In a bold move that shakes up one of Chicago's most enduring business icons, Kmart Holding Corp. pounced on Sears, Roebuck and Co. Wednesday in a merger valued at $11 billion.
The new company, which will be called Sears Holdings Corp., will become the nation's third-largest retailer. It will continue to occupy Sears headquarters in suburban Hoffman Estates.
But it will be controlled by Kmart's chairman, Edward J. Lampert, a 42-year-old Connecticut investor who made his name buying Kmart out of bankruptcy last year and raising almost $1 billion by selling many of its stores to other retailers, including Sears.
Lampert and Sears Chairman Alan Lacy said Wednesday that the idea behind the merger is to build up a new company, not tear down an old one. But they also are betting that a new management team can forge a single, lower-cost competitor out of two perennial laggards, which likely will mean selling off some stores and cutting redundant operations.
"This is going to be an enormous undertaking," said Lampert, who owns 52.6 percent of Kmart and 15 percent of Sears. "We'll need the best of the Kmart team and the best of the Sears team."
The new Sears will marry the originator of the "blue light special" with a retailer that has been an essential part of the Chicago business fabric since it was founded as a scrappy catalog company in 1886. Both have been in decline for decades. Industry giants such as Wal-Mart Stores Inc. and Home Depot Inc. passed them years ago.
But the new company will have greater scale--about $55 billion in sales and almost 3,500 stores. Among other advantages, that should help it negotiate lower prices from suppliers.
Lampert and Lacy plan to push Kenmore appliances, Craftsman tools and DieHard batteries into Kmart's discount outlets at the same time they spruce up Sears' department stores with Kmart's popular Martha Stewart line of linens, kitchenware and garden tools.
Lampert said he has identified ways to wring almost $500 million in savings by combining such things as distribution and purchasing. He pointed out that the company buys $40 billion worth of goods a year, leaving plenty of room to drive down costs by working with suppliers to be more efficient.
Neither Lampert nor Lacy gave an estimate of how many jobs might be lost in this process. But they made it clear that one idea behind the merger is to cut costs and eliminate duplicative operations.
Lampert likened the effort to the merger craze among financial institutions in the 1990s, when many banks enhanced their services while squeezing costs out of their back-office operations. Thousands lost their jobs during that consolidation.
Watching Sears get gobbled up by a once-bankrupt competitor gave many Chicagoans a chill Wednesday.
"It's so much a part of Chicago," said June Rosner, owner of a public relations firm that bears her name. "It would be like losing Lake Michigan."
But economic development officials breathed a sigh of relief that the company will remain based in Hoffman Estates.
"The No. 1 issue is where the headquarters is," said Paul O'Connor, executive director of World Business Chicago. "That's the ultimate pelt in the economic development business."
Investors in Sears and Kmart stock were less sentimental.
"Christmas came early this year," said Chicago investor Jeffrey Maillet, whose Noble Asset Management LLC owns stock in both companies. Sears finished 17 percent higher, at $52.99 a share, while Kmart, which is up 355 percent this year, added another $7.78, to finish at $109.
The deal will pay Sears shareholders $50 in cash or half a share in the new company for every share they own.
Sears stock, which languished 43 percent below its one-year high as recently as late October, has been on the move since Nov. 5. That's when a real estate investment company, Vornado Realty Trust, revealed it had purchased 4.3 percent of Sears, giving the Big Store's stock a 23 percent boost in one day.
Vornado's move, coupled with Lampert's 15 percent stake, highlighted a fundamental shift in the way the market values retailers. With a shortage of new retail space available, prime store properties occupied by sluggish retailers like Sears or Kmart sometimes can be worth more if they are sold to such growing rivals as Target Corp. or Nordstrom Inc.
Lampert has raised more than $1 billion selling off assets at Kmart, sending its stock price soaring. When Vornado bought into Sears, it raised the question of whether the retailer's vast real estate portfolio might be worth more than the market value of its stock. The expectation on Wall Street was that Vornado, Lampert or both eventually would buy Sears and unlock this hidden real estate value.
At the very least, it put heavy pressure on Sears Chairman Alan Lacy to justify the company's weak profits and outmoded merchandising strategies. Sears sales have fallen every year since Lacy took the helm in 2000.
On Wednesday, Lampert tried to play down the real estate angle. But he did say that after decades of wasteful spending on stores and other operations, Sears needs to look at all its assets and determine whether they provide an adequate return on the amount of capital invested.
As this analysis proceeds, Sears may close some stores and sell them to retailers that could use the property more efficiently. The company might plow the cash back into refurbishing other stores or building new ones, Lampert said.
"This does give us an opportunity to go back and look at our [real estate] portfolio differently," said Lacy.
