Attention, Shoppers Kmart to Buy Sears for $11.5 Billion

Financier Lampert's Bet In Retail Is Put to Test;
Chasing After Wal-Mart Craftsman Meets Jaclyn Smith 

AMY MERRICK and DENNIS K. BERMAN / Wall Street Journal 18nov04

Fourteen years after they slipped from their perch as America's top two retailers, the much-diminished Kmart and Sears chains are merging in an $11.5 billion deal that will propel them back into the No. 3 position.

SALES REGISTER

The top 10 U.S. retailers, based on 
2003 annual sales

			     2003 Sales
Company  		     (billions)
Wal-Mart - Bentonville, AR)  $258.68
Home Depot - Atlanta)	       64.81
Kroger - Cincinnati)	       53.79
Target - Minneapolis)	       48.16
Costco - Issaquah, WA)	       42.55
Sears - Hoffman Estates, IL    41.12
Safeway - Pleasanton, CA       35.55
Albertsons - Boise, Idaho      35.44
Walgreen - Deerfield, IL       32.51
Lowe's - Mooresville, NC       30.84

Source: Stores magazine top 100 retailers

The announcement of Kmart Holding Corp.'s proposed acquisition of Sears, Roebuck & Co. gave a dramatic lift to their stocks, suggesting that investors regard marriage as a promising solution for two chains long hampered by outdated stores, inefficient operations and weak management.

Behind the deal is Connecticut hedge-fund investor Edward Lampert, who is betting his $9 billion empire on his ability to become an operating executive in a punishing industry. Wal-Mart Stores Inc. and Home Depot Inc., the nation's two largest retail chains, are battering department-stores like Sears and discounters like Kmart by delivering a wider variety of products at lower prices in better locations.

The 42-year-old Mr. Lampert is gambling that he can wring out efficiencies, allow Sears and Kmart to sell each other's exclusive products and move to address a flaw in what he sees a flaw in the Sears business model: a reliance on mall locations in a retailing landscape shifting to stand-alone big box stores. Many Kmart stores located in prime nonmall spots will be converted to Sears stores. Far from seeking to catch up with Wal-Mart, Mr. Lampert described plans to improve the profitability of existing stores -- and sell off those whose earnings don't meet his hurdle.

The stock-market reaction reflected a belief in Mr. Lampert's track record as founder of ESL Investments Inc. Since 1988, returns on his funds have averaged about 30% annually. Besides holding a majority of Kmart shares, ESL is the largest shareholder of Sears, with a stake of about 15%.

Mr. Lampert said that ESL won't cash out a single share. In the proposed deal, Sears shareholders will choose either $50 in cash or one-half share of Sears Holding Corp. -- the name of the new company -- for each current Sears share. ESL, Mr. Lampert said yesterday, will convert all of its Sears shares into Sears Holding shares. In an interview, Mr. Lampert said ESL will own a percentage of the combined company "in the high-30s to mid-40s," depending on whether Sears shareholders choose cash or stock.

Some of Kmart's biggest shareholders are taking a cautious view. "This deal materially enhances their prospects, but the verdict is not in yet," said Marty Whitman, the chief investment officer of Third Avenue Management, which with 5.5% of the Kmart shares outstanding, is the second-largest holder. "Why don't we talk again in three years."

The deal arose from a development that seemed innocuous when Sears and Kmart announced it back in June: Sears was buying about 50 Kmart stores. Kmart had been downsizing ever since its early 2002 descent into bankruptcy court, from which it had emerged in May of 2003 with fewer debts and with a new majority owner: Mr. Lampert.

But the store sale turned out to be the beginning of a longer conversation. Mr. Lampert and Sears Chief Executive Alan Lacy talked throughout the summer about a larger deal, an idea that gained force in October. Originally talk centered on a Sears acquisition of Kmart. But then Kmart stock soared, forcing Sears into the target role.

Then early this month, another hitch developed: Vornado Realty Trust, a New Jersey real-estate fund, disclosed that it had amassed a 4.3% Sears stake. That news propelled the price of Sears stock, raising the possibility that Sears would become too expensive to acquire. The two sides pushed hard to quickly strike an agreement. "We still didn't have a final deal on price until Tuesday at midday," says one person familiar with the matter. "We were concerned the Sears price might get away from us."

