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October 2004 - November 2005 

Texas Prosecutors to Drop Sears Charge
AP Online via Comtex
December 30, 2004

AUSTIN, Texas, Dec 30, 2004 (AP Online via COMTEX) -- Prosecutors agreed to drop an illegal campaign contribution charge against Sears, Roebuck and Co. in exchange for its cooperation in an investigation of contributions to a political action committee associated with House Majority Leader Tom DeLay.

A Travis County judge signed off on the agreement Thursday. It said the retailer enacted additional internal policies and strengthened its policy against making illegal contributions in any state.

Sears was accused of donating $25,000 to Texans for a Republican Majority during the 2002 legislative campaign. The use of corporate money for political purposes is illegal in Texas.

Sears was one of eight corporations accused of giving money to the PAC. Prosecutors previously dropped charges against Livermore, Calif.-based Diversified Collections Services Inc. under a similar agreement.

Three associates of DeLay also have been indicted in the ongoing investigation, but the lawmaker himself has not been.

"We're certainly delighted with the dismissal in that we had maintained all along that we had not done anything illegal. We're very pleased to put this past us," said Robert J. O'Leary, a Sears senior vice president.

The agreement says Sears will cooperate with Texas "in its prosecution and investigation of any other person for any offense related to the corporate contribution" that Sears made. O'Leary said Sears also will give $100,000 to the University of Texas for a campaign finance law awareness program.

The retailer also will provide public access and disclose corporate contributions on the company Web site.

Travis County grand juries have spent two years investigating contributions in the 2002 legislative campaigns. The election resulted in the first Republican majority in the Texas Legislature in modern times.

One of DeLay's associates, John Colyandro, filed a motion this week to dismiss charges against him, the Austin American-Statesman reported Thursday.

Under Texas law, only candidates, officeholders or political committees are capable of illegally accepting contributions. In court documents, Colyandro's attorney said since the former executive director of Texans for a Republican Majority is none of those, he could not have accepted illegal corporate contributions.

Employer Actions Drive Health Costs For Retirees Higher
By Ellen E. Schultz - Staff Reporter - The Wall Street Journal
December 30, 2004

Last fall, Michael Foster, a retired vice president for Rohm & Hass Co., got a letter telling him that the monthly premium for his health coverage in 2005 was rising to $1,069 a month from $823. "Retiree health-care costs continue to rise," the company explained.

But not all Rohm retirees are feeling the same pinch: those from a different unit of the Philadephia-based specialty-chemicals company will pay just $77 a month for the same coverage. And some pay nothing.

While employers routinely blame rising health-care costs when they increase the amount retirees pay for coverage, retirees may face the price hikes simply because employers change the structure of the plans. Companies may separate retirees into their own pool, charge one group of retirees higher premiums or charge one group higher premiums to, in effect, subsidize another.

NO COMPARISON
Retirees in two divisions of Rohm & Haas pay different monthly HMO premiums for the same coverage.

Sources: Company handouts; Mr. Foster's letter to the chemical company's board of directors

Mr. Foster, who retired from Rohm's electronics materials group in 2002, initially paid $140 a month for coverage, and grew suspicious when his premiums kept rising so steeply. Coverage in an HMO for himself and his wife rose to $288 a month in 2003, and $823 in 2004. He called other retirees and discovered that those in other divisions were paying far less for their coverage.

The reason: the company had established ceilings, or maximum amounts, it would pay for each retiree's health coverage; the retiree pays everything above the companies' capped amount. Rohm capped coverage for some groups of retirees at $16,666 a year for a couple under age 65, while the cap for the electronics division retirees is $2,700 a year per couple. (Retirees in both groups have coverage of $4,000 per couple once the retiree reaches age 65).

More than half of large companies that offer retiree health care, including Aon Corp., General Electric Co., Halliburton Inc. and International Business Machines Corp., have capped what they will spend on their retirees' health benefits.

Nor is it unusual for employers to provide different levels of benefits for different groups. A company may charge salaried retirees more for their benefits, to offset its costs of providing coverage for union retirees, whose benefit it can't unilaterally reduce.

Similarly, if a company used pension assets to pay for the health coverage of one group of retirees, the law prevents it from cutting that group's benefits significantly for five years. But a company may charge other retirees more. Rohms's filings show it transferred excess pension assets to fund retiree medical expenses in 2001, but don't say for which retiree group the money was used.

Mr. Foster says he feels like he is subsidizing other retirees. "This existence of benefits discrimination among retirees in different business units is upsetting," he wrote in a Nov. 12 letter to the board of directors. He says he'll drop his Rohm benefits, because he can find less expensive coverage where he lives, in Wellesley, Mass.

Leslie Johnson, a Rohm spokeswoman, says in an e-mail that the company is addressing rising health-care costs. "We proactively and aggressively negotiate the most comprehensive coverage at the lowest costs, offer multiple options, including less costly programs."

She adds that "the variety of plans offered to retirees is complex, partially as a result of the acquisition of numerous companies over the years." While some pre-1993 retirees are not subject to caps, she says that "company costs for providing benefits to retirees are not subsidized by the premiums paid by retirees."

In general, retiree health-care costs can rise when employers segregate them into their own group, apart from active employees. In the past, employers included all health-plan participants -- active employees and retirees -- in the same "risk pool." This practice spread health-care costs among a wide pool of people.

When retirees are segregated into their own pool, the per-capita costs rise, because an older, sicker population may need more medical care. Employers protect themselves from spiraling costs by adopting ceilings on what they will pay for the retirees.

Xerox Corp., which in 1994 established a ceiling on what it would pay for retirees in the future, split the rating pool of its active and retired employees in 2003, a move that has caused the retirees' costs to nearly double.

Eugene Nathenson, 62, a retired controller of Xerox Financial Services, saw his premiums rise to $3,196 a year in 2004, from $1,645 in 2003. "I said, my God, how could the premiums have gone up that much?" he recalls. Not only that, but the deductibles he and his wife pay will rise in 2005 to $2,400, making his total out-of-pocket costs increase to more than $6,000 a year.

In an e-mail, Xerox spokesman Bill McKee noted that costs for pre-65 retirees are 50% to 60% greater than for active employees. But he added that the company in 2003 began phasing in caps over several years "to partially offset the significant cost increases" for retirees. "Giving Xerox employees and retirees access to affordable and quality health care remains a priority."

Some Xerox retirees have asked the company to merge the risk pools for active and retired participants. There is little reason for a company to do so, however. When a company segregates retirees into their own risk pool, or establishes a limit on what it will pay for their benefits, it can actually profit when medical costs rise.

Rising costs often prompts retirees to drop coverage, starting with the healthiest, who can obtain less expensive coverage elsewhere. In fact, the enrollment booklet distributed to Rohm & Hass retirees encourages them to explore this possibility: "...you may find it advantageous to explore health care options that are available on the open market," and it goes on to provide links to government programs, AARP, and a Web-based insurance broker.

Meanwhile, retirees who can't drop the coverage (perhaps because they have pre-existing conditions that make them uninsurable) remain in the health plan, driving up costs.

When retirees drop out, employers save money, and also book a gain, because they can reduce the liability recorded for retirees, having assumed they would continue to receive coverage until they die.

"When 100% of the increases is flowing through to the retiree, there's no incentive to get the costs down," complains Mr. Foster.

In Ads, AARP Criticizes Plan on Privatizing
By Robert Pear - New York Times
December 30, 2004

WASHINGTON, Dec. 29 - AARP, the influential lobby for older Americans, signaled Wednesday for the first time how fervently it would fight President Bush's proposal for private Social Security accounts, saying it would begin a $5 million two-week advertising campaign timed to coincide with the start of the new Congress.

The organization, which played a huge role in the passage of Medicare drug legislation last year, said it was prepared to spend much more in the next two years to block the creation of private accounts financed with payroll tax revenues.

"This is our signature issue," said Christine M. Donohoo, chief communications officer for AARP, which represents 36 million Americans 50 and older. "We will do what it takes."

The full-page advertisements, to appear next week in more than 50 newspapers around the country, say the accounts would cause "Social Insecurity."

"There are places in your retirement planning for risk," the advertisements say, "but Social Security isn't one of them."

One advertisement shows a couple in their 40's looking at the reader. "If we feel like gambling, we'll play the slots," the message says.

Another advertisement shows traders in the pit of a commodities exchange. "Winners and losers are stock market terms," it says. "Do you really want them to become retirement terms?"

AARP's confrontational stance on Social Security contrasts with its strategy on Medicare legislation in 2002 and 2003.

Senior officials of the group continually talked to the White House and to Republicans in Congress about proposals to add drug coverage to Medicare. But to date, AARP leaders said, they have had few conversations with the White House about Mr. Bush's plans for Social Security.

Lawmakers of both parties said the Medicare bill might not have passed without a last-minute endorsement by AARP, which describes itself as a nonpartisan organization. The endorsement outraged some members of the group and some Democrats in Congress. But now, it appears, AARP will be working with Democrats against Republican proposals for private accounts.

AARP strongly supports new incentives for people to save for retirement, but says such savings should supplement the existing system.

Marie F. Smith, the group's president, and William D. Novelli, its chief executive, set forth the organization's position this month in letters to members and to lawmakers.

Private accounts would worsen the problems of Social Security, they said, adding: "Taking some of the money that workers pay into the system and diverting it into newly created private accounts would weaken Social Security and put benefits for future generations at risk. AARP is opposed to private accounts that take money out of Social Security."

Under President Bush's proposal, workers could divert some payroll taxes to personal accounts that could be invested in stocks and bonds.

At a news conference last week, Mr. Bush defended his proposal as a way to encourage "an ownership society," increase savings and provide "capital for entrepreneurial growth." By investing in private accounts, he said, workers could earn a higher rate of return than they get from the Social Security trust fund, and they could pass on the accumulated assets to their heirs.

Ms. Donohoo said AARP's advertisements were intended to "mobilize seniors" and to educate younger people about the program, which pays monthly benefits to more than 47 million Americans.

The advertisements will generally run three times in each newspaper from Jan. 4, when Congress convenes, to Jan. 20, when Mr. Bush is to be inaugurated for a second term.  e the  libertarian Cato Institute, are also gearing up. But Jamie W. Dettmer, a Cato spokesman, said: "We do not have plans to do advertising or lobbying. Our experts will write op-ed articles, appear on television and radio and testify before Congress if they're invited."

At a White House economic conference this month, Mr. Bush previewed his message to Congress on Social Security. "The crisis is now," he said. "You may not feel it, your constituents may not be overwhelming you with letters demanding a fix now, but the crisis is now."

On the other hand, Ms. Donohoo of AARP said that "rather modest changes" could ensure the solvency of the program for several generations. "It's not a crisis," she said.

Sears, Kmart Merger May End With a Giant Closeout: David Pauly
David Pauly is a columnist for Bloomberg News. His opinions are his own.
December 30, 2004

(Bloomberg) -- It may be over for two U.S. retailers with roots in the late 19th century: Sears, Roebuck & Co. and Kmart Holding Corp., the latter born as the S.S. Kresge dime store chain.

Edward Lampert, a money manager who thinks he's Warren Buffett, is combining the two companies, each of which was once the biggest retailer in the U.S., in an attempt to compete with the current No. 1, Wal-Mart Stores Inc.

Lampert, 42, says he'll close unproductive stores and save about $300 million in annual costs. He also plans to convert many Kmart discount stores to Sears department stores. He then hopes to sell Sears products such as Craftsman tools at remaining Kmarts and Kmart's Martha Stewart home products at Sears stores.

Lampert's plan to retrench and then reinvigorate the new Sears Holdings Corp., to be based in Hoffman Estates, Illinois, is suspect. Whether he really wants to get Sears and Troy, Michigan-based Kmart growing again or to continue a strategy he adopted at Kmart -- liquidate the real estate and leave retailing to history -- he has multiplied his risk several times.

On a Treadmill

Sears's annual sales were stuck at $41 billion in each of the four years ended with 2003. In the third quarter of 2004, its sales in stores open a year or more fell for the 13th time in 15 quarters. Kmart's same-store sales in the quarter ended on Oct. 27 dropped 12.8 percent, an especially bad result if you assume Lampert had dumped some of his weakest stores.

Lampert talks as if he can increase sales at Kmart stores by almost a third simply by converting them to Sears outlets; Sears stores generate that much more in sales per square foot of selling space. The potential for switching Kmart sites to Sears Grand stores that sell a wider variety of goods than department stores helped prompt the merger, Lampert said. New locations would make the Sears name a better draw?

Sears Grand is just one more ploy at a company that may hold the corporate record for flip-flops. Over the years, Sears has gone into and out of casualty insurance (Allstate), real estate brokerage (Coldwell Banker), investments (Dean Witter Discover), specialty stores (National Tire & Battery) and credit cards.

Distractions

Kmart looked smart when it converted to discount stores and eventually replaced Sears as the top retailer. Like Sears, it distracted itself with diversifications -- Borders bookstores, OfficeMax, Sports Authority -- that were eventually jettisoned. When Kmart went bankrupt in 2002, it may have been best known for its sloppy stores.

Lampert may have little choice but to pull back -- and hope his real estate doesn't saturate the market. Kmart's stock has leapt to $99.94 from $15 on Lampert's watch, largely on real estate deals. Kmart's $553 million in third-quarter net income was inflated by $494 million from selling stores and leases.

The key to retailing is picking the right merchandise. Lampert, whose ESL Investment Inc. of Greenwich, Connecticut, got 52.6 percent of Kmart's stock via bankruptcy proceedings and also owned 15 percent of Sears, was in risk arbitrage before he managed money. Alan Lacy, who was Sears's chief executive officer for four years and will be CEO of Sears Holdings, came up through finance. Aylwin Lewis, who will run the stores, was hired by Lampert in October from Yum! Brands Inc., a restaurant company.

Rivals such as Home Depot Inc., Target Corp. and Wal-Mart supply what customers need. That's no longer true at the once- great retailers Lampert controls, and the saddest thing about their end would be that nobody would miss them.

Home Depot Goes Online with Appliance Sales
By Sandra Guy - Business Reporter - Chicago Sun-Times
December 29, 2004

Home Depot announced Tuesday that it has started selling appliances online, joining rivals Lowe's and Sears Roebuck and Co. in a washer-and-dryer Web war.

The Atlanta-based home-improvement retailer launched its online appliance sales earlier this month with 1,800 products, including dishwashers, ranges and refrigerators.

Sears, the market-share leader in appliance sales, started selling appliances on its Web site in 1999, and now sells more than 4,000 items, said a spokeswoman for the Hoffman Estates-based retailer.

Lowe's started selling appliances online in 2000, and sells 5,000 appliance products via its Web site, said a company spokeswoman in Mooresville, N.C.

Home Depot's online venture is the latest in an increasingly fierce battle for sales of big-ticket white goods that boost retailers' bottom lines because they are usually bought on credit and sold with lucrative repair contracts.

Sears' share of the U.S. appliance market is still the largest, but it slipped below 40 percent three years ago and has declined in each of the past two years. Sears has exclusive rights to sell Kenmore appliances.

This fall, Sears introduced a Virtual Kitchen on its Web site. The Virtual Kitchen enables a Web surfer to call up a list of refrigerators that Sears sells, and then drag and drop a refrigerator, one at a time, into the kitchen to see how it looks. The tool enables the Web surfer to insert any appliance into the kitchen.

Sears also lets Web shoppers click on an "auction" tab to bid for used appliances at discount prices.

Home Depot said its appliances sold online will cost the same as those in its stores. Customers who order online will receive a telephone call from a Home Depot employee to confirm delivery and details such as installation charges and local sales tax.

One analyst said Home Depot's move won't help Sears, but it might not hurt Sears, either.

"I'm not sure it will move the needle all that much," said Anthony Chukumba, stock analyst with Chicago-based Morningstar.

Home Depot has such an expansive store base that most people can easily drive to a store, and those who cannot are unlikely to suddenly flock to the retailer's Web site, he said.

Retailer to Offer Washers on Web
Home Depot Site Adds Appliances
By Becky Yerak - Tribune Staff Reporter - Chicago Tribune
December 29, 2004

Home Depot Inc., the nation's No. 3 appliance retailer, will begin selling name-brand trash compactors, dishwashers and about 1,800 other white goods on its Web site in hopes of gaining market share from Sears, Roebuck and Co. and Lowe's Cos.

The announcement by the Atlanta-based home-improvement chain, which in 2001 started stocking appliances in its brick-and-mortar stores, comes less than two months after Sears discussed plans to merge with Kmart Holding Corp.

Sears is by far the nation's dominant seller of appliances, including its top-selling Kenmore line. But with the number of Sears stores stagnating for decades, more vibrant retailers such as Lowe's, Home Depot and Best Buy Co. have chipped away at the Hoffman Estates retailer's market share.

Through its proposed merger with Kmart, however, Sears gains keys to hundreds of additional stores at which to sell appliances.

Sears, with 36.8 percent market share in appliance units sold, down from its peak of 41 percent, began selling white goods online in 1999 and offers more than 4,000 products. Last fall, it added an online feature called Virtual Decorator, enabling shoppers to see how appliances will look in their kitchens before buying them.

Lowe's, which has 14.4 percent market share, began marketing appliances online in 2000 and has more than 5,000 available.

Home Depot has market share of 7.9 percent, according to industry tracker Stevenson Co. Home Depot says its share of major appliances in the third quarter of 2004 is up 40 percent over the same period a year ago.

"Since they're doing research online, we wanted to offer them the convenience of purchasing online as well," a Home Depot spokeswoman said.

But Alan Wolf, a senior editor at TWICE, a trade magazine covering consumer electronics and appliances, said Home Depot's move is unlikely to alter the rankings.

"It won't change the appliance world, but it will make Home Depot sound better," he said.

"It would be generous to say that less than 5 percent of appliance sales" occur online, Wolf added.

Indeed, in Sears' experience, 9 of 10 consumers prefer buying appliances in stores, though 7 of 10 do research online before making a purchase.

Unless consumers live in remote areas, they tend not to buy big-ticket items online, Wolf said, citing automobiles and refrigerators as examples.

"There's something about wanting to open and close the door," he said. "If you go into a store to look at a product, chances are you're not going to buy it online."

That's particularly true as the appliance industry is "focused on aesthetics more than ever before," Wolf said.

Ray of Hope for Sears Apparel
By Becky Yerak - Staff Reporter - Chicago Tribune
Inside Retailing (Excerpt)
December 28, 2004

Ray of hope: Clothing sales at Sears, Roebuck and Co. have dropped every month since February 2004.

But a New York clothing designer recently provided a positive update on Sears' apparel efforts.

In an Oct. 28 presentation about its third-quarter financial results, Liz Claiborne Inc. executive vice president Angela Ahrendts noted that her company's "best-performing, midtier businesses" have been Axcess men's and women's at Kohl's and First Issue at Sears.

First Issue's monthly sales at Sears are consistently up by double digits over last year, she said.

Claiborne also is "encouraged" by early results for its new younger, casual Curve men's and women's brand, Ahrendts said. It launched Curve's women's line last fall in 415 Sears stores and the men's line in 145 Kohl's stores.

Late in the presentation, Claiborne touched on Sears again.

"Sears is a real wild card because you've now got Luis Padilla in there," Claiborne CEO Paul Charron said of the former Target Corp. and Marshall Field's executive who joined Sears as chief merchant last September.

"Luis is an especially talented executive and a real supermerchant. We've spent some time with him recently. So I think you're going to find interesting things coming out of Sears," he said.

Vanishing Coverage - Company Cost-cutting Ax Often Chops Retiree Health Benefits
By Rachel Brand - Rocky Mountain News - Denver
December 28, 2004

Retail giant Sears, Roebuck and Co. is old-fashioned in lots of ways: Its wide array of brand-name durable goods. Its stellar service.

And another anachronism: Its generous retiree benefits.

In an age of ruthless competition from stores such as Home Depot and Wal-Mart, Sears' benefits harken back to an earlier time.

Hoffman Estates, Ill.-based Sears partly pays for 12,000 retirees' pre-Medicare health benefits and also funds care for some of about 50,000 retirees on Medicare.

That benefit soon may be under fire. When Kmart agreed to buy Sears for $11 billion last month, both companies promised to streamline "inefficiencies." Some retirees fear their health care benefit - not protected by law - is among them.

"Kmart retirees don't have medical (coverage)," said retiree Ron Olbrysh, 63, chairman of the National Association of Retired Sears Employees and former legal counsel for Sears. "What's going to happen to all the Sears retirees? A lot of Sears retirees are very concerned they are going to lose their medical."

A Sears spokesman said it's too early to speculate.

Still, the worries are justified. A growing number of retirees - and pre-retirees - are confronting the harsh reality of rising health care costs. And employer-funded retiree health coverage, the supposed golden handshake for a career of service, is rapidly being taken away.

Employers say they can no longer afford the huge bills. So they are raising employees and retirees' co-insurance and co-pays, increasing annual out-of-pocket maximums and offering less-generous health plans.

According to an annual survey by the Kaiser Family Foundation and human resource consultant Hewitt Associates, 79 percent of companies increased their retirees' contributions for premiums in the past year, and 85 percent expect to do so in 2005.

"The prospects for retiree health coverage are slowly disappearing for America's workers, and retirees who have it will be paying more," said foundation President Drew Altman.

None of this is new. Many companies capped retiree health care costs when they began accounting for the expense in the early 1980s.

It's just that those caps arrived sooner than expected.

Olbrysh says he is paying "a dear price" for medical care, around $450 a year as his part of health care coverage, and that's going up to $600 in 2005.

But at least he has coverage. He is among the estimated 4 million "early retirees," people ages 51 to 62, who have some employer or government assistance for health care.

Then there's the shadow majority of workers who'd like to retire - and can't
- because their pre-Medicare retiree health care has vanished.

"Well over half of the labor force doesn't retire as soon as they'd like to because they don't have health insurance," said Dallas Salisbury, president of the Employee Benefits Research Institute in Washington D.C.

That means, in the future, employees now in their 30s and 40s will work longer, likely until they qualify for Medicare. Sears has capped its company contribution toward retiree health care coverage at 2004 levels. It announced that anyone 40 or younger as of Jan. 1, 2005 will not get employer-paid health care coverage when they retire.

It also announced that any new hires after Jan. 1, 2004 are not eligible to join the pension plan.

These changes were "part of a plan to be committed to providing pay and benefit programs that are in line with our best-in-class competition," Sears spokesman Chris Brathwaite said. "Most of our big- box competition doesn't offer benefits like this."

Denver resident and Sears retiree Jerry Sronce, 68, has warm memories of Sears.

"It was like a family," he said, recalling his days selling floor tile, paneling, plumbing and bathroom fixtures. Still, Sronce feels the company broke its promise.

"Working in retail, you never made a lot of money," Sronce said. "The exchange was, not great money, but you get great benefits."

Here's the rub. Retiree health care cuts made by Sears, Lucent, Aetna, Denver-based Qwest Communications and a laundry list of other U.S. employers are perfectly legal.

Pension plans are protected by federal law. But companies can cut health coverage at any time.

Of course, many Americans are coping with rising health care costs. And an estimated 45 million Americans are uninsured. Retirees, though, are especially vulnerable because they didn't set aside money for these cost increases. Also, many can't return to work.

"I'm more than aggravated with Sears," said Jeanne Adams, 75, a former Sears appliance saleswoman and Denver retiree. "They upped (our Medicare secondary
insurance) about $600 for this next year.

"I know all this stuff has gone up, but gee whiz, when you retire, it all gets more expensive."

In 2006, Medicare-eligible retirees may get some relief. The Medicare Modernization Act authorizes Medicare to start paying for prescription drugs, although retirees will still carry some financial burden.

That should make Medicare supplement insurance - private insurance that fills Medicare's gaps - more affordable.

Medicare also will pay companies a tax-free subsidy to continue retiree drug coverage. A December survey by the Kaiser Family Foundation found that three out of five large employers plan to take the subsidy.

But no law can stop the cultural shift that has taken place at work.

What was once a family has become every man for himself. Given shorter employee tenures, skyrocketing health care costs and increasing government involvement in health care, there's little to prevent companies from axing retiree health care coverage - if and when it suits them.

"Of course, I'd like to have to pay nothing at all," retiree Sronce said. "But that's not going to happen, and it may never happen again."

Top Chicago-area Corporations
See Major Changes During 2004
By Mike Comerford - Business Writer - Daily Herald - Suburban Chicago
December 26, 2004

EXCERPT.

Kmart finds Sears special

Sears will continue as a recognized brand but after being bought by Kmart Holding Group what will that name mean?

Hoffman Estates-based Sears, Roebuck and Co. has been based in the Chicago area since the late 1800s and is still the largest department store chain in the country. But it is being bought by the Troy, Mich.-based Kmart in a deal valued at $11.5 billion.

Retail industry analysts questioned the wisdom of combining two companies having trouble increasing same-store sales. Kmart's sales have declined since it exited bankruptcy in May 2003 and Sears has failed to take off since selling its big money maker, the credit unit, in 2003.

Kmart used the increased value of its stock to leverage a buyout of the bigger Sears.

The controller of half of Kmart's shares, real estate billionaire Edward Lampert, has employees and customers alike guessing about his plans for the merged Hoffman Estates-based Sears Holdings Corp.

Will he sell store leases and properties, including the Prairie Stone Business Park in Hoffman Estates, to jump to better earning investments? Will he be able to successfully combine the skills of a discounter with the expertise of a service-oriented, midrange department chain?

With questions unanswered, employees are going into the new year with less of a focus on blue light specials than on caution lights.

Fears of an Identity Crisis for Lands' End at Sears
By Aaron Nathans - New York Times
December 25, 2004

DODGEVILLE, Wis. - Cathy Simplot, a longtime Lands' End customer, said she did not cheer in 2002 when Sears, Roebuck bought the company and was not happy to hear last month that Kmart planned to take over Sears.

"I don't buy clothes at Sears; I buy them at Lands' End," said Ms. Simplot, who was shopping at the company outlet store, just down the street from the sprawling offices of Lands' End. "It's based in a small Midwestern town. I'd hate to see that get lost in the shuffle."

Retail analysts agree that the fit between Sears and Lands' End has been awkward, and with Kmart now in the mix, the clothing line has little to gain and much to lose. Lands' End was a longtime catalog seller that was also a pioneer in Web-based apparel sales. It built a strong following by offering high-quality merchandise like Squall parkas, cashmere sweaters and down vests, a wide range of sizes, and a high level of customer service.

"Lands' End was one of the most brilliant brands of the 20th century, and under Sears, one of the most irrelevant brands of the 21st century," said Burt Flickinger III, managing partner at the Strategic Resource Group, a retail consultant in New York. "Lands' End in the Sears stores is poorly positioned in between men's suits, snow blowers, tools, denim and work clothes."

As for bringing Lands' End products into the Kmart stores, Mr. Flickinger said: "J. Crew, Eddie Bauer and Abercrombie & Fitch would never stand to have their brand image eroded by going down-market to Kmart. Kmart is associated more with a rough-and-tumble blue-collar consumer."

Kmart announced last month that it would buy Sears for $11 billion. The deal is expected to close in March. Sears, Kmart and Lands' End would not comment on what the future holds for the clothing manufacturer once the merger is completed.

Lands' End "continues to be a cornerstone brand for Sears," said a spokeswoman, Lee Antonio. Chris Mordi, a spokesman for Lands' End, referred all calls to Sears, saying only, "Lands' End supports the merger."

Sears, based in Hoffman Estates, Ill., hoped its $1.9 billion purchase of Lands' End would entice customers who were already in its stores buying appliances to buy more apparel. It also gave Sears a readily known brand name to bring in new customers.

From the Lands' End point of view, its merchandise would be accessible to thousands of potential customers at Sears's 870 locations, many in shopping malls. That gave Lands' End an advantage over its main direct competition in the catalog business, L. L. Bean.

But the purchase may have watered down the Lands' End image, and Kmart's takeover of Sears threatens to erode that further, said Stephen Barone, a marketing communications consultant based in Madison, Wis.

"You didn't just buy Lands' End clothes, you selected it," Mr. Barone said. "That creates an exclusivity. Once you begin making the brand instantly available, something you can buy on the way to buying your socket wrenches, you denigrate that exclusivity."

Lands' End features its story prominently on its Web site. Founded by Gary Comer in 1963 in a Chicago basement, Lands' End originally outfitted sailboat racers with equipment and apparel. The company soon moved north to Dodgeville, a farming community that now has 4,220 residents.

Even Sears's chief executive, Alan J. Lacy, has acknowledged that the store has made several missteps in handling Lands' End.

Sears originally ordered too much product from Lands' End, then cut back too far, Mr. Lacy said. Some products came into stores too late in spring. Sears made broad cuts in children's clothing, where Lands' End "didn't quite have the scale yet in their business to really deliver the price value that we wanted to see in our stores," he said then.

In October, Mr. Lacy said third-quarter apparel sales were down, although he said in the summer that profit margins for the catalog and Internet sales of Lands' End were "up nicely."

Charlie O'Shea, a New York-based analyst for Moody's, said of Lands' End: "It hasn't done what I think Sears wanted it to do. The general idea was, take the higher-income demographic, the hard-line appliance shopper, and have them walk across the store and buy apparel. I don't think that's happening."

Some retail analysts have also criticized the scattered placement of Lands' End products throughout the Sears stores. Ms. Antonio, the spokeswoman for Sears, said customers like to shop for clothes within the store's particular departments. "We've been learning from our experience in the store, and tweaking and fixing things as we go. And that will continue."

Richard Donaldson, spokesman for L. L. Bean, based in Freeport, Me., said his company was slowly rolling out its own retail stores, but had no plans to sell through a major retailer. "We have been very methodical and deliberate about getting into retail," he said. Of Lands' End, he said, "It certainly makes for an interesting dynamic, makes the environment ripe for a fair amount of speculation."

One area where Sears has been able to take advantage of Lands' End has been in online retailing, said Carrie Johnson, a senior analyst at Forrester, a technology research company in Cambridge, Mass. Sears used the same company that created the Lands' End "virtual model" to create a "virtual decorator," allowing customers to design their homes online.

That could help Kmart's Web site, but more likely, the larger dynamics of the merger will hurt Lands' End, she said.

"Lands' End is going to be this tiny part of the business that won't get much attention over the next couple of years," Ms. Johnson said. "Sears and Kmart are going to have enough problems defining new brand messaging, determining which stores stay open, and which merchandise mix will be right for this new entity."

Still, there are believers in Lands' End at retail stores. Being able to shop for the clothes in person removes the element of surprise, said Patty Muller of Fitchburg, Wis., who was shopping recently at a Sears in Madison.

"Here, you can test it out before you buy it," Ms. Muller said. Goods from a catalog often look different when they arrive on her doorstep, she said. "Maybe you look at the color, and it isn't exactly what you expected."

Sears Canada Names Interim Replacement for Retiring Chief Financial Officer
Canadian Press
December 24, 2004

TORONTO (CP) - Sears Canada Inc. has named David Merkley to replace its retiring chief financial officer while the retailer continues searching for a permanent replacement. Butcher will take over on at least a temporary basis from John Butcher effective Jan. 1. Sears Canada announced in October that Butcher will retire as chief financial officer and executive vice-president at the end of this year.

Merkley is currently vice-president and corporate comptroller of the corporation. He has been with Sears since 1979 and has held several senior finance positions.

"We have great confidence in David's ability to lead our finance organization through this temporary phase until a new chief financial officer is named," Sears Canada president and CEO Brent Hollister said in a statement.

Hollister succeeded Mark Cohen, who was fired from the company in August. The company recently lowered its profit outlook and has hired an outside consultant to map out a strategy for its future, which could include downsizing.

Sears Canada is one of the country's biggest department store chains. It is 54 per cent owned by Illinois-based Sears, Roebuck and Co., which is in the process of being bought by Kmart.

Clothes Firms Hail Quotas' End
By Sally Beatty - Staff Reporter of The Wall Street Journal
December 23, 2004

Production Costs Should Decline With the Use of Fewer Factories, But Prices Also May Move Lower
 

Those pants you are wearing should cost a lot less to make next month. That's when import quotas on foreign-made apparel are due to expire around the world. It is a development welcomed by the global fashion business, but could create new pressures on U.S. apparel makers.

Elimination of the quota system is expected to reduce apparel costs for U.S. companies by as much as 15%, mostly because big clothing manufacturers will be able to use fewer overseas factories. That should be good news for big American companies such as Liz Claiborne Inc., VF Corp., Polo Ralph Lauren Corp. and Jones Apparel Group Inc.

Manufacturers are salivating over the savings, hoping to translate the windfall into fatter profit margins and better quality clothing, a fast-growing segment of the apparel market.

Still, some on Wall Street are pessimistic about the long-term effects the end of quotas will have on the apparel sector. Import limits are ending at a time of massive oversupply of clothing, which has helped to gradually force clothing prices lower in recent years. Some analysts worry that the expiration of the quota system only will make things worse, exacerbating price declines, maybe not immediately, but certainly over time.

The end of the quota system is a "long-term marginal negative" for the apparel industry overall, Merrill Lynch analyst Virginia Genereux wrote in a research note earlier this year, citing the risk of further price deflation. Ms. Genereux has a "buy" on Polo stock, and "neutral" ratings on Jones Apparel, VF and Liz Claiborne.