Sears' biggest problem, Lampert said, is not its retail strategy but the location of many of its stores. Based in malls, where they compete with flashier department stores and specialty outlets, they don't draw as much traffic as they might if they stood alone in areas buzzing with value shoppers looking for things like hardware and appliances.
As Home Depot and other retailers open stores and beef up their appliance and tool offerings, Lacy has been trying to add stores "off the mall" since 2002. But that is a slow, expensive process, and Sears can hardly afford to wait.
To add outlets more quickly, Lacy began talking to Lampert last spring about buying some of Kmart's free-standing stores. Then this summer, Sears bought 50 of them for $576 million. Lampert said his rationale for selling the stores was that Kmart was making about $1 million a year per store, while Sears, with its superior mix of popular hard-goods brands, could make $2 million to $4 million at the same location.
The trouble was, if you sell off the store and sales rise, "You don't get to participate in the upside," Lampert said. By merging the two companies, he figured, both of them could benefit.
Lampert and Lacy insist the merger was in the works before Vornado showed up and put Sears in play. But a source close to Sears' board said its members first heard about the idea after the stock shot upward on the Vornado news. In considering the merger, it was important to the Sears board that Lampert's reputation as an asset seller at Kmart didn't mean the same would happen at Sears.
"This is about building," the source said.
As far as most retail analysts are concerned, however, the merger better be about execution. If Lampert can't turn around the two sluggish retailers, the value of the new company's stock will quickly recede.
Although Sears does well in appliances and other hard goods, it has been dragged down for years by anemic apparel sales. It has tried to improve the situation with the acquisition of preppy Lands' End, but the brand has proved too upscale for many Sears customers.
Lampert has tried to improve the look and feel of Kmart stores, but that, too, is a struggle. The chain has a reputation for being dirty, crowded and disorganized.
For all of these reasons, many Wall Street analysts approached the merger with caution.
"Neither management team brings a significant track record of operating success to the transaction," Merrill Lynch analyst Danielle Fox told her clients Wednesday.
In a report titled "Money to be made, but from retail?" Goldman Sachs recommended that clients cash out of Sears stock while the getting is good.
Lampert, however, remained confident. Sounding much like the executives at Google Inc. when they said this year that they would never bend to the short-term pressures of Wall Street, Sears' prospective owner said the new company would take its time, try new strategies and not be afraid to make some mistakes.
Under Lampert, Kmart became the only major retailer not to report monthly sales, and he signaled he would do the same at Sears.
"Given the large ownership position of the board," he said, "we will be able to manage strategically and for the long term without having to worry about ... how to make monthly sales targets and without giving out quarterly earnings guidance and trying to manage the business to that guidance."
One convert is Everett Buckhardt, who retired in the 1990s after 10 years as a senior Sears executive. He's convinced that by cutting redundant costs in buying and distribution while making more hay with the Kenmore and Craftsman brands off the mall, the merger "is going to save both companies."
Lampert, who has made billions of dollars seeing value where others don't, put it this way: "The undeniability of the strength of the merger was readily apparent to me. It might take a while to soak in for some people."
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A bigger Big Store
Kmart Holding Co. Sears, Roebuck and Co.
Stores More than 1,500 Full line: 871 Specialty: 1,105
Employees 158,000 in 49 states 249,000 worldwide
Through 3Q $801 million -$867 million (Includes $839
million accounting change charge)
Through 3Q $13.79 billion $24.61 billion
Major brands Martha Stewart Kenmore, Craftsman,
Everyday, Thalia DieHard, Covington,
Sodi, Jaclyn Smith, Apostrophe, Lands' End
Joe Boxer, Kathy
Ireland, Route 66,
New title: Chairman of Sears Holdings
Has held current position since May 2003, helping lead Kmart out
- Chairman and CEO of ESL Investments
Kmart president, CEO
New title: President of Sears Holdings and CEO of Kmart and Sears Retail
- Joined Kmart last month from Yum Brands Inc., the world's largest
Sears chairman, CEO
New title: Vice chairman and CEO of Sears Holdings
- Has held current position at Sears since December 2000
Where the new company ranks among major U.S. retailers
COMPANY 2003 REVENUE (Billions) EMPLOYEES
Wal-Mart $258.68 billion 1.5 million
Home Depot $64.82 300,000
Sears/Kmart $64.52 407,000
Kroger 53.79 300,000
Target 48.16 280,000
Major Chicago-area mergers
DATE PURCHASING COMPANY ACQUIRED COMPANY PRICE
May 11, 1998 SBC Communications Ameritech $62 billion
Aug. 11, 1998 British Petroleum Amoco $48 billion
Jan. 14, 2004 J.P. Morgan Chase Bank One $58 billion
Wednesday Kmart Sears 11 billion
Sources: The companies, National Retail Federation, Hoover's, Tribune reports