Sears-Kmart Merger: Is It a Tough Sell?
According to the CEOs of Sears, Roebuck and Kmart Holding, their plan to merge into a giant $55 billion retail company will produce stronger brands, greater efficiencies in operations and higher returns than either company could achieve standing alone.
Not everyone sees the wisdom of the deal, however. "Here you have two retailers who are doing badly right now and who don't really see a clear way to pull themselves out of the downward spiral," says Wharton marketing professor Stephen J. Hoch, who heads the school's Jay H. Baker Retailing Initiative. "It's hard to fathom how combining them is suddenly going to produce a new entity that will do better. That's tough to do, especially because the competition, including Wal-Mart and Target, isn't exactly standing still."
According to marketing professor Barbara Kahn, "The rationale for this merger clearly has to be operations efficiencies, including the ability to compete more effectively against Wal-Mart, which is the leader in that area. If this is the goal of the merger, then it makes sense," she says. "But that isn't enough, in and of itself, for success. Sears has been struggling for a long time, as has Kmart. Two struggling companies coming together potentially make a bigger struggling company. At the same time, if the merger is done strategically and wisely, it will provide the scale" for the new company to go head-to-head with its toughest rivals.
The merger, announced November 17, will create the third largest retailer in the U.S., behind number-one Wal-Mart and number-two Home Deport. The combined company, to be called Sears Holding, will push Target into fourth place.
The merger announcement caps an interesting two years for Kmart, which in 2002 filed for bankruptcy protection, then 16 months later emerged from bankruptcy and experienced a strong rebound, at least on the stock market. Kmart CEO Edward Lampert is expected to be chairman of the new company, to be joined "in the 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," according to the Sears web site. "Lacy will be vice chairman and chief executive officer of Sears Holdings; Lewis will be president of Sears Holdings and chief executive officer of Kmart and Sears Retail."
Since bringing Kmart out of bankruptcy, Lampert, who owns 53% of Kmart and 14.5% of Sears, has closed down inefficient stores, laid off employees, raised prices and sold some locations to other retailers, including Sears, says Hoch. The real estate question is an interesting one, he adds. Sears stores tend to be located in malls and Kmarts outside of malls. "Kmarts are in declining urban areas, not in the premium kinds of spaces in the non-urban areas that Wal-Mart and Target have. Sears has a bunch of mall locations but they don't need that many" going forward, which strongly suggests that the new company could quickly shed some of its combined 3,500 retail stores. The company itself says it plans to accelerate Sears' off-mall growth strategy.
Hoch also speculates that Lampert, with his huge equity stake in Kmart and smaller one in Sears through ESL Investments, his private investment fund, may have plans to break apart and sell the assets. For example, "he could try to get as much money as he could for Lands' End - the clothing label that Sears bought for $2 billion which has proven to be a disappointing acquisition. I think this merger could be about the financial management of these assets, which obviously the investors feel aren't being valued by the market as highly as they should be. It wouldn't be the first time something like this is broken up and parceled out to people who find the parts more attractive. By merging into one entity, these two companies have more degrees of freedom in terms of dividing it up."
If this is true, the announced merger might probably be more about wheeling and dealing on Wall Street than about combining two stores which, while once the number one and two retailers, are now past their prime, Hoch says. "It's possible, but tough, to reverse that slide. Imagine a Wal-Mart and a Kmart right next door to each other. Would anyone go into the Kmart? In the old days Sears was the place to shop; you can still shop there but there are many other places that are probably more convenient. Not only are Sears stories situated in mall environments - and malls themselves are not doing as well as they once were - but they are not located in premium space. In addition, they have to operate in a lot of different categories against stores that are more specialized, like Best Buy, Home Depot, a huge number of apparel manufacturers and even paint stores. Competition is coming at Sears from different angles. So as a department store, it has to fight a whole bunch of fires that aren't even related to one another."
As for consumers, Hoch says they can probably expect higher prices, at least for now. "That would maximize profits in the short-term, since higher prices go right to the bottom line. It makes no sense, at least now, to drive the business in terms of better prices."
Kahn suggests that consumers may in fact benefit from the merger if "it gives the combined company better cost efficiencies, which usually get reflected in a lower price strategy. If the new company can compete effectively against Wal-Mart, it would also be good for consumers because it would increase competition." And it's not just consumers who would benefit, but small businesses as well, she adds. Wal-Mart has such buying power that for most small companies "it's Wal-Mart or nothing, a situation that has led to the demise of Toys 'r Us and many small manufacturers. Wal-Mart calls all the shots, and that kind of power is ultimately not good for a competitive marketplace."
However, both Sears and Kmart have struggled to attract customers over the past two years. "The continued decline in same store sales shows that neither company has been successful in driving repeat customer traffic to their stores," says William Cody, the Jay H. Baker Retailing Initiative's managing director. "Exploiting operational synergies between the two companies will certainly reduce costs, but unless they can develop and execute a merchandise strategy that resonates with consumers, this deal will not recapture the power of either brand."
Both Kmart and Sears bring visible strengths - and brands - into the deal. Kmart is strong in home furnishings and apparel, including such lines as Thalia Sodi, Jaclyn Smith, Joe Boxer, Martha Stewart Everyday, Route 66 and Sesame Street. Sears is well-known for its appliances - it is still the biggest appliance retailer in the U.S. - and also for tools, lawn and garden products, home electronics, and automotive repair and maintenance. Key brands include Kenmore, Craftsman and DieHard.
The new company will be based at Sears headquarters outside of Chicago, and will continue to use both names on its stores. The merger is expected to be completed by the end of March, pending shareholder approval. 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 the Nov. 16 closing price of Kmart shares) for each Sears, Roebuck share. The current value of the transaction to Sears, Roebuck shareholders is approximately $11 billion.
According to Sears's web site, "Kmart has made great progress over the past 18 months ... in terms of profitability and product offerings. We believe the combination of Kmart and Sears will create a true leader in the retail industry ... and will further enhance our capabilities to better serve customers by improving in-store execution and ultimately transforming the customer's in-store experience."
The merger is expected to generate $500 million of annualized cost and revenue synergies by the end of the third year after closing, the web site claims. The companies also expect to realize approximately $200 million 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. Additional annual cost savings of over $300 million are expected through improved purchasing, supply chain, administrative and other operational efficiencies.