"There is a window here where people will capture some extra margins," says Fernando Silva, a vice president of Kurt Salmon Associates, a consulting firm. "But it's not going to last more than 18 months. There is just too much supply around the world."

Not all companies are equally exposed to any falling prices, though. Companies such as Liz Claiborne, Jones Apparel, Polo and VF can use their greater scale and greater proportion of high-end brands to withstand price pressure, says Noelle Grainger, an analyst with J.P. Morgan. She says smaller players, such as Kellwood Co. and Phillips-Van Heusen Corp., could feel pressure to lower prices sooner and more steeply, reflecting their increased exposure to the moderately priced and mass-market retailers, where competition is most intense.

About 74% of Liz Claiborne's revenue comes from "better" priced clothing and other items, according to a J.P. Morgan analysis. Only 30% of Phillips-Van Heusen's business comes from better priced clothing, and only 5% of Kellwood's business. A spokeswoman for Kellwood says the company's better-priced business now stands at 10% of revenue. Ms. Grainger has an "overweight" rating on Jones Apparel and "neutral" ratings on Liz Claiborne, VF, Kellwood and Phillips-Van Heusen.

Under the quota system, in place since the early 1970s, developed markets such as the U.S. and Europe limited how much apparel could be imported from less-developed markets. Certain factories in these less-developed countries, such as China, have quotas that give them the right to export a certain amount of apparel.

Production costs are about 10% higher because apparel makers have to use more factories than they would otherwise, estimates Bob Zane, senior vice president of New York-based Liz Claiborne. The per-item cost of obtaining quota adds an average of about 5% to manufacturing costs, Mr. Zane says.

The system is due to expire Dec. 31, although the impact could be reduced somewhat because China decided earlier this month to levy a tax on some clothing exports. The U.S. also is weighing some temporary restrictions.

About $30.8 billion of imported apparel, or nearly half of all imported apparel, was subject to quotas in the 12 months ended in September 2004, according to the Commerce Department.

Individual companies are affected differently, depending on the type of apparel they make. Only about a quarter of apparel imported by VF is subject to quota, for example, whereas 55% to 65% of apparel sold by Liz Claiborne is subject to quota limits, according to executives at the two companies. VF has a higher concentration of denim and underwear, which it makes in countries subject to fewer or no quota limits. Liz Claiborne, by contrast, makes a lot of its clothing, such as women's jackets, in markets subject to stricter quota limits, such as China.

To import enough apparel, U.S. companies such as VF and Liz Claiborne produce through independent factories in as many as 40 countries. That will change over time once the quota system ends. Liz Claiborne plans to reduce by about half the number of countries in which it operates, says Mr. Zane. VF expects to concentrate the bulk of its production sourcing in just 10 countries in the next few years, down from about 40 today, says Tom Glaser, managing director in charge of global sourcing at VF.

Fewer, better factories should lead to shorter turnaround time, says Peter Boneparth, chief executive of Jones Apparel, increasing the odds that apparel marketers will have the right product in stores at the right time.

Besides sweetening their bottom lines, apparel makers hope to use the cost savings from the end of the quota system to better take advantage of booming demand for luxury goods. "The consumer has voted," says W. Lee Capps III, chief financial officer of Kellwood. "They're saying they want more fashion." To capture a bigger share of the higher-end market, Kellwood, the maker of moderately priced women's brands such as Sag Harbor and Koret, recently has diversified. It acquired the Phat Farm urban label earlier this year and also recently began producing clothing under license for Calvin Klein.

Likewise, Liz Claiborne and Jones Apparel say they intend to invest at least part of any savings in better fabrics or trims, such as nicer buttons or other details, to improve the quality of their offerings.

But the companies haven't given details yet of any plans, saying there is too much uncertainty about the implications of the end of the quota system. "The theory is we will all be more profitable," says Mr. Boneparth of Jones. "But it is an overly simplistic view of the world to say that quota will automatically take everybody's margins up by whatever you had to pay before," he says. Raw-materials prices are going up. "You can't just say, 'By the way, your costs are going to go down by the collapse of quotas.' "

Ultimately, some apparel executives and analysts argue, it will be competition among retailers, not apparel suppliers, that will determine whether companies will succeed in retaining the quota savings, or whether they will be forced to pass that savings on to consumers in the form of lower prices.

As a result, investors so far aren't reacting to the end of the quota system. Apparel stocks tend to trade in line with apparel-sales trends, analysts say. Some of the stocks that stand to benefit the most, such as Liz Claiborne, already have a premium valuation to other apparel stocks.

In general, apparel stocks have outperformed the broader market so far this year, thanks largely to fast sales of colorful new fashions introduced last spring. In 4 p.m. composite trading yesterday on the New York Stock Exchange, Liz Claiborne stock was down two cents at $40.86, near a 52-week high of $42.35. Jones Apparel was down 27 cents at $35.83, near a 52-week low of $33. VF was down 19 cents at $54.01, near a 52-week high of $55.29. Polo Ralph Lauren was up 44 cents at $39.66, just below a 52-week high of $40.94.

Still, there may be some opportunities. David Griffith, a senior analyst with Tradition Asiel Securities, has a "buy" rating on Jones Apparel, which is expected to benefit from the end of the quota system. The company, which has a market capitalization of about $4.4 billion, only recently has entered the luxury business through its acquisition last month of upscale retailer Barneys New York.

Its stock, which has been hurt lately by weaker sales of footwear and questions about the Barneys acquisition, is trading at a multiple of about 12 times 2005 estimated First Call consensus earnings. That compares with multiples of between 13 for Liz Claiborne and 14 for Polo. In contrast, a smaller apparel company such as Kellwood, whose stock has been hurt lately by weak sales of moderate apparel, trades at a multiple of 11.

Kmart, Sears Withdraw Hart-Scott-Rodino Filings
DOW JONES NEWSWIRES
December 22, 2004

TROY, Mich. -- Kmart Holding Corp. (KMRT) and Sears Roebuck & Co. (S) voluntarily withdrew their filings with the Federal Trade Commission, which has requested more time to review the $11.5-billion merger in light of the holiday season.

The retailers will resubmit the filings, called the Hart-Scott-Rodino Notification and Report Forms, by Dec. 28. The companies said they are confident the merger will get antitrust clearance without delay and maintained their early-March target for the deal's closing.

Kmart and Sears now expect the FTC review period to expire in January 2005.

Kmart's proposed acquisition of Sears can be terminated by either party if the deal doesn't close on or before June 1, according to a November regulatory filing.

That walkaway date, included in the merger agreement filed with the Securities and Exchange Commission, is conditioned on several factors, including the receipt of regulatory approval.

Kmart Losing its Exclusive Deal to Sell
Sesame Street Clothing
By Sandra Guy - Business Reporter - Chicago Sun-Times
December 22, 2004

Sesame Street's children's clothing will no longer be sold exclusively at Kmart starting in July, dealing a potential blow to Kmart's plans to leverage its proprietary brands with Sears, Roebuck and Co.

Sesame Workshop, the nonprofit educational organization that runs Sesame Street, has yet to determine if it will set up an exclusive arrangement with another retailer or sell the clothes at a variety of stores, a spokeswoman said Tuesday.

The decision will mark the end of Kmart's seven-year reign as the exclusive retailer selling Sesame Street's newborn, infant and toddler apparel, featuring such well-known characters as Elmo, Big Bird and Cookie Monster.

The decision was mutual, said spokesmen for Kmart Holding Corp. and Sesame Workshop.

Kmart and Sears have touted their proposed $11 billion merger as a way for each retailer to sell the other's exclusive brands. Kmart has Joe Boxer underwear and Martha Stewart Living home decor, while Sears sells Kenmore appliances and Craftsman tools.

However, Sesame Workshop could still decide to sell its children's clothing at Sears stores in the future, and it already sells its Latino apparel line, Plaza Sesamo, at Sears.

A Kmart spokesman said Kmart will continue to sell "certain apparel items" from Sesame Street.

Beatrice Chow, spokeswoman for the New York-based Sesame Workshop, said, "We are opening up the market for ourselves."

"As to who else we might be partnering with, when and where, I have no details," Chow said.

The manufacturer of the Sesame Street children's clothing will change when Kmart loses its exclusivity. No one would confirm the identity of Kmart's manufacturer.

The new manufacturer will be Children's Apparel Network, which makes Sesame Street's Latino apparel line.

Sesame Street also announced that it will introduce two new apparel lines at a fashion trade show in February -- Sesame Beginnings featuring baby versions of Sesame Street characters, and Sesame Street by Nicole Miller.

One retail consultant said Tuesday that Sears can live without Sesame Street.

"Sesame Street is a good brand, but it's certainly not a world-beater brand," said Neil Stern, senior partner at Chicago-based retail consultancy McMillan Doolittle. "Sears already has a fairly strong lineup" in the children's department with apparel brands such as TKS, Gerber and Carter's, and a limited selection by Lands' End.

"When you start playing mix-and-match with the brands, the only sure-bet Kmart brand that would transfer to Sears would be Martha Stewart," Stern said.

How Ex-con Martha Can Aid a Merged Sears-Kmart Merger
By Sandra Guy - Business Reporter - Chicago Sun-Times
December 22, 2004

Martha Stewart must be spending parts of her days in prison busily nit-picking every detail of her new homemaking TV show. The show, complete with a live audience, is slated to debut in September.

While Martha is planning, Kmart's $11 billion acquisition of Sears Roebuck and Co. is expected to move ahead, though analysts still speculate that a rival bidder may yet emerge.

If the merger of the two hobbled retailers succeeds, Sears likely will start selling Martha Stewart Everyday merchandise, ranging from paint to bath towels to a ready-to-assemble furniture line.

How could Martha spin Sears when she reappears on air?

* The Softer Slide. Martha uses her new-found experience with wearing orange jumpsuits to introduce a brightly colored yet tasteful clothing line to help boost Sears' struggling women's apparel section.

* Dirt to Dazzling. Martha devotes a section of her TV show to demonstrating how Sears can transform Kmart's notoriously dirty and dingy stores into Sears "Baby Grands," stand-alone stores that sparkle and show off the latest in window treatments.

* Tool Housekeeping. Martha discovers Sears' manly "Tool Territory," and uses the hot new PLS Laser Level to prepare the perfect souffle.

* Tie up Ty. Martha's lonely. So she invites Sears hunky spokesman, Ty Pennington, onto her show, a la Ellen DeGeneres, to demonstrate how adorable he is.

* Crafts-man. Martha puts new meaning into Sears' proprietary Craftsman tool brand by using a Craftsman drill to more securely and accurately fasten a bow onto a holiday wreath.

* The Kenmore Difference. Martha points out that she uses only the Kenmore electric, no-stick, free-standing range with radiant elements to cook up a stew. She stores it in the Kenmore Elite Convertible Refrigerator/Freezer.

* Lands' Up. Martha shows off her preppy style by modeling Lands' End clothing.

* Washed-Up. At the end of each show, Martha shows off a new set of Sears washers and dryers, in which she tosses her dirty towels and tablecloths.

* Discount Diva. Martha uses her expertise in getting by on 12- to 40-cents-an-hour prison pay to advertise the latest Sears coupons and specials.

**The next Warren Buffet? Martha retrieves her hard-won knowledge about stock transactions to trade a "Stock Tip of the Day" with Kmart/Sears Chairman Eddie Lampert.

Insider Transactions
Thomson Financial - Chicago Tribune
December 20, 2004

Listed below are insider transactions of 1,000 shares or more for the Chicago area's largest publicly traded companies as filed with the Securities and Exchange Commission. Insiders are officers, directors or owners of 10 percent or more of a corporation's stock.

Sears Roebuck and Co.:
Sara Laporta, officer, exercised an option for 20,000 shares at $21.64 to $23.85 each on Dec. 6 and sold 20,000 shares at $53.21 to $53.30 each on Dec. 6.

Glenn R. Richter, officer, exercised an option for 50,000 shares at $44.53 each on Dec. 6 and sold 50,000 shares at $53.21 to $53.30 each on Dec. 6. Janine M. Bousquette, officer, exercised an option for 45,000 shares at $44.53 each on Dec. 6 and sold 45,000 shares at $53.40 to $53.42 each on Dec. 6.

William C. White III, officer, exercised an option for 69,800 shares at $21.64 to $44.53 each on Dec. 3 and sold 69,800 shares at $52.32 to $52.35 each on Dec. 3.

Robert J. O'Leary, officer, exercised an option for 25,000 shares at $33.20 to $44.53 each on Dec. 2 and sold 23,700 shares at $52.80 each on Dec. 2.

Michael James Graham, officer, exercised an option for 25,000 shares at $44.53 each on Dec. 2 and sold 25,000 shares at $52.01 to $52.24 each on Dec. 2.

Mindy Conover Meads, officer, exercised an option for 25,000 shares at $44.53 each on Dec. 3-6 and sold 25,000 shares at $52.50 to $53.25 each on Dec. 3-6.

What's in Store for Lands End?
Some analysts think it would be better off on its own
By Doris Hajewski - Milwaukee Journal-Sentinel
December 20, 2004

Lands' End is a great brand that might be better off if it wasn't part of Sears, some retail industry watchers are saying.

A spin-off of the Dodgeville catalog business into a separate company could be a welcome outcome of Kmart Holdings Corp.'s proposed acquisition of Sears, Roebuck and Co., one camp says. The other - which includes Sears - believes Lands' End could add value to the merged operation if it remains in the fold. "I think that will be good for Lands' End to be its own public company," said James E. Schrager, a clinical professor of entrepreneurship and strategy at the University of Chicago Graduate School of Business. "Lands' End was a wonderful company that Sears has done absolutely nothing for."

But Chris DuBois, a senior manager with Ernst & Young's Milwaukee office, said he'd hate to see Sears sell off Lands' End.

"Sears could keep it and make it work. There's a lot of upside to it."

Sears has given no indication that Lands' End will not be a part of Sears-Kmart after the transaction closes next spring.

Still, speculation about a possible separation of Lands' End continues to mount.

Possible methods for separating Lands' End from its parent company include a sale, a leveraged buyout by Lands' End management or a public stock offering.

No one, however, has come up with the name of a possible buyer for the catalog business.

Some analysts say Sears' 2002 acquisition of Lands' End was a mistake that may be undone as a result of Kmart's anticipated acquisition of Sears for $11.5 billion.

Sears bought Lands' End as a way to boost sales on the soft side of the store.

The Lands' End customer profile was a good fit with the demographics of buyers of Sears appliances and tools, and Sears aimed to use the preppy brand to lure those affluent shoppers to the apparel and home goods departments.

"In hindsight, it has been an acquisition that hasn't worked," said an equity analyst who asked for anonymity.

Sears has had a tough time attracting new customers to buy the brand in its stores, he said. And the longer the brand is sold at Sears, the greater the risk of cheapening it.

"It's a strong company, still," said Jan Owens, assistant professor of marketing at the University of Wisconsin-Parkside School of Business and Technology.

But Sears blew the opportunity with the way it's marketed Lands' End, Owens said.

It underestimated the interest that middle-class America would have in buying Lands' End fashions at Sears, and then didn't stock enough styles, Owens said.

"When you did go in, it was so skimpy, why bother?" she said.

Sears announced recently that Lands' End merchandise is selling well in Sears' top 300 stores, but was lagging at the bottom 300.

"We're being more strategic about what we put there," Sears spokesman Chris Brathwaite said of the underperforming stores.

When the Sears-Kmart deal was announced a month ago, Sears Chairman Alan Lacy said the transaction could result in the conversion of hundreds of Kmart locations into Sears Grand stores, a new off-mall format that the company has been testing at various locations across the country.

It is too early to say what the stores will look like after the transaction with Kmart is completed, Brathwaite said, and way too early to speculate on the future of the Lands' End brand.

"Lands' End is a very important brand for Sears. As a company, we're excited about the possibility of a Sears-Kmart merger and what it can mean for consumers."

Kmart Store Sites Picked Over
By Susan Chandler and Geoff Dougherty - Tribune staff reporters
Chicago Tribune
December 19, 2004

The retailer sold a chunk of its stores, enabling it to buy Sears. But the prime real estate is gone and remaining assets may be short on value.

It's one of the most amazing corporate comeback stories in recent history: Only 18 months out of bankruptcy, Kmart Corp. launches an $11 billion takeover offer for Sears, Roebuck and Co.

Where did Kmart get the dough?
Most of it came from the company's stock, which soared this summer after Kmart announced the sale of fewer than 100 Kmart stores to Home Depot and Sears for as much as $910 million. That amount exceeded the value placed on all the company's real estate in bankruptcy court.

Investors used that premium price to value the rest of Kmart, giving Kmart Chairman Edward Lampert the purchasing power to pull off the Sears deal.

But a Tribune analysis of Kmart's remaining 1,400 stores indicates that Kmart's real estate may be far less valuable than Wall Street thinks.

The Kmart stores sold to Home Depot and Sears weren't representative of the overall portfolio because they were located in more affluent communities than the average Kmart store, the Tribune analysis shows.

For instance, the stores sold to Home Depot were located in areas with average household incomes of almost $65,000. Kmart's remaining stores are found in places where the average household income is below $52,000.

In ZIP codes where Kmart stores are situated, 21 percent of households earned less than $20,000 a year and almost 50 percent earned less than $40,000.

"Kmart has the oldest and poorest customers of any discount store," said Howard Davidowitz, chairman of Davidowitz & Associates, a retail consulting and investment banking firm based in New York.

"They sold the cream [of their stores]. That's what I tried to tell people. Never in retail history has a retailer who wanted to stay in business sold their good stores."

A Kmart Corp. spokesman declined to comment on the Tribune's findings.

Carol Levenson, a debt analyst with Gimme Credit, doesn't pretend to understand how the stock market is valuing Kmart these days. But she notes that publicly available information about property ownership and lease terms is so sketchy it is almost impossible to put a price on a retailer's real estate portfolio.

Real estate executives who specialize in retail workouts agree that valuing a portfolio as big as Kmart's is fraught with the potential for large errors.

It's not a simple institutional investment, they say, because stores in a single retail chain may vary widely in size and have vastly different lease terms, including landlord rights. Finding new tenants for old retail space is a store-by-store slog that can take years.

Other retail experts say it is highly unlikely Kmart's remaining stores would fetch anywhere near the premium of those already sold.

At Kmart, more than 90 percent of its stores are leased, far more than most department store chains, which tend to own their real estate.

While Kmart's long-term leases with below-market rents may have value to others, the leases become less valuable the longer Kmart occupies the properties.

The Tribune's analysis shows that a third of Kmart's store leases will expire within the next two years, although it's unclear what options to extend those leases Kmart holds. A spokesman would not comment on that issue.

"Every day that Kmart is around, the leased stores are all losing value," said David Neff, a Piper Rudnick attorney who represented Kmart's creditors in the bankruptcy proceedings.

Besides, not all of Kmart's leases are at below-market rents, real estate and retail experts say.

"My guess is they already have been looked through pretty aggressively by companies, and there aren't that many of [the good ones] left," said Neil Stern, a retail consultant with Chicago's McMillan/Doolittle. "I don't know there's that much gold to tap into there."

Another hurdle for Kmart is that its stores aren't a good fit for other retailers.

"A hundred thousand square feet--it's a 'tweener size," said Allen Joffe, principal with Baum Realty Group, a Chicago real estate firm specializing in retail properties. "Home Depot is much bigger and Kohl's is much smaller."

Liquidation appeared to be Lampert's game plan when he began buying up the debt of Kmart for pennies on the dollar while the company was in Chapter 11.

Lampert is a value investor, which means he looks at underperforming companies and out-of-favor industries for bargains. His hedge fund, ESL Investments Inc., has taken large stakes in several retail companies, including AutoZone, which sells auto parts, and AutoNation, which sells new and used cars. In 2002, Lampert became the single largest shareholder in Sears, the nation's fourth-largest general merchant.

Lampert not averse to risk
His biggest bet by far, however, has been Kmart, the nation's third-largest discount chain, which filed for bankruptcy court protection from creditors in January 2002.

During bankruptcy, an analysis prepared by its former management and an outside firm estimated its remaining 1,500 stores, 16 distribution centers and fixtures would fetch only between $593.4 million and $879.0 million if they all went on the market at once as part of a Kmart liquidation sale.

That would have been a real Blue Light Special; Kmart had listed more than $6 billion in real estate and fixtures on its balance sheet when it entered bankruptcy.

Spending less than $1 billion, Lampert was able to take a controlling position in Kmart debt during its reorganization. Kmart's debt was converted into equity when the company emerged in May 2003, leaving Kmart nearly debt-free.

ESL emerged with a 53 percent stake in Kmart's new equity, and Lampert became Kmart's chairman. Kmart's old stock was cancelled and those shareholders got nothing.

"Nobody twisted the previous owners' arms to sell out on the cheap, but that's exactly what they did," said Jeffrey Maillet, a principal with Noble Asset Management in Chicago, which owns both Kmart and Sears shares.

"Lampert went in and saw the immense level of value. Some people have the capability to see the forest for the trees, and Lampert is a master," Maillet said.

At first, Lampert took steps that looked like he was only interested in keeping the company alive long enough to avoid a fire sale of assets.

He cut back on inventory levels and slashed capital spending on new stores and remodels. By the fiscal fourth quarter of 2003, Kmart was back in the black for the first time in years.

Then, in August, Kmart disclosed that the board had given Lampert permission to invest the company's cash in non-retail businesses.

Investors who had ridden Lampert's coattails to big gains in Kmart stock were ecstatic that he would use the company's cash and tax credits to invest in faster-growing non-retail businesses. Within a few months, Lampert was crowned the new Warren Buffett by BusinessWeek magazine.

Some keep their distance
While Kmart's stock was soaring, its core business was suffering. Sales at Kmart stores fell by double-digits every quarter this year, a dramatic falloff that shrinks Kmart when powerful rivals Target Corp. and Wal-Mart Stores Inc. continue to expand.

Kmart should have been an ideal investment for George Putnam, editor and founder of "The Turnaround Letter," a Boston newsletter that analyzes bankruptcies and turnaround situations. Putnam, who specializes in analyzing the hidden value of a company's assets, does more than give advice. When he finds a promising play, he invests in it.

Putnam looked at Kmart stock when it was $30 a share and then again at $50 a share and took a pass both times.

"It's the kind of stock we would like to recommend," Putnam said. "But I could never get comfortable with the valuation even at much lower levels."

When the store sales to Home Depot and Sears were announced, Putnam got out his financial models again, but the calculations still didn't make sense.

"We looked at the price per store from the Home Depot deal and the Sears deal. The only way you get anywhere close [to Kmart's market value] was if you assumed that Home Depot and Sears were buying the worst stores and Lampert was being left with the best," Putnam said. "And that wasn't logical."

The speculation that Lampert intended to diversify out of retailing ended Nov. 17, when Kmart announced it was acquiring Sears for $50 a share in cash and stock, pending regulatory and shareholder approvals.

The speculation about the hidden value of retail real estate only got hotter.

Sears owns or has long-term leases on its 870 department stores around the country, many of which are located in the best shopping malls. The Hoffman Estates-based retailer counts an additional 1,100 U.S. specialty stores among its holdings, as well as department stores in Canada.

Kmart name likely to fade
While the deal helps answer the question of what will become of hundreds of Kmart stores--they will be converted to Sears stores--it doesn't provide an answer to what will happen to the bulk of Kmart locations, many located in less-than-attractive areas.

Kmart says the new company will operate under both the Kmart and Sears banners, but retail experts say that is extremely inefficient. It's more likely, they add, that the Sears deal is a way to liquidate Kmart over a longer period of time.

After the Sears deal was unveiled, Kmart's stock hit an all-time high of $119 a share. Since then, it has drifted down to just over $100.

It doesn't take a lot of buying to push the stock up, investment experts note, because Kmart's float isn't very large and more than half of its stock is held by ESL and Lampert, making it fairly illiquid.

Meanwhile, some top-level Sears executives are bailing out of Sears stock, which now trades in tandem with Kmart's.

More than $30 million in Sears shares have been sold by at least eight top company executives since the deal was announced in mid-November. Publicity surrounding the sell-off prompted Sears to issue a letter to employees this month saying that the stock sales don't indicate a lack of confidence in the combined company's prospects.

Some skeptics compare Kmart's still lofty valuation to the Internet bubble in the late 1990s. Eventually, though, investors ran out of patience with highfliers such as Webvan, Pets.com and EToys Inc. when significant profits failed to materialize.

For Lampert, investor confidence is critical. If Kmart stock falls below $100 a share before the end of March when the Sears deal closes, Sears shareholders would end up with less than the $50 per share price they expect based on the 2-1 stock ratio laid out in the merger agreement.

A lot of short sellers are still betting that Kmart stock will fall to earth eventually. Almost 25 percent of its shares are sold short in early November, the latest figure available, an usually large amount that means investors are hoping to profit by selling Kmart shares now and buying them back for less at a later date.

But so far, the shorts have been wrong and Lampert has been racking up billions of dollars in profit on his Kmart holdings.

"Investors are always looking for the next hot stock, and sometimes they will buy a story without doing the analysis," notes Putnam, the turnaround investor. "Their memories are short."

- - -

How we analyzed Kmart's real estate
The Tribune's examination of Kmart real estate is based on a court filing containing the address of each store leased by the retailer when it emerged from bankruptcy in May 2003. The newspaper then combined that information with income data by ZIP code from the 2000 Census.

The analysis does not include stores that are owned, rather than leased, by Kmart. It may also include non-store properties leased by Kmart, and properties Kmart has relinquished since emerging from bankruptcy.

Kmart declined to provide a current list of store locations, but more than 90 percent of Kmart stores are leased, and a spokesman said the retailer has disposed of only a handful of properties since emerging from bankruptcy.

Retirees Are Paying More for Health Benefits, Study Says
By Robert Pear - New York Times
December 15, 2004

WASHINGTON, Dec. 14 - Retirees who receive health benefits from their former employers saw premiums shoot up an average of 25 percent this year, a new study says.

The study, issued Tuesday by the Kaiser Family Foundation and Hewitt Associates, showed a continued erosion of retiree health benefits among large employers.

Companies are requiring retirees to pay a larger share of premiums and other health costs. While continuing to provide coverage for people who have already retired, about 8 percent of large private employers took action in the last year to end all subsidized health benefits for future retirees, and another 11 percent said they would do so next year.

"Prospects for retiree health coverage are slowly disappearing for America's workers, and retirees who have it will be paying more," said Drew E. Altman, the president of the Kaiser Family Foundation, which conducted the study with Hewitt, a benefits consulting firm.

Asked about Mr. Altman's assessment, Kate Sullivan Hare, executive director of health care policy at the United States Chamber of Commerce, said: "That's absolutely true. I can't disagree." The chamber represents businesses of all sizes.

New hires, in particular, are less likely to receive any promise of retiree health benefits. That trend has significant implications not only for young workers, but also for middle-aged employees who want to change jobs but feel they cannot sacrifice health benefits.

"That really alarms me, the fact that some people stay in jobs because of the health benefits, not because of the job," Ms. Sullivan Hare said.

In an effort to rein in drug costs, employers increased co-payments for prescription medicines, required retirees to get prior approval for certain drugs or insisted that retirees use mail-order pharmacies.

The survey examined benefits at 333 large companies with 1,000 or more employees. The companies, which include one-fifth of the Fortune 500, provide health benefits to 4.9 million retirees and spouses.

For companies providing retiree health benefits, costs increased an average of 12.7 percent this year, the study said.

A typical worker under age 65 who retired this year paid $2,244 annually in health premiums - 27 percent more than a similar worker who retired in 2003, the study said.

For a typical worker 65 or older who retired this year, the annual premium for health benefits was $1,212, about 24 percent higher than the comparable figure for 2003. Medicare, the federal health insurance program, covers most medical costs for these older retirees. But most workers retire before reaching 65.

Noting the sharp rise in retiree premiums, Mr. Altman said, "Employers tell us to expect more of the same next year."

An employer's power to cut retiree health benefits depends on the terms of the documents that establish a health plan. Courts have generally said that if an employer explicitly reserves the right to reduce or eliminate health benefits, it can do so.

The new Medicare law may stop the erosion of drug benefits at least temporarily, the study said. Most employers in the survey said they were likely to continue offering drug benefits to retirees 65 and older because the companies could get federal subsidies under the new law. Eighty-five percent of these employers said they would probably retain current levels of drug benefits, which are more generous than the standard Medicare drug benefit.

"Employers are signaling their intent to stay the course, at least in 2006," said Frank B. McArdle, manager of Hewitt's Washington research office.

But Mr. McArdle added, while employers intend to continue drug benefits in 2006, they could increase the employee's share of the cost for drugs or other medical benefits.

In the new law, Congress provided subsidies to encourage employers to continue providing drug benefits to retirees. Medicare is expected to spend $71 billion on such subsidies from 2006 to 2013. To qualify for assistance, an employer must certify that its retiree drug benefits are worth at least as much as the standard Medicare drug benefit.

Gary R. Karr, a spokesman for the federal Medicare agency, said the data on employers' intentions showed that "the new law is working as Congress intended." Senator Charles E. Grassley, Republican of Iowa and an architect of the legislation, said, "We sought to stem the downward trend in the availability of retiree drug benefits, and the survey is a good sign that we're accomplishing that goal."

Among employers in the survey, 79 percent said they increased premiums for retiree health benefits this year and 45 percent increased co-payments for a range of health care services. In addition, 53 percent of employers increased co-payments specifically for prescription drugs.

The typical co-payment is $10 for a month's supply of a generic drug, $20 for a brand-name product on a list of preferred drugs and $35 for other drugs.

Ms. Sullivan Hare said the cutbacks in retiree benefits came as employers were struggling to provide coverage to active workers.

The long-term trend is clear. Among employers with 200 or more workers, Kaiser said, 36 percent offered retiree health benefits this year, down from 66 percent in 1988.

Analyst Sees Home Depot, Lowes as Sears Bidders
By Sandra Guy - Business Reporter - Chicago Sun-Times
December 15, 2004

An analyst speculated Tuesday that Lowe's or Home Depot could emerge as a viable rival to Kmart Holding Corp. in its bid to acquire Sears Roebuck and Co.

The home-improvement chains covet Sears' proprietary brands, primarily Craftsman tools and Kenmore appliances, and could jettison Sears' "softer side," said Craig R. Johnson, president of Customer Growth Partners, a New Canaan, Conn.-based consulting firm.

Though department-store companies such as May and Federated could make a play for Sears, a home-improvement retailer makes a more compelling case, Johnson said.

"Whether it's Home Depot that wants to solidify its strong position, or Lowe's seeking to jump from No. 5 to No. 2," the idea is plausible, he said.

Both retailers have the necessary market capitalization and financial wherewithal to make a play for Sears, the market leader in home-appliance sales with 37.6 percent of the $36 billion market in 2003. Sears sells the country's top six appliance brands. In 2003, Lowe's held a 14.1 percent market share and Home Depot followed with a 6.2 percent market share. Sears' market share has slipped from 41 percent in 2001.

A home-improvement retailer would likely sell or spin off Sears' apparel and other "soft lines" businesses, Johnson said.

The new speculation about a Sears suitor coincided with a separate analyst's report that Vornado Realty Trust, owner of the Merchandise Mart in Chicago and shopping centers nationwide, might be better off taking the money it's made from its Sears investment and running.

Analysts have speculated that Vornado, a New York-based real estate investment trust, would challenge Kmart by making a counter-bid for Sears. Vornado has had no comment on the speculation, or about why it bought 1.2 million shares of Sears and acquired an economic interest in another 7.9 million.

Gimme Credit, an independent research firm in New York, said in a report Tuesday that a deal to beat Kmart's $11 billion bid for Sears would hurt Vornado's debt rating and prove too rich for its own good.

"Given (Vornado's) reluctance to overpay for assets, we would not be surprised to see Vornado pocket its gain -- in excess of $100 million -- on the Sears investment, and focus on other opportunities," according to the Gimme Credit report.

If Kmart remains the winning bidder, Sears' top executives stand to win big. CEO Alan Lacy is set to receive a 50 percent increase in salary, to at least $1.5 million from $1 million last year, as well as stock and stock options in the combined Kmart-Sears company, Sears Holdings Corp.

Retirees May Lose Paid Drug Benefits
Study: 8% of firms to drop coverage
By Bruce Japsen and Barbara Rose - Tribune staff reporters - Chicago Tribune
December 15, 2004

Hundreds of thousands of retirees with company-sponsored drug coverage may lose their employer-paid benefit when the new Medicare drug law takes effect in 2006, a new study suggests.

A Kaiser Family Foundation and Hewitt Associates report released Tuesday showed that 8 percent of major employers surveyed planned to drop drug coverage to economize in an era of double-digit cost increases for retiree health benefits. In 2004, the survey found, employer-paid premiums rose 12.7 percent on average for retiree health benefits.

Hewitt and Kaiser's study surveyed 333 companies that provide benefits to 3.5 million Medicare-eligible retirees and spouses--nearly 30 percent of the 12 million-plus retirees and spouses covered by employer plans.

