Kmart and Sears: An $11 Billion Goliath


By Robert Berner In the biggest retail combination in history, Kmart Holding (KMRT) and Sears, Roebuck (S) agreed to merge on Nov. 17, combining two of the retail world's largest, if faded, icons. The move brings to light the grand plans of investor Edward S. Lampert, whose ESL Investment had gained control of Kmart in a bankruptcy reorganization in May, 2003, and bought the largest stake in Sears, leaving many guessing as to his intentions.

Lampert's investment style has been likened to the early days of Warren Buffett and Berkshire Hathaway (BRKA). And his every move seems to cause big swings in the stock prices of the affected outfits (see BW, 11/22/04, "The Next Warren Buffett?").

IRONIC TWIST. Under the terms of the Kmart-Sears deal, valued at $11 billion, the two retailers will merge into a new company, Sears Holdings Corp. The combination will reinforce Sears' position in a retail landscape that's hyper-competitve and has too many stores, even though consumers have kept a directionless economy afloat most of the last three years.

The new company will become the nation's third-largest retailer, displacing Target (TGT), which moves to No. 4. Largest is Wal-Mart Stores (WMT), followed by Home Depot (HD). The merged entity will continue to operate both Kmart and Sears stores, but executives note that it's likely some Kmarts will be converted to Sears, accelerating the latter's strategy to move off the mall.

Lampert, who became Kmart's chairman when it exited Chapter 11 bankruptcy protection, will now become chairman of the Sears Holdings. Sears CEO Alan Lacy will become chief executive of the new concern. In an ironic twist, Sears had looked at the idea of combining with Kmart about four years ago, but the idea was "rejected outright by Lacy," according to a former Sears executive.

RIVALS' PUNCHING BAGS. The combined outfit is expected to have $55 billion in annual revenues. It will have 2,350 full-line and off-mall stores, in addition to 1,100 specialty stores. Kmart shareholders will receive new Sears Holdings shares for each Kmart one. Sears investors, meanwhile, can choose $50 in cash or half a share of Sears Holdings stock.

In early trading on Nov. 17, stock of both Kmart and Sears soared. Troy (Mich.)-based Kmart's shares rose 17% in late-morning trading, to about $119.03, continuing a roll that has seen them gain over 600% in the last 18 months. Sears shares surged 21%, to $54.90 a share. To see stocks of both outfits rise after a merger announcement is unusual and reflects investors' view that the deal is beneficial to both retailers.

Indeed, both retailers have been virtual punching bags for the competition. Kmart has lost market share to Wal-Mart for two decades and to Target more recently. Sears' share in apparel has been eroded by the likes of Kohls (KSS), Target, and J.C. Penney & Co (JCP), and Home Depot and Lowe's (LOW) has been making inroads into its important appliance business. But the deal positions both Kmart and Sears better against those rivals.

PLENTY OF CASH. In a conference call today, Lampert and Lacy said they would explore selling some of Sears successful brands within Kmart, such as Kenmore appliances, Diehard batteries and Lands' End clothing. In instances where demographics include more high-income shoppers, the executives noted, Kmarts would be converted into Sears stores.

Sears has struggled with declining sales at its 870 mall-based department stores as shoppers go to more convenient big-box rivals like Home Depot, Best Buy (BBY), and Kohls. In response, it has started a big-box store of its own called Sears Grand, of which it now operates four. Earlier this year, Sears bought 50 Kmart stores to accelerate its move off the mall. Now, having the option to convert more Kmarts will accelerate that plan.

Lampert will be the big winner in the end. The financier has wanted to create an investment vehicle like his hero Warren Buffett did with Berkshire Hathaway. With the combined cash the newly formed outfit could ultimately throw off, he will have more money to invest elsewhrere. Berner is a correspondent in BusinessWeek's Chicago bureau


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