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Last gasp for Sears

October 17, 2011: 9:54 AM ET

The struggling corporate mash-up that Eddie Lampert built is finding short-term fixes that may end up hurting it, leaving one big question still unanswered: What is the endgame for Sears?

By Kit R. Roane, contributor

SearsFORTUNE -- In what seems an admission that the Sears shopping experience continues to have about as much appeal as getting a root canal, Sears Holding Corporation has moved to expand partnerships over the last few months that allow competitors to sell its most storied brands. Craftsman tools and DieHard batteries have already escaped the big-box retail behemoth, and it's probably only a matter of time before Kenmore makes a break for freedom as well.

The move is an ingenious elixir for near-term earnings, providing incremental cash flow to the struggling corporate mash-up that Eddie Lampert built, and is a delightful added discomfort to Sears' high-interest-paying shorts, who have watched the company's float vanish thanks to Lampert's aggressive stock buybacks. But critics worry that it could, in the end, just be digging the once omnipresent retailer a deeper grave.

"It will have a short-term benefit, but long-term it will be a disaster," predicts Howard Davidowitz, Chairman of Davidowitz & Associates, Inc., a national retail consulting and investment banking firm. "Sears is in total collapse -- earnings, sales, everything is tanking -- so they embark on this strategy with their brands that fundamentally goes against what every retailer in the United States is doing, what every retailer is trying to accomplish, which is to differentiate themselves from their competitors."

Macy's (M) keeps expanding exclusive sales arrangements with brands like Tommy Hilfiger, and J.C. Penney (JCP) recently went from an exclusive license of Liz Claiborne to an outright purchase of Liz Claiborne brands. Davidowitz says these are the types of deals that allow retailers to survive in a time with moribund consumers, rising bankruptcies and over-capacity in the retail industry, which still provides a whopping 43.6 square feet of retail selling space per capita in the country.

Sears obviously sees the move differently, talking up the ability to extend brand reach by moving its products outside of Sears' stores. Some shoppers have been able to buy Craftsman tools at Ace Hardware since last year, a deal that has now expanded from about ten hardware stores to almost 1,000.

But over the last month, Sears has also inked deals with Costco (COST) to sell the Craftsman brand and is allowing Meijer Inc., a Michigan-based retailer, to offer its well-known DieHard car batteries. In June, Sears reached an agreement with Dorcy International to sell DieHard-branded alkaline and rechargeable batteries.

Last week, new reports suggested that Sears is planning to hire an agent who can license Craftsman, DieHard, and the Kenmore appliance brands to a host of other retailers. According to Bloomberg, any agreement would differ from some previous deals by being a pure licensing play; in some incarnations, Sears (SHLD) has sold its own products within competitors' stores, collecting a percentage of the profit from sales.

"[T]o grow the value of our proprietary brands, we evaluate all avenues including extending the brands into new markets and categories," says Larry Costello, a Sears Holdings spokesman, in a prepared statement. "As part of that evaluation, we consider a variety of partnership structures and consider both agency based and direct licensing relationships. The DieHard announcements with Dorcy and Meijer are both examples of direct licensing relationships."

Sears proper already has a curious relationship with its most profitable brands. In 2006, Sears Holdings securitized Kenmore, Crasftsman and DieHard, putting them into a separate special-purpose entity called KCD IP, which acts as a bankruptcy remote subsidiary. Sears pays a royalty fee to KCD, which uses the money to pay the interest on about $1 billion in bonds  stuffed into a Sears insurance subsidiary. Theoretically, the move could protect these profitable brands from certain Sears' bondholders. It also helps KCD gain better ratings and cheaper financing.

It's unclear how the move to license the brands outside Sears fits within the strategy for KCD, which has been a busy trademarker of late. Even Professor David Stowell, an expert in financial engineering at Northwestern University's Kellogg School of Management, admits that, more generally, he's "not sure what the endgame is."

"I do think Lampert is trying to utilize his assets in the most efficient way, which is what people who run companies are supposed to do," says Stowell, who has studied Sears structure under Lampert. He adds that the hedge fund guru has done better for shareholders than many will admit. "If you can maintain cash flow in the context of declining revenues, that is a pretty good outcome. I give him credit for generating a lot more shareholder value than would have been created in the absence of the Lampert ownership period."

Original investors in Lampert's reorganized Kmart have done well enough, at least if they didn't keep buying stock (as Lampert has), through the merger with Sears, Roebuck and Co. in 2005 and the other various inspired initiatives and management shakeups that followed.

In an attempt to boost its financials, Sears has been attempting to shed unproductive stores, enliven its internet presence and lease out bits of the 133,000 square feet that encompass its average location to other retailers, such as Forever 21, Edwin Watts Golf Shops and Work 'N Gear, as well as grocery and health club chains.

But revenues were down to $43.3 billion last year, from $50.7 in 2008. In August, the company reported that Kmart's comparable store sales were flat in the second quarter, while Sears stores in the U.S. saw a decline of 1.2%. Net loss for shareholders for the quarter equaled $1.37 per diluted share, compared with a 35-cent per diluted share loss in 2010. Cash flow from operations was barely positive for 2010 and was negative $467 million for the 26 weeks ending July, 30, 2011.  The consensus estimate is for Sears Holdings to show a loss of $2.29 per share when it reports in mid-November.

In June, Fitch downgraded Sears Holdings debt to "B" from "B+," due to the continuing deterioration of earnings, particularly the "precipitous decline during the first quarter of 2011." The problem illuminated by Fitch is that domestic Sears and Kmart stores have continued to underperform other retailers on top line growth and operating margins have also lagged. The rating agency says its greatest concern is "the magnitude of decline in profitability and the lack of visibility to turn around operations."

Professor Steve Hoch, who teaches marketing at University of Pennsylvania's Wharton School, notes that Sears' latest licensing move will help bolster its income by pulling in some additional, albeit lower-margin sales. It will also possibly help a little with store recognition due to the "implicit endorsement by the other retailers," but he sees Sears' ultimate benefit from the licensing deals as being rather small.

There's no sense in trying to divine a grand plan from the move, according to Davidowitz . "Sears is saying we got all this crap, we've got a new president and we need to buy some time to come up with something online, and this will be something we can do so people won't question if we should even be in business," he opines. "It's about survival."

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