In the survey sample, the firms dropping drug benefits provide coverage for about 4 percent of retirees over age 65, or more than 100,000 retirees, Lincolnshire-based Hewitt said. Extrapolating that percentage to the 12 million-plus retirees suggests that 480,000 people age 65 and older could lose employer-paid drug coverage.

"This is the third year of double-digit cost increases in the three years of the survey for total employer and retiree health-care costs," said Frank McArdle, manager of Hewitt's Washington office. "Some of these companies who say they are going to eliminate drug coverage may have been looking at this option for several years."

The study showed that escalating health-care costs result in companies shifting more costs to retirees, who pay even higher premiums and co-payments.

For example, a typical worker under age 65 retiring in 2004 would pay $2,244 a year in premiums--24 percent more than a worker who retired in 2003. Meanwhile, a typical Medicare-eligible retiree would pay $1,212 annually in premiums, up 27 percent in 2004, the survey found.

Dropping the drug benefit is one way companies can reduce costs, and more appear to be considering that option for 2006, when the new Medicare drug benefit comes online. In the survey, 8 percent of companies said they are considering dropping drug coverage at that time.

Under the new Medicare law signed last year by President Bush, companies that continue to provide drug benefits to Medicare-eligible employees are eligible for a tax-free government subsidy. Fifty-eight percent of companies surveyed said they are likely to continue to offer prescription drug benefits and accept the subsidy.

Nearly 70 percent of employers said their company's current prescription drug benefit is more generous than the standard Medicare benefit, which is expected to offer seniors about $1,600 in annual drug benefits after they pay a $400 annual premium, according to McArdle. By comparison, employer-paid retiree drug plans provide about $2,000 a year in pharmacy benefits, McArdle said.

"By and large, employers are providing generous drug coverage," he said. "For the most part, these benefits are richer in value than what Medicare would provide under the standard benefit."

Findings worry retirees

Retirees who lobbied against the Medicare revamp, fearing the loss of their employer-paid drug plans, were not reassured by Hewitt and Kaiser's findings.

"I have a big question mark on it," said James Norby, president of the National Retiree Legislative Network, citing last year's study by the Congressional Budget Office estimating that 3.8 million retirees would see their employer coverage reduced or discontinued.

Norby also was critical of the government's plan to offer $89 billion in subsidies to encourage employers to continue their plans.

The government subsidies "have the added effect of taking a commitment that employers made and dumping it on taxpayers," Norby said.

Retirees fear the subsidies will encourage companies to continue to shift costs onto retirees because companies are reimbursed on the amounts retirees pay, as well as the company's contributions.

Employers are eligible to be reimbursed for 28 percent of a portion of retiree's drug costs, regardless of who pays.

For employers, drug costs are a major concern because they represent a large portion of escalating health-care costs for retirees over 65.

General Motors Corp. recently reported that its health-care costs are running higher than anticipated this year, making it likely GM will exceed its projected $3.4 billion in cash payments for retiree health care.

"We're spending more than we thought we would, in large part because of prescription drugs," said spokeswoman Toni Simonetti.

The company, which offers benefits to about 1 million retirees and their spouses, reported that the Medicare drug benefit reduced 2004 expenses by about $150 million per quarter. Even though the subsidies will not be paid until 2006, companies were permitted to book the value of their anticipated payments starting last year.

GM's benefit, while significant, "doesn't come close to offsetting the escalation in our health-care costs," Simonetti said.

The company estimates its total health-care liability for retirees, based on their average lifetime expectancy, is $65 billion. The Medicare drug benefit is expected to reduce the total liability by $4 billion, or about 6 percent.

Lucent Technologies Inc., the telecom equipment-maker, recently reported it expects to receive a subsidy for drug benefits of about $60 million in 2007, although the company cautioned that final regulations could change the estimated effect.

The company also anticipates the new Medicare law will reduce the cost of providing benefits by about $90 million because some retirees are expected to opt out of Lucent's plan in favor of less-expensive Medicare coverage.

Lucent, with about 125,000 retirees and spouses, recently reached an agreement with its unions calling for higher co-pays on prescription drugs.

More than 50 percent of the companies surveyed by Hewitt and Kaiser increased co-payments for prescription drugs in the last year, and 49 percent expect to follow suit in the coming year.

Nearly 80 percent increased retirees' contributions for premiums, and 85 percent expect to do so next year.

Discounting at Sears Stirs Apparel query
Analyst suggests excess inventory
By Becky Yerak - Tribune staff reporter - Chicago Tribune
December 15, 2004

To lure holiday shoppers, Sears, Roebuck and Co. has dangled deals ranging from free $10 gift cards for early birds to $450 price tags on 20-inch liquid crystal display televisions originally $600.

But have the crowd-pleasing bargains been part of a grand plan by the Hoffman Estates-based retailer to rid itself of unwanted clothing inventory?

That's what one Wall Street analyst suggested Tuesday during a conference call about this year's uneven holiday season.

Daniel Barry of Merrill Lynch noted that Sears seems to be discounting more than many other retailers.

"My guess is that their sales are pretty good, even though they're doing it, in part, because their inventories are out of line," he said.

At the end of Sears' disappointing third quarter, its inventories were up 2.5 percent and its sales were down 2.4 percent, Barry said. Clothing sales fell more than 7 percent.

"So we think they're running all these promotions to get rid of excess apparel," Barry said.

At the time, Sears ratcheted down fourth-quarter sales expectations. Sears said it canceled some shipments to keep goods from piling up during the holidays. But the retailer cautioned that shipments, particularly apparel, would still exceed what Sears expected to sell in the fourth quarter.

"As a result, we're prepared to employ a clearance strategy on slower-moving items should it become necessary," said Glenn Richter, chief financial officer.

On Tuesday, Barry guessed it has become necessary, and even though Sears' holiday sales appear to be brisker than those of some other retailers, "they're giving the store away, so to speak," he said.

Heading into the holidays, Sears tripled the number of items on sale and gave out $10 gift cards. It worked, attracting crowds twice the size of last year's. Sears' sales on the day after Thanksgiving rose 25 percent over the same day a year ago, the company said Tuesday.

The following weekend, deals largely mirrored the kind offered a year ago. Last weekend, however, new doorbusters helped generate better traffic.

Spokesman Chris Brathwaite said that many of the retailer's departments are offering doorbusters and it's not designed to move excess clothing in particular.

"Particularly during the holidays, we want to win the Saturdays," Brathwaite said.

Apparel and accessories account for a quarter of Sears' sales, estimates Prudential Equity Group.

Separately, Sears said in a regulatory filing Tuesday that its 2005 long-term incentive plan, approved Dec. 8, will be canceled if its merger with Kmart Holding Corp. is consummated. Employees eligible for the incentives include Chief Executive Alan Lacy and his direct reports. No incentives have been granted this year.

A Shopper Never Stops
By Robert Johnson - New York Times
December 12, 2004

Like many other people in this holiday season, Arthur C. Martinez is ready to shop till he drops. For him, though, shopping is a year-round passion.

"You can take the boy out of the store, but you can't take the store out of the boy," said Mr. Martinez, the retired chairman and chief executive of Sears, Roebuck.

That's fine with his wife, Elizabeth, who does most of the buying while he spends time inspecting how different stores do everything from allocating shelf space to designing window displays. "It's a busman's holiday kind of thing," said Mr. Martinez, who took early retirement from Sears in 2000, when he was 60, after running the company for five years; he now lives in Greenwich, Conn.

Perhaps his biggest claim to fame came in the early 1990's, when sales at Sears were flagging. Back then, when he was in charge of merchandising, Mr. Martinez introduced the "Softer Side of Sears" advertising campaign, which succeeded in attracting more women as customers. Still, just before his retirement, analysts were expressing displeasure with his growth strategies.

On a recent vacation to China, Mr. Martinez said, he and his wife were dazzled by the growth of retailing there. In particular, he noticed the expansion of a Sears competitor that had outflanked him in the United
States: Wal-Mart.

"The fascinating thing to me on our trip was to see China as a market of awesome size," he said. "There's a huge middle class, and the energy there is incredible."

Mr. Martinez declined to comment on the recently proposed merger of Sears and Kmart - on grounds that he wishes to avoid second-guessing current management.

He is still in big demand as a corporate director, serving on the boards of PepsiCo, International Flavors and Fragrances, ABN Amro of the Netherlands and Liz Claiborne Inc.

"Liz Claiborne gives me an excuse to keep my nose in retailing, which I just love," he said.

He and his wife are planning a vacation to India in February, "to experience the culture." High on their activities list, of course, are shopping expeditions.

Dangerous liaison?
Fate of Sears-Kmart merger will depend on how well they expand the customer base
By Anne D'Innocenzio and Herbert G. McCann
The Associated Press - Kansas City Star
December 12, 2004

It didn't take long for skepticism to set in after Kmart Holding Corp. and Sears Roebuck and Co. announced their $11 billion takeover. Kmart's stock has fallen by about $5 a share amid growing doubts that the marriage of two laggard retailers can succeed.

But one statistic stands out as evidence that the deal may prove to be a master stroke for Kmart chairman Edward Lampert, the 42-year-old hedge fund manager who engineered the merger: 48 percent of Americans who shop at Sears and other mall retailers never set foot in the stores of discount retailers such as Kmart, Wal-Mart or Target.

That means merchandise with strong brand equity now sold exclusively at Kmart - including Joe Boxer and Jaclyn Smith clothing and the Martha Stewart line of linens and kitchenware - can easily be marketed to a whole new audience of potential customers in Sears stores, according to analyst Marshal Cohen of the market research firm NPD Group.

Similarly, sales of Sears' Craftsman tools and other branded goods may soar if the number of customers grows at remodeled Kmart stores where those products are introduced and at Kmarts that are converted to Sears' new off-mall format called Sears Grand, which also offers grocery and convenience items.

The number of these stores was scheduled to jump from three to 60 next year, and now should accelerate into the hundreds after the takeover, which is expected to close in March.

Ultimately, the fate of the two struggling chains will depend on how successfully they expand their base of consumers, who have plenty of alternative choices on where to shop.

True, the combination is expected to generate $500 million a year in savings within three years. But to survive in the long term, the new giant called Sears Holdings Corp., with $55 billion in sales and 3,500 stores, will have to come up with a merchandising formula that will woo customers away from competitors like Target and Wal-Mart, the nation's largest retailer, which generated $256.3 billion in sales last year at more than 4,800 stores.

Burt Flickinger III, managing partner at Strategic Resource Group, a New York-based industry consulting group, estimates it will take three years for the new merchandising strategy to be executed.

But, he said, "they don't have three years," given the fierce competition.

Both retail brands are broken in different ways. Kmart has had a hard time keeping its shelves stocked with essential items, suffers from messy stores and is caught between cheap chic discounter Target and everyday low-price operator Wal-Mart. Sears' biggest problem is that it still struggles with a lack of a unified marketing and merchandising strategy for its appliances and apparel.

Britt Beemer, chairman of America's Research Group, based in Charleston, S.C., expects poor-performing brands and labels that cannibalize each other to be eliminated. At the same time, he expects the new company to keep both Lucy Pereda clothing, named after a Latina fashion designer and lifestyle expert, that's exclusive to Sears and Kmart's Thalia Sodi label, named after a Hispanic pop star, since they focus on the fast-growing Hispanic market.

Tim Calkins, a former marketing manager at Kraft and now a clinical professor of marketing at Northwestern University's Kellogg School of Management, sees problems ahead for Lands' End, a brand Sears bought in 2002 in the hopes it would become the marquee clothing offering at its 870 mall stores. Analysts say the price of Lands' End products make it a bad fit for Kmart.

"Lands' End doesn't make a lot of sense for either Sears or Kmart," Calkins said, noting the brand has a reputation of exceptional customer service. "You don't get that at either Sears or Kmart."

Consumers haven't gone out of their way to buy Lands' End items at Sears stores. Mall shoppers accustomed to buying Lands' End items in catalogs seem unwilling to change.

That could mean big changes for Lands' End and several other tough calls for Lampert and Sears CEO Alan Lacy if the combined company is to achieve Lampert's goal of a 10 percent operating profit margin, a level generated by such retailers as Gap Inc.

Another question is how Lampert and his team will react to Whirlpool Corp.'s plan to raise its wholesale prices effective Jan. 2 because of higher costs of steel and other raw materials.

Whirlpool, a Sears supplier since 1916, got more than $2 billion, or 18 percent of its revenue last year, from its sales to Sears of clothes washers, dryers and major kitchen appliances under the Kenmore brand. Kmart does not carry Whirlpool products.

Unions Plan Big Drive for Better Pay at Nonunion Wal-Mart
By Steven Greenhouse - New York Times
December 11, 2004

The A.F.L.-C.I.O. and more than a half dozen unions are planning an unusual - and unusually expensive - campaign intended to pressure Wal-Mart, the world's largest retailer, to improve its wages and benefits.

The campaign will be highly unusual because it will not, at least at first, focus on unionizing Wal-Mart workers, but will instead focus on telling Americans that Wal-Mart - with wages averaging between $9 and $10 an hour - is pulling down wages and benefits at companies across the nation.

The unions are talking of spending $25 million a year on the effort, more than has ever been spent before in a union campaign against a single company.

"This isn't a campaign, this is a movement," said Greg Denier, spokesman for the United Food and Commercial Workers Union. "There's no precedent for this. It's a movement to confront the reality of Wal-Mart-ization. No other company has ever had the global economic impact that Wal-Mart has."

Wal-Mart has 1.2 million workers in the United States, more than any other company, but no unionized workers. It has a history of fiercely resisting unionization efforts.

Wal-Mart executives say that its wages are competitive with those of other retailers. But critics assert that now that it has become the nation's largest company, Wal-Mart, like General Motors of old, has a responsibility to be a model on wages and benefits.

Christi Davis Gallagher, a Wal-Mart spokeswoman, warned that higher wages could lead to higher prices.

"It appears the unions want to take millions of dollars in dues from their members and use them to rob average Americans of their right to pay less for the basics in life," Ms. Gallagher said. "You need to ask one question: Is it fair to ask American consumers to pay higher prices to subsidize a relatively small pocket of individuals just because they are making the most noise?"

The new effort, to be announced officially in several months, will also be unusual because most union campaigns involve just one union. Because Wal-Mart is so huge, labor leaders have concluded that several unions should work with the A.F.L.-C.I.O. on the effort.

Among those participating are the Service Employees International Union, the International Brotherhood of Teamsters and the United Food and Commercial Workers Union. Many union leaders have criticized the food and commercial workers for doing too little over the past decade to unionize Wal-Mart, but the union's new president, Joseph Hansen, has vowed to do more.

Andrew L. Stern, the service employees' president, said: "Wal-Mart is much too big for any one union to tackle. The Wal-Mart-ing of the economy is a threat to every union."

Last winter, California's three largest supermarket chains waged a 20-week labor battle, involving a strike and lockout, in which they urged the food and commercial workers union to make major concessions on wages and benefits to help the companies compete with Wal-Mart. The supermarkets emerged victorious, getting the union to agree to a lower wage and benefit scale for new hires.

The unions plan to work with community groups fighting the construction of Wal-Mart stores and are contemplating lawsuits accusing the company of forcing employees to work unpaid hours off the clock. The unions are also planning a publicity campaign in which union members distribute fliers and hold protests at hundreds of the nation's 3,600 Wal-Mart stores.

The unions also plan an intense effort in several regions where they might set up committees of current and former Wal-Mart workers to publicize what they consider inferior wages and health benefits. These committees might also serve as the base for future unionization efforts.

While attending a labor conference in Japan on Monday, the A.F.L.-C.I.O.'s president, John J. Sweeney, met with union leaders from several countries that have Wal-Mart stores, including Mexico and Brazil, to strategize on how to pressure Wal-Mart. Mr. Sweeney said the unions would urge Wal-Mart to stop pressing suppliers to cut costs so low that the suppliers' workers receive low wages.

"We're also concerned about the 20,000 workers at Wal-Mart stores in China and about the 6 million Chinese workers who produce goods sold at Wal-Marts," he said.

Mr. Stern of the service employees' union has proposed financing the campaign by using the $25 million the A.F.L.-C.I.O. receives yearly from its Union Plus credit card.

Mr. Sweeney said, "I'm not sure if $25 million is enough."

Ms. Gallagher of Wal-Mart said, "One thing that the unions seem to miss is that Wal-Mart's ability to offer the lowest prices around is driven by a passion to drive costs out of our business at all levels," including information technology.

She added, "While the unions want people to believe that we drive down our costs primarily through our wages or benefits, that is simply not the case."

Sears Reassures Employees on Kmart Merger
Dave Carpenter - Associated Press - Miami Herald
December 10, 2004

CHICAGO - Sears, Roebuck and Co. reaffirmed confidence in its prospects following the proposed merger with Kmart Holding Corp., telling employees the move will expand Sears' opportunities and emphasizing that Kmart is not taking over the retailer.

The comments, made in weekly comments distributed to employees and disclosed in a regulatory filing Friday, came after a slew of stock sales by company executives since the Nov. 17 merger announcement.

Cashing in on a run-up of the company's stock, top Sears officials sold or exercised options for shares totaling about $30 million in the first three weeks after the transaction was proposed, according to the company.

Spokesman Ted McDougal said that because of confusion surrounding those sales, the company decided to address the issue in its weekly Q&A.

At least one retail analyst has suggested that selling the stock suggests Sears executives are pessimistic about the future. The company denied that.

"The actions of associates with options should not be interpreted as a lack of support for or confidence in the prospects for the merged company," the retailer said in the posting. "Many Sears associates, including senior executives, continue to hold Sears stock beyond their options."

Sears' stock jumped 21 percent the day the merger was announced, to $54.89 a share. On Friday, shares declined by 24 cents to $52.51 in afternoon trading.

The company said senior executives and others have sold shares, and may continue to up until the merger's expected closing date, "based on their personal financial needs."

Answering a question about why Sears wasn't content to stick with its own plans for growth away from shopping malls, the company said: "The proposed merger dramatically accelerates our off-mall growth and our ability for the Sears name to touch more customers. ... We simply could not grow quickly enough if we built on our own, nor could we be assured of optimum locations that fit our demographics."

Company officials also dismissed any concern about Sears having a minority of shareholders and board members of the new company, Sears Holdings Corp.

"What is more important are the prospects of the combined company going forward and the great opportunity, not only to continue the Sears name and what it stands for, but also to grow the Sears name through the conversion of potentially hundreds of off-mall stores to the Sears nameplate," the company said.

Sears Tries to Reassure Employees on Stock
By Becky Yerak - Tribune staff reporter - Chicago Tribune
December 11, 2004

Defending millions of dollars in executive stock sales in the wake of a planned merger with Kmart Holding Corp., Sears, Roebuck and Co. felt compelled to reassure workers that there is reason for optimism about the retailer's future.

"The actions of associates with options should not be interpreted as a lack of support or confidence in the prospects for the merged company," the Hoffman Estates-based retailer said in a letter to employees on Thursday that was filed Friday with the Securities and Exchange Commission. "Many Sears associates, including senior executives, continue to hold Sears stock beyond their options."

The company, on pace for its fourth-straight year of falling sales, is getting many questions from workers about the merger, spokesman Ted McDougal said Friday.

As a result, Sears has been posting correspondence, including questions and answers it gets from workers during the course of the week, to a company intranet every Thursday.

"We're committed to open communication," McDougal said, adding that Sears is also required to inform the SEC.

Taking advantage of a run-up in Sears' stock, at least eight top executives sold or exercised options for shares since the deal was announced Nov. 17. Sears' chief financial officer, its general counsel and its top personnel executive were among those who had sold $15.7 million in stock, according to figures from Thomson First Call.

In contrast, before the proposed deal, top Sears executives had dumped $2.58 million in stock in 2004.

Since Dec. 1, at least three more top executives, including the heads of public relations and strategy, have cashed in. In the first three weeks after the transaction was proposed, total stock sales have reached about $30 million, the company told the Associated Press.

Sears has pointed out that, as part of the merger, all Sears' stock options will be cashed out at the closing. About 17,000 Sears workers have options, all of which vest before or at the deal's closing.

"Based on their personal financial needs, we expect that many of those associates, including senior executives, may elect to exercise some or all of their options over the period leading up to the closing," Sears said.

The company also addressed a worker's question on why it didn't continue to try to expand away from shopping malls on its own.

The company replied: "The proposed merger dramatically accelerates our off-mall growth. We simply could not grow quickly enough if we built on our own, nor could we be assured of optimum locations that fit our demographics."

Earlier this year, Sears purchased about 50 stores from Kmart and Wal-Mart Stores Inc. in what marked its biggest growth spurt in decades.

But now the merger with Kmart means that hundreds of additional Kmart stores will be converted to the Sears banner.

Sears-Kmart Merger: Is It a Tough Sell
Wharton management report
December 10, 2004

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 Depot. 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 stores 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.

From the Current Issue

Crazy Eddie -- Hasn't Mentioned the One that Seems Most Likely: Liquidation.
Mark Tatge - FORBES.COM
December 13, 2004

Eddie Lampert says he has grand plans for Sears and Kmart. But he hasn't mentioned the one that seems most likely: liquidation. What's really behind Eddie Lampert's $11 billion takeover of Sears? Edward S. Lampert, the chairman of Kmart Holdings, insists he's determined to merge and resuscitate the two retailing legends, one way or another.

Maybe, but don't mistake Lampert for some kind of born retailer itching to upgrade the merchandise selection. And forget the hype about Lampert's being the next Warren Buffett, the hands-off investor who wants to own good businesses forever. Lampert's genius is as a trader. He is more likely to liquidate Sears' 1,200 properties than to refashion them.

When the deal was announced, Lampert, 42, and Sears Chief Executive Alan Lacy, 51, cited cost savings, cross-selling and offering better-priced goods in better locations to counter the Wal-Mart threat. But two dumb retailers don't suddenly get smart by merging, says Gimme Credit analyst Carol Levenson. To make Sears competitive, Lampert needs to boost Sears' $300 sales per square foot to the per-square-foot sales posted by Wal-Mart ($412) or Best Buy ($834). Good luck. "I just don't buy it," says Levenson. And who decides to merge one week before the big Christmas sales season--unsettling customers, suppliers and employees? Maybe Lampert and Lacy figured that since so few people shop their stores, the timing didn't matter. Kmart's comparable store sales dropped 13.7% this year, while Sears' fell 2.1%.

But what could a real estate operator, as opposed to a merchandiser, do with Sears? Sell off its properties. Sears holds 22% of all U.S. mall anchor space. Of its 871 mall stores, Sears owns 60%; the remaining ones it leases, some at rates as low as $3 to $5 per square foot. Sears' real estate is worth upwards of $44 a share, or $10.8 billion, more than double what it's carried for on the books, concludes UBS' Gary Balter. The favorable leases typically are transferable to new tenants--that is, the leaseholds are salable. Sears hinted before the merger announcement that it wants to unload 250 underperforming stores. That could be just the start.

Alpine Management and Research Chief Executive Samuel A. Lieber calls the deal a "slow liquidation" that will take place over the next five to seven years. In this scenario, as Lampert sells the real estate he will buy back stock, reduce debt and plow some money into a shrunken version of Sears-Kmart--a Kohl's-type format (an average 75,000 square feet) pushing well-known brands. But if that mini-Sears concept turns into a loser, Lampert may end up dumping the entire retailing operation.

Lampert engineered Kmart out of bankruptcy by cost-cutting. He closed 600, or 30%, of Kmart's stores. He sold 68 Kmarts to Home Depot and Sears for $846 million. Then he leveraged his 15% Sears stake into a marriage of the two retailers, claiming $500 million in future cost savings and selling "synergies." Sears' (and Kmart's) real value isn't on the shelves. It's in the retailer's real estate and, to a lesser degree, its brands: Kenmore, Craftsman and DieHard. Target, Home Depot, Best Buy and Kohl's are all reportedly lining up to see what will go on sale first.

One roadblock: taxes. Most of the stores were built 40 or 50 years ago. If you simply sell them off and liquidate the company, you wind up with two rounds of capital gains taxes: Sears would owe a corporate gains tax and Sears shareholders would owe tax on whatever's left, assuming equity is distributed to shareholders.

But there are potentially two ways to dodge this problem. One is to take advantage of Kmart's $3.8 billion tax-loss carryforwards. The other is to convert part of the retail company into a real estate investment trust, monetizing the assets by converting them into a stream of lease payments. The REIT can then raise or borrow capital to expand, says Thomas Nice, tax accountant with the Reznick Group. That's how Vornado Realty Trust's Steven Roth exploited the failed Alexander's department store chain. Alexander's main asset, a prime piece of land in midtown Manhattan, is now being redeveloped into a 1.3 million-square-foot multiuse property anchored by Bloomberg. The property is owned by a REIT that is one-third-owned by Vornado, which, interestingly, also sees value in Sears. It owns 4.3% of the shares.

Bypassed for Penneys
CEO, Castagna May Still be Winner
By Becky Yerak. Tribune Staff Reporter - Chicago Tribune
December 10, 2004

When J.C. Penney Co. looked for a new chief executive officer earlier this year to replace the retiring Allen Questrom, Vanessa Castagna was widely considered the front-runner.

After all, she had spent five years in what was essentially the No. 2 post at the retailer, which is on pace for its fourth straight year of sales growth. She was considered a key player in Penneys' remarkable turnaround.

The top job, however, ended up going to an outsider and Castagna left in November. "I'm very disappointed I didn't get that," Castagna said Thursday. "But that's life."

And life today is not so bad for arguably the hottest free-agent retailer available.

"I've talked to many diverse types of companies," said Castagna, also a former Wal-Mart Stores Inc. executive. "I've certainly had a lot of interest from both large and small and public and private companies."

Kmart Holding Corp. Chairman Edward Lampert is said to be one of the suitors interested in Castagna, according to a Women's Wear Daily report Thursday. Also in hot pursuit is Office Depot Inc., the report said. The office products' chain fired its CEO in October.

"She's an excellent retail executive," said Elaine Hughes of the E.A. Hughes & Co. executive search firm.

One possible hitch for Kmart, as well as Sears, Roebuck and Co., is that Castagna has her eye on a CEO suite.

"I'm not limited to that, but that's my ambition--to run a company," she said Thursday.

When Kmart and Sears announced a merger in November that is expected to close in March, the future organizational chart was also laid out. Sears' CEO Alan Lacy would become CEO of the new Sears Holdings Corp., and Kmart CEO Alywin Lewis would become CEO of Sears Retail.

In a conference call, Sears and Kmart found themselves having to reassure analysts that existing management was capable of running the merged business.

In August, Sears hired former Target Corp. executive Luis Padilla to oversee marketing and merchandising. Sears said then that it was in no rush to fill the retail president's role, a position it reiterated Thursday.

Castagna, however, confirmed Thursday that Sears is among the retailers reaching out. No negotiations, however, are under way, she said. She declined to say which Sears' official contacted her or what job was dangled.

Asked whether Lampert had called, she replied, "He has not called me." She declined to say whether any other Kmart official had called her.

One retail industry observer who asked not to be identified said it once was widely believed that Castagna would join Kohl's. The person also said that, despite pronouncements about Lacy's role in the merged company, questions persist about his staying power.

Still, it would be costly for Sears to put Castagna in the top spot. In a recent filing, Sears said that when Lacy takes over the new Sears Holdings Corp., his base salary will increase to at least $1.5 million from $1 million in 2003.

And if he is terminated without cause, he receives two times his annual base salary and target bonus, plus accelerated vesting of equity awards and two more years of benefits.

One retail industry consultant figures Lacy has little to fear. "Wal-Mart wants her back badly," said Burt Flickinger III, managing partner of Strategic Resource Group.

It just so happens that the world's biggest retailer has a vacancy. On Monday, Vice Chairman Tom Coughlin--who oversees Wal-Mart stores, Sam's Club and the company's U.S. online business--announced a January retirement.

A high-profile job at Wal-Mart would be a feather in Castagna's cap, Flickinger said.

"Having a worldwide business base instead of a contracting U.S. business base would be more appealing to her, working for a $300 billion retailer rather than a contracting $20 billion retailer on the way out," Flickinger said of Kmart, which has annual revenues of $17 billion.

And while it's joining forces with Sears, the latter "has become a political piranha pit" with rampant management turnover.

Castagna said she hasn't talked to Wal-Mart. But she noted, "I love the company, I love the people, I love what they're doing."

- - -

Vanessa Castagna's resume

November 2004: Leaves J.C. Penney after being passed over for CEO job.
August 1999-November 2004: Head of J.C. Penney stores division and catalog.
1994-August 1999: General merchandise manager posts in women's, juniors' and children's apparel, intimate apparel, accessories, home decor, furniture, crafts and children's apparel at Wal-Mart.
1992-94: Senior-level posts for women's and juniors at Marshalls stores.
1985-92: Vice president of merchandising for women's apparel at Target.
1972: Began career at Federated Department Stores.

Source: Women's Wear Daily

John Wiebe, Sears Information Systems Executive, Dies
CHICAGO TRIBUNE
December 8, 2004

John Wiebe, 69, of Henderson, NV, formerly of Plantation, FL, where he resided for the past 12 years, died December 1, 2004.

He was born on March 19, 1935, in Sioux Falls, SD. He was the son of Irwin
(Feist) and Leona Wiebe. He graduated from Washington High School in 1953 and the University of South Dakota where he was a member of Delta Tau Delta Fraternity. He also served in the United States Air Force.

Mr. Wiebe worked for Sears & Roebuck Co. in Chicago, IL, Louisville, KY and Philadelphia, PA. He worked for 27 years until he retired as a Senior Information Systems Executive.

He was an avid reader and had a great passion for the Chicago Cubs and college basketball, especially the Louisville Cardinals.

He is survived by his wife of 42 years Norma Wiebe; a daughter and son-in-law Amanda and Todd Lauster of New London, NH and a son and daughter-in-law Adam and Hendy Wiebe of San Francisco, CA; in addition, he is survived by his loving grandchildren Robert John and Courtney Brooke Lauster and Roger Jacob Wiebe. He is also survived by his sister Jeannine Olsen of Destin, FL.

A Memorial Service will be held in Sioux Falls in the Summer of 2005.

More Math on Sears' Land
By Nat Worden - TheStreet.com - Staff Reporter
THE STREET.COM
December 8, 2004

New research argues that the real-estate holdings of Sears Roebuck (S:NYSE) are worth twice as much as Wall Street thinks, opening up a new round of argument in the debate about Ed Lampert's master plan.

Citigroup Smith Barney analyst Jonathan Litt raised his estimate of Sears' real estate portfolio to $8 billion to $10 billion from $4 billion to $6 billion, based on a study of 866 Sears stores. The list included information on location, square footage, year-of-construction, landlord, estimated sales volume and sales per square foot.

Lampert has consistently played down the role of real estate in his decision to merge Kmart (KMRT:Nasdaq) with the department-store chain three weeks ago. A vocal chorus of observers, nevertheless, doubts it when he claims asset sales were never a factor in his reward calculus.

"I don't think any retailer should aspire to have its real estate be worth more than its operating business," Lampert told investors, even as he acknowledged the role land and store sales had in running Kmart up 70% prior to the merger.

Pundits are still debating Lampert's prospects for competing with the likes of Wal-Mart (WMT:NYSE) and Target (TGT:NYSE) as the chairman of the new, combined company, Sears Holdings. Litt's research, however, implies Lampert is sitting on a goldmine before he integrates a thing.

Litt put Sears' overall value at about $17 billion, or $80 a share, significant upside to its current market value of $53.11 a share. Such a valuation suggests Lampert's merger proposal, which values the company at $10.6 billion, or $51 a share, is low.

But Litt's valuation is not uncontroversial. The market's main reservation about Sears' real estate is that an estimated 90% of its sites are mall-based properties. With the latest trends showing consumer spending migrating away from malls, analysts questioned whether buyers exist for Sears properties. Even the merger strategy unveiled by Lampert involves moving Sears stores into Kmart's attractive, off-mall locations.

"I'm just not sure who is going to want to move into the mall right now" said Morningstar analyst Kim Picciola. "Not only is it a question of who, but it's also when. It's not like you're going to unleash the value of these stores all at once, especially if the economics in the market happen to have more supply than demand."

Also, mall properties like those usually used by Sears, known as anchor stores because they make up the biggest space in the mall, are often leased through complex agreements with the mall landlord. These agreements can strip the retailer of its leverage in liquidating the value of the lease.

Litt acknowledged that these factors make Sears' mall-based locations worth less than its free-standing locations. "However, the last thing a mall landlord wants is to have a closed anchor," he wrote. "The value of the mall anchor box ... is not completely lost as the mall anchor has certain of its own rights" under the covenants of the agreement.

Litt said landlords have used vacated anchor locations to build new department stores or open movie theaters, big-box retail stores, food courts and outdoor, lifestyle wings, incorporating things like restaurants and specialty retailers.

The report estimates that Sears owns 60%, or 516, of its 871 stores. Meanwhile, the company's free-standing sites, making up around 10% of its portfolio, have huge potential for untapped value, like a 165,000 square-foot store in Santa Monica, 10 blocks from the beach, or a 133,000 square-foot store at the bottom of a large office building on 2 North State Street in downtown Chicago.

