What’s he building in there?
What the hell is he building in there?
He has subscriptions to those magazines...
He never waves when he goes by.
He’s hiding something from the rest of us.
He’s all to himself.
I think I know why.

Tom Waits, “What’s He Building?”

Introduction

For nearly a decade, investors have speculated as to the end game of Eddie Lampert’s investment in Sears Holdings (SHLD). Will the real estate value prove to be as high as some models suggest? Can the retail operation generate enough cash during runoff to pay down the pension shortfall and other liabilities? How will Lampert retain and grow the value of the proprietary Sears brands – especially the Kenmore, Craftsman and Die Hard (KCD) hard lines – once they are no longer sold at Sears big box locations?

The recent spinoff of Sears Hometown and Outlet Stores (SHOS) appears to provide the answer. Through a carefully orchestrated series of restructurings, amounting to no less than corporate mitosis and meiosis, Lampert has created a vehicle in SHOS to preserve the brand equity of Sears as the destination of choice for consumer appliances and hardware. Consciously modeled after two of the best retail store models of recent times – off-price retailers like Ross and TJ Maxx, as well as franchised restaurants like McDonald’s – Sears Hometown and Outlets has been built as a capital-light, fast-growth business. Earnings will convert at a high rate into free cash flow, and Lampert – who is known for his influence on the repurchase plans at AutoZone, AutoNation, and the Gap – will control that free cash flow stream. Even better, thanks to skepticism surrounding Sears Holdings, and a complex spinoff, the business is available today at a discount to comps with much less growth potential than SHOS. Looking at appropriate comps, the stock should double from here as investors awaken to Lampert’s plan in the coming year or two.