration of Sears:

"As a result of such dealings — which include five major asset sales and 15 financings — ESL hasn’t lost the entire $1.5 billion it invested in Sears and Kmart equity. Including the gains and losses on the major spin-offs, dividends, and interest income, it appears that loss was narrowed to about $624 million. Adding back the $2 billion in gains from hedge fund fees would give Lampert a net profit of approximately $1.38 billion. And that’s not even counting the uncertain value of his $2.6 billion in Sears debt, with its liens on Sears real estate, among other items."

Where did Lampert misstep? In my opinion, Hempton hit it square on the nose - Lampert made his move (buy Sears on the cheap and extract the property values) without calculating the repercussions from counterparties, competitors, or stakeholders (creditors, employees, etc.). But this isn't how the game is played in reality. Investing is hard. Business is hard. One man can do but so much when faced with billions in debt, tens of thousand of employees (many with their pensions in danger), and a swiftly declining business. Which leads me to my next topic: strategic thinking.

Chess and investing

I love playing Chess. I started playing this year for the first time seriously and haven't looked back since. The thrill of beating an opponent through sheer mental warfare, the rage that happens when you realized you've made a fatal blunder, the strategy that you can learn from thinking critically. I can't say enough positive things about how playing a game like chess - or backgammon, or poker, or bridge, or blackjack - can develop your sense of strategy, mental acuity, and competitive edge.

There are countless lessons that are available through learning a game like chess, but the main mental model that I have gained from continuing to study the game is that of anticipation. Anticipating your opponent's (or your business or the industry competitors, etc.) next move is crucial to your current state of play. It is important to think about your move in context with the range of possible countermoves. You are always on the lookout for a possible threat as well as a potential blunder by your opponent whereby you can gain the upper hand. Admittedly, Chess is not a perfect analogy to the business world where, for example, a rogue competitor (Amazon to Sears) can simply wipe you off the map, or economic forces outside of your control (2008-09 GFC) can wash over your business with tidal wave force. However, the idea of anticipation is critical because it always keeps you on your toes as to the best way forward and forces you to think about protecting your pieces (business) from possible threats. To use Buffett's famous phrase, it really forces you to examine what kind of 'moat' you have vs. your opponent and understand the competitive landscape.

And here is where I believe Lampert went wrong. The more I study the situation, the more it looks like a forced liquidation from the start. However, he didn't anticipate the visceral reactions of his competitors (Amazon), his tens of thousands of employees, and his customers (to the lack of capex at stores, etc.). Only time will tell how the game will end, but the lesson I want to learn from studying the debacle is that of anticipation. We can't know the future, but we can do our best to prepare for it.

Dell-DVMT deal gets approval

I have written multiple times about Michael Dell's bid for DVMT and Carl Icahn's ensuing activism with the company here and here. Last week it was announced that Dell and DVMT shareholders had reached an agreement. Seems as though Icahn's and other activists' agitation may have won a small bump in the per share value of the deal for minority shareholders. Per Pitchbook:

"After months of negotiations, Dell Technologies has received shareholder approval for a return to the public markets without conducting an IPO, with the company's Class C shares set to start trading on the NYSE on December 28. The move will come as part of a complicated transaction that involves Dell buying back tracking stock related to its VMware software affiliate for $120 per share, or about $23.9 billion. That's up from an initial offer of $21.7 billion, with pressure from activist investors including Carl Icahn ultimately driving the price up. Silver Lake acquired Dell in a take-private deal worth nearly $25 billion in 2013. Then, in 2016, the pair completed a mammoth $67 billion add-on of EMC, adding a bevy of software tools to Dell's offerings as well as billions in debt to the company's balance sheet. But Silver Lake doesn't seem to be in any hurry to unload its shares. In October, the firm transferred a roughly $1 billion stake in the business from its third flagship fund to a new vehicle, ensuring it could hold on to the investment longer, per Bloomberg."

Have a Merry Christmas and Happy New Year!

- Benton

ARTICLES

- Taking the long road with volatility - Real Vision interview with Artemis Capital's Chris Cole

- Brian McCullough - "How The Internet Happened" - Talks at Google

- Investing ideas that changed my life (Morgan Housel)

- Stan Druckenmiller & Kevin Warsh - quantitative tightening is not the right policy move

- What you can learn from one of Warren Buffett's long term investors (Jason Zweig, WSJ)

- Are Sears employees' pensions in danger? (New Yorker)

- SpaceX is raising money at a $30B valuation to ramp up its satellite internet service (WSJ)

- How long can the housing boom last? (Robert Shiller, New York Times)

- Farnam Street's 2018 annual letter (Shane Parrish, fs.blog)