The potential for upside value led Litt to conclude that Lampert's plan to merge the company with Kmart is not yet a done deal. Vornado (VNO:NYSE) , the real estate investment trust whose recently disclosed stake in Sears sparked the asset-value speculation, is evaluating the deal. (Litt acts in a fiduciary capacity for an account of a nonprofit organization that holds a long position in Vornado, and Citigroup has an underwriting relationship with Vornado.) Others could be interested as well.

"Potential bidders for Sears include other retailers, private opportunity funds and real estate players," Litt said. "We believe Vornado is not alone in taking a hard look at making a bid for Sears, given the apparent value remaining in the shares.

Kmart Deal May Not be End of the Story on Sears
By Becky Yerak - Inside Retailing - Chicago Tribune
December 7, 2004

The wheeling and dealing for Sears, Roebuck and Co. might not be over.

Despite a recently announced merger deal between the Hoffman Estates retailer and Kmart Holding Corp., another party could still emerge to ignite a bidding war, according to an analyst report published Sunday.

The matrimonial march between Sears and Kmart, whose chairman owns about 15 percent of Sears, was announced only 12 days after Vornado Realty Trust disclosed a 4 percent stake in the nation's biggest department store chain. In the past, Vornado has liquidated languishing retailers for big gains.

"We presume Sears decided to go with the devil they know rather than risk ending up with the devil they don't know," one bond analyst speculated at the time.

But since the deal doesn't close until March, it leaves an opening for other interested parties.

"We think Vornado could still team up with a private equity partner or another retailer to bid for Sears, and/or another dark horse bidder may still emerge," Citigroup Smith Barney said in a Dec. 5 report.

While Kmart has agreed to pay nearly $11 billion for Sears, Citigroup estimates that Sears could be worth $15 billion to $17 billion.

Citigroup's not the only one that believes another bid could be brewing.

During a Nov. 29 conference call about retail sales, Deutsche Bank analyst Bill Dreher mentioned that he was still recommending Sears stock and seemed to imply that the best is yet to come.

"We stand by our valuation of Sears. We really think that was, frankly, a bit of a take under," Dreher said cryptically. "It'll be interesting to see what next chapter of that could be."

Citigroup once pegged the value of Sears' real estate at $4 billion to $6 billion but has since raised it to $8 billion to $10 billion. Sears' State Street store is one of the jewels of the chain, the 26-page report said.

"A number of Sears' free-standing stores may provide significant value given the peripheral development that has occurred around the sites over the past few decades," Citigroup said, citing a 165,000-square-foot Sears store in Santa Monica, Calif., 10 blocks from the beach.

"Equally appealing could be the 133,000-square-foot Sears store at the bottom of a large office building on 2 N. State St. in downtown Chicago," Citigroup said. "The presumably leased store may have substantially below-market rents appealing to a potential buyer."

For its part, Sears said its board considered "alternative strategies"--including a leveraged buyout and breaking off parts of the company--as part of its due diligence. But it concluded that those options entailed greater uncertainties and lengthier execution periods.

Sears also said its financial adviser, Morgan Stanley, felt the Kmart offer was fair.

Jeweler hires ex-Sears exec: Whitehall Jewellers Inc. of Chicago has hired Lucinda Baier as its new president.

Baier, an Illinois State University accounting graduate, most recently was senior vice president and general manager for Sears' credit and financial products business.

She had joined the retailer in 2000 as a vice president in Sears' tax department but left in early 2004 to pursue other interests. Baier also worked at Arthur Andersen.

At Whitehall, she'll report to Hugh Patinkin, chairman and chief executive officer of the Chicago-based jeweler.

Whitehall runs 386 U.S. stores under the names Whitehall, Lundstrom and Marks Bros.

Sales at stores open at least a year fell 3.9 percent in the latest quarter.

Sears-Kmart Merger Could Get Some Competition
By Sandra Guy - Business Reporter - Chicago Sun Times
December 7, 2004

A real estate investment trust that owns the Merchandise Mart might counter Kmart's bid to take over Sears Roebuck and Co., an analyst speculated Monday.

Vornado Realty Trust, the New York-based trust that announced on Nov. 5 that it had bought a 4.3 percent stake in Sears, could still team up with a private equity partner or another retailer to bid for Sears, according to a report by Jonathan Litt, senior real estate analyst at Citigroup Smith Barney.

If Vornado fails to act, another dark-horse bidder for Sears could still emerge, Litt wrote in a report dated Sunday.

Another possibility is that Sears could offer Vornado the real estate assets it wants in exchange for Sears' stock, Litt said. In other words, Vornado would get to cherry-pick the best Sears locations as long as Vornado gave up some or all of its ownership stake in Sears.

WHAT IS VORNADO?

Which Sears store in Illinois is the top moneymaker? It's the Sears at Ford City Mall on the Southwest Side, according to Litt's report. The Ford City store reaps $294 in yearly sales per square foot, or $43 million a year, besting the Sears store at 2 N. State St., which takes in $284 per square foot, or $38 million annually.

Vornado had no comment Monday.

A Sears spokesman said executives at the Hoffman Estates-based retailer believe that the company's takeover by Kmart Holdings Corp. represents the best long-term value for shareholders, and for the vast majority of employees of both companies.

Sears' biggest shareholder and Kmart's chairman, Edward Lampert Jr., is believed to have been pushed into announcing Kmart's $11 billion takeover bid for Sears on Nov. 17 because of Vornado's purchase of an ownership stake in Sears. Lampert holds 14.7 percent of Sears' stock, but will own more than 40 percent if the Sears-Kmart merger goes through.

Here's how Litt sized up the situation: Toys R Us, the toy retailer, is the focus of a bidding war by real estate operators, including Vornado, and private-equity players.

Why wouldn't these same players go after Sears, especially after Litt upped his estimate of Sears' real estate value to $8 billion to $10 billion from his previous estimate of $4 billion to $6 billion?

Indeed, Sears could be worth $15 billion to $17 billion, or $70 to $80 per share, if the value of its top brands, Craftsman and Kenmore, are added to the equation, Litt wrote.

Craftsman tool sales totaled $4.1 billion last year, while Kenmore appliances garnered $5.5 billion. Litt speculated that the sales could double if Wal-Mart or Home Depot successfully bid to sell the popular brands.

Ironically, Litt's report coincided with Sears' decline to 12th place from third in the latest listing of the top 100 global retailers. The list is based on retail sales and is compiled by Chain Store Age magazine. Wal-Mart ranked No. 1, and Home Depot stood at No. 3.

Litt speculated that the preppy Lands' End apparel and accessories brand would sell for $1.5 billion, less than the $1.9 billion Sears paid for it two years ago, because of its poor sales at Sears stores.

Nevertheless, Litt believes that Vornado will not be easily deterred, not even by a $400 million, or $2 per share, break-up fee if the Sears-Kmart deal falls through. After all, Vornado has generated a $120 million pre-tax gain on its 4.3 percent stake in Sears with little outlay of capital. Vornado used derivatives for part of its share ownership.

Vornado's leader, real estate mogul Steven Roth, started building his reputation 24 years ago when he masterminded a takeover of the failing Two Guys retail stores. Roth closed the stores, and turned the retail chain into a real estate company.

He took a similar tack with Alexander's Inc. department store in New York. After Roth gained control, he built a tower on the former store site. The tower houses condos, retail shops and Bloomberg News headquarters.

In the meantime, the Sears-Kmart deal is drawing criticism from shareholders who have filed lawsuits alleging the deal is unfair and inequitable. Separately, several Sears executives have sold shares, especially since the stock price has shot up. Sears' shares ended the day Monday up 91 cents, or 1.74 percent, to $53.21.

A Sears spokesman said Monday that the company has obtained an opinion from Morgan Stanley that its offer to shareholders is fair from a financial point of view.

Kmart's takeover of Sears is scheduled to close in March, pending regulators' approval.

Analysts continue to believe the deal is about real estate, not retail.

"We're headed to asset optimization. We're headed to cash acquisition as opposed to customer acquisition," said retail analyst Howard Davidowitz in an earlier interview.

"We'll be in the business of losing customers ... everything will be sold," said Davidowitz, chairman of Davidowitz & Associates Inc., a retail consulting and investment banking firm based in New York City.

George Whalin, president of Retail Management Consultants, based in San Marcos, Calif., said Vornado will not be easily denied Sears' real estate, especially after it lost a bid for Mervyn's department stores. Target Corp. announced in July it would sell Mervyn's to an investment group for $1.65 billion.

"Sears is going to move off mall, so this becomes a real estate play on getting rid of the [870] mall-based stores," Whalin said.

Lampert isn't going to roll over and play dead, either, Whalin said.

"This could be really fun to watch."

Analyst: Vornado, Others May Counter Kmart Bid for Sears
By Bob Sechler - Dow Jones Newswires
December 6, 2004

Of DOW JONES NEWSWIRESAUSTIN, Texas -- Citigroup Smith Barney estimated that Sears, Roebuck & Co. (S) may be worth $15 billion to $17 billion, adding that Vornado Realty Trust Inc. (VNO) and a partner could counter Kmart Holding Corp.'s (KMRT) $10.85  billion bid for the company.

"We do not believe the Sears/Kmart merger is a done deal just yet," Smith Barney analyst Jonathan Litt wrote in a research report Monday.

Litt said Vornado, which already owns 4.3% of Sears, could team with a private-equity partner or a retailer to counter Kmart's November offer, or a "dark horse bidder" could emerge.

"We believe Vornado is not alone in taking a hard look at making a bid for Sears, given the apparent value remaining in the shares," Litt said.

He pegged Sears' value at $70 to $80 a share. The stock was trading recently at $53.20, up 1.7% from Friday's close.

Smith Barney previously estimated the value of Sears' real estate at $4 billion to $6 billion, but Litt said in his note that a revised analysis puts the range at $8 billion to $10 billion. He also said Sears' Craftsman and Kenmore brands could be worth substantially more than currently thought given broader distribution.

Still, Litt cautioned that his real estate analysis has been hampered by a lack of disclosure from Sears, although he said Smith Barney managed to compile a detailed list of holdings on its own.

Regardless, "in the interest of maximizing shareholder value, Sears should provide a property list, sales figures, owned versus leased stores, term remaining on leased stores, as well as the operating covenants and/or reciprocal easement agreements between Sears and its landlords," he said. "Estimating the value of the real estate without this information is largely guesswork."

Litt also noted that Kmart "is clearly not playing a guessing game," given Kmart Chairman Edward S. Lampert's major stake in Sears and seat on the Sears' board.

Litt doesn't own a stake in Vornado, according to Citigroup's disclosure, although he acts in a fiduciary capacity for a non-profit entity that owns its shares. Citigroup has had an investment-banking relationship with Vornado.

Vornado Could Bid for Sears
FORBES.COM
December 6, 2004

Smith Barney: Firm may team with partner to bid for retailer; real estate valued at $8B-$10B.

NEW YORK (Reuters) - Smith Barney said Monday Vornado Realty Trust could team up with a private equity partner or another retailer to bid for Sears, Roebuck & Co. following Kmart Holding Corp.'s offer to buy the retailer.

Smith Barney said in a research note that it has revised its estimate value of Sears' real estate to $8 billion to $10 billion from $4 billion to $6 billion.

In early November, Vornado Realty (down $0.03 to $73.97, Research) acquired a 4.3 percent stake in Sears (up $0.85 to $53.15, Research), which highlighted the value of Sears' vast property holdings. This was followed by Kmart' (up $0.41 to $104.37, Research)s announcement that it will buy Sears for $10.85 billion in a bold play to revive two of America's best-known, but long-struggling, retail brands.

"We think Vornado could still team up with a private equity partner or another retailer to bid for Sears, and/or another dark horse bidder may still emerge," Smith Barney's note said.

Vornado shares edged higher on the New York Stock Exchange, while Sears shares gained 1.7 percent.

From Bentonville to Beijing and Beyond
By Constance L. Hays - The New York Times
December 6, 2004

MORE than a decade ago, Wal-Mart set its sights on conquering the globe with a mix of cheaply produced goods, discount prices and aggressive store growth. Using that formula, the company has become the dominant retailing force in the United States, but its experience overseas, which began in earnest in 1991, has been checkered.

Wal-Mart has stores in Argentina, Brazil, Britain, Canada, China, Germany, Mexico and South Korea - as well as a nearly 40 percent stake in Seiyu, a Japanese retailer. It also owns stores in Puerto Rico.

The company, based in Bentonville, Ark., likes to celebrate its international flavor at its annual shareholder meeting by having foreign workers get up and lead the Wal-Mart cheer ("Give me a W!") in Korean, Spanish or Portuguese.

But analysts say there is not always something to cheer about. In some places, Wal-Mart can be called a success story, at least for the time being. In others, the "Wal-Mart way" has barely gotten off the ground.

Cultural obstacles on both sides of the relationship are often the reason; products that sell out quickly in American stores may simply clog the shelves abroad, and there can be built-in resistance to the encroachment of an American company on local business. Also, big, deep-pocketed companies like the French retailer Carrefour can be powerful competitors.

Then there are political and labor issues. Although it is known for being anti-union, Wal-Mart gave way to Chinese pressure - and law - last month and said it would allow its workers in China to unionize.

"It's a mixed bag out there for Wal-Mart," said Steve Spiwak, an economist with Retail Forward, a research and consulting firm in Columbus, Ohio, that counts Wal-Mart among its clients. "Their problems have been trying to transplant their stores without molding them to local customs."

Not surprisingly, the company disagrees with that assessment. "I'd say we have a good story to tell" about international operations, said Bill Wirtz, a spokesman for Wal-Mart. Pointing to economic difficulties in countries like Argentina and Germany, he added, "It's a measure of our success that we've survived." In fact, he said, the international unit has grown more in its 13-year history than the Wal-Mart chain, which began in 1962, grew in its first 13 years. "It's a growing part of the business," he said of the foreign operations.

Mr. Spiwak said that an early miss was Indonesia, where Wal-Mart began trying to build a business in 1996. Indonesians turned up their noses at the brightly lighted, highly organized stores, he said, and because no haggling was permitted, considered them overpriced. A year later, Wal-Mart packed up and left.

In Argentina and Brazil, an apparent ignorance of local preferences regarding cuts of beef alienated many potential customers, Mr. Spiwak added. And in Germany, shoppers gave a cold shoulder to the greeters that Wal-Mart uses to lend a friendly atmosphere to its sprawling American stores. "It was viewed as too friendly and disruptive, invading their space," he said.

International sales made up 18.5 percent of the $256.3 billion Wal-Mart took in last year, and international operating profit of $2.37 billion was 15.8 percent of the total. In general, the discounter has had better luck by purchasing foreign chains and turning them into Wal-Marts than by building a business from scratch.

Growth abroad is increasingly important to Wal-Mart, said Burt Flickinger III, a retail consultant who has followed the company for years. "As efforts to block Wal-Mart stores in the continental United States continue, Wal-Mart desperately needs to be successful in South America and in southern Asia," he said.

Lands' End is An Ultimate Online Model
By Lorrie Grant, USA TODAY
December 3, 2004

DODGEVILLE, Wis. - For catalog retailer Lands' End, the decision a decade ago to start selling on the Internet was as casual as the clothes it sells. "It wasn't, 'Hey, the Internet is going to change the world and we need to be there,' " says Bill Bass, who heads its online business. "It was, 'Hey, here's another way of reaching our customers. Let's test it and see how it goes.' "

Lands' End had little company then among established catalog rivals or bricks-and-mortar retailers. Even direct sellers already taking orders by phone, fax and mail mostly chose to go slow with the Internet, using it for electronic billboards, if at all, and leaving it to dot-com start-ups to try taking orders online.

By the time the competition took the plunge, the dot-com bubble had burst and Lands' End already had honed its site into a sophisticated and lucrative component of its direct sales operation. Online sales were $511 million last year, a third of Lands' End's business.

"Lands' End has been the ultimate model in how to do an Internet business. The transition they made (immediately benefited) the customer," says Donald Libey, managing director of Libey-Concordia, advisers and investment bankers to the catalog industry.

With the holidays around the corner, all of Lands' End's systems face their toughest tests of the year next week.

The second Monday after Thanksgiving - Dec. 6 this year - is typically the peak day for phone orders. An army of nearly a thousand sales reps will be working the phones, handling as many as two calls a second at the busiest time. The online order peak - 50,000 in one day last year - is expected to come Wednesday. Another holiday catalog is dropping in mailboxes now to prime that pump.

"Knowing that Christmas is a couple of weeks away, (people) have to get their gift-giving hats on. And they've had the Thanksgiving weekend to be around friends and family to see what they want," says Jackie Johnson-Caygill, director of customer sales and services.

Those orders will tax a massive distribution operation here that last year pumped out more than 355,000 items on its peak day, vs. an average of 100,000 other days.

Johnson-Caygill's been in customer sales 25 years, through the expansion from phone to fax to computers. "We're going to meet customers in whatever channel they want."

The company even still gets snail-mail orders, though just 2,200 on the peak day last year vs. 8,400 a decade ago. But it's the online operation that has Lands' End poised to cash in this holiday on the retail industry's fastest-growing channel. Online sales are projected to grow 18% to $13 billion this holiday season from $11 billion a year ago. For the year, online sales are pegged to hit $145 billion, a 27% climb over $114 billion last year.

Lands' End would not give sales forecasts for the season and no longer reports financial results since its acquisition by Sears in 2002. Its overall sales have averaged 5% annual growth since 1998.

Since Landsend.com went up 10 years ago (first sale: $60), more than the site has evolved: so have the customers. While online buyers now reflect the overall customer base, Web buyers then were mostly men who bought basics: cotton dress shirts, chinos, soft luggage.

As an "e-tailer," Lands' End was unconventional for those early dot-com days. Based in southwestern Wisconsin, it was a long way in a lot of ways from California's Silicon Valley. Also, it was run by baby boom retail vets, not 20-year-old tech geeks. But the folks here quietly tweaked the site, building sales, as well as a reputation as online innovators. In 1998, they devised a "virtual model." It let online consumers - by now including many women - create a three-dimensional model of themselves to see how clothes would fit.

Subsequent site innovations included "Lands' End Live" - customer assistance around the clock via online chat or a call back by phone. The only time the call center shuts down is Christmas Eve through 4:30 a.m. the day after Christmas.

Also, online customers can now enter their measurements to order custom-fit jeans and pants.

Bass is already on to the next big thing. He believes personalization of the online-shopping experience - letting the site serve users like a sales associate - will help keep it on the cutting edge of the industry. To do that, Bass and managers from the merchandise and design departments are strategizing how to tap into consumers' preferences.

"Once you understand their preferences, it's pretty easy to make good recommendations for them," says Bass, 42, a former Army paratrooper whose modest office is decorated with model helicopters.

Mixing it up

Lands' End's approach would work like this: Outfits would be posted on the Web site (though it's not doing away with separates). Shoppers would be surveyed on which they like better.

"So how do you make sure it's true? You mix it all up," says Bass. "It's not like I'm going to show you a fashion-forward outfit and a classic outfit. I'm going to show you two outfits with elements of fashion-forwardness and classicness ... one will have slightly more of one element in it than the other, and one will have slightly different colors than the other. After a few selections, a consumer's preferences will be revealed.

"It's the opportunity to reset how customers shop," he says.

Adds David McCreight, head of merchandising: "We have lots of data on customers that we combine to know the range that's in their closet, what's not in it and to make sure there's really something fresh in it."

Keeping up the pace of online innovation is even more critical now. Rivals, particularly L.L. Bean and J.C. Penney, are hot on Lands' End's heels. J.C. Penney's 6-year-old e-commerce business made $600 million in sales last year. L.L. Bean, online for nine years, is privately owned and does not disclose sales.

Bass is aware that these and other catalog sellers know Internet selling is now an essential additional sales avenue for the customer base, call centers, distribution systems and shipping relationships they've already built.

Catalog retailers will get 40% to 50% via the Web this year, up from 35% to 40% last year, says Steve Trollinger of direct marketing consultants J. Schmid & Assoc. Widely recognized brands such as Lands' End are in the 50% range.

"If you're a cataloger and not doing well online, you're screwing up," says Bass, who was an e-commerce coach for retailers at Forrester Research before signing on with Lands' End in 1999.

Rival Web sites are much improved. They've become easier to navigate and have features similar to the Lands' End site. They have learned how to zoom in to show fabric patterns, how to show colors more precisely and how to store information to simplify checkout.

Many of today's rivals also have something Lands' End has only begun to
have: a presence in physical stores. Many are using that presence to gain an edge by giving online buyers the option of quicker and cheaper pickup of merchandise at stores, as well as returns.

Lands' End has only 16 stores in four states selling overstocks: Lands' End Inlet. A selection of current merchandise now is sold in the 870 stores of parent Sears, but the future for the more upscale merchant is more uncertain since Sears recently announced plans to be acquired by discounter Kmart.

Bass, however, is keeping his focus on the online competition, such as Amazon, which launched the same year Lands' End went online. He admires the constant innovation that drove Amazon's sales growth of 35% last year to $5.3 billion.

Among its advances, he says, is an order history database, which enables Amazon to make recommendations based on a user's past purchases. Bass says, however, there has been a lull in online innovation recently: "A lot of people that were really pushing the envelope pulled back, or they went away. I don't think you've seen a big breakthrough in a while."

One reason is that the electronic retailers still standing have had to focus on making a profit before innovation. But overall online sales are projected to continue rapid growth - to $316 billion by 2010 from an estimated $145 billion this year, according to Forrester Research, driven by more online-shopping households and smarter and more creative selling.

"Along with organic growth from consumers, retailers will propel online sales over the next six years by capitalizing on past successes and investing in site and multichannel strategies to grow future sales," says Carrie Johnson, an analyst at Forrester. For Lands' End, that means more technology, but backed up, officials say, by a continued focus on old-fashioned customer service by people.

Lands' End saw "the primacy of customer service to be superior to the demand for profit and, as a result, they were far more profitable," says catalog industry adviser Libey.

Specialty shopper, please

At the company's main customer call center here (there are three others in the state), representatives get 80 hours of training to be ready to answer most questions. When they're stumped, a "specialty shopper" is brought onto the call.

Specialty shoppers work in a room next to the call center and have access to samples of all Lands' End products. They've been called on to match products, explain how certain accessories look with a product, pop holiday crackers to gauge the sound and submerge a child's water-resistant boot.

Some thought the Internet would eventually eliminate such services. Lands' End has found it makes them more critical.

"What do you do as a company? If it's not taking care of the customer, what's your job?" Bass says.

Hundreds of Extra Workers Help Handle Holiday Rush
By Lorrie Grant, USA TODAY
December 3, 2004

DODGEVILLE, Wis. - Lands' End promises regular orders will arrive anywhere in the USA two business days after leaving the warehouse. "If you order on Monday, we pack and ship on Tuesday, and the items are delivered by Thursday," says COO Dennis Honan, who came from Sears after it acquired Lands' End in 2002.

It's here in a distribution center the size of 16 football fields where they have to make it happen. It's a multilevel tangle of belts and chutes that move an average 100,000 items a day - and more than triple that at the height of the six-week holiday period. On the busiest day last year, 355,000 pieces were pushed out the door.

The crush is already on this year, with peak days expected to be Monday for phone orders and Wednesday for online orders.

To handle the crush, hundreds of seasonal workers from around the area - mainly retirees and college students - are bused here to boost the staff of 800 a day to 1,400 and add a second shift. Work done here includes not only shipping, but also tasks ranging from monogramming to hemming to gift wrapping.

Also boosting staffing: All Lands' End employees and executives, even CEO Mindy Meads, help through the peak. How it gets done:

1. Boxes of merchandise arrive from vendors, get a bar code and are stacked as high as four stories in an inventory bay.

2. As customers' orders flow in, needed boxes are pulled.

3. Individual items are packed in clear plastic and given a bar code that includes any special instructions, such as gift wrapping.

4. Items to be monogrammed, hemmed or cuffed (military, regular or straight) are shifted to a different belt. When the task is done, they are sorted via bar code to catch up with the rest of the order.

5. A packer checks that the merchandise matches the order form, seals and labels the package and slides it onto a chute for the 12 shipping bays.

6. The ZIP code is scanned and the package is loaded onto one of 12 UPS trucks (the primary shipper) headed for the appropriate UPS hub.

Good Holiday Start Lifts Sears
CRAIN'S CHICAGO BUSINESS ONLINE
December 2, 2004

November same-store sales climb 2.8%

(AP) - Sears, Roebuck and Co. enjoyed a rare good month among U.S. retailers in November, reporting modest gains Thursday while most of its competitors were disclosing disappointing results. The department-store chain, which is in the process of merging with Kmart, said same-store sales rose 2.8 percent last month. Wall Street had expected a 0.3 percent decline.

Total sales rose 1.9 percent. It was the second straight month of better-than-expected results and a small increase in comparable sales for Sears. But there still was no sign of a turnaround in clothing sales, which Sears said declined in the mid single-sigit percentages.

Home appliances, consumer electronics and tools led the way for Sears, and bigger discounts and earlier store openings on "Black Friday" - the day after Thanksgiving - also boosted results for the month.

"We were pleased with our November sales results, especially our strong start to the holiday shopping season," Sears CEO Alan Lacy said. "Despite sluggishness early in the month, we enjoyed particularly strong customer response to our enhanced promotional events and had record sales the day after Thanksgiving."

One of the only other retailers to report good results for November was J.C. Penney Co.

Sears shares rose 16 cents to $52.66 in midday trading on the New York Stock Exchange. They have held steady since shooting up 17 percent when the merger plans were announced on Nov. 17.

Wal-Mart to Launch Advertising Blitz
Associated Press - FORBES.COM
December 2, 2004

Wal-Mart Stores Inc., stung by a lackluster start to the holiday shopping season, said Thursday it is launching a new advertising campaign to remind its customers of its low prices.

The world's largest retailer is starting the price-focused ad blitz Friday in newspapers, television and radio, said spokeswoman Mona Williams, and feature two dozen key items, mainly toys and electronics, on which the company is cutting prices. "That's what people are buying," she said.

Wal-Mart reported growth of a mere 0.7 percent for November in stores open at least a year and said its day after Thanksgiving sales were not up to expectation.

"We have great prices, and we are really beefing up our communications to make sure that we get that word out," Williams said.

On Thursday, the company advised that its same-store sales growth would be between 1 percent and 3 percent for December, but it left unchanged its fourth-quarter guidance of 2 percent to 4 percent growth. Same-store sales measures sales at stores open at least a year are considered the best measure of a retailer's health.

Williams would not say how much the company is spending on the new advertising. She said Wal-Mart is financing the ad buys from its existing advertising budget.

"This is money that is already in the budget, but for more generic holiday advertising ... showing the store experience," Williams said. "We have now diverted that money for item pricing advertising."

The company has customarily shunned ads printed on newspaper pages themselves, but Williams said the company is buying what's known as run-of-press ads to help get the company message out.

She said the company decided that emphasizing individual item prices "is a better way to deliver our price leadership message."

The company will also issue on Dec. 10 an electronic version of its circular, which will have a format that will allow for easy updates.

Williams said the 24 items in the ad being launched Friday will include a 7-inch portable DVD player, LeapPad, and Elmo toys, a Black and Decker jar opener and fleece loungewear sets for men and women. She would not reveal prices Thursday.

Prices on the items are being cut, some by as much as one third, Williams said.

As for how Wal-Mart found itself in a fix, Williams said the company opted against "tricks and giimmicks to lure customers in" on the day after Thanksgiving, content to rely on its status as "the price leader."

"Our competitors drew traffic in with a lot of one-day specials and gimmicks," she said. "We just think that long-term we don't serve our customers well by having 75 toys or 25 DVDs that sell out in the first 15 minutes."

SEC Files Charges Against 3 Ex-Kmart Execs
Associated Press - FORBES.COM
December 2, 2004

Federal regulators on Thursday filed civil fraud charges against three former Kmart Corp. executives and five current and former managers of big vendor companies, saying they engineered a $24 million accounting fraud by the retailing giant.

The Securities and Exchange Commission, which has been investigating Kmart's decline into bankruptcy, said the retailer inflated earnings by improperly booking millions of dollars of payments from the vendors - Eastman Kodak Co., Coca Cola Enterprises Inc., and PepsiCo Inc. and its Frito-Lay division.

Five of the former Kmart and vendor company executives settled the SEC's charges Thursday by agreeing to pay civil fines totaling $160,000 and to refrain from future violations of securities laws. In one case, a former Kmart vice president was prohibited for five years from serving as an officer or director of a public company. They neither admitted nor denied wrongdoing.

The cases are pending against the other three executives: John Paul Orr, a former vice president of Kmart's photo division; David C. Kirkpatrick, a former national sales director for Coca Cola, and David N. Bixler, a former national sales director of PepsiCo's Pepsi-Cola division and current vice president and general manager of PepsiCo.

Their attorneys couldn't immediately be reached for comment.

Neither Kmart nor the vendor companies have been charged by civil or criminal authorities.

Kmart spokesman Stephen Pagnani declined comment on the SEC's action.

Federal prosecutors last year dropped their fraud case against two other former Kmart executives in the middle of their trial on charges they conspired to inflate the retailing giant's earnings.

In a civil lawsuit filed in federal court in Detroit, the SEC accused the eight Kmart and vendor executives of causing Kmart to issue false financial statements by improperly accounting for millions of dollars worth of vendor "allowances" prior to the company's bankruptcy in January 2002. The vendors paid Kmart the fees for promotional and marketing activities, according to the SEC.

Troy, Mich.-based Kmart emerged from bankruptcy in 2003 as Kmart Holding Corp. Last month, the discount retailer announced a planned $11 billion acquisition of Sears, Roebuck and Co.

The deceptive scheme caused Kmart to overstate by $24 million, or 10 percent, its earnings for the fourth quarter and fiscal year ending Jan. 31, 2001, the SEC alleged.

The executives caused Kmart to prematurely book the vendor payments on the basis of false information provided to the company's accounting department, the agency said. It said several vendor company managers took part in the fraud by signing false and misleading accounting documents.

The executives agreeing to settlements with the SEC were:

_Michael K. Frank, a former vice president and general merchandise manager of Kmart's food division, who accepted a five-year bar from serving as a public company officer or director. Frank was not fined because he had demonstrated he was unable to pay, the SEC said.

_Albert M. Abbood, a former vice president of non-perishable products in Kmart's food division, who agreed to pay a $50,000 civil fine.

_Darrell Edquist, a former vice president and general manager of Eastman Kodak, a $55,000 fine.

_Randall M. Stone, a former national account manager at Frito-Lay, a $30,000 fine.

_Thomas L. Taylor, a former director of sales at Frito-Lay, a $25,000 fine.

SEARS AND KMART -- A Marriage of Inconvenience
By Andy Serwer - FORTUNE
December 13, 2004 issue

The new Sears will be plenty big and have a few recognizable brands but that's just about it.

When all the screaming and shouting and light-bulb popping have died down, there are a few things we can safely say about Eddie Lampert's orchestrated purchase of Sears by Kmart. First and foremost, even if this marriage does work over the short to intermediate term, in no way does it threaten Wal-Mart or Target or Home Depot or Costco. Just as significantly, the Big Store Part II poses even less of a threat to next-generation hot retailers like Williams-Sonoma, H&M, and Bed Bath & Beyond. Yes, the new Sears will be plenty big-3,500 stores, about as many as Target and Home Depot combined-and it will have a few recognizable brands: Craftsman, Kenmore, Lands' End (all from Sears), and of course Martha, but that's just about it. Otherwise what you have here is a clumsy amalgamation with no buzz, tired locations, and declining same-store sales.

So what's it all about, Eddie? Good question. You could argue that mostly it's about Eddie Lampert moving pieces around the game board so that he and investors in his reported $9 billion hedge fund, ESL, can enjoy another one of those reported 29% yearly returns to shareholders it's now famous for. There's nothing wrong with that, as long as you don't get caught up in merger rhetoric about retailing synergies, economies of scale-both Sears and Kmart already had that-and taking on Wal-Mart. (When told about the merger, one Wal-Mart exec responded by asking, "Oh, are we being blamed for this
too?") No, this much-hyped $11 billion deal-the same size as this year's Rouse/General Growth Properties deal, or did you miss that one?-is about lashing together two wallowing ships long enough to keep 'em afloat to squeeze some value out of them. (Or as one Wall Street wag said of the deal, "It's a suicide pact.")

On the other hand, squeezing out value is a strategy that Lampert has excelled at recently. In mid-November, Kmart was up eightfold in the 18 months after Lampert nursed it out of bankruptcy, to $109 a share. (It has since backed off to about $100.) Most of Lampert's alchemy in the case of the Big Red K has been turning what appeared to be backwater real estate into gold. He made quite the splash selling 68 Kmart stores to Home Depot and Sears recently for $847 million. That's about half the total number of stores Kmart owned (as opposed to stores that it leases). The only problem with selling real estate as a strategy is that it isn't sustainable. Nor does it make for a growth company.

How bad has it become for Sears and Kmart? A recent ranking by Morgan Stanley of retailers' sales per square foot is telling. Near the top are Best Buy and Costco, with $913 and $858, respectively. Wal-Mart and Home Depot check in around the middle at $472 and $380. Further down is Sears, at $243. Kmart doesn't even make the list. But Lampert on the day of the merger was quoted saying that Sears, in which ESL owns a 13.5% stake, does $80 per square foot more than Kmart. That means that Kmart does about $163 per square foot, well below J.C. Penney and Advanced Auto Parts.

