- The Washington Times - Sunday, November 21, 2004

NEW YORK - Two struggling retailers with dismal sales merge, and how do investors react? They send the stocks of both companies soaring.

With last week’s surprise announcement that Kmart Holding Corp. was buying Sears, Roebuck & Co. in an $11 billion deal, it seems investors are focused on how the combined company will parcel off its valuable real estate.

But that could be shortsighted, given the many concerns over the new company’s potential viability.

Sears Holdings Corp., as the new company will be known, would be the nation’s third largest retailer with $55 billion in annual revenues. But it still lags far behind its biggest competition, Wal-Mart Stores Inc., with $280 billion in annual revenues.

The deal was orchestrated by Edward Lampert, Kmart chairman and Sears shareholder. It is Mr. Lampert’s role that is fueling speculation about how the merged company will unlock value in its real-estate holdings.

Since taking over Kmart when it emerged from bankruptcy court protection in May 2003, he has led an aggressive strategy of closing or selling about 600 stores. That has been the major contributor to its speedy financial turnaround, which includes posting a profit in each of the last four quarters and a sevenfold increase in the company’s stock price from $15 a share when it emerged from bankruptcy.

Clearly, investors are hoping for more of the same from the merged company. Both Kmart and Sears have properties that are underperforming or in undesirable locations that could go.

That seems to be what drove Wednesday’s stock rally, with Kmart’s shares climbing 7.7 percent to $109 on the Nasdaq Stock Market, while Sears shares soared 17 percent to $52.99 on the New York Stock Exchange. Shares of Sears fell 85 cents to end at $52.95 Friday, while Kmart shares rose $1.28 to close at $104.99 — about $4 lower than Wednesday’s high.

“Kmart and Sears shares have run up based on their presumed underlying real estate values. We expect another swirl of real estate announcements,” Oppenheimer retail analyst Bernard Sosnick wrote in a note to clients. But he warned, “After that, it will be down to the business of running stores, which neither Kmart or Sears has been adept at doing.”

Sears, for one, has struggled with slumping sales at its 870 mall stores in recent years as investors turned to more convenient big-box retailers for their appliances and clothes. Kmart hasn’t been able to invigorate sales at its stores.

Yet the troubles these retailers are having with retailing is something that executives at both companies tried to brush off during a press conference after the announcement of the merger. They talked at length about all the potential synergies — a buzzword that is often trotted out when mergers are announced.

Among their plans: Squeeze suppliers, thanks to the $40 billion a year in merchandise that the two companies buy, and lower costs by doing such things as streamlining its back-office operations. The new company is expected to have annual savings of $500 million within three years.

Whether they can achieve those ambitious goals remains to be seen.

“The way they say they are going to lower costs, those are really long shots in my view. Even in the best of times, they are difficult to realize, and now these are two struggling organizations trying to make that happen,” said Sidney Finkelstein, professor of strategy and leadership at the Tuck School of Business at Dartmouth College and author of the book “Why Smart Executives Fail.”

In addition, there are the difficulties of synchronizing Kmart and Sears in such areas as merchandising and planning. There are also no guarantees that cross-selling between the stores — like bringing Craftsman tools into Kmart or Martha Stewart-branded goods into Sears — will drive business.

UBS retail analyst Gary Balter points out that 64 percent of Sears full-line stores are within one mile of a Kmart store, and he notes that 68 percent of Target and Wal-Mart stores are within the same radius of a Kmart or Sears store. That Kmart and Sears “overlap could lead to some cannibalization and possible brand deterioration,” he said in a note to clients.

Some wonder why Mr. Lampert would engineer such a takeover for cash-rich Kmart, which could have had its pick of investment opportunities. He often is called the next Warren Buffet, whose successful investing technique of buying solid, unflashy and undervalued companies is one that the 42-year-old Mr. Lampert has followed closely.

Consider what Mr. Lampert has done with AutoZone Inc., the auto-parts retailer that was struggling when he bought his initial stake in 1997. By 1999, he had a seat on the board, and eventually brought in a new CEO and boosted cash flow. The result was much improved earnings and a fourfold surge in stock price.

With his proven track record, the Kmart-Sears deal could turn out to be Mr. Lampert’s next success story. Maybe the investors really are betting on him.

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