ValuePlays – Page 776 – A value investing site launched in Jan 2007

Sears Holdings (SHLD), Time To Enter The Insurance Biz?

Yesterday I opined about a few retail aquisitions Mr. Lampert could consider and what he should avoid. Let go a completely different route today.

Much has been said about SHLD becoming another Berkshire Hathaway. In Berkshire’s early years, Buffett made several very diverse aquisitions. For SHLD to follow in this path, might it be time to jump outside of the retail space? Perhaps follow into Warren’s footsteps and enter the insurance business? This does have the immediate benefit of officially qualifying SHLD as a holding company and not just a pure retailer. This will change how it is veiwed and shift the focus from the current miopic hysteria over its same store sales and onto its profits and investable cash (like Berkshire) were it should be. So, if we decide to go into the insurance biz, where to look?

I enected a couple of parameters here for looking at companies. I am looking for:

Can it be bought with cash? I do not want to use debt to purchase something
Does it have relatively high insider ownership
Billions in investments
Must have low debt
Trade reletively cheap to insurance peers

I came up with a few:

Zenith National Insurance (ZNT) Does business pricipally in California insuring the workers compensation market. Insiders own approx. 13% of the business. Earnings growth has been very strong ($67 million in 2003, $112 million in 2004, $157 million 2005, and $174 million through the first 3 quarters of 2006). Total debt now stands at $59 million, a pittance. Here is the kicker, it has an investment portfolio Eddy would now control of $2.7 billion and a market cap of only $1.7 billion. Currently it trades at a pe of only 7 times ttm earnings and 7 times next years, well below its peers. Return on equity stands a 31%.
Aspen Insurance Holdings (AHL) Headquatered in Bermuda, Aspen is another attractive candidate. Insider own 9% of the business. The investment portfolio here is the story, it currently stands at $4.4 billion vs. a market cap of only $2.4 billion. It trades at only 8 times ttm earnings and only 6 times next years projected. Total debt is higher than Zenith at $250 million but low for the industry and it recently began to accelerate its stock buy back program.
Mercury General Corp (MCY) Insiders own 34% of this one. The investment portfolio here is another story. It stands at roughy $4.2 billion dollars and management has earned about 4% on it for the past several years. Can you imagine what Eddy could do to this ones earnings with his ability to invest? It has a market cap of $2.8 billion. Currently trades at 13 times ttm earnings and about 11 times next years projected, still a bit below inudstry average. Total debt stands at about $145 million.

All three would make excellent additions. They can be had for below market prices and come with billions in investments for Eddy to play with. Even better, they can be had without SHLD taking on any additional debt or shareholder dilution.

An aquisition of another retailer would have SHLD valued on the potential merits of its retail operations. Should Lampert instead gobble up an insurer, I beleive SHLD’s valuation would explode to the upside as Berkshire Hathaway comparisons would have more merit and people who missed the Berkshire boat many years ago would not make the same mistake twice. This would cause a rush to buy a stock with a small public float creating massive upward pressure. Add to this the large short position in SHLD and you could have a move to the upside that could bust many of the shorts.

Either way, this will be very interesting…..

OK, so we expect SHLD to have about $3.5 billion in its piggy bank at the end of the quarter. time to go shopping? I think so. If we are, what makes sense?

Invest More In Current Locations: NO!! the current program is working just fine. Lets not forget when Eddy bought Kmart it was fresh out of bankruptcy with bleak prospects and Sears was heading there when he bought it. Now the combined entity is throwing off almost a billion a year in profits. What is the problem? As an investor, the number of sweaters they sell does me no good, the money they make from those sweaters does. Eddy talks of the same store sale fallacy retail metric here: http://www.searsholdings.com/invest/ . Read it carefully to get an idea of the direction he is taking both Sears and Kmart. He has no vision of either of them growing into a colossus. What he wants is for them to become as profitable as possible to provide him $$ to grow Sears Holdings. It is a subtle but very important difference. If you have been to a Sears that has the Land’s End “store in a store” concept, it is a great change.
Buy Home Depot: NO!! HD was a great value play 2 years ago. Not anymore. Add to this the current hostility towards the board of shareholders (they would almost certainly reject any recommended offer from the board, forcing a hostile bid) and you have the making of a very long, expensive process, nothing Eddy wants
Buy BJ’S: Dare to dream? This would wonderful. At its current valuation Eddy could write a check for it. It would add almost a dollar a share to next years earnings (adding another 10% growth) without making any assumptions on the financial benefits of synergies. The synergies there are exciting. We would be able to sell more Craftsmen and Kenmore items in BJ’s. Think also of the Sears / Kmart apparel line that could also be sold through BJ’s. Picture a Land’s End closeout section in BJ’s. BJ’s also sells home heating oil in the northeast. The purchase of this would go nicely with Sears service agreements on home heating and cooling systems. Once in the door, sell windows, siding etc. Same with BJ’s auto service locations, picture all the extra Die Hard batteries we could sell . The increase in assets due to BJ’S real estate holding would be a plus for us in a leveraged play later on if he wished. Another oft overlooked plus: we could instead of selling the under performing Kmart and Sears locations, convert them to BJ’s and in one fell swoop preserve the asset base and increase profits. The conversion from a Kmart or Sears to BJ’s would be dirt cheap. Just gut it and stock it… they are warehouses for crying out loud!! Eddy are you listening? I have a real hard time finding any negatives to this scenario.
Buy Radio Shack: Until last night I though this was just a desperate idea being floated out there, then we scooped John Warren from Best Buy. The knock on The Shack has always been a disconnect between it and its customers. I had not seen anyone at SHLD capable of effectively fixing that (since its own electronics dept. is no world beater). Mr. Warren is arguably the best out there today in the electronics world at??? Consumer Relations … HMMMMMM. That does get the wheels turning. Why would would you raid the #1 electronics retailer for their #1 consumer guy? It must have cost a pretty penny. I am sure that you want to improve your own operations but electronics is only a portion or our business, can he really make that much of a difference? Unless maybe you are planning on buying an electronics retailer with a troubled history defining itself. If you look at the Shack currently Julian Day is turning the books around there. Cash is growing ($225 million to $450 million, profits look to go from 30 cents a share to almost 90 cents next year, but same store sales are falling (does any of this sound familiar?) Did I mention Mr. Day is a former SHLD exec? It would appear that maybe you at SHLD are preparing to make a purchase in this area and want your ducks in a row first. This purchase would vault us to the #2 electronics retailer over night. Might Mr. Warren’s desire be to the then make us #1 over his old friends at Best Buy? This is yet another purchase Eddy could do with a check and would have friends in management there to make it happen. It would add 30 to 40 cents a share to next years earnings again assuming no financial benefits to the obvious synergies. This one is starting to excite me now..