None of that has been lost on the market. Since 1980 shares of Wal-Mart have risen more than 28,000%, Target is up nearly 4,900%, while Sears is up a mere 694%. (Kmart had dropped to being worthless before it was resurrected by Lampert.) Well, perhaps that's the point, right? Buy low, sell high, or so Lampert hopes. After all, he is the man some call the next Warren Buffett, a moniker that is neither new nor, strictly speaking, accurate. Fifteen years ago FORTUNE asked whether Lampert was the next Oracle of Omaha (see "Are These the New Warren Buffetts?" on fortune.com), and said, "The dozen young investment managers you'll meet here are brainy, ethical, and good at making money grow consistently." (Besides Lampert, the irrepressible Jim Cramer also made the list.) In a 1995 article in the Washington Post the same comparison was made, as it was again in New York magazine (by Jim Cramer no less!) in June. Though Buffett waves off any such comparisons, it should be pointed out that he makes a practice of buying healthy companies with strong management, while Lampert is an interventionist, a fixer-upper.

Lampert, who didn't return a call to be interviewed, learned at the feet of Nobel laureate James Tobin at Yale, then Robert Rubin at Goldman Sachs, and then Richard Rainwater in Texas, and he has hit home runs with investments in AutoZone and AutoNation. Lampert even talked his way out of the clutches of kidnappers last year, and has attracted investors like the Tisch family, David Geffen, and Michael Dell. But now he has taken a huge leap into the public eye, as well as into Wal-Mart's sandbox. It is a world of high-profile brands, endless media scrutiny, and giant elbows. Oh, and by this point, it's likely the easy money has already been made.

Targeting Wal-Mart
By Amy Merrick, Gary Mcwilliams, Ellen Byron & Kortney Stringer
Staff Reporters - The Wall Street Journal
December 1, 2004

Suddenly, Savvy Competitors Are Giving the Big Discounter
A Run for Its Holiday Money

When she set out to do her Christmas shopping last weekend, Terry Snook skipped Wal-Mart and instead drove several miles to Target. The 43-year-old Houston audiologist says she wanted to avoid the crowds she sometimes runs into at Wal-Mart. And she found better deals on toys at Target: She bought a Little Mommy shopping cart for her daughter and a CD player and board games for her son. "Target had some really good specials," she says.

When Wal-Mart lets down its guard, the competition came out swinging.

The nation's largest retailer is still expected to ring up nearly $300 billion in sales this year. But its surprisingly poor kickoff to the Christmas selling season last weekend revealed that the seemingly invincible company has vulnerabilities that rivals can quickly exploit.

Wal-Mart has readily admitted it faces stronger competition than ever, as it explained its disappointing weekend sales. Target Corp., which is pushing its fashion edge and continually adding more food offerings, is one of its hottest rivals. And Wal-Mart faces several other increasingly savvy competitors, including Best Buy Co., Richfield, Minn., in consumer electronics and Bed Bath & Beyond Inc., of Union, N.J., in home furnishings.

These companies are beefing up their offerings in apparel and electronics, product categories in which Wal-Mart has fewer advantages. And they are trumpeting discounts loudly, while taking care not to engage Wal-Mart, with its enviable cost structure, in a price war.

Target, for one, advertised hot items such as a 4 megapixel Samsung digital camera for $97 (regularly $159) in its Thanksgiving weekend circular. The least expensive digital camera in Wal-Mart's circular was a 3. 1 megapixel Kodak EasyShare for $149. (regularly $198).

Wal-Mart learned a lesson. "Our customers can trust us to be as aggressive as ever on pricing through the holiday season and beyond," says Mona Williams, vice president of communications for Wal-Mart. "We are the low-price leader in retail and will not cede that ground to anyone."

But rivals are hammering away at two other themes: aesthetics and unique products, says Richard Hastings, a retail analyst with Bernard Sands LLC. "They're watching Wal-Mart's merchandising and very carefully calculating how to be different. Wal-Mart is still doing value retailing, but they've done nothing to improve the aesthetics of the store experience."

J.C. Penney Co., Kohl's Corp. and others have made money competing against Wal-Mart in apparel. Penney transformed its stodgy fashion sense while strengthening private-label brands, such as Arizona and St. John's Bay. Private-label brands now make up about 40% of Penney's sales and are growing twice as fast as overall sales, the retailer says. And even though Kohl's stumbled by letting its styles become dowdy, new lines such as Daisy Fuentes are enticing customers back to stores.

In home furnishings, Bed Bath & Beyond is giving Wal-Mart headaches. Lee Scott, Wal-Mart's chief executive, singled out the chain, with its large selection of both inexpensive and higher-priced goods, as a model for his company. "Bed Bath & Beyond is about selling lifestyle, and Wal-Mart is about selling a commodity," says Marshal Cohen, chief industry analyst at NPD Group, a Port Washington, N.Y., market-research company.

Bed, Bath & Beyond's retailing culture gives it an advantage over others trying to eke out market share in the competitive home-furnishings sector, says A.G. Edwards retail analyst Brian Postol. Like department stores of yore, Bed Bath allows the manager of each store to be entrepreneurial, giving each room to make independent merchandising decisions and tailor their store to its local customers. "That culture enables them to compete against the likes of a Wal-Mart," says Mr. Postol. (The strategy also has translated into big returns for the company, earning it $399.5 million for the fiscal year that ended Feb. 28, a 32% increase over the prior year.)

Of course, even given its recent missteps, Wal-Mart's status as the world's leading retailer is hardly in danger. On the day after Thanksgiving alone, Wal-Mart stores together probably sold more than $1.5 billion in merchandise, estimates Craig Johnson, president of Customer Growth Partners, a New Canaan, Conn., retail consulting firm.

Wal-Mart is still the dominant force in several mainstay retail categories, including toys and food. The Bentonville, Ark., company commands about 25% of the U.S. toy market and more than 17% of the U.S. food and drug retailing market. Even though Target has focused on rapid growth for its grocery-selling SuperTargets, it has only 136 of those locations, compared with Wal-Mart's 1,671 Supercenters.

"Other retailers have emulated Wal-Mart, but Wal-Mart is not a standing target," says Bill Dreher, a Deutsche Bank Securities Inc. analyst. "Wal-Mart may have lost the retailing battle on Black Friday, but no doubt they'll win the race in any category they focus on as they have done in toys and food."

To fight back, Wal-Mart is aiming to improve merchandising in its consumer-electronics, home decor and apparel departments. Indeed, Wal-Mart's post-Thanksgiving Day circular displayed a DVD player for $27.87; six pages were devoted to apparel, including a $26.82 plaid blazer. Meanwhile, to increase its dominance in distribution, Wal-Mart is spearheading an effort to implement so-called radio-frequency identification technology, which could sharply cut distribution costs and potentially save the company billions of dollars.

But beyond the admission that it didn't discount aggressively enough, Wal-Mart has other troubles. It has difficulty merchandising television sets and videogames properly because of crowded aisles and locked cabinets, says Adam Levin, a Beachwood, Ohio, consumer-technology marketing consultant. "Physically, Wal-Mart doesn't have enough space in its stores," he says. "As electronics has grown in volume, they haven't added space. Stuff is scattered around the store."

Space is so tight at some Wal-Marts that the stores sent customers buying 27-inch TVs out to the parking lot, to pick up their set from tractor trailers. And Wal-Mart's reliance on no-name and private-label electronics brands, such as Ilo and Symphonic, to keep prices low is a strategy that backfires at Christmas. "People like to buy name brands when giving a gift," Mr. Levin says.

HITTING THE SPOT

Retail giant Wal-Mart still towers over Target.
For fiscal year ended Jan. 31, 2004:

(1) Includes credit card revenues
(2) Wal-Mart stores as of Oct. 31; Target stores as of Nov. 4

Source: the companies; Sanford C. Bernstein, LLC; TNS Media Intelligence/CM

And as for Wal-Mart fashion, some retailing experts say it still needs some work. Wal-Mart's apparel sales make up about 10% of the U.S. total, says Deborah Weinswig, a senior analyst at Smith Barney. "Given the high gross margins of apparel and home furnishings, Wal-Mart needs to expand its presence in these areas to keep driving its profitability," she says.

Two years ago, Wal-Mart signaled serious intentions in fashion when it rolled out a contemporary apparel line called George, a successful, decade-old label in the U.K. Today, it is a small part of Wal-Mart's offering of clothes in the U.S., and the retailer continues to tinker with it.

Target's strong showing -- driven partly by hip, designer products from the likes of Michael Graves and Isaac Mizrahi -- has been years in the making. Same-store sales, which are sales at stores open at least a year, outpaced Wal-Mart's during every month of 2004. (The comparison excludes Target's department stores, which have been sold, and Wal-Mart's Sam's Club warehouses.

With the recently launched athletic brand C9 and other lines, Target has steadily built a reputation for well-designed clothes. Target created C9 with the sportswear-manufacturer Champion. Target has cut its product-development cycle, once more than a year, down to somewhere between 10 weeks and nine months, depending on how trendy the item is.

In food, SuperTarget stores have increased the number of private-label items to draw budget-constrained customers. And Target is advertising discounts more heavily, displaying more 2-for-1 grocery specials and other bargains.

Target has overcome brutal competition to achieve its gains: 97% of Target's stores are within 10 miles of a Wal-Mart, according to Emme Kozloff, a retail analyst at Sanford C. Bernstein. By contrast, at Wal-Mart, with its greater number of stores and its dominance in rural America, only 48% of its stores are within 10 miles of a Target.

And with some customers, Wal-Mart has an image problem. "I feel like when you walk into a Wal-Mart. . . they want you in and out as quickly as possible," says Manuel De Pena, a 44-year-old software company executive in Sterling, Va. Target stores, he adds, "seem to be constantly getting better and friendlier."

Sears Execs Cash in on Deal -
Kmart Merger Spurs Stock Sales
By Becky Yerak and Andrew Countryman
Tribune staff reporters - Chicago Tribune
December 1, 2004

When Kmart Holding Corp. announced plans to buy his company last month, Sears, Roebuck and Co. Chief Executive Alan Lacy told employees that the deal is "one of the great mergers in corporate history."

At least eight high-level Sears executives also believe it's a great time to cash in some stock. And they haven't been increasing their stakes in the retailer since the deal was announced, either.

Since a merger of the two struggling retailers was announced Nov. 17, Sears' chief financial officer, its general counsel and its top personnel executive were among those who have sold $15.7 million in company stock, according to Thomson Financial. Total profits realized: $5.5 million.

In contrast, before the proposed deal, top Sears executives had dumped $2.58 million in stock in 2004.

Meanwhile, no Sears insiders have made open-market purchases of the Hoffman Estates-based retailer since Kmart Chairman Edward Lampert announced the merger. Although insiders might sell shares for reasons ranging from estate planning to portfolio diversification, experts view purchases as a vote of confidence about a company's prospects.

Lon Gerber, who tracks insider transactions at Thomson Financial, said it's not unusual to see such stock trades as mergers play out, and as employees who may lose their jobs cash out.

But "it's a fairly decent size group, for sure," Gerber said of Sears' contingent. "The size of the trades are bigger than what you normally see there."

For its part, Sears said terms of the merger require all stock options held by employees to be cashed out when the deal closes. The deal is expected to close in March. All salaried Sears workers--of which there are about 17,000--are eligible for options.

"Like any other eligible employees, these executives can exercise their rights to sell their stock and would do so for a variety of reasons based purely on personal timing decisions, tax planning, personal cash needs and the like," said Sears spokesman Chris Brathwaite.

The executives' stock sales shouldn't be seen as pessimism about the future, Brathwaite added.

"Most, if not all, of these folks still own Sears stock," he said.

At least one retail observer believes Sears executives are cashing in stock because they are downbeat about the future.

"They're going to say they're diversifying their portfolios, they're paying their taxes. Why are they really bailing out? Because Sears has gone from a mess to a colossal mess," said New York investment banker Howard Davidowitz.

Sears' sales, for example, are down 2.1 percent year to date, while Kmart's were off 12.8 percent in its latest quarter.

Meanwhile, over the short term, Sears and Kmart have more on their plate than retailing. There are business processes to integrate, stores to be sold or converted, and brands to be incorporated into new stores.

"They'll spend years on this. Wal-Mart and Target are expanding madly, and here's Sears muddling around with systems integration and putting home offices together," Davidowitz said. "Are you kidding? Sell the stock."

But Laurel Bellows, a Chicago executive-compensation lawyer, said the stock sales might have less to do with uncertainty about the merger and more about realizing gains on what had been a slumping equity.

As recently as Oct. 21, Sears stock traded at $33, down from $55 last December. Today, Sears stock is back in the $50 range.

"Executive compensation has trended so toward options that executives have difficulty diversifying their own portfolios, and at the same time they're under increased pressure to show faith in the company," Bellows said.

"This merger is a more understandable opportunity to enjoy the market's approval of the merger and at the same time diversify their portfolio."

Those who began selling Sears stock Nov. 19 include Glenn Richter, chief financial officer; Greg Lee, senior vice president for human resources; Andrea Zopp, general counsel; Janine Bousquette, chief marketing officer; and Mindy Meads, Lands' End CEO.

According to a Nov. 19 letter from Lacy to Sears' workers, Richter will be Sears' point person on a transition team that will integrate the two retailers.

Kmart Buys a Retailer -- Commentary
By James E. Schrager, clinical professor of entrepreneurship and strategy at the University of Chicago Graduate School of Business and editor of
Turnaround Management Journal and the Journal of Private Equity
Chicago Tribune
November 30, 2004

Lacking customer appeal, the blue-light discounter
snags Sears and hopefully customers

This is a test. Circle the right answer. Kmart Holding Corp. buying Sears, Roebuck and Co. is best represented by:

1) Two heads are better than one;
2) the blind leading the blind;
3) two wrongs can make a right;
4) location, location, location;
5) none of the above.

History is full of failed mergers, and from this pile of wasted effort, patterns emerge. The most powerful one is that the best chance for success exists when a company with a strong balance sheet, deep management team and effective strategies buys a company with less of each of those attributes.

General Electric Co. is a good example of a company able to consistently beat the odds on mergers. It swallows up acquisitions and does what sounds easy but is in fact very hard: It adds value. Few companies are organized to make mergers work because for most companies, a merger is an activity well outside of the normal flow of their business. Worse, the requirement of wisdom in doing a merger is often lacking in the occasional acquirer and, as we have so often seen, wisdom is frequently developed through failure.

If you circled "two heads are better than one," you made the wrong choice. Sears and Kmart will be run independently, and although there may be some home-office sharing, this isn't where value is added in retail.

The value here is all added in the stores, by merchants.

These all-purpose managers make the key decisions, such as what merchandise to buy, when to buy it, how to price it, how to display it and how to promote it. This is, by necessity, a local decision. The best retailers develop ranks of skilled merchants to make these calls. Two heads are not needed nor planned in this merger; rather, both companies urgently require a sizable stable of very sharp merchants.

Many of you may have selected the second choice above, "the blind leading the blind." Why would you be so harsh on these two venerable American retailers? Because you should be. No need to recount Kmart's ignominious slide into bankruptcy, a decades-long assault from below by Wal-Mart Stores Inc. and above by Target Corp. (say "Tarjay," it is after all an upscale brand). Just walk through a few Kmart stores today to realize that management must be blind to operate out of the often shabby and unkempt premises that remain even after the last culling of undesirable locations.

As for Sears, it cut loose its profitable and well-known Allstate insurance unit to concentrate on retailing, and then cut loose its profitable credit card operation to concentrate on retailing. This is the strategy of focus, in general a good move. But what now is the vision of the Sears retailing business?

We've just been told. The board of Sears would rather sell than stay independent. So how are these two blind mice going to run this business? This can't be the right answer.

Option No. 3 makes no sense; I hope few of you selected this one. Two wrong strategies don't make a right one. Kmart and Sears have been sliding for years, and joining forces is unlikely to make either management team more creative.

Location is vital in retailing, so perhaps this merger is all about getting the right locations for each brand. Can there be some location synergies, as Yum! Brands Inc. has developed with its combination Taco Bell/KFC food franchises, a strategy called "multibranding?" Can we imagine a Sears within a Kmart? Or Kmart moving to major regional malls?

The economics fail in both cases, as Kmart can't generate the margins to support mall rents and Sears appeals to a different price point than shoppers at Kmart. As a going business, it is hard to see any strong location synergies.

If it's none of the above then what is going on? No one but Kmart's board of directors really knows, but we have several hints and they don't have much to do with retailing. First, Edward Lampert, the new chairman of the combined company, isn't a merchant, he's a finance guy (not that there's anything wrong with that). Next, his style is to broker assets, not to make fundamental strategy changes. He's already been busy with a sale of a block of Kmart's best real estate. Is this the work of a fellow who wants to grow the business? Finally, the stock price of Sears took a hefty spike upward when a real estate specialist recently bought a big position.

So forget the idea of running these two tired businesses as the driving force. This is a deal all about extracting value that the wider stock market doesn't see by taking these companies apart and selling the pieces.

Is this good for all of us blue-light shoppers? Sure. When managements can't devise a workable strategy or execute it, they have to walk the plank. This is the market's way of voting them out of existence so that better, smarter, more nimble players can take their place.

Sometimes none of the above can be the best answer.

Wal-Mart Loses Discount Edge In Sluggish Early Holiday Sales
By Ann Zimmerman - Staff Reporter - The Wall Street Journal
November 30, 2004

Wal-Mart Stores Inc. acknowledged that a strategic shift to boost profits by ratcheting back discounts has backfired, damping sales during the crucial Thanksgiving holiday period and forcing the company to revise its November sales forecast.

Even as anecdotal evidence suggested that other retailers were enjoying a strong start to the Christmas season, sales at the world's largest retailer were sluggish. The company now forecasts a negligible 0.7% year-over-year increase in same-store sales for November, down markedly from the previous forecast of 2% to 4%.

Part of the problem was that rival retailers were beating Wal-Mart at its own game, discounting even more than the No. 1 retailer. But the giant chain itself, in an unusual statement, laid out the issues in detail:

"We are disappointed with our sales performance for the Friday after Thanksgiving and the full weekend," said Mona Williams, vice president of communications for Wal-Mart. "While our prices were generally as low as they have ever been, our competition was even more aggressive. Also in hindsight we can see our overall program was too predictable and our competition capitalized on this. Specifically, our store hours, newspaper advertising-circular layout and distribution, marketing strategies and especially our merchandising selection were too similar to [those of] years past."

Ms. Williams went on to suggest that Wal-Mart might rethink its discount shift, saying that "these are all things we can learn from and react to quickly - a particular strength of Wal-Mart. ... We will be responding to what our customers have told us during the remaining four weeks of the holiday season."

Besides compounding pressures the retailer already faced from a rising number of direct competitors such as Target Corp. and Best Buy Co., the pullback on discounts ran counter to the economic burdens facing the lower-end customers who form Wal-Mart's core business. They have been particularly hurt this year by higher gasoline prices.

At this late date, Wal-Mart has a limited number of options to spur its Christmas sales. It can't make a wholesale change in its merchandise. Instead, the retailer may have to revert to extensive and deep discounts and more aggressively advertise them. Its revised November sales forecast sent Wal-Mart shares sliding $2.17, or 3.9%, to $53.15 in 4 p.m. composite trading on the New York Stock Exchange.

The sheer size of Wal-Mart, which accounts for 8.5% of nonautomotive retail sales in the U.S., means any shift in its business could have broad economic implications. As a result, Wall Street analysts yesterday sought to decipher how much its disappointing sales growth reflected Wal-Mart's less-aggressive discounting and how much might suggest that lower-income consumers are staying on the sidelines in general.

"When Wal-Mart sneezes, the rest of the retail sector gets the flu," says Bill Dreher, retail analyst at Deutsche Bank. "Its surprising sales announcement is a real concern." Nonetheless, many analysts expect Wal-Mart to hit its quarterly earnings forecasts.

From Wal-Mart's inception, founder Sam Walton insisted on giving consumers consistently low prices rather than the occasional sale. Those rock-bottom prices drove increasing sales and profits, stoking the so-called productivity loop. Under this system, lower prices lift sales. In essence, Wal-Mart was willing to accept less profit on each item but expected to make it up in volume.

That philosophy helped propel Wal-Mart from a regional retailer to the world's biggest merchant. This year, Wal-Mart is expected to rack up close to $300 billion in sales, four times the sales of No. 2 retailer Carrefour SA.

Wal-Mart has about 3,500 stores in the U.S., including units of Sam's Club, a membership wholesale outlet. Best Buy has 670 stores in the U.S. and Target has 1,449 stores in the U.S.

For this Thanksgiving, Wal-Mart issued its typical 40-page newspaper circular, advertising discounted prices on electronics, toys and other gifts. But there was a difference. Company executives acknowledge that they purposely offered less-aggressive discounts and pared prices on fewer items than in years past.

To some degree, though, competitors caught Wal-Mart napping. In past years, Wal-Mart drove Black Friday sales by having the best prices on the newest electronics. The retailing world so dubs the Friday after Thanksgiving because it's the day when many retailers supposedly go into the black, or start making a profit, for the year.

This year, Wal-Mart's lowest price on a DVD player was $79 while Best Buy sold DVD players for as little as $14.99 after mail-in rebates. In some stores, Best Buy sold out of them in as little as 15 minutes. At the same time, Wal-Mart devoted a full page to promoting a $99 remote-controlled Cadillac Escalade for children.

Last week, Target said it was on pace to post a same-store sales increase between 2% and 4% when retailers report November results this Thursday. However, Target tends to attract higher-income consumers and its sales have been outpacing Wal-Mart for several months. Target was also more aggressive in pushing consumer electronics than Wal-Mart in its advertising.

The Wal-Mart juggernaut appears to be running up against several new challenges, starting with higher energy prices. Gasoline prices have climbed 60% from a year ago, and customers are also paying more to heat their homes this winter because of higher prices for heating oil and natural gas.

At the same time, Wal-Mart appears to have hit the wall on the productivity loop. Analysts who have talked to Wal-Mart executives say the retailer felt it had reached a point of diminishing returns on lowering prices -- that discounts weren't producing as big an increase in sales as they did previously. Instead, Wal-Mart officials concluded they were just hurting their profit margins, the analysts say.

In the past year, Wal-Mart has been more strategic in lowering prices -- remaining below the competition, but not as significantly underpricing other retailers as in previous years.

Even though Wal-Mart's sales have been relatively soft since June -- several times it lowered its sales estimates in midmonth -- it has continued to hit its earnings targets. For the fourth quarter ending Jan. 31, 2005, Wal-Mart forecasts profit of 73 cents to 75 cents a share. The retailer said it expects comparable-store sales for the fourth quarter to grow 2% to 4%. Despite missing its sales forecast for November, which represents 30% of sales for the quarter, Wal-Mart didn't make any changes to its sales or earnings forecast for the period.

Analysts still expect Wal-Mart to hit its quarterly earnings forecast, provided there are no more missed sales plans. In its previous fiscal quarter, which ended Oct. 31., Wal-Mart missed its sales plan in October but still hit the high end of its earnings per-share range of 54 cents a share.

Emme Kozloff, a retail analyst at Sanford C. Bernstein, says it is too early to call the holiday season weak or to predict that Wal-Mart's quarterly earnings are at risk. But she wonders if Wal-Mart underestimated the effect on sales of being less promotional and whether stiff discount competition from the likes of Best Buy and other retailers will eventually force Wal-Mart to return to its early strategy.

Some experts predict that Wal-Mart will ratchet up discounts as the season progresses if traffic does not pick up. But some analysts maintain that Wal-Mart's Black Friday misstep is no big deal. "They had a tough year in sales and that hasn't changed," says a hedge fund analyst. "They went out of their way to be less promotional and it makes sense. When they ran extreme discounts last Thanksgiving, they still had negative comparative sales for the day. And they came back and did fine."

Shoppers: Sears Could Help Kmart
By Theresa Howard, USA TODAY
November 29, 2004

PARAMUS, N.J. - If most holiday shoppers have any say about it, Kmart's purchase of Sears will leave that venerable department store chain mostly unchanged.

In fact, shoppers at both Sears and Kmart stores on Black Friday in this shopping mecca said Kmart could learn something about service, store cleanliness and product quality from Sears. The combining of the two companies could be completed by spring.

"Kmart, forget about it," says Livio Udina, who was shopping at Sears. "They have people who can't even help you. I hope Sears doesn't go down like Kmart."

Udina, who lives in Washington Township, and other area residents know something about shopping. Paramus is home to virtually every major retail chain. It boasts the ZIP code - 07652 - that generates more retail dollars than any other in the USA. Though Kmart and Sears stores stand just two miles from each other on Route 17, their brand perceptions among shoppers seem to be a million miles apart.

Paul Brener, 65, shopping at Sears for leather gloves, says he won't shop at Kmart because he thinks the stores "don't have as quality merchandise as Sears."

Even Kmart shoppers tend to agree. Andrea Stern, 28, shopping with her parents for donations for an "Angel Tree" charity, says, "We needed toys, clothing and pharmaceutical stuff." She concedes, "We knew we could get more for our money, but maybe not get the best quality."

Kmart's five-hour sale Friday offered discounts of 70% on fine jewelry, 50% on sterling silver and 20% on men's, women's and kids' apparel. But for Ron Brandes and his wife, Sylvia, the lure was Christmas lights.

"We like Sears," she says. "I don't like Kmart, but I saw something in the circular."

What do they admire about Sears and dislike about Kmart? "Sears has always been very consistent," he says. "And, in general, Kmart has always been associated with cheapness."

And, to some, uncleanliness. Stephanie Hinson and her husband, Darin, of Garfield, N.J., shop at Sears for clothes and at Kmart for toys. But the family shops only at the two area Kmart stores they consider the cleanest. "Some of the other stores are really nasty, so we only shop at selected ones," says Stephanie, a mother of six.

Some think Sears' solid standing with consumers could be a boon to holiday sales.

"There is little doubt in my mind that this holiday will be the best we've had to date," says Sears' store manager Linda Longo.

Sears' History, Haphazard Ways Pose Challenge
By Susan Chandler and Michael Oneal - Tribune staff reporters - Chicago Tribune
November 28, 2004

Merger with Kmart Holding Corp. doesn't undo damage of failed strategies and lack of focus

A dedicated shopper can find Lands' End merchandise all over the place at Sears Roebuck and Co.'s flagship State Street store in the Loop, but it's something of a treasure hunt.

The first-floor women's apparel department has a special Land's End boutique, but an assortment of preppy Land's End sweaters and shirts also hangs beneath a large painted sign for Covington, one of Sears' private-label brands. On floor two, the Lands' End men's pattern-pinpoint dress shirts are not in the men's boutique but a few steps away from a column labeled "Young Men's."

"My wife and I shopped Lands' End at Sears, but we gave up and went back to the catalog. It's the only way to find the stuff you want," said Sid Doolittle, retail consultant with Chicago's McMillan/Doolittle.

When retail experts say Sears has trouble executing its retail strategies, this is the sort of thing they are talking about.

While the company has tried hard over the last two years to integrate its $1.9 billion acquisition of Land's End, Sears has failed to create a clear, coherent message about who should buy the brand and why it costs more than the rest of Sears' apparel offering.

As Connecticut investor Edward J. Lampert studies his proposed $11 billion merger of Kmart Holding Corp. and Sears, a history of poor execution at both retailers highlights the magnitude of the challenge he faces. While Lampert has been adept at cutting costs and selling stores to raise cash, he has yet to prove he can turn around a struggling retailer.

"What they don't have is a team in place that has experienced success," said a former top-ranking Sears executive. "It's not the big think stuff that consultants talk about. It's the blocking and tackling."

The case of Sears and Lands' End fits an unfortunate pattern, retail experts and former executives say. Sears has often laid out aggressive plans but rarely followed through with the long-term attention to detail that would make the company's strategies stick with shoppers.

Instead, Sears' management often abruptly changes course when results come in below target and then announces some new strategy to get the franchise moving again.

"There are a lot of people making decisions all over the place and people unmaking decisions all over the place," Doolittle said. "Whenever they find something positive, they make an announcement. Then there are people rethinking it based on later information or new information."

Cynthia Cohen, president of retail consulting firm Strategic Mindshare, attributes Sears' frequent course changes to a search for "the silver bullet"--a single stroke that will make the company a winner again.

Under former Chief Executive Arthur Martinez, the silver bullet was "The Softer Side of Sears," a marketing and merchandising campaign to win back women shoppers who thought Sears' apparel was dowdy.

For a few years, the Softer Side looked like a big success, but when apparel sales flattened in the late 1990s, Martinez was out and current CEO Alan Lacy was in.

Lacy backed away from the Softer Side, dumping the Circle of Beauty cosmetics line that Sears had spent several years and millions of dollars developing in the mid-1990s.

Ditto for the Great Indoors, an upscale home remodeling chain created by Sears that features brands like Viking ranges and Sub-Zero refrigerators.

At first, Lacy was a big fan of the Great Indoors. Customers loved the open feel of the store and the one-stop shopping experience for everything from kitchen cabinets to bathroom towels.

By the time the second Great Indoors opened in October 1999, Sears announced it would roll out 150 of them as soon as possible.

But two years later, Lacy had soured on the Great Indoors because the stores were too expensive to build. He canceled some store openings and postponed others. A handful were even shuttered.

Today, there are 17 Great Indoors stores and the chain is in limbo. Meanwhile, Expo Design Center, a rival chain owned by Home Depot Inc., has expanded to more than 50 stores.

Ann Raives, a retail expert with consulting firm BearingPoint Inc., says the hallmark of a successful retailer like Wal-Mart Stores Inc. or Target Corp. is not the in-store assortment or store locations. Those things are important. But the crucial competitive advantage stems from a company's clear understanding of its customers. That's what brings focus to the assortment, store location and all forms of marketing.

"It's all about the insights you have so you can offer a relevant customer experience," Raives said.

While Wal-Mart delivers "Everyday Low Prices" with a vengeance and Target has carved out a lucrative youth niche with its "cheap-chic" housewares and fashions, Sears serves up a muddled message, marketing experts say.

A history of bobbing and weaving hasn't helped.
"Sears hasn't said, `What is our core competence? What are we good at?'" said Christie Nordhielm, associate clinical professor of marketing at University of Michigan's Ross School of Business.

"Right now, they aren't good at anything. While they were messing around with all these strategies, Wal-Mart and Target were investing in clear strategies and pulling light years ahead of them."

Target has been following the same basic game plan, shaping itself into a "trend merchant," for the past 30 years. As a discounter, it could have tried matching Wal-Mart's rock-bottom prices, but that would have been a losing battle, retail experts say.

Instead, Target stayed true to its plan to differentiate itself with higher-quality, more fashionable merchandise.

Long-term struggle
Such observations aren't rocket science, but figuring out how Sears should get back on track has defied an easy answer for almost two decades.

Under Lacy, Sears went without a top merchant for two years and then hired Mark Cosby, an executive from fast-food chain KFC, to be president of its 870 full-line stores.

After only 20 months in the job, Cosby found himself out the door last summer and his job was eliminated. Sears hired a former Target executive as its new president of merchandising in August.

Of the top 50 retail executives at Sears, about 20 of them have joined the company in the last three years, Lacy told analysts last week.

"There is a culture of fear and anxiety that has been there for the last two or three years," said the former executive. "There's no stability in the organization."

The management turnover has not helped Sears' strategy with Lands' End.

After buying the chain in 2002, Sears hoped it would be the silver bullet for pulling well-heeled appliance buyers into its apparel departments.

But after forcing it into its full-line stores, Sears discovered that many customers, especially in lower-income neighborhoods, weren't interested in its higher-price chinos and polo shirts.

"They spent so much on the acquisition that they felt they had to put it in a lot of places quickly without understanding what they were doing," said a former executive.

So Lacy retrenched, pulling back in some stores and pushing forward in others.

Even so, the execution has been spotty and disorganized, experts say. The display of men's pinpoint shirts at the State Street store provides a good example. On a recent visit, a sign said the shirts cost $36 apiece, but that appeared to be true for just a single pinpoint with blue stripes. Most of the shirts carried lower price tags and one with gray stripes could be had for $29.50.

Retail and marketing experts don't begrudge Sears for trying to fix the strategy. But they insist many of the mistakes could have been avoided if Sears had stepped back and tried to evaluate who it wanted to target.

"You have to manage expectations in the retail business," Cohen said. "Sears' management has that responsibility, and they haven't been doing it."

Managing expectations
Lampert has already learned that much. At the Nov. 17 press conference announcing the Kmart-Sears merger, he went out of his way to manage expectations.

"We're not going to try to generate steady progress," he said. "It'll probably be lumpy progress over time."

A key rationale for the merger is to transform many of Kmart's freestanding stores with key Sears brands like Kenmore, Craftsman, DieHard and Lands' End. Lampert and Lacy also insisted that the new Sears Holdings Corp. won't abandon its full-line mall-based stores.

But everything depends on the execution, retail expert warn, and the two chains' record on that score is clear. Merely the challenge of transforming hundreds of Kmart stores into Sears outlets will tax the new company's resources.