Both Mr. Lampert and Mr. Lacy saw a huge strategic flaw in the Sears empire: the chain's old affinity for traditional malls. Sears stores followed the population growth into the suburbs over the decades, but by the late 1990s malls had lost much of their retailing prowess. More than 80% of consumer shopping dollars, excluding purchases of food and drugs, are now spent in locations outside malls, according to research by Customer Growth Partners LLC, a consulting company in New Canaan, Conn. That compares with about 60% in 1995. And six of the nation's largest retailers are off-mall operators -- double the number in the late 1990s.

"The problem is they are not where the customers are, and that's the big opportunity," said Mr. Lampert of Sears yesterday. "It is not that the retailer per se is weak, but if you have the greatest store and it's not where the customers are, that's a problem."

Mr. Lacy, 51, will be chief executive of Sears Holdings. Under him as chief executive of Kmart and Sears Retail will be Aylwin B. Lewis, 48, who joined Kmart one month ago as CEO. Before that he was a top executive of YUM Brands Inc., owner of the KFC and Taco Bell chains.

In interviews yesterdays, Mr. Lampert talked about how the blended operations could produce a stronger retail behemoth. Calling Sears the stronger brand, he talked in particular about the chance to expand that chain's products and presence into Kmart country. Mr. Lacy said that "several hundred" Kmart stores could be converted to Sears stores. Some would be part of a new chain called Sears Grand, which adds products such as food and CDs to the typical Sears store.

Both stores have popular exclusive brands, and it's not clear which products will cross from one store to the other. Investors clearly expect Martha Stewart Everyday products -- a huge seller for Kmart -- to gain access to Sears stores, because shares of Martha Stewart Living Omnimedia Inc. rose yesterday on news of the acquisition. Martha Stewart products already sell in Sears stores in Canada.

Among the brands for which Sears long has been famous, Craftsman tools will likely be introduced to the shelves of Kmart, perhaps bolstering its ability to compete against Home Depot. A bigger question is whether Sears will move its home-appliance products into Kmart stores. Through its Kenmore brand as well as through the sale of Whirlpool, General Electric and Maytag models, Sears is the nation's largest purveyor of refrigerators, washers and dryers, although it has been losing marketshare in recent years to Home Depot and Lowe's Cos.

The success of Home Depot and Lowe's shows that customers appreciate the convenience of buying appliances at stand-alone stores away from malls. Placing those products in Kmart stores could strengthen the Sears hold on that category, but it would also pose logistical problems. Appliances consume a large amount of space, meaning that other products would need to be eliminated. And appliances also require knowledgeable sales people.

With other products, mixing and matching is highly questionable. Shoe giant Nike Inc. sells its shoes inside Sears but so far has resisted a relationship with Kmart.

The combined company, to be called Sears Holdings Corp., will be based in Hoffman Estates, Ill., where Sears has its headquarters. Kmart will continue to have offices in Troy, Mich. Of the combined company's 10 directors, seven will come from Kmart's board, the other from the Sears board.

The deal is likely to be investigated by the Federal Trade Commission, which reviews most retail mergers, but seems unlikely to face significant antitrust opposition given the changing marketplace and the power of industry leader Wal-Mart Stores Inc.

Kmart was a dominant discount retailer for decades until it began losing ground to Wal-Mart in the 1980s and 1990s. Following a disastrous management scheme to load up on inventory and slash prices to compete with Wal-Mart head-on, Kmart filed for Chapter 11 bankruptcy-court protection in January 2002. Mr. Lampert then made his move. Through ESL, he acquired about half of Kmart as part of its reorganization plan. The company emerged from court protection in May 2003, with Mr. Lampert as its chairman.

During Mr. Lacy's four-year tenure, Sears has repeatedly overhauled its stores and cut costs in an effort to compete with a host of fast-growing rivals, from Wal-Mart, Target Corp. and J.C. Penney Co. to Home Depot and Lowe's Cos. In 2002, Sears purchased the Lands' End apparel brand for $1.86 billion. In July of 2003, it sold its credit-card business for about $3 billion to Citigroup Inc. While better known for its department stores and selling Craftsman tools and Kenmore appliances, credit cards had been a big part of the company for 91 years.

