Retailer Federated Is in Discussions To Buy Rival May

Combination Would Create A Department-Store Giant With Greater Industry Clout

DENNIS K. BERMAN and ELLEN BYRON / Wall Street Journal 20jan2005

Federated Department Stores Inc. is in preliminary talks to buy rival May Department Stores Co., said people familiar with the matter.

A combination would create a national colossus of nearly 1,000 department stores under iconic names ranging from Bloomingdale's and Macy's to Marshall Field's.

The talks are the latest sign of a new round of consolidation in the U.S. retailing sector, especially among mainstream, mid-market mass retailers. These stores are getting squeezed between the growing might of discount giants like Wal-Mart Stores Inc. and upscale retailers such as Neiman Marcus Group, Saks Inc.'s Saks Fifth Avenue and Nordstrom Inc. They are also losing business to fast-growing specialty retailers specializing in areas such as apparel and home furnishings.

Just two months ago, Sears, Roebuck & Co. and Kmart Holding Corp. agreed to merge in an $11.5 billion deal, hoping they could compete better as a combined entity than either managed on its own.

The discussions between Federated and May are at a delicate stage after several meetings, and there is no guarantee a deal will be reached, people familiar with the situation said. The value of a possible deal isn't clear. May, which is based in St. Louis and operates 501 department stores, has a current market value of about $9.2 billion. Federated, which is based in Cincinnati and has 459 stores, has a slightly larger market value of $9.7 billion. That suggests a stock swap as the most likely path to a transaction.

Representatives for both Federated and May declined to comment.

Federated, the parent of chains such as Bloomingdale's and Macy's, and May, which owns Marshall Field's, Lord & Taylor and Filene's, have flirted with each other in the past. In 2002, the companies held unsuccessful merger talks that foundered partly over management concerns.

But those issues may have been resolved by the abrupt resignation last Friday of May's chairman and chief executive, Gene Kahn. With Mr. Kahn gone, and no clear successor in place to fill his role, the coast could be clear for Federated Chairman and CEO Terry Lundgren to lead a combined company. The last time the two talked, Mr. Lundgren wasn't yet the CEO of Federated. But he was rising, and the role he would play in a combined company was a major sticking point in a potential merger, said people familiar with those discussions.

In Mr. Kahn's absence, May named President John Dunham as interim chairman and CEO, while launching a management search. The company has said its search would include internal and external candidates.

Mr. Kahn's departure sparked immediate speculation that May could enter into a merger agreement. On Tuesday, the first day of trading after Mr. Kahn's departure, shares jumped about 15%, or $4.37, to $32.21 in 4 p.m. composite trading on the New York Stock Exchange.

Yesterday, they fell back 84 cents to $31.37, while shares of Federated dropped 89 cents to $57.08 in 4 p.m. composite trading on the Big Board.

With nearly $30 billion in combined sales, a combined entity would gain vast clout with apparel manufacturers, landlords and advertising outlets. Together, the two companies would dominate "anchor store" positions in shopping malls across the country, and increase their ability to influence the taste and fashion styles of the women who are their core customers.

Undoubtedly, they would still face enormous pressures on all sides, since department stores continue to wrestle with an erosion in their market shares against their many new rivals. Moreover, a proposed combination likely would draw heavy scrutiny from antitrust regulators, particularly in those instances in which the two together would have multiple stores in shopping malls. May outbid Federated to buy the 62-store Marshall Field's chain for $3.2 billion last year, which could heighten the hurdles, said one person familiar with the discussions.

But people familiar with the matter said that in the event of a deal the two companies likely would argue that the retailing business has changed drastically since department stores reached their heyday during the 1950s.

At the time, department stores were pillars in local communities, dominating retailing in their spheres and authoritatively dictating fashion trends in many medium-sized cities. But their power waned as fashion-oriented specialty chains grew, especially those reaching out to women entering the workplace. In recent years, they have faced the rise of national competitors like Wal-Mart and Target Corp. and increasing acceptance of shopping over the Internet.

May's weak financial performance in recent years has fueled speculation that it could be a takeover target. Its sales have long trailed those of competitors, particularly Federated. For its part, Federated has made little secret of its interest in acquisitions -- while insisting it would be choosy.

Federated has reason to be careful. While it has a history of big, successful acquisitions, its last such deal, the $1.7 billion purchase of direct marketer Fingerhut Cos. in 1999, turned into a disaster. The retailer ended up dumping Fingerhut after racking up millions in losses, mostly from credit delinquencies among low-income customers. Since then, some investors have speculated that Federated has grown gun shy about big acquisitions.

One of the biggest advantages of a potential merger would be the ability to win better deals from suppliers. One of Wal-Mart's strengths is its ability to use its market clout to squeeze ever-lower prices from its vendors. A combined Federated-May could increase pressure on apparel makers such as Polo Ralph Lauren Corp. and Jones Apparel Group Inc., whose labels are mainly carried in their stores.

A combined entity also could potentially cut costs in areas such as advertising and purchasing, and reduce staff.

Last week, after Mr. Kahn's resignation, Deborah Weinswig, a managing director for Smith Barney, noted in an interview that the two have less geographic overlap than investors might think. "You'd bring together Federated, which is known for strong merchandising, combined with May, which is known for strong expense management," she said. "It's a marriage made in heaven in terms of talent."

Both May and Federated are products of acquisitions made over generations. May Department Stores Co. dates back to 1877, when David May opened what would become the chain's first store in Leadville, Colo., a silver-mining boom town. With headquarters in St. Louis since 1905, May grew by acquisitions, slowly swallowing other regional department-store chains as the retail industry consolidated over the century. Under Mr. Kahn's watch, the company began rapidly acquiring bridal businesses, hoping to boost its favor with younger customers as they begin families and households.

For its part, Federated celebrated its 75th birthday last year, but most of the department-store chains it has acquired have roots in the mid-1800s. Its most famous chain, Macy's, was founded in 1857 as a dry-goods emporium, moving to its flagship location in Manhattan in 1902. That location is now the world's largest department store. Macy's merged with Federated in 1994.