"The problem is the Sears organization has no experience doing anything of this level," the former Sears executive said. "It will be a daunting effort."

- - -

Searching for a strategy, again and again
Since the early 1990s, Sears has tried numerous concepts to spruce up its retail performance. But execution has been poor, and many new product lines and retail concepts have been abandoned rather than fixed.

Sears Grand
In recent years, Sears has focused on a free-standing store that combines traditional Sears products like tools and appliances with convenience items such as milk and snack foods. Sears continues to tinker with Sears Grand, saying it isn't profitable enough yet.

Lands' End
In a move to strengthen its beleaguered apparel business, Sears bought the preppy catalog and Web retailer for $1.8 billion in 2002, betting Lands' End would draw new, more affluent shoppers to its stores. But Sears mishandled the rollout. It couldn't ramp up production fast enough to keep the brand in stock and it put Lands' End in stores where urban shoppers rejected the look.

Great Indoors
The tony home-decorating concept, first tested in 1997, held great promise as it drew upscale customers who normally bypass Sears. But the company has slowed growth plans and shut stores since 2001 because the stores weren't making enough money.

Sears Hardware
Another off-the-mall chain, it was created to appeal to the convenience shopper. It was cited as a specialty success story early on, but CEO Alan Lacy shelved expansion plans because of low profit margins.

Circle of Beauty
Launched in 1995, this private-label cosmetics line was another strategy to woo more middle-class female shoppers. But women did not want to buy makeup at a store better known for Craftsman tools and Kenmore appliances. The line was discontinued in 2001.

HomeLife
Sears began moving furniture out of department stores and into freestanding HomeLife Furniture stores in the early 1990s. Growth accelerated as it emphasized apparel in the department stores. Once touted as its hottest growth vehicle, the 126-store chain gave Sears more headaches than stellar performances. It was sold in 1998 to a venture capital group and later liquidated.

The Softer Side of Sears
Aimed at drawing more women into its department stores, the memorable advertising slogan from 1993 to 1999 played up the retailer's apparel and accessories. The campaign worked at first, but sales began slumping in 1998 and the theme was criticized as stale. It was replaced by the tagline: "The Good Life at a Great Price. Guaranteed."

Battle of the Boxes:
Kmart, Sears Deal Fuels Appliance Wars
By Dan Morse and Steven Gray - Staff Reporters - The Wall Street Journal
November 26, 2004

On a recent night at the Sears, Roebuck & Co. in Atlanta's Northlake Mall, shoppers strolled among 110 different models of refrigerators, 87 oven ranges, 45 dishwashers, 51 washers and 42 dryers. Three salesclerks, with expertise by appliance category, stood ready to answer questions about energy efficiency, "quiet" dishwasher cycles and maintenance plans.

Sears' breadth of bulky kitchen products -- not to mention attentive sales help -- has helped make it the nation's appliance king, with its in-house Kenmore brand alone commanding a 25% share of the $27 billion category. In total, Sears owns nearly 40% of the appliance market.

But selling what used to be called "white goods" -- never a cakewalk -- is getting harder. Customers want more fashionable options in stainless steel, fast delivery, and the removal of their old, wheezing machines. Big retailers, faced with tough product margins and intense competition from regional and mom and pop stores, have swung in and out of the game: Circuit City Stores Inc. went up against Sears in the 1990s but bailed out of large appliances altogether about four years ago. Even behemoth Wal-Mart Stores Inc. backed down after testing the concept. "It's a tough business," sums up a Circuit City spokesman.

Now, with Kmart Corp.'s proposed $11.5 billion acquisition of Sears, the appliance stakes are about to rise again, and may eventually affect how the new entity, Sears Holdings Corp., fares with consumers and investors alike.

Big box retailers -- notably Home DepotInc. Lowe's Cos. and Best Buy Co. -- have nibbled away at Sears's appliance lead. Unlike Sears's mall-based locations, those retailers operate convenient stand-alone stores. Both Home Depot and Lowe's are making inroads in the appliance aisles by broadening their product selection, promising on-time or free delivery while flexing the same pricing muscle used to conquer other home-improvement retailers.

The two chains also have an advantage over Sears in their ability to bundle appliances with sales of cabinets, countertops as well as full-service kitchen makeovers. Best Buy, even though it has fewer stores, has been able to sell hip-looking products such as front-load washing machines that appeal to the same design-conscious consumers who snap up plasma TVs.

Sears is gearing up for a counterstrike. The deal with Kmart is expected to result in the conversion of hundreds of Kmart stores to Sears locations, plopping washers and other large appliances right in the backyards of big box retailers. Kmart has about 1,500 stores; Sears has nearly 900 standard stores plus 1,100 specialty locations.

Some investors aren't convinced that combining two once-dominant retailers will be enough to overcome their recent history of lackluster management and inefficiency. But if Sears turns 300 Kmart locations into Sears stores with full-fledged appliance departments, retail analysts at Sanford C. Bernstein & Co. estimate that Sears could boost its appliance sales to $13 billion a year from the current $10.3 billion. Such a sales surge would lift Sears's market share, in dollars, to 47% from 38% -- and cost Lowe's and Home Depot more than $1.1 billion in annual sales.

In addition to its Kenmore brand, Sears carries top outside names, such as Whirlpool Corp.'s KitchenAid, Frigidaire from Electrolux AB and models from General Electric Co. Over the years, Sears has leveraged its brand position by outfitting stores with huge appliance sections.

Of course, it isn't clear that the proposed, new No. 3 retailer would be able to pull off its appliance strategy. Converting Kmart stores to Sears stores will be costly, and analysts don't expect the merged company to push appliance sales in the remaining Kmarts. Merger talk aside, a Sears spokesman says the company is "very pleased" with its current appliance sales. The company has improved store displays and added more low-price models, which has helped it stem unit sales share declines in recent months, according to industry figures.

But the triumvirate of Lowe's, Home Depot and Best Buy is still fighting. Lowe's made major renovations to its appliance sections eight years ago, and says it was the first retailer to haul away old appliances at no extra charge. Lowe's appliance sections now approach the size of those at Sears sections, with a Lowe's store near Atlanta displaying about two-thirds as many appliances as a Sears nearby. Lowe's, with approximately 1,031 stores, sells almost all of the brands carried by Sears.

"We believe our best days are still ahead in appliances," says John Kasberger, a top merchant at Lowe's. He declined to comment specifically on the Sears-Kmart merger. Lowe's, based in Mooresville, N.C., has 14.1% of appliance unit sales market-share.

Home Depot is newer to the appliance battle, and though its selection is substantially smaller than that at Sears or Lowe's -- it relies mostly on GE and Maytag brands -- customers can order from more than 2,000 models that can be delivered within three days. Unlike Sears and Lowe's, Home Depot doesn't pay employee commissions on appliance sales, yet its enormous store base has helped it build an 8.6% share of the market.

The Sears-Kmart merger also could shake up appliance makers. Whirlpool is the largest manufacturer of Sears's in-house Kenmore brand. Any surge in orders from Sears could give the retailer more leverage to squeeze Whirlpool on pricing. At the same time, other suppliers are likely to approach Sears if it needs to bulk up its Kenmore line. "I think it's a jump ball for Kenmore," says Laura Champine, a Morgan Keegan & Co. analyst.

A Whirlpool spokesman says the company views the likely addition of appliances to converted Kmart stores positively. "Any move that's good for Sears is good for Whirlpool," he says. Whirlpool also sells appliances to Lowe's, Best Buy and to the 54-store Expo home-design chain owned by Home Depot -- but not to the approximately 1,602 warehouse-style Home Depot stores in the U.S.

Eric Brosshard, an analyst with Midwest Research, says that Home Depot will face pressure to bring in more brands and make more room in its stores for appliances if the conversion of Kmart locations near Home Depot stores is successful. "They have to fish or cut bait, and I think they'll fish," he says of Home Depot.

75% of Survey Won't Miss Kmart,
Select Sears as Surviving Brand Name
By Sandra Guy - Business Reporter - Chicago Sun-Times
November 26, 2004

The demise of Kmart was one of the first reactions to news of Kmart's planned takeover of Sears Roebuck and Co.

A new survey shows that few people would miss the Kmart name. A whopping 75 percent of Americans surveyed chose Sears as the name that should survive the Sears-Kmart merger, if only one of the two names survives, according to the survey of 1,050 adults commissioned by Rivkin & Associates, Inc., of Glen Rock, N.J. The survey was conducted Nov. 19-22 by Opinion Research Corp.

"Kmart is a damaged brand name," said Steve Rivkin, founder of Rivkin & Associates.

Sears had an especially favorable rating among men, among adults with higher household incomes and among college graduates, while Kmart scored marginally higher with older consumers and people with lower household incomes.

The reaction is likely because Sears is better known for its Craftsman tools, Die-Hard batteries, auto centers and higher-priced goods than its discount rivals, while Kmart stores are primarily located in urban, multiethnic neighborhoods.

Speculation about the demise of Kmart started as soon as the $11 billion retail megamerger was announced on Nov. 17.

Kmart's and Sears' largest shareholder, Connecticut billionaire Edward Lampert, is known for cutting costs at companies he runs and selling their real estate to generate cash.

Lampert's reputation has led many retail experts to believe he has no intention of keeping either Kmart or Sears alive.

One analyst speculated that no company that wanted to stay in retail long-term would drop a bombshell as large as the Kmart-Sears merger so close to the holiday season. The news unsettled employees, suppliers and customers, said Carol Levenson of Gimme Credit, an independent research firm.

"The lack of a compelling strategic rationale (for the merger) could be the source of additional real estate speculation by those who believe these companies are worth more dead than alive," Levenson wrote in a report to investors.

Clean Start
By Keith Naughton - Newsweek
November 29, 2004 issue

Target Is the Target
By David Meier - CBS MARKET WATCH
November 24, 2004

The Kmart/Sears merger is not about real estate or synergies. Eddie Lampert is taking a big swing at greatness by combining two has-beens into a future champion. And the goal is to be just like Target.

Eddie Lampert: Value investor?

Nearly every article I read last week about the merger between Kmart

(Nasdaq: KMRT) and Sears (NYSE: S) opined that Eddie Lampert is the next Warren Buffett. They talked about how Lampert has studied Buffett's every move, how Lampert is a value investor, and how their records compare favorably even though Buffett's is over a longer period of time.

Frankly, I don't care if Eddie Lampert is the next Warren Buffett. And I have a feeling he doesn't care either. I would guess that he wants to make his mark as Eddie Lampert. But I do care that Lampert seems to be a value investor because there is something we can all learn from that.

Price is what you pay The first tenet of value investing is to buy assets at bargain basement prices. Using bankruptcy as a call for a blue-light special, Lampert picked up his 53% stake in Kmart for about $1 billion and his investment has increased seven-fold since then. Looks like Hidden Gems analyst Rex Moore has company.

To purchase Sears, Lampert offered $50 in cash or half a share of Kmart stock for each share of Sears stock. Take your pick, but either way Sears comes out with a price tag of about $11 billion.

When you add them together, it looks like Lampert will spend about $12 billion to gain control of two retailers that have fallen hard from grace because they did not know how to compete with those "hillbillies" from Bentonville, Arkansas, and their 800-lb gorilla, Wal-Mart (NYSE: WMT).

But why would someone pay $12 billion for a couple of has-been retailers?

Value is what you get It all comes down to what you get out of the deal.

Kmart has 1,504 stores. Sears has 1,971 stores, of which 870 are mall-based and 1,101 are stand-alone. After purchasing his controlling interest, Lampert sold 68 Kmart stores for $846 million, or about $12.4 million per store. Now let's assume that he could liquidate the entire portfolio of stand-alone stores, all 2,605, for $6 million per store (this is only a wild guess based on 50% of the $12.4 million Kmart store price tag above). That would value the portfolio of just the standalone stores at $15.6 billion.

But let's not forget a very important piece of a retailer's puzzle that I have not heard much about yet. I'm guessing Lampert picked up two distribution systems quite cheaply. Now I know that my example is based on the $6 million assumption (a wild assumption, remember), but nonetheless, I believe Lampert bought some pretty good assets at bargain prices.

Think of it another way. Target (NYSE: TGT) has 1,554 stores under its umbrella. According to its balance sheet, Target has $15.4 billion of property and equipment when you add back the accumulated depreciation. Thus, Target seems to have spent an average of $10 million per store, not accounting for distribution system costs.

Could Lampert have built a retailer from the ground up for $10 million per store? No way! It would take far too long and cost far more to do so effectively. Instead, he bought the pieces of two existing ones and will attempt to put them together to set the new company up with enormous economies of scale.

But the really cool thing is what else Sears brings to the table -- the brand-name merchandise. Sears generates $41 billion of sales using household names like Kenmore, Craftsman, and DieHard. Now if only those sales could be used productively to create value.

The role of the CEO Just because the stores are under one roof now does not guarantee success. In fact, the cards are definitely stacked against the new company. It is going to take a great leader to create value out of the situation.

Warren Buffett, chairman of Berkshire Hathaway (NYSE: BRK.a), says he has two roles: motivator and capital allocator. I think the same principle applies to Lampert. For the company to create value for shareholders, Lampert will have to allocate capital and motivate people in such a way to make the business productive. Over the years, Wal-Mart has redefined retailing by using productive systems to lower costs. Costco (Nasdaq: COST) relies on a similar productivity model but really understands the value of motivated employees.

In my mind, the easy part of the deal is the capital allocation piece. Capital should be spent to upgrade the distribution system as well as others like the point-of-sale system. It should also go to modernizing the stores to give them a fresh, new look. The hard part is going to be creating a culture that strives for low costs in order to make sure that sales create value. Wal-Mart and Target already have this. Lampert does not.

The fruits of his labor

In the press release following the merger announcement, Lampert specifically said that his team would manage the company for the long term and would not worry about bumpy earnings along the way. That's good because this culture thing is going to take time and money.

But if he can pull it off, I think there's a great deal of value to be created along the way. To find out how much, let's look at a peer-group comparison.

$ in billions

Enterprise value is equal to market capitalization plus debt minus cash. Comparing the EV/sales ratios for the retailers, we see that the market places considerably less value on the sales of Kmart and Sears. If the new company can achieve Target-type respect, then its value could triple (1.15/0.37 = 3.1). This is the payoff that Lampert is striving for during this journey.

Margin of safety

So what if it doesn't work out? Let's say that Lampert has to liquidate the portfolio and distribute the cash to shareholders. How much could he give back to them?

$ in billions

Trust me, I know this is an estimate and that actual distributions would be based on all sorts of complicated negotiations with lawyers and such. Plus, in the event of a real liquidation, it's not certain what sort of prices the stores would fetch. But to me, this says that there is some margin of safety built into the strategy.

Eddie Lampert: Value investor

I believe Lampert has one goal in mind -- to create and capture as much value from the assets as possible. He started things off right by buying decent assets at low prices. He has plenty of capital to allocate to those assets to increase their value. And there appears to be some margin of safety built into the plan if he cannot.

Is this merger about synergies? No way. It's about competing effectively against the best retailers in the industry today. That's how he will try to make his mark. But can he lead the turnaround and create a culture that can control costs and create value from those $55 billion worth of sales? Lampert's made a big bet on his ability to do so.

Perhaps one lesson from Buffett that Lampert needs to remember is that Buffett started small. He took lots of smaller swings before he took the big ones. By doing so, Buffett learned how to lead a business along the way. This is an awfully big swing for someone making the same transition from managing a hedge fund to managing a company. Personally, I think the inertia of the current culture will be much harder to turn around than anticipated and I will be more than happy to watch this from the sidelines.

It's Not About Retailing
By Allan Sloan - NEWSWEEK
November 29, 2004

Sears and Kmart execs say they're combining to make each chain stronger.
But other factors drove this deal

When you see two store chains combining, you generally figure it's about retailing. But to understand Kmart's stunning purchase of Sears last week, you've got to think about real estate. And Wall Street. And about clever lawyers keeping the taxman at bay by using a "horizontal double dummy." (That's a type of corporate structure, not a critique of the dealmakers'
IQs.)

These companies are combining because of hedge-fund manager Edward Lampert, whose investors own a majority of Kmart and 15 percent of Sears. Wall Street has fallen in love with Kmart's stores since its emergence from bankruptcy last year. Not with the stores' performance, but with the price Lampert got by selling some of them. Lampert has become a Wall Street hero, the stock has turned into a real-estate play, septupled and become a valuable takeover currency.

Meanwhile, the Street's fallen in love with Sears's real estate, too. Its stock, depressed for years as strategy after strategy failed, rose 23 percent on Nov. 5 when Vornado Realty disclosed that it controlled a big stake. Lampert, already negotiating a Sears-Kmart combo, acted quickly before the price ran up even more. Vornado, controlled by dealmaker Steven Roth, has made about $100 million but is likely to complain that Sears is selling out too cheap. It's not clear if the gripes of Roth can derail the deal.

This $11.5 billion transaction is a sad commentary on how far Sears has fallen. It used to be the nation's dominant retailer. Now it's got the same number of stores it had in 1970-and its stock-market value is actually less than it was then. In 1970, Sears made up 2.5 percent of the value of the S&P 500 stocks. Today it's a skosh more than a tenth of 1 percent. And it's being bought by a corporation half its size that's 18 months out of bankruptcy. Sad.

Because the companies are close in stock-market value, you need a complicated structure for Sears holders to get Kmart shares tax-free while letting Kmart retain its ability to shelter about $3 billion of future profits from taxation. Under normal circumstances, Kmart would have to buy at least 80 percent of Sears for stock to let Sears holders do a tax-free share-for-share exchange. But issuing that many shares might have hurt Kmart's tax shelter. So instead, Kmart is creating a new holding company that will buy both Kmart and Sears-the double-dummy structure. For reasons you don't want to know, doing the deal this way lets Kmart offer a tax-free stock-for-stock exchange while buying only 55 percent of Sears for stock, rather than the aforementioned 80 percent. Kmart's tax shelter springs no leaks. This structure also allows Sears and Kmart to dodge potential legal problems with landlords, lenders and vendors.

So the dummy deal is pretty smart. So is Lampert, who bought Kmart bonds when the company was in bankruptcy and has parlayed about $800 million into more than $5 billion. Now it's time to see how smart the companies' managers are. Can they successfully turn Kmarts into free-standing Sears stores? Can the new "Searsmart'' fend off Wal-Mart, Target and Home Depot while merging two disparate operations? If Lampert pulls this off, he really is a genius. If not, he'll become the latest in a long line of Sears suckers.

Two-for-One Sale
Can Kmart and Sears Create a Whole New Kind of Department Store?
By Daniel Eisenbern - TIME
November 22, 2004

Shoppers Venturing into the new supersize Sears Grand concept store in Rancho Cucamonga, Calif., off the old Route 66, can be forgiven for double-checking the name on the façade. Perhaps it's the barbecue grills on sale outside the entrance, an echo of Home Depot's parking-lot bonanzas, or the reams of DVDs, CDs and books that make you think you've stumbled into Wal-Mart.

Maybe it's the colorful signs hanging from the industrial, sky-high ceiling, festooned with cheeky slogans like IT'S THE LITTLE THINGS THAT COUNT, which remind one of the king of cheap chic, Target. Then again it could be the 10-ft.-wide aisles and end-cap displays with towering boxes of bulk sodas, detergent and paper towels that look straight out of Costco, or the smarter, casual clothes that smack of Kohl's. Sure, this Sears store still has its standard array of Kenmore appliances, Craftsman power tools and DieHard batteries, but there's also a wine section and an eye-care shop. Most important, there isn't a musty, aging shopping mall anywhere in sight.

If Sears' odd amalgam of its rivals' successful retailing strategies seems a bit disorienting, consumers may have to get used to it. Until now, the Grand store has been just a small-scale experiment to lure shoppers in more often and stop Sears from being squeezed by discounters on the low end and big-box specialty retailers on the high end. Think of it as the wider side of Sears. But in the wake of last week's $11 billion megamerger with floundering discounter Kmart, the Sears Grand could be the foundation of an extreme and long-overdue makeover.

By melding the Sears savvy in selling so-called hard goods like dishwashers, lawn mowers and flat-panel TVs with Kmart's upmarket "soft" brands like Martha Stewart Everyday, Jaclyn Smith and Joe Boxer, the sales pitch goes, the two perennial retail losers just might create a winning formula. On the other hand, by combining two badly managed retail dinosaurs into one, wags say, the companies may simply save themselves some bankruptcy fees when they inevitably go extinct.

Notwithstanding all the talk about scale, $300 million in annual cost savings and sizable purchasing power, the merger isn't so much an attempt to take on a behemoth like Wal-Mart as it is to survive in spite of it. Even with a combined $55 billion in annual sales, Sears and Kmart will be just one-fifth the size of Wal-Mart, which "is so overwhelming in terms of market share, logistics and efficiency that going up against them would be futile," as Michael Appel, managing director of Quest Turnaround Advisers, puts it.

For the moment, at least, Sears and Kmart will operate as separate chains under one corporate umbrella, Sears Holdings, and each will probably offer a smattering of the other's trademark brands. But all indications are that as time goes by, Sears, the more productive store operator and the more respected brand, will subsume Kmart and try to carve out a successful niche as a middle-market power retailer focused on fashion and the home, with more attitude and style than JCPenney could ever hope to have. "We are the trade up," Sears CEO Alan Lacy said almost defiantly at the announcement of the deal. "We sell better things than Wal-Mart and Target. We've got better brands [and] better service."

The shotgun marriage between Sears and Kmart is the brainchild of Kmart chairman and maverick investor Edward Lampert. A billionaire finance whiz who counts David Geffen and Michael Dell as clients and Warren Buffett as his idol, Lampert took control of Kmart when it came out of bankruptcy 18 months ago. Since then Lampert, 42, who also happened to be Sears' largest single shareholder through his ESL Investments, has turned Kmart into a cash cow, albeit a shrinking one. Although critics describe his moves as short-term fixes, he reduced inventory, slashed costs, limited discounts and sold off some of Kmart's lucrative real estate to the likes of Home Depot and, yes, even Sears.

It's no wonder that so many skeptics think Lampert's latest gambit is more about real estate than retail, part of a long-term liquidation plan to unload billions of dollars' worth of property, as well as perhaps some valuable brands, to the highest bidders. But it's a notion that the notoriously reticent Lampert took pains to reject last week. While acknowledging that some underperforming stores would continue to be disposed of, he told investors, "I don't think any retailer should aspire to have its real estate be worth more than its operating business."

Lampert may have no operational merchandising experience - after Yale, he worked at Goldman, Sachs under the tutelage of Robert Rubin, and went off to start his own fund at age 25 with the help of legendary Texas investor Richard Rainwater. But Lampert does have ideas about how to run a retailer, such as an unwillingness to throw money at updating stores without clear evidence of a return, and a firm refusal to play the short-term, quarterly-earnings game that Wall Street so often demands. In April, he brought in a design team led by former Gap executives to freshen up Kmart's clothing lines.

"Eddie is relentless and a harder-nosed operator than most people want to believe," says Henry Miller, a leading business-restructuring adviser who worked with Kmart during its bankruptcy. "In point of fact, he is a retailer, in his mind. He will fight for a nickel, and mind every penny." (If anybody doubted how good a dealmaker or student of risk Lampert was, he proved it in January of last year, when he was kidnapped. He talked his captors, who were holding him for a $1 million ransom, into letting him go with the promise he would pay them $40,000 a few days later.)

Over the past couple of decades, both Sears and Kmart have become mere shadows of themselves, plagued by aging, poorly stocked stores; management turmoil; outdated merchandise; and a lack of sophisticated IT systems - or, for that matter, a clear identity. Whereas Kmart has failed miserably to compete on price with Wal-Mart or on style with Target, Sears has found it harder and harder to stay relevant at its aging 870 mall locations, about the same number of stores it had back in 1970. It has tried everything from financial services (its "socks and stocks" period) to home improvement (the Great Indoors experiment) to returning to its catalog roots, with the purchase of the upscale Lands' End catalog, which has proved to have less broad appeal than Sears had hoped.

In one key sense, at least, there is no denying that the merger is all about real estate. For years, Sears has claimed to be the prisoner of its once pioneering shopping-mall locations, where, in fact, Americans do less and less of their shopping, especially on big-ticket items. By transforming several hundred of Kmart's 1,500 freestanding and strip-mall outposts into New Age Sears stores, at an estimated price of about $3 million apiece, the company hopes it can finally reach its best potential customers. That assumes, of course, that those customers want to reach Sears. For even if Sears and Kmart can assemble a compelling assortment of exclusive product lines to sell, they are still, in a sense, "going to have to transcend their own [weak store] brands," says Kevin Keller, professor of marketing at Dartmouth's Tuck School of Business.

Whether Sears and Kmart can do that by incorporating the best elements of much stronger brands in the industry remains unclear. "It could be more like a Bed Bath & Beyond meets Best Buy meets Target," says Marshal Cohen, chief fashion analyst at industry researcher NPD Group. "They've got a second chance here." But if Eddie Lampert can't make it work this time, it's likely to be their last.

With reporting by Jeffrey Ressner/Rancho Cucamonga; Jyoti Thottam; Dody Tsiantar/New York City

Kmart-Sears Deal Won't Pose Much of a Threat to Wal-Mart
By James B. Stewart - SmartMoney - The Wall Street Journal
November 24, 2004

I've often said how much I like so-called horizontal mergers, which are mergers between competitors. They often eliminate competition, cut overhead and other costs, and boost economies of scale and profits. So why am I underwhelmed by news of Kmart Holding's takeover of Sears Roebuck?

Even under antitrust laws, which subject horizontal mergers to close scrutiny, there's an exception for so-called failing companies. Kmart, just out of bankruptcy court, had already failed. I wouldn't call Sears failing, but it has certainly been struggling. Putting the two together is probably better than the status quo, but not much.

Wal-Mart Stores is the big problem for chains such as Sears and Kmart. The bigger Wal-Mart gets, the greater its economies of scale, the more leverage it has with suppliers, and the more aggressively it can compete on price. A combined Kmart-Sears won't have an effect on this.

As I've been saying for some time, Wal-Mart's real competition might be Amazon.com, and even Amazon can't compete with Wal-Mart's network of stores and distribution centers. Wal-Mart runs an excellent Web site, although it doesn't get credit for it. I own some long-term Wal-Mart call options, and they fell slightly on the Kmart-Sears news. I'd call that a bargain.

* * *

James B. Stewart is an editor at large at SmartMoney magazine and a contributing editor at SmartMoney.com. He may have positions in the stocks he writes about in this column."

Will Lampert Get It All to Fit?
By Jesse Eisinger - The Wall Street Journal
November 24, 2004

The Kmart takeover of Sears could be Eddie Lampert's Waterloo -- and he isn't the Duke of Wellington.

The would-be Warren Buffett has defied the nattering nabobs on Kmart Holding
-- including this columnist -- in stunning fashion. But, of course, past results are no guarantee of future performance. Mr. Lampert is no longer just a hedge-fund whiz against whom it is suicidal to bet. He is also chairman of a mastodonic retail company that has to compete against companies with better brands, better management, more money and more customers.

Mr. Lampert has a sizable stake in a Kmart-Sears long-term success, and he has yet to sell a share of his holdings in the combined companies. (He has a big chunk of Kmart and a smaller chunk of Sears Roebuck stock.) But the deal raises questions about the various bullish theses surrounding Kmart in its pre-Sears deal days. And hedge-fund economics shouldn't be overlooked in evaluating the whys and timing of the Kmart-Sears combination.

Some bulls had argued that Kmart could turn around by getting the retailer to eschew the Wall Street obsession with same-store sales and concentrate on return on investment -- a strategy that Mr. Lampert backs and on which he is largely right. But poor third-quarter earnings, buried in the avalanche of Kmart-Sears news, raises questions about Kmart's turnaround prospects. Moreover, by acquiring Sears, no small deal, Mr. Lampert demonstrates that the patient turnaround strategy alone wasn't working. Kmart, hemorrhaging customers, was too weak to survive on its own.

Other bulls argued that Mr. Lampert planned to follow a Berkshire Hathaway model, taking the cash flow from the declining business, as Mr. Buffett did with his textile company, and investing it with aplomb. But Mr. Lampert is departing from Mr. Buffett's MO by buying a lousy business under siege by dominant retailers such as Wal-Mart Stores and deciding to oversee the company himself.

A third faction of Lampertites thought that he would liquidate Kmart to get at the underlying real estate. A concern with this was once he had cherry-picked the best locations to sell off, he would have been stuck. Instead, Mr. Lampert is doubling down on retail with a company that also had been rising on speculation it too could liquidate its real estate. Perhaps the new Sears holdings can hive off enough real estate, but that assumes the real-estate market stays attractive, even as interest rates have commenced their upward trajectory.

And while Mr. Lampert has demonstrated fealty to long-term thinking (thus the Buffett comparisons), he also runs a hedge fund that has calendar-year incentives. Hedge-fund managers such as Mr. Lampert take 20% of the fund's realized and unrealized gains at the end of the year. What he plans to do with that gain is unclear. Mr. Lampert declined to comment.

Even if Mr. Lampert keeps his money in the fund, he would garner a bigger portion of the fund through his mark-to-market gains at the end of the year.

Let's walk through an example. Say that Mr. Lampert's fund has $100 million (it has much more) and that his stake is $10 million while his partners' stake is $90 million. In the year, the fund makes 100% and is now valued at $200 million. His $10 million stake goes up to $20 million. Of that $100 million gain, $20 million (his 20% fee) would go to Mr. Lampert, boosting his stake to $40 million. He now has a 20% stake in the fund, up from 10%. Let's say the next year, the fund falls back to $100 million. Despite the round-trip, he has still doubled his original $10 million. Thus, Kmart-Sears could fall back next year, yet Mr. Lampert could still emerge a winner.

Of course, the Kmart-Sears deal could work out well, and Mr. Lampert's fund could continue his long run of strong years. If Mr. Lampert's audacious retail strategy succeeds, then everyone -- except the shorts -- wins.

Over the short term, Mr. Lampert can buy time. He will cut costs hither and thither and improve cash flow by reducing advertising and administrative costs. Perhaps he will even be able to raise prices. The new company may be able to sell off bits and pieces.

But it will take quite a lot to successfully meld two creaking retailers whose foes eat Napoleons for breakfast.

In Memorium: Lew Orlow
NARSE Founding Board Member
November 21, 2004

Lewis Lucien Orlow (Lew), a founding Board member and dear friend to NARSE, passed away last night after a long illness. The following obituary will appear in local papers November 23, 2004:

Lewis Lucien Orlow, formerly of Villa Park, Illinois and Barefoot Bay, Florida, Army Veteran of WWII, retired employee of Sears, Roebuck and Co.; loving husband of the late Margaret "Marge"; dearest father of Dan (Pat), Janet (Tom) Stimson, Sue (Larry, M.D.) Barr and the late Larry Orlow; cherished grandfather of Katie Orlow, Stephanie and Anna Stimson and Allison and Emily Barr; fond uncle of many nieces and nephews; dear friend of many.

Visitation will be Tuesday, November 23 from 5:00 p.m. until 9:00 p.m. at the Gibbons Funeral Home, 134 South York Road, (1/2 mile North of St. Charles Road) Elmhurst, Illinois.

Friends and family will meet for a Mass of Christian Burial on Wednesday, November 24 at 10:00 a.m. at Immaculate Conception Catholic Church 134 West Arthur Street, Elmhurst, Illinois. Interment will be private.

In lieu of flowers, memorial contributions may be made to the American Cancer Society, Glen Ellyn, Illinois. For more funeral information, please call 1-630-832-0018 or www.gibbonsfuneral homes.com.

May God bless our dear friend Lew. We all will miss you.

Skepticism Persists on Kmart-Sears Merger
Associated Press - FORBES.COM
November 23, 2004

It didn't take long for skepticism to set in after Kmart Holding Corp. and Sears, Roebuck and Co. announced their $11 billion takeover - Kmart's stock has fallen nearly 16 percent amid growing doubts that the marriage of two laggard retailers can succeed.

But one statistic stands out as evidence why the deal may prove to be a masterstroke for Kmart chairman Edward Lampert, the 42-year-old hedge fund manager who engineered the merger: 48 percent of Americans who shop at Sears and other mall retailers never set foot in the stores of discount retailers like Kmart, Wal-Mart or Target.

That means merchandise with strong brand equity now sold exclusively at Kmart - including Joe Boxer and Jaclyn Smith clothing and the Martha Stewart line of linens and kitchenware - can easily be marketed to a whole new audience of potential customers in Sears stores, according to analyst Marshal Cohen of the market-research firm NPD Group.

Similarly, sales of Sears' Craftsman tools and other branded goods may soar if the number of customers grows at remodeled Kmart stores where those products are introduced and at Kmarts that are converted to Sears' new off-mall format called Sears Grand, which also offers grocery and convenience items.

The number of these stores was scheduled to jump from three to 60 next year, and now should accelerate into the hundreds after the takeover, which is expected to close in March.

Marni Murphy, 33, of Bryn Mawr, Pa., would appear to be exactly the target customer for these changes.

"It might make it easier if they bring some of the things at Sears to Kmart and vice versa. Make it one-stop shopping," she said. "You're running around
- I have two kids - you just want to go to one place."