Beginning with its first large mail-order catalog in 1896, Sears pioneered retailing in the U.S., dotting the land with department stores from coast to coast. In the 1980s, it expanded into a brokerage business and real estate, but it later decided those businesses were distractions and disposed of them.

--Ann Zimmerman and Joann S. Lublin contributed to this article.

Kmart 1. June 1, 2000: Charles C. Conaway named CEO 2. Jan 22, 2002: Files for bankruptcy protection 3. May 6, 2003: Stock stops trading under symbol "KM" on NYSE. Company emerges from bankruptcy protection next day. 4. June 10, 2003: New stock begins trading on Nasdaq under symbol "KMRT" 5. March 5, 2004: Martha Stewart convicted 6. April 27, 2004: Kmart extends deal with Martha Stewart Living source: Standard and Poor's Compustat® data

Sears 1. Nov. 1, 1999: Sears is removed from the Dow industrials 2. Sept. 11, 2000: Alan Lacy named CEO 3. May 4, 2002: Company acquires Land's End 4. Nov. 17, 2004: Sears and Kmart agree to merge source: Reuters Investor

Research: WSJ.com

Coming to a Store Near You?

What the Kmart-Sears Deal Means For Consumers, Companies and Industry 

ELIZABETH WEINSTEIN / Wall Street Journal 17nov04

Could Jaclyn Smith be hawking her leather jackets at Sears sometime soon? For shoppers absorbing the news of Kmart Holding's proposed acquisition of Sears, Roebuck & Co., the prospect of Martha Stewart linens at Sears or Lands' End sweaters at Kmart may not be far off the mark, says Madison Riley, a strategist at retail consulting firm Kurt Salmon Associates. He spoke with The Wall Street Journal Online about how the new company stands among its fierce competitors, what it needs to do going forward and how the merger will change the retail landscape.

Will these two retailers make a viable challenger to Wal-Mart and Target?

I don't think [the combined company] will be a much more significant challenge to Wal-Mart. They both have clearly defined positions in the marketplace. Consumers think that when they want price they go to Wal-Mart. When they want value -- a little fashion -- they go to Target because of the way they merchandise the stores, the exclusive brands and the advertising. There's a sense of getting a little more in terms of fashion and style sensibility for the money. Kmart and Sears don't have this clear value proposition on a stand-alone basis or combined.

To me it's much more about back-office cost rationalization. They can probably take a lot of costs out -- they can probably enhance their supply chains, their logistics network, how they source, how they buy, their [information technology] infrastructure … where there's lots of opportunity to save money and drive more profit to the bottom line.

For consumers, how much cross pollination will we see with the stores' name brands like Martha Stewart Everyday at Kmart or Lands' End at Sears?

I think we'll see Martha Stewart at Sears because Sears -- as you look at the tiering of retail -- tends to be a little higher priced and a little more up-market than a Kmart. So it would be natural to say that Martha Stewart, which is this great brand, certainly can sell in a higher, slightly better channel of distribution.

The other way around, Craftsman, which is one of Sears's great American brands, I see at Kmart. Lands' End is a question though. It's a good brand, but Sears has not done much with it. So the question is, do we take that a step down to Kmart? And they may well choose to do that.

But this is one of the questions of this merger … how do we rationalize, or do we rationalize these two nameplates into one nameplate? How do we move, or not move, brands across the two stores? What will they stand for in the marketplace that is distinct from Target and Wal-Mart? And that's not clear. Because there are only so many things you can do: you can be about price, you can be about product and fashion or you can be about service. And Target already has the fashion angle, Wal-Mart already has the price angle and they live in a self-service environment. Based upon [Kmart Chairman] Edward Lampert's track record, he will be looking across Sears properties and where he doesn't think they're stand alone, successful properties he'll either consider, "can I make it a Kmart or should we close it down?"

How will the mall scene change?

