Kmart to Buy Sears in Record Retailing Deal

By Leslie Earnest and James F. Peltz

Nov. 18, 2004 12 AM PT

Times Staff Writers

The owner of the Kmart chain, which came out of bankruptcy protection just 18 months ago, is buying Sears, Roebuck & Co. in an $11.5-billion deal that would create the nation’s third-largest retail operation.

Under terms of the deal announced Wednesday, the combined company would be headed by Kmart Chairman Edward Lampert, a 42-year-old billionaire who also is Sears’ largest single shareholder. The boards of both companies have given the marriage their blessing.

It was a surprising move for Kmart Holding Corp., a discounter that for years limped along in the shadow of Wal-Mart Stores Inc. and Target Corp. and now could have sufficient girth to be a more competitive player.

“This truly is an historic day,” Lampert said, adding that he expected “lumpy progress over time” in blending discount stores known for their “blue light specials” with Sears, which was founded in 1886 as a mail-order catalog house.

Among the changes: Several hundred Kmart stores around the United States would be given the Sears name, and shoppers might be able to buy Kenmore appliances and Craftsman tools at Kmart and pick up Martha Stewart sheets and Jaclyn Smith shirts at Sears.

Although Kmart would be the buyer, the new company would be called Sears Holdings Corp. and Sears Chief Executive Alan J. Lacy would be the CEO. But it was Kmart’s maneuver that received attention Wednesday.

“It’s amazing,” said Frederick Schmitt, vice president of Sage Group, a Los Angeles investment bank. “This company was upside down a year ago. Now they’re going to be in control of the third-largest retailer in the U.S.”

Investors saw the upside: Kmart stock hit a 52-week high of $119.69 before closing at $109, up 8%, on Nasdaq. Sears’ stock jumped 17% to $52.99 on the New York Stock Exchange.

“I think it’s a dream deal made in heaven,” said Kurt Barnard, president of Barnard’s Retail Trend Report, which predicts consumer spending patterns. “If I were talking to Wal-Mart today I would say, ‘You better pay attention.’ ”

With $58 billion in annual revenue, Sears Holdings would have vast purchasing power to stock more than 3,500 stores.

But it would be dwarfed by Wal-Mart, a $257-billion behemoth and the world’s largest company. And there was ample skepticism among retail experts that a wedding would cure all that ails Kmart and Sears, which have struggled to gain and hold their footing in a competitive environment.

The acquisition, which must be approved by antitrust authorities and the shareholders of both companies, would be the largest such deal on record, according to research firm FactSet Mergerstat in Santa Monica. By comparison, the union of R.H. Macy & Co. and Federated Department Stores Inc. a decade ago created the nation’s biggest department store company, with what at that time were 335 stores and annual revenue of about $13 billion.

The two companies said they expected to gain as much as $500 million annually within three years because of factors including improved sales of products with higher profit margins, possible store closures and job cuts, mostly of administrative positions.

Analysts said shoppers might see generally lower price tags because the new company could cut deals with vendors. And vendors themselves might benefit.

“I think it is fantastic for the industry,” said Isaac Larian, chief executive of Van Nuys-based MGA Entertainment Inc., which makes the popular Bratz line of dolls, electronics and home furnishings. Kmart and Sears may not be similar, he said, but they are complementary, each bringing different locations and customers to the mix.

“Both retailers were injured,” Larian said. “Before I didn’t think Kmart was going to make it.” Now, he said, “you put the two of them together and they will be very strong. I think we are going to grow our business.”

An alliance of Kmart and Sears would no doubt intensify competition among some of the largest retailers. Wal-Mart, Target and Kohl’s Corp. all could feel the effects. Appliance sellers, including Home Depot Inc. and Lowe’s Cos., also may feel the pinch if Sears appliances begin showing up in retail centers, away from the shopping malls, that have become magnets for suburbanites.