But Amy Crooks, 31 of Newton, Iowa, was more puzzled about the combination.

"I was really surprised about the merger," she said. "I didn't put the two together. I kind of think of them as dinosaurs. They have been around so long."

Ultimately, the fate of the two struggling chains will depend on how successfully they expand their base of consumers, who have plenty of alternative choices on where to shop.

True, the combination is expected to generate $500 million a year in cost savings within three years. But to survive in the long term, the new giant called Sears Holdings Corp., with $55 billion in sales and 3,500 stores, will have to come up with a merchandising formula that will woo customers away from competitors like Target Inc. and Wal-Mart Stores Inc., the nation's largest retailer, which generated $256.3 billion in sales last year at more than 4,800 stores.

Burt Flickinger III, managing partner at Strategic Resource Group, a New York-based industry consulting group, estimates it will take three years for the new merchandising strategy to be executed.

But he said, "They don't have three years," given the fierce competition.

Both retail brands are broken in different ways. Kmart has had a hard time keeping its shelves stocked with essential items, suffers from messy stores and is caught between cheap chic discounter Target and everyday low-price operator Wal-Mart. Sears' biggest problem is that it still struggles with a lack of a unified marketing and merchandising strategy for its appliances and apparel.

Britt Beemer, chairman of America's Research Group, based in Charleston, S.C., expects poor-performing brands and labels that cannibalize each other to be eliminated. At the same time, he expects the new company will keep both Lucy Pereda clothing, named after a Latina fashion designer and lifestyle expert that's exclusive to Sears, and Kmart's Thalia Sodi label, named after the Hispanic pop star, since they target the fast-growing Hispanic market.

Tim Calkins, a former marketing manager at Kraft and now a clinical professor of marketing at the Northwestern University's Kellogg School of Management, sees problems ahead for Lands' End, a brand Sears bought in 2002 in the hopes it would become the marquee clothing offering at its 870 mall stores. Analysts say the price of Lands End products make it a bad fit for Kmart.

"Lands End doesn't make a lot of sense for either Sears or Kmart," Calkins said, noting the brand has a reputation of exceptional customer service, friendly and helpful. "You don't get that at either Sears or Kmart."

Consumers haven't gone out of their way to buy Lands' Ends at Sears stores. Sold through catalogs before and after its purchase by Sears, mall shoppers accustomed to buying Lands' End seem unwilling to change.

That could mean big changes for Lands' End and several other tough calls for Lampert and Sears CEO Alan Lacy if the combined company is to achieve Lampert's goal of a 10 percent operating profit margin, a level generated by such retailers as Gap Inc.

Another question is how Lampert and his team will react to Whirlpool Corp.'s plan to raise its wholesale prices effective Jan. 2 because of higher costs of steel and other raw materials.

Whirlpool, a Sears supplier since 1916, got more than $2 billion, or 18 percent of its revenue last year, from its sales to Sears of clothes washers, dryers and major kitchen appliances under the Kenmore brand. Kmart does not carry Whirlpool products.

"I think the retailers understand the increases in prices in raw materials that all manufacturers are facing and I think these retailers realize that modest 5 to 10 percent increases won't have a significant impact on sales," said Whirlpool spokesman Stephen Duthie.

Shares of Sears and Martha Stewart Living Omnimedia Inc. also have pulled back since the announcement of the takeover. But not all analysts are downbeat about their prospects.

"For Martha Stewart, it's got to be the best thing that ever happened to them," said George Whalin, president and founding partner of Retail Management Consultants, a San Marcos, Calif.-based firm that offers services for retailers and consumer-products manufacturers. "It just gives them dramatically more distribution and far more store fronts and a much more credible retailer. When you put a brand like that at Sears, you give it instant credibility."
---

Associated Press writers James Prichard in Grand Rapids, Mich., Michelle Spitzer in Des Moines, Iowa, and Jennifer N. Kay in Philadelphia contributed to this report.

Execs Put Best Face on Faces Running a Merging Sears-Kmart
By Becky Yerak - Chicago Tribune
November 23, 2004

Facing its fourth straight year of falling sales, Sears, Roebuck and Co. had to reassure Wall Street analysts last week that its existing management is capable of running the retailer amid its merger with struggling Kmart Holding Corp.

"Do you have the retail talent in place to achieve the vision for the company? Or will you look for additional talent to make this happen?" Goldman Sachs analyst George Strachan asked during a conference call. "Some very important personalities have come onto the market recently."

Names weren't named, but elephants in the room included Vanessa Castagna and Allen Questrom. Castagna was No. 2 at J.C. Penney Co., behind Questrom, but was passed over for the top job when Questrom left earlier than expected. Castagna quit Penneys earlier this month.

Sears Chief Executive Alan Lacy replied that Sears has upgraded its management recently. In fact, about 20 of Sears' top 50 retail executives have joined the Hoffman Estates company in the past three years, he said.

"While we have a little more to do, I think our organizational structure is largely in place," Lacy replied.

Chimed in Kmart CEO Aylwin Lewis: "As we assess who's on the team, where there are gaps, I think we can go out and get the best in the market."

Merrill Lynch analyst Daniel Barry wanted specifics.

"Do you plan to hire any consultants to help you? It's a bold move and makes sense, but execution is the answer," Barry said. "Any way you could give us comfort that you can execute other than you `have a good team'?"

"I understand the skepticism because this is a significant task," replied Edward Lampert, the Kmart chairman heading the merged company. "But we're pretty good at solving problems. If we need to bring people in from the outside to help, we have the resources to do it."

In August, Sears hired former Target Corp. veteran Luis Padilla to head marketing and merchandising. So far, he has gotten good marks.

"I think they'd want to give him [Padilla] a chance to address issues without bringing in someone else who's supersenior," the source said. "Vanessa is extraordinarily talented, but one would have to question whether she and Luis would be duplicative."

Some also wonder whether, given the fact that Penneys passed over Castagna for the top job at an already well-oiled machine, she's qualified to turn around Sears and Kmart.

Soggy execution: A photo accompanying a Chicago Tribune story on Sunday about a new Sears store in Pekin, Ill., alarmed one former executive.

The photo showed seven identical boxes of Special K cereal next to each other, on two shelves, facing out, with an eighth box on top a variation. The space appears empty behind the boxes on the lower shelf.

"The buyers and marketing people are probably living in this store," the source said. "Don't you think somebody would ask: `Why are there eight facings of Kellogg Special K cereal?'

"Have you ever seen eight facings of any one cereal at Jewel or Dominick's? Any merchant worth their salt would have all eight boxes [behind one another] in one row. Then they'd have something else next to them.

"Sears doesn't get the basics right. There's no reverence for sales per square foot."

 

Cash Flow Suggests Sears Bust-up
By Sandra Jones - Crain's Chicago Business
(November 22, 20040

Selling stores produces cash, fixing them consumes it; Lampert's past shows preference for the former

Wondering if billionaire investor Edward Lampert will fix Sears, Roebuck and Co. or break it up? Consider the cash impact of each option. Selling off Sears' stores would generate up to $7 billion in cash. Mr. Lampert last week tried to dampen talk of such a scenario, which would claim tens of thousands of jobs. But the move would fit his pattern of squeezing cash out of Sears and Kmart Holdings Corp. since he became an influential shareholder in both.

Turning the two ailing chains into a retail power on par with Wal-Mart Stores Inc. and Target Corp. would require Mr. Lampert to spend billions. Sears Holdings Corp., the proposed name for the company to be formed in the $11-billion merger Sears and Kmart announced last week, wouldn't have that kind of cash. As of Sept. 30, Sears had $2.7 billion in cash and Kmart had $2.6 billion, for a combined $5.3 billion. Credit rating agency Fitch Ratings Ltd. estimates the deal, which Kmart and Sears are funding with their own cash and stock, would eat up about $4.7 billion in cash paid out to Sears shareholders who choose to cash out rather than get stock in the new company. That would leave Sears Holdings with about $600 million.

Cash flow is weak at both companies. Kmart operations generated $171 million in the nine months ended Oct. 27. Sears' operations consumed $1.8 billion in cash in first nine months of 2004. Excluding one-time events, analysts figure Sears' operations would have produced $700 million in cash, down from $1.3 billion in the same period last year. Cash flow at retailers surges in the fourth quarter, but Sears no longer owns the credit card business that boosted its cash flow in past years.

That leaves little cash to follow through on Sears Chairman and CEO Alan Lacy's vow last week to convert "hundreds" of Kmart's 1,500 stores to a new store format called Sears Grand. Mr. Lacy, who will become vice-chairman and CEO of Sears Holdings, estimated the conversions would cost about $3 million per store. That's $1.5 billion for every 500 stores converted. Borrowing to pay for the conversions would be costly, as Sears' credit rating teeters just above junk.

Store conversions would be only the first step in overhauling Hoffman Estates-based Sears and Michigan-based Kmart. Untold amounts of money would be needed to modernize the merged chains' inventory management, purchasing and distribution systems to create the kind of efficiencies Wal-Mart and Target enjoy.

Such expenditures aren't Mr. Lampert's style. Since he took control of Kmart in Bankruptcy Court, spending on store remodels and inventory has dropped. Sears, for its part, recently disclosed plans to reduce the $1 billion it spends annually on store remodeling.

Mr. Lampert, who would be chairman of Sears Holdings, leans more toward moves that generate cash. Kmart, where he has been chairman since the company emerged from bankruptcy protection in May 2003, sold 68 stores for $847 million this year. Since he disclosed a 7.2% stake in Sears two years ago, the company sold its credit card business for $3 billion and shed its National Tire and Battery chain for $225 million.

Selling stores would fit that pattern. Real estate experts value Sears' 870 mall stores alone at $5 billion to $7 billion.

"I am totally convinced it's just a real estate deal," says Carole Pechi, a retail real estate attorney at Holland & Knight LLP in Chicago.

What would Mr. Lampert do with the cash raised from selling stores? At Sears, since 2000 he has pressed for the return to shareholders of $7.5 billion through share repurchases. With 30% to 40% of the merged company's shares, he'd collect billions if the proceeds of store sales are used for buybacks. The 42-year-old Warren Buffett admirer could use the cash to fund other investments.

Of course, part of the cash raised could be used to refurbish some stores and create a smaller chain. But it's not clear such a chain could compete with far-bigger rivals.

Goldman Sachs Group Inc. analyst George Strachan wrote last week that "management did not present a long-term vision for Kmart, in our opinion, that would make the bulk of its stores worth more than its real estate."

A Sears spokesman says selling real estate isn't the motivation for the deal, calling it a "growth-oriented merger."

Nonetheless, Mr. Lampert said last week, if after "the best attempts" Sears Holdings is unable to make a store worth more than its real estate, he would look to sell it.

Paul Merrion contributed to this report.

Actors at center stage - and in the wings

Alan J. Lacy
Then: Kraft, Sears finance exec. Became Sears CEO in 2000. Sold credit card biz.Never got the hang of retailing.
Now: Could be squeezed out.

Edward S. Lampert
Then: Warren Buffett-wannabe runs hedge fund. Talked his way out of a kidnapping.
Now: With 30%-plus of stock, firmly in charge.

Aylwin B. Lewis
Then: Veteran KFC and Pizza Hut exec became Kmart CEO last month.
Now: He'll run Sears, too.

Luis Padilla
Then: Former Target, Marshall Field's exec hired in August as Sears' head merchant.
Now: Merger's top retailer, but could be squeezed out.

Vanessa Castagna
Then: Wal-Mart exec, helped turn around J. C. Penney, left in November when passed over for CEO's job.
Now: Wants to run a company.

Alvah C. Roebuck
Then: Co-founder hired by Richard W. Sears in 1887.
Now: Name disappears from parent company.

Martha Stewart
Then: Home-making diva, CEO
Now: Prisoner number 55170-054 for lying about a stock tip. Likely out by March, in time to stock Sears stores.

NOT SO FAST, EDDIE
By Christopher Byron - New York Post
November 22, 2004

IT was thrilling last week to hear journalism's Hallelujah Choir sing the praises of Kmart Corp.'s merger with Sears, even as we witnessed the deal's architect, hedge fund baggie Edward Lampert, ascend bodily into heaven as the newest addition to American business's Hall of Heroes. But is Fast Eddie Lampert really destined to become - in the words of Business Week's current cover story on the man - Wall Street's "next Warren Buffett"?

Viewed with the proper sense of detachment - and without the distracting chorus of "It's A Win-Win For Everyone" playing in the background - the secret ingredient in Fast Eddie Lampert's recipe for success has time and again boiled down to setting himself up at the center of inherently conflicted situations and then exploiting them for all they are worth.

Lampert's investment in Kmart has been marked from the start by both melodrama and mystery, for Kmart was a company in which the hedge fund investor had no seeming interest in whatsoever - at least so far as the public at large was aware - until the discount retailer collapsed in bankruptcy in January of 2002.

In fact, though, Lampert had been a controlling 21 percent investor during the previous two years in a shoe retailer called Footstar, Inc., which relied on sales through Kmart stores for nearly 60 percent of its revenues, and as such he was afforded a close-up and personal perspective on Kmart's waning fortunes that few other outsiders enjoyed.

So it is perhaps not surprising that as Kmart's slide into insolvency quickened, Lampert began frantically buying up Kmart's increasingly worthless senior debt.

He did so because federal bankruptcy law, senior creditors stand first in line with a claim on a busted company's assets, and by spending what eventually totaled $153.4 million of Kmart's ruined debt, Lampert was able to buy himself a ticket of admission to Kmart's bankruptcy proceedings as its largest bondholder and thus chairman of the creditors' committee.

In this way, Kmart emerged from bankruptcy in January of 2003 with the previous shareholders wiped out and with Fast Eddie and his hedge fund standing in their place as owners of 51.4 percent of the reorganized and debt-free company's new common stock.

IN the process, Eddie and his boys clearly saw the handwriting on the wall for Footstar, Inc. That's because the Kmart reorganization plan, made public in January of 2003, set forth plans to close down at least 326 of Kmart's retail stores, on top of 283 stores that had already been closed during the reorganization.

The store closings represented an eventual 29 percent reduction in Kmart's retail distribution outlets, promising to destroy it as a pipeline through which Footstar could reach enough potential customers to earn a profit from selling shoes to the public.

So was this the reason why Fast Eddie's hedge fund - Greenwich, Conn.-based ESL Partners - began quietly shedding its Footstar holdings as Kmart's woes mounted, from a pre-bankruptcy total of just under 4.4 million shares at the start of 2000, to a trough of barely 2.6 million once Kmart emerged from its reorganization in early 2003?

NOBODY asked Fast Eddie that question at the time, so he never had to answer it and the truth may thus never be known.

And more of the same followed once Lampert gained control of Kmart officially and became the company's chairman of the board in the spring of 2003.

And once again, it was information about Kmart's stores that put Fast Eddie in the catbird's seat.

One key reason why Fast Eddie was able to gain majority control of America's second largest retail chain was that a court-appointed team of appraisers had valued Kmart's vast real estate holdings - most of which were in the form of long-term property leases for its retail stores - at a mere fraction of their actual worth during the bankruptcy proceedings.

Why this happened is also a question that has never been satisfactorily answered, by Eddie or indeed anyone else, perhaps because - with the exception of a column devoted to the matter in this space four months ago ("Kmart's Realty Deal" July 11, 2004) - no one has ever asked it.

Yet the facts are all there, in full public view, on Kmart's first post-bankruptcy balance sheet, which shows the company's total real estate holdings to be worth less than a mere $10 million, a function of the complex mathematics of what is known as "fresh start accounting."

Whatever the reason for the ridiculous valuation, only someone privy to talks that began last spring in which Kmart sought to sell several dozen of those stores to rival retailer Sears Roebuck & Co. could have known their true worth.

And in that regard, no one had a better or more fully informed view of the proceedings than Fast Eddie Lampert, who was not only the controlling shareholder and chairman of Kmart, but by the time the talks began was also found sitting on the opposite side of the table as well with a controlling 14.6 percent stake in Sears.

THE news - quickly re leased by Kmart to the world in late June - that Sears had agreed to buy 50 of Kmart's stores for $575 million in cash, set the Kmart shares ablaze, and the world watched in awe and amazement as they soared from $40 to more than $80 per share on projections of what the stock would be worth if the rest of the company's real estate were similarly valued.

It is Kmart's stock, upwardly valued in just this way, that Lampert has now used as his currency to buy Sears itself - for barely half the price he would have had to pay if he had bought Sears back in June instead of selling it some of Kmart's stores.

Merger talks of this sort are typically conducted in secret in order to prevent arbitrageurs from trying to get in on the action, thereby driving up the price to the suitor. But in this case, the beneficiaries also included Sears' top dog, Alan Lacey, who might have been beheaded by his own shareholders if the word had gotten around as to what he was really up to.

After all, here was a CEO who had just agreed to buy $575 million worth of Kmart real estate, for cash, from one of Sears' largest shareholders. Yet now he was preparing to sell it all back - along with the whole rest of Sears, to boot - for Kmart stock instead of cash, and at what amounted to a discount of fifty cents on the dollar.

How many more individuals than Lampert and Lacey were even aware of the talks is hard to say, but the wall of secrecy seems to have been all-but-impenetrable.

In fact, if the remarks of Kmart's newly appointed CEO under Lampert, one Aylwin Lewis, are to be believed, not even Lewis himself knew about the merger idea when he accepted the CEO offer from Lampert and took the job last month.

One finds other odd and intriguing gaps in The Eddie Lampert Story as well.

There are plenty of questions still to be answered, for example, regarding Lampert's bizarre starring role as the victim of a kidnapping at just the time Kmart was emerging from bankruptcy.

To that end, it is not often that a gang of ghetto kids are able to kidnap a wealthy businessman whom they've never before laid eyes on, hold him overnight for a reported ransom of $2 million, then set him free the next day on nothing but his promise to pay them $40,000 at some point in the future.

These are elements of an exciting life to say the least. But they hardly add up to America's next Warren Buffett. And for now at least, that seems to be about all one needs to know, or say, when it comes to Fast Eddie Lampert.

Lampert's Potent Force in Investing Branches into Retailing
By David Lieberman - USA Today
November 22, 2004

NEW YORK - DreamWorks SKG co-founder David Geffen laughs when asked what it's like to invest with Edward Lampert, the hedge fund manager and Kmart chairman who startled the business world last week with Kmart's $11 billion deal to buy Sears.

He doesn't make it easy," Geffen says.

Those who want to get into Lampert's ESL Investments fund have to put up at least $10 million. But then - the hard part - they have to forget about it for five years. For all that, Geffen says, "He doesn't stay in touch with clients at all."

But the legendary music executive doesn't regret his decision in 1991 to turn $200 million over to ESL. Its return on investment has averaged 30% a year, he says.

Lampert, 43, is "a workaholic, and he's as smart as they come. He's a voracious reader," Geffen says. "Of all the people I've known who do this, including Warren Buffett, he has a high, high degree of integrity, high personal commitment to investors, and he puts 100% of his own money into the fund. He's there with you."

The secretive, Long Island-born value investor has a knack for impressing people, from a Nobel laureate to a bunch of hapless hoods who kidnapped him last year.

Now, with backing from superwealthy clients, including Michael Dell, Thomas Tisch and members of the Ziff family, Lampert has emerged as a potent force in retailing, and possibly the most influential investor of the decade.

Lampert, who declined to be interviewed, became fascinated with the arcane world of finance as a child in well-to-do Roslyn, N.Y. At age 10, he pored over the stock pages with his grandmother.

But money issues changed at age 14 when his father, a partner at a New York law firm, died of a heart attack, and his mother took a job as a clerk at Saks Fifth Avenue.

Helped by savings and scholarships, he went to Yale in 1980, where he majored in economics.

His fascination with finance blossomed as he did research for Nobel Memorial Prize-winning economist James Tobin, and won a coveted internship at Goldman Sachs. He graduated summa cum laude

Although accepted to law schools at Yale and Harvard, he went to Goldman as a junior research analyst on the risk arbitrage desk. There, Lampert caught the eye of Robert Rubin, who became vice chairman in 1987.

But Lampert had also become friends with investor Richard Rainwater, who had just left Goldman. He urged Lampert to do the same and put $28 million into Lampert's newly formed ESL, which he ran from his backer's Fort Worth office.

The team joined a winning 1989 campaign to defeat Honeywell's effort to adopt anti-takeover protections. Lampert also became a part owner of the Texas Rangers baseball team, joining George W. Bush.

The relationship with Rainwater soured, though. He pulled out of ESL as Lampert fought for more control over his firm's investments. Lampert persevered, seeking bargain stocks in companies he could help run, including AutoZone, AutoNation and Payless ShoeSource.

By 2003, he was a billionaire and the second-richest person in Connecticut. That made him the target of Renaldo Rose, 23, a former Marine who scoured the Internet for a rich person to kidnap. At 7:30 p.m. on Jan. 10, 2003, Rose and three accomplices took Lampert at gunpoint from the garage at his Greenwich office, forced him into their SUV and took him to a Days Inn. They handcuffed him in a bathtub, fed him takeout chicken and threatened to kill him unless they got a big ransom.

True to form, Lampert cut a deal: He agreed to pay $40,000, he recently told BusinessWeek, and about 30 hours after his abduction, they let him go. Police caught them when they used Lampert's credit card to order a pizza.

Lampert went right back to work, crafting a deal to pay less than $1 billion for 52% of Kmart, taking it out of Chapter 11.

Now, with the Sears deal, he faces his greatest challenge: making two struggling chains a success.

But with his track record, many industry watchers give Lampert a shot at it. "There are only a handful of supercreative people who can do this kind of thing," says Faith Hope Consolo, vice chairman at Garrick-Aug, a retail leasing and consulting firm. "He's one of them."

Contributing: Bruce Horovitz

Lampert Plays Craftsman for Sears-Kmart
Chicago Sun-Times
November 22, 2004

Edward Lampert began studying the shareholder letters published by billionaire investor Warren Buffett while working at Goldman, Sachs & Co.'s risk arbitrage department during the 1980s.

Buffett's practice of buying assets shunned by most other investors might have served as a model for Lampert, 42, who controls Kmart Corp. and last week bid $11 billion for Sears, Roebuck and Co.

"Eddie is very skilled at asset redeployment," said Martin Whitman, 80, chairman of Third Avenue Management in New York, which owns about 5 percent of Kmart and is the second-largest shareholder after Lampert. "As stand-alones, Kmart and Sears haven't been all that successful."

Lampert, who owns a 15 percent stake in Sears through his ESL Investments Inc. hedge fund, is combining his two biggest holdings to squeeze out as much as $500 million in savings from the retail chains and make the company a viable contender to Wal-Mart Stores Inc. If successful, the renamed Sears Holdings Corp. might also serve as a vehicle similar to Buffett's Berkshire Hathaway Inc. to make more acquisitions, investors including Whitman said.

The transaction isn't the first time Lampert has gone against the consensus opinion and made a big bet in one industry. Greenwich, Conn.-based ESL, founded by Lampert in 1988, also held shares in AutoZone Inc., the largest U.S. auto-parts retailer, and AutoNation Inc., the biggest U.S. retailer of new and used cars.

Lampert, who got his first taste of Wall Street as a summer intern from Yale University in the sales and training program at Goldman, has focused on buying companies that are undervalued.

"He was always a very focused individual," said Earl Graves Jr., chief operating officer of Earl G. Graves Publishing, who attended Yale University with Lampert. "He knows what he wants to do."

Pulling off the merger of Kmart and Sears might cement his reputation as shrewd and focused.

Henry Miller, when he was a financial adviser to Kmart during its time in bankruptcy court, dealt with Lampert as the largest creditor.

"If he was a football player, he would be a fullback, because he sees the goal line, and you can't stop him," said Miller, chairman and managing director of Miller Buckfire Lewis Ying.

In an interview last year with Bloomberg News, Lampert said he was drawn to Buffett's investment philosophy because of the similarities to merger arbitrage. He decided to follow Buffett's advice and to invest in companies trading at a big discount to the present value of their future cash flow. "It really trains you to make decisions, and to understand risk and reward," Lampert said.

The surprising, headline-grabbing deal creates more brouhaha than the low-profile father of two usually wants. His ESL fund has no identifying signs in the standard-issue Greenwich office tower where it is housed. Security is very tight, not the least because last year he was kidnapped at gunpoint while leaving work, and held for ransom.

He was kidnapped for 30 hours, before persuading two men to let him go with a promise to pay ransom.

"I think to measure Eddie you only have to look at when he got kidnapped and talked the kidnappers into letting him go," Whitman said. "That's Eddie. He's very skillful, very smart, very personable."

Bloomberg News, Gannett News Service

Are more suitors lining up for Sears?
By Shobhana Chandra and Josh Fineman - Chicago Sun Times

Is another suitor lurking in the bushes, waiting to plead his case for the hand of Sears, Roebuck and Co.?

Many investors think so, and they've bid up the price of Sears stock to a level above the $50-per-share offer that came last week from Kmart Holding Corp.

After languishing below $40 since May, Sears stock soared on Wednesday after Kmart made its $11 billion bid. The stock ended the session $52.99, up $7.79.

It has held that level, closing Friday at $52.95.

Vornado Realty Trust, which owns about 5 percent of Sears, might come up with a competing offer, Jonathan Litt, an analyst at Smith Barney in New York, wrote in a report. Vornado made its Sears stake known in a regulatory filing two weeks ago.

"It could be that Sears rushed to the alter with Kmart to thwart an unwanted suitor, Vornado, who would surely break up Sears for its real estate," wrote Litt, who has a "buy" rating on Vornado. ''A competing bidder like Vornado could finance an acquisition of Sears using Sears' virtually debt-free balance sheet."

Kmart's $50 cash offer applies to 45 percent of Sears; the stock offer applies to the remaining 55 percent. Kmart holders will receive one share of Sears Holding Corp. for each share.

Sears shares are "well above on the rumor that Vornado is going to make a counter bid," said Tom Burnett, who tracks acquisitions as president of Merger Insight. "They are a likely bidder, but that doesn't mean they are going to do anything."

Some investors ruled out the possibility of a counter offer for Sears by Vornado or by another retailer.

"I don't see it happening," said Scott Rothbort, president of Lakeview Asset Management, which owns shares of Sears and Kmart. "Vornado is already part of the deal. I don't see Wal-Mart or Target coming in because that would violate antitrust regulations. It's a done deal."

Bloomberg News

Sears-Kmart Might Just Be A Real Estate Deal
By Jerry Knight - Washington Post
November 22, 2004

If you believe Sears and Kmart are going to continue in business as sister chains, I've got a couple thousand Kmart signs to sell you.

Merging Sears, Roebuck and Co. and Kmart Holding Corp. and then maintaining two brands makes little sense -- even though that's what the people who put together the $11 billion merger are saying they plan to do.

As somebody who grew up in retailing -- my dad sold Big Smith overalls and Hart Schaffner & Marx suits in a small town, and I spent many years writing about the business -- I'm dubious about that and much else of what's been said about Kmart's plan to take over Sears.

For example, some people predict it will produce windfalls for Martha Stewart's company -- Kmart's best brand name -- as well as for Danaher, the Georgetown company that makes Sears's Craftsman hand tools and for Whirlpool, maker of Kenmore appliances. Shares of all three have jumped since the merger was announced Wednesday, based on the premise that the Kenmore and Martha brands will be sold at Sears and Craftsman at Kmart.

But cheap Chinese tools are what Kmart shoppers buy today, not Craftsman, which cost two or three times as much. Moving the Craftsman and especially Kenmore brands into Kmart risks cannibalizing their sales at Sears. And succeeding in appliances requires well-trained, well-paid sales people, a species foreign to Kmart.

If there is a Kmart.

Although Kmart is buying Sears, Sears Holding Corp. will be the name of the surviving company because it has a much better image, along with a coveted single-digit stock trading symbol -- S -- on the New York Stock Exchange.

The merger grew out of the Sears purchase of a batch of Kmart stores, and executives now are talking about converting "hundreds" of Kmarts into Sears stores.

The strategy is to move Sears out of malls, where it no longer belongs, and into Big Box Land, where Kmart has many locations that could generate far more sales and profits as free-standing Sears stores. That's a smart move. People don't go to the mall to shop and then drop into Sears to buy a stove. They go to Sears for appliances, and if spending hundred of dollars doesn't sate their shopping urge, then they wander around the mall. In fact Sears has trouble getting its Kenmore and Craftsman customers to shop for soft goods even in its own stores, let alone mosey through the adjacent malls.

The Sears store at Montgomery Mall, aka Westfield Shoppingtown Montgomery, is a prime example of a Sears store that could be put to better use. Sell that building to Macy's and the sales volume for that space would explode. The whole mall would enjoy higher traffic. It would take a total turnaround at Sears and years to make as much money out of that store as you could get by selling it as soon as possible.

There are dozens and dozens of other Sears stores in high-end malls that are worth more to other retailers -- or chopped up into multiplex cinemas -- than they are as Sears stores.

The lack of a clear retail strategy for Sears and Kmart is further evidence that buying Sears is first and foremost a real estate play. We learned that a couple of weeks before the Kmart deal when a big block of Sears stock was bought by Vornado Realty Trust -- the company that previously bought Crystal City by acquiring Washington-based Charles E. Smith Commercial Realty for more than a billion dollars.

Vornado practically invented the "real estate is worth more than the retailing" concept. Thirty years ago, Vornado ran a New Jersey discount chain called Two Guys From Hackensack. Two Guys folded, but the store sites became the foundation for what is now one of the biggest commercial real estate firms in the nation.

The underlying value of Sears's real estate radically lowers the risk of the acquisition for Kmart Chairman Edward S. Lampert. Lampert fancies himself another Warren E. Buffett, who is known for buying undervalued assets.

But there's a difference between undervalued businesses and damaged goods, which is what you get with Kmart and Sears. Neither can match the buying and distribution efficiency of Wal-Mart Stores or the merchandising savvy of Target and J.C. Penney.

Turning around Sears after 30 years of mediocre management is going to be difficult and take a long time. There's more money to be made, in less time, by selling off a couple of hundred locations like Montgomery Mall.

Then where does Sears go?

The Montgomery Mall Sears could move north to Kentlands, where Kmart has a new store, in a new and still expanding exurban retail complex, with a Giant next door, a Lowe's across the parking lot and lots of little stores. That is the kind of place America shops these days.

The second and more difficult step is figuring out what Sears ought to sell besides Kenmore, Craftsman and Martha Stewart. Another clothing name as magical as Martha is desperately needed. Lands' End, which Sears bought a couple of years ago, hasn't filled that need. It might be part of the answer, but there is already speculation that Lampert might sell it.

Nobody can underprice Wal-Mart in clothing. Target doesn't try; its niche is a notch above Wal-Mart in price and a couple of decibels higher on the buzz scale. The Isaac Mizrahi line sold at Target generates the buzz, but what makes the bucks is solid lines of simple clothing -- the kind of stuff you found at Sears 25 years ago.

The clothing problem is even more acute at Kmart. If the best Kmart locations are turned into Sears stores, it ruthlessly ratchets down the opportunities for Kmart.

Sears and Kmart aren't in quite the same business, but they are too close together for the kind of segmentation that works for Federated Department Stores with its Macy's and Bloomingdale's brands or for May Department Stores with Hecht's and Lord & Taylor.

It is possible to envision how Sears could create a niche as a hard-goods-heavy alternative to Target and Kohl's and be able to compete with them and with Lowe's and Best Buy in certain categories.

But where does that leave Kmart? If Sears moves up a notch, conceivably Kmart could be downscaled, but trying to low-ball Wal-Mart is a thankless and perhaps profitless ambition.

Reinventing Sears is going to be hard enough, let alone simultaneously transforming Kmart. Perhaps the sister chain strategy will work. More likely, Kmart will become Kmort -- if not dead, then dumped after its best stores have been turned into Sears and its saleable properties auctioned off.

Gain in Employer Costs For Health Care Slows
By Vanessa Fuhrmans - The Wall Street Journal
November 22, 2004

Smaller Rise Is Expected In '05 as Premium Growth Slackens, Workers Pay More

U.S. employers' health-care costs rose 7.5% in 2004, much less than anticipated, and are likely to slow even more next year, a new nationwide survey shows.

Two major factors appear to be slowing the growth in companies' medical
spending: more costs shifted to employees, and smaller premium increases by health insurers after several years of booming profits, said Mercer Human Resource Consulting, which conducted the survey. Not-for-profit insurers are now trying to pare excess reserves with lower premium increases, intensifying price competition across the industry.

The increase is the smallest in five years after several years of double-digit increases. Mercer's survey, of more than 3,000 employers, is the largest of its kind and typically offers the final and most comprehensive picture of employer medical-cost trends in a given year.

The jump in absolute dollars still remains large. Per employee, the cost of health care rose to $6,679 from $6,215. "The dollars are still very daunting," said Helen Darling, president of the National Business Group on Health, a coalition of many of the country's largest employers.

Next year, employers predict the average health-benefit cost per employee will rise 6.6%, after renegotiating, switching or making adjustments to health plans. About one-fifth of employers said they also would increase employees' costs, either with higher deductibles, co-payments or out-of-pocket maximums, while an equal share said they would raise employees' premiums.