I don't think much … There may be some C-level malls where they want to change Sears out to Kmart stores perhaps, but I don't envision that they'll change that business model dramatically. … From the consumer perspective, it's now about "how can I take Martha Stewart products, which used to be in Kmart, and put that in the Sears stores?" So Sears consumers get access to a great brand and a good product line.

What are the real-estate implications of this deal? Will we see a lot of selling off and consolidation of stores?

Sears was going to buy some of the Kmart locations and Kmart has already sold off a lot of real estate and already closed a bunch of stores. The real-estate play is that Sears can now move off-mall. They can move into the real-estate arena where growth has been and will continue to be -- those strip or lifestyle lifestyle centers where consumers prefer to shop. Parking is easier and access to the store is easier. That gives them an immediate quantum leap into that arena.

So is Kmart really the dominant partner in this relationship?

It's a great question. I don't see one or the other as the dominant player. From the financial perspective, Kmart is taking over Sears but if you stand back from a branding perspective, you have two brands that are American icon brands but not particularly strong and I don't think either one of them outweighs the other in strength of consumer equity.

After the merger activity dies down and stores have been sold off, the companies will get back to the business of running these stores, a task both have struggled with. What needs to happen to get day-to-day details of store management back on track? Do they need to bring in a top-tier retail manager?

They'll attain all of the operational synergies -- they'll look for, "Where can we combine our supply chain, our warehouse and IT infrastructure in such a way that we can save costs by eliminating people and jobs?" That will be a first step in addition to what real estate they can eliminate and sell off. Once they've captured that benefit, concurrently they have to think about their strategy going forward and "What is the strategy under which we'll combine these firms under one name plate? What is the positioning of that combined entity? And what does that mean for cross-brand fertilization?"

With these details in mind, what will these stores look like in a year?

In the first year, you'll see two separate Kmarts and Sears as they've been for some time, so it will be invisible to the consumer. It will be about internal back-office synergies. It will not be a major change for the consumer … other than a few things. Maybe they'll walk into Kmart and see a great Craftsman display, for example.

How will this merger affect the move to the megaconcept stores like Sears Grand?

That's one of the things that Kmart brings to the table -- their ability to help Sears think about and refine and drive that Sears Grand concept to the next level. But again, you have to say how will that fit into an overall strategy? You have to start at the top with who are we going to be? Will we be under one name or two? And then depending on how you answer that question, where do these different concepts fit into this strategy? And what will these concepts mean to the consumer?

What does this mean for investors? Is it the right time to put money into this new company or should they take a wait-and-see approach?

I think it's a good move for investors … as you look down the road short-term in the next year, they should be able to improve profitability and therefore prove shareholder value as they combine these two companies. You have two different retailers that bring two core competencies -- one that's a mass merchant and one that's a mid-tier national retail chain. So there will be cross learning, cross savings and all these brands … So the expectation is that this will mean improved and sustained profitability over time.

Top Players in the Deal

Wall Street Journal 17nov04

A look at the top executives at Kmart and Sears

Edward S. Lampert, 42
Chairman, Kmart Holding 
Mr. Lampert will be chairman of Sears Holdings and the company's biggest single holder, through his hedge fund, ESL Investments Inc. based in Greenwich, Conn., which he founded in April 1988. Before founding ESL, Mr. Lampert worked for Goldman, Sachs & Co. for a number of years. He serves on the board of AutoNation Inc. and AutoZone Inc.

Alan J. Lacy, 50
Chairman and CEO, Sears Roebuck
Mr. Lacy will be vice chairman and CEO of Sears Holdings. He was named chairman and CEO of Sears in December 2000, after joining the company in 1994 as a senior vice president for finance. He also served in executive positions at Philip Morris and Kraft.

Aylwin B. Lewis, 50
President and CEO, Kmart Holding
Mr. Lewis will be president of Sears Holdings and CEO of Sears Retail. Before joining Kmart in October 2004, he served as president, chief multi-branding and operating officer of YUM Brands Inc., which owns Taco Bell and KFC. Mr. Lewis spent 13 years at YUM and was in the restaurant industry for 26 years.