About 52% of shoppers who frequent malls also patronize discounters such as Kmart and Wal-Mart, which means that moving Kmart products into Sears stores could expose its popular brands such as Joe Boxer, a teen apparel line, and Route 66, a top-selling jeans brand, to the remaining 48%.

“You’re not going to beat Wal-Mart at Wal-Mart’s game,” said Marshal Cohen, chief industry analyst for market research firm NPD Group. But Kmart “found a way to change the playing field.”

As for Sears, its growth has been mostly stagnant for years; it had about 870 stores in 1970, about the same number as today.

The chain has been reinventing itself in recent years, CEO Lacy said, adding new brands, selling its credit card business and planning for growth. It has been slowly unfurling its Sears Grand stores, which are situated outside malls and, in addition to typical Sears goods, sell groceries and cleanings supplies. The fourth Sears Grand opened in Rancho Cucamonga this month.

For Lampert, Kmart’s purchase of Sears would be a coup. And the stakes he owns in both companies, as well as his pivotal role in moving to combine them in a friendly deal, probably preclude a hostile bidder from joining the fray with an offer for either Sears or Kmart, analysts said.

“He’s going to go with his own deal, unless someone offered an incredibly obscene amount of money,” said Ivan Feinseth, research director at Matrix USA, an investment firm in New York. The terms being offered to both companies’ shareholders are fair and “cost prohibitive” to another suitor thinking of pursuing either chain, he said.

The deal shouldn’t run into antitrust problems, because Kmart and Sears operate in a fiercely competitive business, said Jonathan Ziegler, a principal at PUPS Investment Management in Santa Barbara.

Other analysts said the deal was unlikely to spark other big mergers among retailers.

“This is an unusual deal with unique synergies and a unique catalyst, Eddie Lampert,” analyst Daniel Barry of Merrill Lynch & Co. said in a note to clients.

Lampert made his fortune heading the privately held hedge fund ESL Investments Inc. -- the initials are his -- of Greenwich, Conn. Its wealthy clients have included Dell Inc. founder Michael Dell and media mogul David Geffen.

With an estimated net worth of $2 billion, Lampert is listed as one of the youngest members of Forbes magazine’s list of the 400 richest Americans.

Lampert, known as a risk taker who has often provided investment clients with double-digit annual growth, initially snapped up several hundred million dollars of Kmart’s battered bonds after the retailer filed for bankruptcy protection in early 2002. Frustrated that his bonds weren’t performing better as Kmart moved through its Chapter 11 reorganization, Lampert maneuvered to take control.

His effort was interrupted by a bizarre turn in early 2003 when he was kidnapped at gunpoint by four men as he left his office. They demanded millions of dollars in ransom but released him after two days, reportedly after Lampert promised them a payment, and were later arrested.

Lampert promptly went back to Kmart, converted most of his debt to Kmart stock and brought the retailer out of Chapter 11 in May 2003. He and ESL now own 53% of Kmart’s stock, which, after the deal with Sears was announced, soared in value by $419 million to $5.9 billion. Lampert and ESL own 31 million shares, or 14.6%, of Sears that were worth $1.6 billion at the close of trading Wednesday.

The deal calls for Kmart shareholders to receive one share of stock in the new Sears Holdings for each of their Kmart shares. Current Sears investors could elect to receive $50 in cash or a one-half share of Sears Holdings. Based on Wednesday’s closing price for Kmart’s stock, that half-share of Sears Holdings was worth $54.50. However, the companies said payments to current Sears shareholders would be prorated to ensure that 55% of their total is in Sears Holdings stock and 45% in cash.

The new company would be based in Hoffman Estates, Ill., where Sears has its headquarters.

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Retail combo

Kmart and Sears, Roebuck are combining in an $11-billion deal that will create the nation’s third-largest retailer

Kmart

Founded: 1962

Headquarters: Troy, Mich.

Employees: 144,000

Stores: 1,511 in 49 states, Puerto Rico, Virgin Islands

2004 revenue: $17.1 billion

2004 net income: $248 million

Sears