Still, that sort of cost-shifting is expected to be more restrained than in 2003, when companies significantly raised deductibles and co-payments for workers. Those steeper out-of-pocket costs helped slow employers' medical spending more than anticipated this year.

"When you start the year with a $1,000 deductible and don't see any major expenses ahead, you think twice about going to the doctor if you have a cold," said Blaine Bos, a Mercer consultant and one of the study's authors. "The downside, of course, is that you may also put off getting necessary care."

The benefits to employers from cost-shifting may not be as pronounced in coming years, he added. Higher deductibles and co-payments usually steer consumers toward lower-costing generic drugs or away from an extra visit to a specialist physician, but beyond that their savings potential is limited.

Some employers say they are benefiting from longer-term cost-containment measures, such as disease-management programs that monitor and teach preventive health to people with chronic diseases such as diabetes and heart disease.

Mr. Bos said he also expects consumer-directed health plans, usually high-deductible plans offered alongside a tax-saving health spending account, to grow in popularity. Currently just 1% of employers offered them this year. But 26% of large employers are likely to add one by 2006, most of them with the newly created Health Savings Accounts.

Citigroup Dials in to Sears Deal as Lampert Calls Mentor Rubin
By Dennis K. Berman - Staff Reporter - The Wall Street Journal
November 22, 2004

Robert Rubin gave Edward Lampert one of his first big breaks nearly 20 years ago, when he brought the just-graduated Mr. Lampert into his high-profile inner circle at Goldman Sachs Group Inc.

Last week, Mr. Lampert returned the favor.

Citigroup Inc., where Mr. Rubin serves as chairman of the executive committee, was named Thursday as an official adviser to Mr. Lampert's Kmart Holdings Corp. in its $11 billion takeover of Sears, Roebuck & Co. Citigroup was added, people familiar with the matter say, because of a telephone conversation the old mentor and protege had after the deal was announced Wednesday.

The length and substance of that conversation remain unclear. But the effect will be quite noticeable inside the gossip-hungry realm of mergers and acquisitions work: Citigroup now can add the value of the transaction to its totals in the "league tables," which rank investment banks by the dollar volume of transactions for which they provide advice. The media, including The Wall Street Journal, often cite these rankings as a way of charting the banking industry's winners and losers.

Enhancing one's position on the league tables has a long tradition on Wall Street, where reputation and bragging rights are a currency all their own. And even though the banks widely view the tables as a flawed measure, they have been incapable of detaching themselves from the competition those tables create. In America Online Inc.'s historic $189 billion merger with Time Warner Inc., three investment banks earned credit for advising on a deal they didn't know about until after it was announced.

Without the value of the Kmart-Sears deal, which data provider Thomson Financial pegs at $13.8 billion including debt, Citigroup would fall to No. 4 among the ranks of U.S. M&A advisers in the year to date. By putting the deal under its banner, Citigroup is now credited with advising on $162.5 billion of U.S. transactions so far this year, placing it at No. 3 and beating out Lehman Brothers Holdings Inc., which advised on $154.5 billion.

Ironically, Lehman was originally listed as Kmart's sole merger adviser. That was a huge coup for Lehman, given it had little prior involvement with Mr. Lampert or Kmart. But even Lehman's participation was somewhat minimal, having been brought in during the last days to provide a fairness opinion to Kmart's board.

A Citigroup spokeswoman declined to comment yesterday, and wouldn't say what work Citigroup was doing or whether it would be paid a fee for its involvement. Through a spokesman, Mr. Lampert also declined to comment.

There is some business rationale for including Citigroup in Kmart's adviser roster. Kmart may need to borrow money to help fund the Sears acquisition or just for general corporate use. Adding Citigroup as an adviser helps cement that relationship.

Most bankers at competing Wall Street banks view the inclusion as yet another example of a firm elbowing its way into the league tables. That doesn't mean they won't employ the same tactics: Goldman Sachs is pushing hard for Sears to include it among its official adviser list, say people familiar with the matter. Goldman didn't immediately comment.

Talk of reforming the league tables has gathered strength in the past year, after a series of scuffles among the banks.

The most recent debate was over the $80 billion reorganization of Royal Dutch/Shell Group. Citigroup earned full credit from Thomson for putting the two closely related but separately traded units together. A competing financial data firm, Dealogic, denied Citigroup credit, saying there wasn't any exchange of value and therefore no merger.

SEARS HOLDINGS CORP. PRESIDENT --
After years in fast food, `coach' on fast track in retailing game
By Barbara Rose and Michael Oneal Tribune staff reporters - Chicago tribune
November 21, 2004

There was a hint of something grander in the works when Aylwin Lewis met Kmart Chairman Edward Lampert at the investor's Greenwich home on Labor Day.

It was the first meeting in a swift courtship that installed Lewis as Kmart's chief executive officer last month.

Lampert mentioned he was "always looking for opportunities" and hinted something "may happen," Lewis recalled.

"I didn't pay attention at the time," Lewis said Friday. "I thought, `I've got a big enough challenge here.'"

And so he has. The job is an enormous task for the 50-year-old native Texan, a first-time CEO and 26-year veteran of the fast-food industry with no merchandising experience.

But it just got a lot bigger. His new boss announced an $11 billion deal last week to buy Sears, Roebuck and Co. and merge it with Kmart to create a retailer with $55 billion in sales and nearly 3,500 stores.

Lewis will add Sears' retail operations to his Kmart role.

"Are you up to it?" Lampert asked Lewis when he dropped the bombshell two weeks ago during one of their daily telephone conversations.

"It was a little overwhelming," Lewis recalled Friday. "[But] immediately I thought, `Well, why not?'"

The challenge facing Lewis is one of the most daunting in retailing. For the new Sears Holdings Corp. to succeed as an operating company, industry experts say, Lewis will have to combine two lousy retailers into a single good one with enough moxie to compete against powerful rivals like Wal-Mart Stores Inc. and Target Corp.

That will entail vaulting all the normal hurdles posed by any merger of two massive enterprises. But it will also mean overcoming a special challenge: Neither Kmart nor Sears has a workable merchandising strategy. So the new company will have to carve a new one--something that would strain the talents of even a veteran merchant, let alone a former restaurant executive.

Lewis is undaunted.

"I'm a realist, so I understand the difficulties ahead, but the upside is tremendous," he said.

The job is a big leap from Yum Brands Inc., a PepsiCo Inc. spinoff with $8 billion in annual sales that operates KFC, Pizza Hut, Taco Bell and other restaurants, which systemwide generate more than $24 billion annually for their owners.

Lewis rose through a variety of operating jobs at KFC, Pizza Hut and Yum in the last 13 years, including a two-year stint managing 450 KFC stores in the Chicago area in 1993-95.

In his last post as president at Yum's headquarters in Louisville, he oversaw training and systems support for the chain's 33,000 restaurants worldwide. He also spearheaded a multibranding initiative known as "fish first," which put Long John Silver's stores with other brands under the same roof.

Silver's and A&W All-American Food restaurants reported directly to him.

Industry insiders describe the onetime high school football captain as a well-liked and modest executive with a ferocious work ethic and a talent for motivating employees.

"People are drawn to him," said Patricia Dailey, editor in chief of Restaurants & Institutions magazine in Oak Brook. "He has a very clear vision of who he is, who his team is and what he wants to accomplish. When you have somebody who can do that, you attract followers."

He grew up in Houston, the son of churchgoing parents who instilled a strict work ethic.

His father was out the door every morning by 5:30, working various jobs including as a porter for a pipe-bending company. Lewis continued that habit at Yum, where he was in his office before 6:30 a.m. to start 12- and 13-hour days.

His mother bought him books and magazines even when money ran short, instilling an appreciation for reading and learning. Lewis planned on a college teaching career after he graduated from the University of Houston in 1976 with dual degrees in English literature and business management.

Instead, a management trainee job at Jack in the Box to earn money while he was studying for a doctorate in English literature changed his career dreams.

"I fell in love with the notion of serving customers," he said. "Even as an assistant manager, I liked doing the hiring, the ordering, overseeing the food quality. I loved being a leader."

New approaches

He also recalled being drawn to an industry that provides a stepping stone into the middle class for employees who are willing to work hard.

On his way up the corporate ladder, he has tried to change behavior that feels discriminatory.

When he noticed that Yum employees who golfed did business on the course--leaving out those who didn't--he declared his team would discuss no important decisions over golf.

"I felt if I ever got to this position, I'd try to undo some of the stuff that didn't feel good when it happened to me," he said.

Al Salas, who owns 80 Pizza Hut restaurants in South Florida, recalled how Lewis earned the nickname "coach," a revered title in Yum's bottom-up culture.

Lewis, then Pizza Hut's chief operating officer, came to help Salas in the late 1990s when Salas was running 150 restaurants for the chain.

"The `Red Roofs' were not doing as well as they should, and employees were giving up a little bit," Salas recalled. "He asked a lot of questions before he did anything."

Then he instituted a program called "Owning Friday Night," an all-hands pep rally to kick off the weekend--prime time for restaurants.

Managers made sure they had their best employees on hand, from cooks to delivery drivers, and they set aggressive sales goals.

"You got everybody all fired up to hit that goal," Salas recalled. "What happened was it worked so well it carried on into Monday, Tuesday and through the week. It became an everyday situation."

Salas credits Lewis for his current success as a restaurant owner.

"He gets you to do what you think you can do and more," he said. "He makes you better from the inside out."

Yet some question whether "Coach" Lewis' skills will be enough to set the merged Sears Holdings on track. They speculate Lampert may end up reshuffling his team and bringing in a more experienced executive such as Vanessa Castagna, the former No. 2 executive at J.C. Penney Co.

After the merger, Lewis will be president of Sears Holdings and CEO of Kmart and Sears Retail. He will be part of an "office of the chairman" led by Lampert with Sears CEO Alan Lacy, who will become vice chairman and CEO of the holding company. Lacy never managed to devise a successful merchandising strategy for the retailing icon.

Stores have big differences

"The challenge before Lewis is to be part of a team putting together two rather disparate enterprises," said Hinsdale-based executive recruiter Peter Crist.

"He's going to have to wring out costs and create a strategy that suggests a number of those stores are going to be winners, knowing that he's got Eddie Lampert sitting on his shoulder expecting significant changes," Crist added. "Whereas Sears was slow to change, the dynamic now is going to be high velocity."

Richard Galanti, chief financial officer of Costco Wholesale Corp., points out that it took 18 months for Costco to fully absorb Price Club when the two warehouse clubs merged in 1993. And they had almost identical strategies. Sears and Kmart, on the other hand, are very different animals--one a discounter, the other a mid-range department store.

"What they have in common is that they're both retailers," Galanti said. "It took us 18 months of a lot of hard work. By definition it has to take them a lot longer."

Long before the merger, Sears and Kmart had tried to focus their offerings, cut costs and improve their information systems. But retail experts agree that neither chain has been able to devise and execute a consistent, winning strategy.

To succeed, said a former high-ranking executive at one of the chains, Lewis will first have to figure out who the new company's target customer is and then decide which of the Sears or Kmart brands and formats make the best fit. He will also have to forge a strategy to hone the merchandise mix, create an integrated marketing plan, streamline the supply chain and apply new technology to better manage inventory.

"The problem is you've got two badly wounded organizations with no real foundation for success," retail consultant George Whalin said.

Kenneth Berliner, an investment banker with Peter J. Solomon in New York, agreed. Anybody can put financial controls in place, he said, but merchandising is a lot harder. Coming up with the right products is a real talent."

For now, with less than one month on the job, Lewis, who is devouring books about retailers, said his main focus is learning Kmart's operations and "trying to be a good leader."

"What's going to be very critical to making this work is having a culture that's well-defined," he said. "We'll have two brands, but we have to have a unity of purpose around a culture. If you have that, this deal will be magical."

Few predict magic, but Lewis' fans warn not to underestimate him.

Jack in the Box Inc. Chairman and CEO Robert Nugent said his one-time protege is a quick study with "good strategic thinking skills and wonderful interpersonal skills."

"If anybody can pull it off," he said, "Aylwin can."

A Stock Party, Then a Retail Hangover
By Gretchen Morgenson - The New York Times
November 21, 2004

EW things stir the heart of stock investors like a huge merger deal. And last week's shotgun wedding between Kmart and Sears, two limping retailers, was no exception.

But while equity investors celebrated the $11 billion deal, pushing up Sears's stock 15 percent for the week, questions about the likelihood of this union's success should set in soon.

Wall Street, as usual, played its part in promoting the deal. Some of the breathless commentary brought back fond memories of how Mary Meeker, Morgan Stanley's Internet analyst, rhapsodized over the Time Warner-AOL merger in 2000. That one turned out to be perhaps the most disastrous combination in corporate history.

Assessing the Kmart-Sears merger, analysts trilled over its possibilities as an asset play on the nation's incendiary real estate market. They also talked up the tax benefits of applying Kmart's net operating losses to Sears' books.

Martin J. Whitman, manager of the Third Avenue Funds, investor extraordinaire, Kmart holder and incorrigible curmudgeon, dismissed both notions.

"This deal will be made or broken on retail," he said. "We've got to carve out a niche and find a role for ourselves in a field dominated by Wal-Mart, Target and Costco."

Mr. Whitman's Third Avenue Value fund owned 8.9 percent of the Kmart Holding Corporation's shares as of Sept. 30, a result of his involvement as one of the company's creditors in its recent bankruptcy proceeding.

Investors can be forgiven for thinking that the deal might represent a real estate play. After all, Kmart Holding's chairman, Edward S. Lampert, recently sold 68 stores or leases to Home Depot and Sears, raising almost $850 million. That was almost equal to the value Kmart assigned to all its stores in its bankruptcy documents. And a few weeks ago, Vornado Realty Trust, a real estate investment trust in New York City, disclosed that it had bought a 4.3 percent stake in Sears.

But Mr. Whitman countered that while some real estate would be sold, it is wrong to assume that there would be a broad-based liquidation for cash. "Most of the assets are going to be dedicated to retail," he said.

In any case, it is difficult to find past examples of shareholders becoming rich off liquidated retail real estate. Caldor, W. T. Grant, Woolworth, Bradlees and Ames are just a few of the companies that tried - and failed - to wring real money out of their properties when they could no longer make a go of retailing. One exception to the rule was Alexander's Inc., the discounter whose flagship store sat on a very prime piece of Manhattan real estate.

As for the tax benefits of the merger, Mr. Whitman said that while some analysts claim the losses at Kmart will shelter much or all of Sears's income going forward, they are wrong. Under Internal Revenue Service rules, a change in ownership limits the benefits of using losses to shelter future earnings at an enterprise. Mr. Whitman reckons that the benefit to the new company would be no more than $80 million to $100 million a year.

Still, Mr. Whitman said he was hopeful that the merger would work. "The verdict is still out, but this materially enhances our chances for success," he said.

Carol Levenson, an analyst at Gimme Credit, an institutional bond research firm, isn't so sure. In a report to clients entitled "Marry in Haste, Repent at Leisure," she speculated that the merger was a hurried defensive move by Mr. Lampert, who owns major stakes in both companies. Why else, she asked, would a company unveil such a bombshell, unsettling workers, customers and suppliers just before the Christmas selling season began?

Noting that neither Kmart nor Sears makes much money in retailing, Ms. Levenson wrote in a report to clients: "We suppose Sears can lord its negative 2.1 percent year-to-date comparable-store sales over Kmart's negative 13.7 percent."

Ms. Levenson said that the combined entity would be financially weaker than Sears is today, and she estimated that promised cost savings would not offset the business risk of hooking up with "the obsolete Kmart."

Shares of Kmart have been nothing short of awesome this year, up more than 300 percent. It certainly is one heck of a stock. Now we will see what kind of a company it is.

The Sears Kmart Merger -- Searching for Store Magic
By Becky Yerak - Tribune Staff Reporter - Chicago Tribune
November 21, 2004

Pekin's version may provide hint of future direction, but some have doubts about long-term success

PEKIN, Ill. -- Three times in less than two weeks, Holly Chism visited the new Sears store in this Peoria suburb about 180 miles southwest of Chicago.

The 49-year-old housewife wanted to see what the fuss was about. The store, once occupied by Wal-Mart, sells Sears standbys such as appliances, tools and clothing but also magazines, CDs and groceries. Chism later returned to redeem a $10 coupon toward a Disney blanket and to shop for a $300 Craftsman saw.

But don't assume she's a satisfied customer of the new store, which is less than a mile from Wal-Mart's new Supercenter.

"I don't like this Sears store," Chism said, noting that she'll continue to drive to the Sears at Northwoods Mall in Peoria for everything but tools.

"With this new store putting in products that a convenience store has, Sears seems to have cut down on the size of the other departments. A true Sears store doesn't have greeting cards."

That's not the sort of Hallmark sentiment that Sears, which has 870 mall-based department stores, wants to hear as it bets more of its future on stand-alone stores selling a wider array of products.

With Wednesday's announcement that Kmart Holding Corp. is buying the Hoffman Estates retailer, the 120,000-square-foot Pekin Sears is the first of what will be hundreds of smaller versions of Sears Grand, the 200,000-square-foot format that debuted in 2003.

Increasingly squeezed by Wal-Mart Stores Inc., Target Corp. and other more convenient retailers, Sears is trying to spark growth outside of its usual milieu of enclosed shopping malls, which account for a dwindling percentage of retail sales.

"We had 870 stores in 1970. In three decades, we've not grown our store base," Sears Chief Executive Officer Alan Lacy said during a conference call Wednesday.

Meanwhile, Sears' key rivals have a total of 8,000 stores and are "adding stores to the tune of 700 or 800 a year," Lacy said.

The Pekin store marks Sears' return to the town of 33,000. In 1993, the department store chain closed its store in Pekin Mall. The new freestanding store, which opened Nov. 8, is part of a batch of 56 stores that Sears bought from Kmart and Wal-Mart last summer for about $600 million.

Wal-Mart put its Pekin store on the market after firming up plans to open a Supercenter less than a mile away.

The Pekin store will be the only one among the 56 to be converted to the Sears banner this year. What Sears learns there will influence its plans for not only the other 55 stores, which average 100,000 square feet, but now the conversion of hundreds of additional Kmarts to Sears stores.

In developing a new off-mall franchise, Sears will borrow liberally from its four Sears Grand stores.

Sears opened its first Sears Grand, with 210,000 square feet, in September 2003 in Utah. A 201,000-foot Gurnee site followed in March.

A third opened in July in Las Vegas, encompassing 165,000 feet, and a fourth, with 180,000 feet, debuted last month in California.

Sears Grand, but smaller

Essentially, the Pekin store is a scaled-down version of the Gurnee Sears Grand, with some exceptions. There's no bank or portrait studio, for example. And the number of cosmetic brands was trimmed from three to two.

But the large and small formats have much in common. Like Sears Grand, the Pekin store has an optical center, centralized checkouts, shopping carts with coffee holders and a one-hour photo operation. The merchandise ranges from 99-cent animal crackers to baby clothes, and mattresses to toys.

Price-check scanners are scattered throughout the store, but half of them weren't working Thursday afternoon.

Among the lessons that Sears has learned off-mall so far: Nurseries and mattresses are hot. Unlike Utah, Gurnee didn't open with a nursery.

That was a "big miss" that has since been corrected, a spokeswoman said. Pekin will have a nursery.

Utah, meanwhile, didn't open with a mattress inventory but now has one. The California store is the first Sears Grand to test beer and wine sales.

Sears has been tight-lipped about sales per square foot at Sears Grand compared with its traditional mall stores, but has said that revenues are exceeding expectations by 30 percent and that customers are shopping the stores more frequently than at the mall.

"We've been more than delighted with the customer response to these stores," Lacy said. "They value the fact that we offer better things than Kmart and Wal-Mart and Target and Home Depot."

In fact, 70 percent of Sears' retail revenues come from product categories that shoppers usually buy at off-mall stores, whether from Sears or rivals like Home Depot.

"In many ways, it's more of the sweet spot of our franchise than the mall," Lacy said.

As for profits, Sears has said only that Sears Grand margins are "still not what we'd like."

"The expense structure is still not right," Lacy said in February. "The store operates very differently from full-line stores, so we're still learning."

Sears expects the cost structure to improve as it opens more Sears Grand stores and is able to extract economies of scale from its suppliers.

Also, while clothing sales at Sears' mall stores shrink, that department is among the stronger performers at Sears Grand.

Why that's significant: Apparel carries relatively high margins and can compensate for sales of lower-margin products such as snacks.

During Wednesday's conference call, Edward Lampert, the Kmart chairman who'll head the combined company, tackled a question about whether he sees himself heading a much smaller, more profitable retailer.

"I think the strategy is to operate a significantly more profitable retailer, and the size of the retailer will be based on opportunities," Lampert said.

"You could see two things going on at the same time: A broader rollout of Sears Grand at the same time we prune the portfolio, whether because of leases that run out or poor locations."

Still, Sears has its work cut out as it meets head-on with Wal-Mart.

On Thursday afternoon, Pekin's new Wal-Mart Supercenter had more than twice the cars in the parking lot as the new Sears.

Four checkout lines were open in the Sears store at 2 p.m.; 16 were available to ring up purchases at Wal-Mart at 3 p.m.

"Sears can never compete with Wal-Mart's prices," said Chism, the shopper who prefers Sears' traditional format to its off-mall store.

A recent study backs her up.

"Despite problems in its core mall business, Sears is venturing off the mall with prices 12.7 percentage points above Wal-Mart's on commodity items, according to a study we recently did outside Salt Lake City," Goldman Sachs said in an Oct. 15 report.

While Sears often had lower prices than Wal-Mart Thursday for products that it touted in a store circular, a price comparison of two randomly selected products found Wal-Mart to be cheaper.

A 12-oz. bottle of Alcon contact lens solution cost $8.99 at Sears and $7.42 at Wal-Mart. A 3-oz. package of Whiskas cat food cost 39 cents at Sears and 22 cents at Wal-Mart.

But Sears' new off-mall store landed the business of Bill Norton Thursday.

The Morton retiree, who refuses to shop at Wal-Mart, spent about $70 for a pair of Reeboks and four 100 oz. bottles of Tide detergent priced at two for $10. At Wal-Mart, the same size Tide sold for $5.56.

Of the new Sears store, Norton said he would be back.

And that's a sentiment Sears likes to hear.

Who's Afraid of Kmart and Sears? Not Target
By Dan Mitchell - The New York Times
November 21, 2004

ET'S assume that the merger of Kmart and Sears is exactly what it's being sold as: a way to combine the remaining strengths of two well-known but struggling retailers. Sears can extricate itself from shopping malls and join the exodus to large stand-alone stores, called "big boxes" in the industry. Kmart can resurrect its sullied image by bringing in some of Sears's popular brands like Craftsman tools.

What, then, will this produce?

"A cadaver," says the retail consultant Howard Davidowitz, chairman of Davidowitz & Associates, a consulting business in New York.

Others in the industry are not as pessimistic. But many of them agree that while the merger may be a great financial deal for both sides, the new entity, the Sears Holdings Corporation, would face formidable challenges, not the least of which is falling sales.

Analysts also agree on what advice they would give Wal-Mart Stores and Target, the big-box general-merchandise superpowers that are likely to be the most directly affected by the merger: Don't change a thing. As Sears Holdings spends the coming months and years making the merger work, Wal-Mart and Target will be better off if they worry more about each other, they say.

Even if Sears Holdings emerges as real competition, Target already does what it needs to do: concentrate on promotions and merchandising, increase same-store sales, expand carefully and wisely, and add to the bottom line.

Its operating margins are often better than Wal-Mart's, analysts say, and its same-store sales, those for stores open at least a year, rose 4.5 percent in the third quarter, compared with a 1.7 percent increase at Wal-Mart's stores in the United States.

Wal-Mart still dominates the market. Its nearly 3,000 stores had revenue of $247 billion in 2003, compared with $43 billion for Target's 1,300-plus stores. But Target's stock is ahead, rising more than 60 percent in the last two years while Wal-Mart's has gained less than 5 percent. And Target's niche as Middle America's "cheap chic" destination is secure, analysts say.

As Target whittles away - slowly - at Wal-Mart's lead in sales, analysts add, the merger of Kmart and Sears is unlikely to distract it from that formidable task. That is because Target has grown in newer, more affluent suburbs, while Kmart remains concentrated in downmarket urban areas and older suburbs.

And Kmart stores in areas with above-average incomes are likely to be converted to Sears stores. "There are several hundred opportunities" for such conversions, said Alan J. Lacy, the chief executive of Sears, and other opportunities for new Sears stores in areas where there is "more of a Sears demographic than a Kmart demographic."

Mr. Davidowitz noted that 30 percent of Kmart's shoppers did not have bank accounts. "Target is focused on a family of four earning $50,000 a year," he said. "Wal-Mart's customers make $40,000 a year. Kmart's make $32,000. You tell me which chain is more attractive in the long run."

That leaves Sears, which, Mr. Lacy contends, sells "better things than Wal-Mart or Target." Maybe, but the trick is to put customers into the stores to buy those things. Analysts are skeptical that Sears - which has many of its stores in malls, where traffic is declining - can build or buy big-box locations quickly enough to draw customers away from Target, and then make money selling to them.

Target stores have recently started stocking more consumables - everyday products like soap and paper towels - and has put them near cash registers and in other high-traffic areas. Sears sells fewer of these items and is best known for its brand-name durable goods - like Craftsman tools and Kenmore appliances. While those products, and Sears's many clothing lines - like Lands' End, which it bought in 2002 - are popular, they don't do much to drive foot traffic.

Shoppers go to Wal-Mart for low prices, to Sears for the brands, and to Target for both, analysts say. While many people shop at Target for Michael Graves toasters and Isaac Mizrahi sweaters, they also pick up a lot of paper towels and soap. Those products make real money for Target.

Still, with Wal-Mart not yet encroaching much on Target's middle-class turf and Kmart in many lower-income areas, Sears may present Target with its toughest store-to-store competition. The combined operations of Sears Holdings - with Kmart's 1,482 stores and Sears's 871 department stores and 1,100 specialty stores - are on a path to top Target in sales this year, making the combined entity the nation's third-largest retailer on that basis, after Wal-Mart and Home Depot. "This deal makes Sears at least a player," said Gary Balter, a retail analyst at UBS Investment Research. But, he added, "it will take years, not months," to see what results from the merger.

While Sears executives have not yet said a lot about their post-merger plans, they often mentioned Sears Grand stores during a conference call announcing the merger. So far, Sears has only four of these big outlets - megastores, in industry parlance - but the frequent references last week suggest that it sees them as important to its strategy.

Wal-Mart was a pioneer in opening these megastores - which often include full-size supermarkets and larger assortments of the usual inventory. Target soon followed with Target Greatland stores, which were bigger than regular stores and sold some groceries; in 1995, it opened its first SuperTarget, which includes a full supermarket.

Sears Grand stores are more like Greatland outlets - some food, but mostly more space for appliances, sporting goods and tools. Bread, milk and paper towels may help attract shoppers, but the stores are not meant to compete with the biggest megastores of Target and Wal-Mart, which can sprawl over 200,000 square feet - 40 percent more space than their regular stores. The food section of most Sears Grand outlets "is no bigger than a convenience mart," said Lois Huff, senior vice president at Retail Forward, a consulting business.

BEFORE Target and Wal-Mart need to start worrying, analysts say, Sears Holdings will have to show that it has managers up to the job of merging two very large chains, then fixing their problems and reversing their slides. Kmart's chairman, Edward S. Lampert, hired Aylwin Lewis away from the fast-food operator Yum Brands to run Kmart just last month. Mr. Lewis has no retail experience but has been lauded for his knowledge of operations.

Mr. Lampert himself is a hedge fund manager who will control about 40 percent of the combined company. While he is credited with bringing Kmart out of bankruptcy in May 2003, analysts note that he did this largely through cost cutting, closing stores and casting off real estate. Same-store sales continued to tumble on his watch, dropping 12.8 percent in the third quarter.

"He doesn't invest in stores," said Mr. Davidowitz. "He cuts costs; he cuts expenses. And by the way, here's another thing he cuts: customers."

If that continues, Target may have more reason to celebrate than to worry.

Eddie's Master Stroke
By Robert Berner, with Joseph Weber, in Chicago - Business Week
November 29, 2004 edition

The Sears-Kmart merger creates a retail giant -- and a platform Lampert can use for more deals

Edward S. Lampert has made no secret of wanting to follow in the footsteps of his hero, Warren E. Buffett. Like the Sage of Omaha, Lampert formed a partnership at age 25 and invested in old-line companies that throw off lots of cash. And just as Buffett did with Berkshire Hathaway Inc. (BRK ), Lampert gained control of bankrupt discounter Kmart Corp. (KMRT ) last year, hinting he would turn it into a powerful investment vehicle. Then, on Nov. 17, Lampert swooped in and launched an $11 billion purchase of Sears, Roebuck & Co. (S ).

Most investors loved the deal. Kmart's stock soared 8% the day of the announcement -- instead of falling, as the stocks of an acquiring company usually do -- fetching a huge premium over the value of Kmart's business. The reason is simple: Many investors are buying Lampert, not Kmart, and they see Kmart not as a retailer trying to move product but as a springboard for lucrative deals. "This is the first move of many in the years to come with [the merged company] as [Lampert's] investment vehicle," says John C. Phelan, a former Lampert associate who is now managing partner at MSD Capital, which manages money for Dell Inc. (DELL ) founder Michael S. Dell.

TREASURE CHEST Still, Lampert's latest move didn't please everyone. Some fear he will get bogged down for several years trying to turn the two struggling retailers around rather than using the formidable cash pile Kmart is amassing to move more quickly into other, more promising investments. "Kmart shareholders may not appreciate the merger," said UBS analyst Gary Balter in a report. "The hope was that ESL would take a bold move with the cash and start to invest in growth opportunities. This is not the type of move we were looking for to create the next leg of value for shareholders."

Yet for now, that appears to be a minority view. And there's little question that the merger, if it succeeds, will eventually arm Lampert to the teeth to pull off more deals. He's squeezing cash out of every corner of Kmart and has built a $3 billion cash hoard. Sears has its own $2.7 billion cash reserve that will grow as Lampert wrings inefficiencies out of the aging department-store chain. Lampert says the combination will save $300 million annually in costs and add $200 million to profits by promoting each chain's brands in the other's stores. Kmart also has $3.8 billion in tax credits carried over from previous losses that should shield profits from taxes for several years. UBS (UBS ) estimates that Kmart will book about $885 million of that benefit this year. What's more, if the stock price keeps rising, Lampert may preserve much of his cash pile and instead use his super-rated shares, which now trade around $110, vs. $15 just 18 months ago, as currency for other dealmaking.

Sears investors also applauded the deal. Sears surged 17%, to $53 a share. The big winner, of course, is Lampert's private investment fund, ESL Investments Inc. in Greenwich, Conn. It holds 52.6% of Kmart and 14.6% of Sears. Analysts estimate that ESL will hold 42% of Sears Holdings Corp., which will own Sears and Kmart after the merger. Sears shareholders have the option of getting half a share of Sears Holdings for each Sears share, or $50 in cash. But with Sears shares trading above $50, investors apparently want to skip the cash and take the new stock. If they all go that way, there won't be enough to go around, so they'll receive up to 45% in cash and 55% in stock.

Either way, Lampert will be forking over a good deal of cash for Sears. Phelan estimates that the combined Kmart-Sears will be down to about $1.5 billion in cash on hand after the transaction. If Lampert improves the combined retailers' performance, he'll rebuild his cash faster. And he will probably also get higher prices when he offloads marginal stores if he can sell them at a measured pace. Indeed, there may be a lot of upside in Sears Holdings earnings just by squeezing more sales out of Kmart stores. Lampert says Kmart's sales are $80 a square foot below those of Sears. With Kmart's 100 million square feet of real estate, boosting its sales to Sears' level would create $8 billion in annual revenue.

So expect the 42-year-old Lampert to focus on making sure the Kmart-Sears combo works -- producing the cash and valuable shares investors expect. Like Buffett, Lampert wants to build a reputation as someone who offers sound business advice -- a reputation that would help him team up with executives in future acquisitions.

Lampert, now Kmart's chairman, will become chairman of Sears Holdings. Sears Chief Executive Alan J. Lacy will become vice-chairman and CEO of the new company, and Kmart CEO Aylwin B. Lewis -- named to the post just last month
-- will become president of Sears Holdings and CEO of Sears retail. Combined sales would total $55 billion and rank Sears Holdings as the nation's third-largest retailer behind Wal-Mart Stores Inc. (WMT ) and Home Depot Inc. (HD ), displacing current No. 3 Target Corp. (TGT ). "We think there is opportunity for a broader customer base and much expanded sales," Lampert says.

Both Kmart, with 1,500 discount stores, and Sears, with 870 mall-based stores, have seen declining sales as shoppers have gravitated to savvier rivals. To counter that trend, Sears has launched its own off-mall concept, called Sears Grand. Kmart helped accelerate that strategy this year when it sold 50 stores to Sears.

In a conference call, Lacy told investors the merger will allow for the conversion of more Kmarts in markets where the stores better fit Sears' demographic of slightly higher-income shoppers. He also said Kmart will benefit from cross-sell