Glenn R. Richter, 42
Senior Vice President and Chief Financial Officer, Sears
Mr. Richter will be executive vice president and chief financial officer of Sears Holdings. He was named senior vice president and chief financial officer for Sears, Roebuck in October 2002. Before joining Sears, he worked in senior finance posts at Dade Behring International and PepsiCo.

William C. Crowley, 46
Senior Vice President, Finance, Kmart
Mr. Crowley will be executive vice president, finance and integration of Sears Holdings. He has served as an officer of Kmart since 2003. Mr. Crowley also serves as the president and chief operating officer of ESL Investments. Before joining ESL in 1999, he was a managing director at Goldman Sachs. Mr. Crowley serves on the board of AutoNation.

Sources: WSJ.com research, companies

Sears-Kmart Press Release

Combination Creates 3rd Largest U.S. Retailer With $55 Billion in Annual Revenues; Will Have Broader Retail Presence and Improved Scale and Operational Efficiency November 17, 2004 1:04 p.m. TROY, Mich. & HOFFMAN ESTATES, Ill. – Kmart Holding Corp. and Sears, Roebuck & Co. announced today they have signed a definitive merger agreement that will combine Sears and Kmart into a major new retail company named Sears Holdings Corp. Sears Holdings will be the nation's third largest retailer, with approximately $55 billion in annual revenues, 2,350 full-line and off-mall stores, and 1,100 specialty retail stores.

Both Sears, Roebuck and Kmart have made significant strides in transforming their organizations, and the merger will further accelerate this process for both companies. Sears Holdings will be headquartered in Hoffman Estates, Ill., and Kmart will continue to have a significant presence in Troy, Mich. The combined business will have a broader retail presence and improved scale through a national footprint of nearly 3,500 retail stores. The combined company will also benefit from improved operational efficiency in areas such as procurement, marketing, information technology and supply-chain management.

Under the terms of the agreement, which was unanimously approved by both companies' boards of directors, Kmart shareholders will receive one share of new Sears Holdings common stock for each Kmart share. Sears, Roebuck shareholders will have the right to elect $50.00 in cash or 0.5 shares of Sears Holdings (valued at $50.61 based on yesterday's closing price of Kmart shares) for each Sears, Roebuck share. Shareholder elections will be prorated to ensure that in the aggregate 55% of Sears, Roebuck shares will be converted into Sears Holdings shares and 45% of Sears, Roebuck shares will be converted into cash. The current value of the transaction to Sears, Roebuck shareholders is approximately $11 billion. The transaction is expected to be tax-free to Kmart shareholders and tax-free to Sears, Roebuck shareholders to the extent they receive stock.

Edward S. Lampert, chairman of Kmart, will be the chairman of Sears Holdings. He will be joined in an Office of the Chairman by Alan J. Lacy, current chairman and chief executive officer of Sears, and Aylwin B. Lewis, current president and chief executive officer of Kmart. Mr. Lacy will be vice chairman and chief executive officer of Sears Holdings; Mr. Lewis will be president of Sears Holdings and chief executive officer of Sears Retail. Glenn R. Richter, currently executive vice president and chief financial officer of Sears, Roebuck, will be executive vice president and chief financial officer of Sears Holdings. William C. Crowley, currently senior vice president -- finance of Kmart and a Kmart Board member will be executive vice president, finance and integration of Sears Holdings.

Messrs. Lampert, Lacy and Lewis will join a ten-member Sears Holdings board of directors, which will include a total of seven members of the current Kmart board and three members of the current Sears, Roebuck board. Sears Holdings will act as the holding company for the Sears and Kmart businesses, which will continue to operate separately under their respective brand names.

Mr. Lampert said, "The combination of Kmart and Sears is extremely compelling for our customers, associates and shareholders as it will create a powerful leader in the retail industry, with greatly expanded points of distribution, leading proprietary home and apparel brands and significant opportunities for improved scale and operating efficiencies. The merger will enable us to manage the businesses of Sears and Kmart to produce a higher return than either company could achieve on its own."

