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Federated Is Better Off On Its Own


Speculation has been rife in recent weeks that Federated Department Stores Inc. (FD) is in discussions to acquire weakened rival May Department Stores Co. (MAY). Neither company, respectively No. 1 and No. 2 in the department store world, will confirm that they're talking. But should the deal go through, it would create a retailing colossus with nearly 1,000 stores across the nation and $30 billion in sales.

The question is: Would such a combination help Federated regain market share lost to specialty retailers? While buying May likely would boost Federated's earnings in the short run, it could derail the company's strategy of heading upmarket. What's more, Federated could wind up sinking money into May that it could better use itself. "The end result," predicts Daniel Hess, CEO of researcher Merchant Forecast LLC, "will be further market share erosion for the combined Federated and May."

It's not as though buying May makes no sense at all. The department-store sector has been losing share for a decade. In theory, by acquiring May, Federated would gain heft, giving it more clout with suppliers, advertisers, and landlords.

But a May acquisition could potentially undo the gains Federated has made over the past few years. Since taking the helm in 2003, CEO Terry Lundgren has moved Federated aggressively upmarket. By offering more unique and higher-priced merchandise at its Macy's and Bloomingdale's Inc. divisions, Federated managed to boost same-store sales 3.3% over the last 12 months. That's a whole lot better than the story at May, where same-store sales fell 1.6% in the same period. But it's nowhere close to recouping Federated's same-store sales decline over the previous three years.

UNFORTUNATE OVERLAP

Analysts believe Federated would take May upmarket, too -- likely converting its Kaufmann's, Filene's, Lord & Taylor, Marshall Field's, and Robinsons-May stores into Macy's. That's easier said than done. May has long catered to the mid-market. More than half of its stores are in the middle of the country, where not enough people can afford Macy's $100 to $200 designer denim to make an upmarket strategy fly. By contrast, most of Federated's stores are on the generally more affluent East and West Coasts.

Making matters worse, most of May's and Federated's overlapping stores are on the coasts. As a result, UBS Securities (UBS) estimates that Federated could be forced to jettison nearly 100 of May's most productive stores. That would further crimp Federated's ability to take May upmarket. In addition, it could leave a potential opening for upscale retailer Nordstrom Inc. (JWN) to move into those malls, giving Federated's best Macy's and Bloomingdale's stores stiffer competition.

Finally, while Federated could get the usual savings by cutting duplicate operations, it would be tough to wring out further efficiencies. That's because May already runs leaner than Federated, with sales and administrative expenses that run 29% of sales, vs. 31%. If anything, analysts believe May has cut expenses too much -- particularly by slashing staff. As a result, says UBS analyst Linda Kristiansen, "Federated would likely have to invest more into May at the store level."

For all of these reasons, Federated might be better off flying solo -- continuing to steal business from May while honing an upscale strategy to fend off specialty stores. Sometimes walking away from a deal is the smartest move.

By Robert Berner in Chicago


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