Kmart Holding Corp. and Sears, Roebuck and Co., once the nation’s two largest retailers, have agreed to merge in a surprise deal valued at $11 billion.
The combined company, Sears Holdings Corp. will have roughly $55 billion in annual revenues, 2,350 full-line and off-mall stores, and 1,100 specialty retail stores. Yet even after the merger — the deal is expected to close by the end of March — Sears Holdings Corp. will be only the nation’s third-largest retailer by revenue, trailing both Wal-Mart Stores and The Home Depot Inc.
Yesterday, Kmart’s stock rose more than 7 percent on the news while Sears soared more than 17 percent.
However, Standard & Poor’s said it will probably cut its credit ratings on Sears to “junk” after it is acquired by Kmart, which is unrated after emerging from bankruptcy in May 2003. “Despite the company’s much greater size, and synergies that are estimated by management of about $500 million per year after the third year, both companies lag their peers in terms of store productivity and profitability,” said S&P, in a statement.
Kmart’s same-store sales decreased 12.8 percent for the third quarter, according to the company’s earnings release on Wednesday; Sears’ year-to-date same-store sales are down 2.1 percent.
In recent months, Sears has been selling a number of its stores. Retail analysts and investors believe that a major motivation for the merger is to unlock the considerable value of both companies’ huge real estate holdings, either in shopping malls or as stand-alone stores.
“There’s been a lot of speculation about real estate strategy and real estate values, and I think there is some truth to the notion that there are certain retailers whose real estate is worth more than its operating business,” said Edward S. Lampert — Kmart’s chairman and the chairman-to-be of Sears Holdings — according to TheStreet.com. “While that may have been true at Kmart at one time, we’ve worked very, very hard to improve the profitability of each of our stores and to make those stores worth a lot more as an operating business than as real estate.”
In a statement, Kmart and Sears said that conservatively, the combination will generate an estimated $500 million of annualized cost and revenue synergies. In addition, said the companies, they will enjoy another $200 million in incremental gross margin from revenue synergies through cross-selling Kmart and Sears proprietary brands and by converting off-mall Kmart stores to Sears-branded stores. However, the combined company will still have to deal with the same issues that have made Kmart and Sears retail also-rans in recent years — Wal-Mart and Target Corp. are growing much faster and are much more profitable because they offer lower prices and are better defined as retailers.
Observers foresee little regulatory opposition to the deal. “I don’t think this will be a big antitrust problem,” said Mike Cowie, formerly senior litigation counsel at the Federal Trade Commission and now a partner with law firm Howrey Simon Arnold & White. Cowie noted that retailers with a direct overlap in formats typically receive greater scrutiny, citing as examples supermarket chains in general and the blocked Staples-Office Depot merger in particular. “This seems to be more complementary,” he added.
Tom Burnett, who tracks acquisitions as president of New York-based Merger Insight, agreed. “We expect the FTC to take a full review of this [deal],” said Burnett, but “we don’t see any reason why they will try to block it.”
Lampert’s latest deal may come as little surprise to CFO.com readers. As we noted last month, Lampert — who is also the chairman and chief executive officer of Greenwich, Connecticut-based hedge fund ESL Partners — has not only controlled Kmart since it emerged from bankruptcy, but has also been a major shareholder of Sears.
Lampert will be joined in an Office of the Chairman by Alan J. Lacy, now the chairman and chief executive officer of Sears, who will be vice chairman and chief executive officer of Sears Holdings; and Aylwin B. Lewis, currently president and chief executive officer of Kmart, who will be president of Sears Holdings and chief executive officer of Kmart and Sears Retail.
Glenn R. Richter, currently executive vice president and chief financial officer of Sears, will be executive vice president and chief financial officer of Sears Holdings. William C. Crowley, now the senior vice president of finance for Kmart and a Kmart board member, will be executive vice president, finance and integration, of Sears Holdings.