ESL Investments and its affiliates, which are controlled by Mr. Lampert, have agreed to vote all Kmart and Sears, Roebuck shares they own in favor of the merger and to elect stock in the transaction with respect to their shares of Sears, Roebuck.

Mr. Lacy said, "The combination will greatly strengthen both the Sears and Kmart franchises by accelerating the Sears off-mall growth strategy and enhancing the brand portfolio of both companies. This will clearly be a win for both companies' customers while significantly enhancing value for all shareholders. We will have a total combined store base of nearly 3,500 stores and the leading service organization in the industry capable of a major expansion to serve the needs of existing Kmart and Sears customers."

Mr. Lewis said, "Kmart has made great progress over the past 18 months to strengthen the organization in terms of profitability and product offerings. We believe the combination of Kmart and Sears will create a true leader in the retail industry -- both as a key part of local communities and as a national presence. Together, we will further enhance our capabilities to better serve customers by improving in-store execution and ultimately transforming the customer's in-store experience."

Sears Holdings will feature a powerful home-appliance franchise as well as strong positions in tools, lawn and garden, home electronics, and automotive repair and maintenance. Key proprietary brands include Kenmore, Craftsman and DieHard. The company will have a broad apparel offering, including such well-known labels as Lands' End, Jaclyn Smith and Joe Boxer, as well as the Apostrophe and Covington brands. It will also have Martha Stewart Everyday products, which are now offered exclusively in the U.S. by Kmart and in Canada by Sears Canada.

Kmart specialty retail stores will continue to carry their current lineup in proprietary home and fashion lines including Thalia Sodi, Jaclyn Smith, Joe Boxer, Martha Stewart Everyday, Route 66 and Sesame Street.

The combination of the two companies is conservatively estimated to generate $500 million of annualized cost and revenue synergies to be fully realized by the end of the third year after closing. The transaction, after giving effect to estimated synergies, is expected to be significantly accretive to earnings per share in the first year before one-time restructuring costs.

The companies expect to realize approximately $200 million in incremental gross margin from revenue synergies by capitalizing on cross-selling opportunities between Kmart and Sears' proprietary brands and by converting a substantial number of off-mall Kmart stores to the Sears nameplate in addition to the 50 Kmart stores Sears acquired earlier this year.

The company expects to achieve annual cost savings of over $300 million principally through improved merchandising and nonmerchandising purchasing scale as well as improved supply chain, administrative and other operational efficiencies. In addition, the combined company will complete a full store asset review as part of a plan to monetize nonstrategic real-estate assets as appropriate.

Messrs. Crowley and Richter will jointly lead an integration team of key operating executives from both companies to drive planning and execution of the integration of the companies' operations.

The merger, which is expected to close by the end of March 2005, is subject to approval by Kmart and Sears shareholders, regulatory approvals and customary closing conditions. Lehman Brothers served as financial advisor to Kmart, and Simpson Thacher & Bartlett LLP provided legal counsel to Kmart. Morgan Stanley served as financial advisor to Sears, and Wachtell, Lipton, Rosen & Katz provided legal counsel to Sears.

About Kmart Holding Corporation

Kmart Holding Corporation and its subsidiaries (together, "Kmart") is a mass merchandising company that offers customers quality products through a portfolio of exclusive brands that include Thalia Sodi, Jaclyn Smith, Joe Boxer, Martha Stewart Everyday, Route 66 and Sesame Street. For more information visit the company's Web site at kmart.com.

About Sears, Roebuck & Co.

Sears, Roebuck & Co. is a leading broadline retailer providing merchandise and related services. With revenues in 2003 of $41.1 billion, the company offers its wide range of home merchandise, apparel and automotive products and services through more than 2,300 Sears-branded and affiliated stores in the U.S. and Canada, which includes approximately 870 full-line and 1,100 specialty stores in the U.S. Sears also offers a variety of merchandise and services through sears.com, landsend.com and specialty catalogs. Sears is the only retailer where consumers can find each of the Kenmore, Craftsman, DieHard and Lands' End brands together -- among the most trusted and preferred brands in the U.S. The company is the largest provider of product repair services with more than 14 million service calls made annually. For more information, visit the company's Web site at sears.com.