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Sears, Kmart get together in $11B deal

What will happen to Grass Valley’s Kmart and Sears stores remains to be seen after their parent firms announced a merger Wednesday.

Kmart officials in Grass Valley could not speak about the merger, which is expected to make the combined company the nation’s third largest retailer. But corporate spokeswoman Nina Devlin said “there have been no specific decisions on any stores.” She also said merchandise lines are being evaluated and some from Kmart will be brought into Sears stores or vice versa.

Devlin said that decisions about store closures or the conversion of several hundred free-standing Kmarts into Sears stores will not come until the merger sale is final in March 2005. It will create the new Sears Holdings Corp.

New Board Chairman Edward Lampert said it is unlikely any Sears stores will be converted to Kmarts, but store closings are a possibility.

“I think we’ll probably end up over time opening more stores than we close, but obviously if we don’t operate the stores well, it might be the other way around,” he said.

He also would not provide any details on possible layoffs, except to say, “There will be some head count changes that come out of this.”

Owner Ron Gaynor of the Sears appliance store on Idaho-Maryland Road in Grass Valley said he had not heard directly from Sears or Kmart. But Gaynor said he owns his store and sells Sears products in “a dealer store,” under a contract with them.

Sears corporate spokesman Chris Brathwaite said it is just too early to know if there will any changes for Gaynor’s stores or all the others in the now huge chain.

However, he did say “the dealer stores are a very important part of our business.”

Kmart in Grass Valley survived the threat of closure in 2002 when the retail chain filed for protection bankruptcy, because the store here was one of the firm’s top earners. Kmart closed 600 stores across the country and has since bounced back.

What did close at Kmart here in May 2002 was the attached Penske Auto Center, run independently of the store. That area now is used for Kmart storage.

The local Kmart also does not fit the free-standing model for new Sears stores. Kmart is part of a strip mall on McKnight Way in Grass Valley.

For Sears, the merger allows the company to move more quickly to where it believes its strongest base of customers is. “Off mall is where we need to move very aggressively,” said Sears Chairman and CEO Alan Lacy, who will become vice chairman and chief executive of Sears Holding.

Kmart has 1,504 retail stores in 49 states, Puerto Rico and the Virgin Islands. The first store opened in Michigan in 1962.

Sears goes back to the late 1800s, when if offered merchandise to farmers through the mail. The company has about 2,000 stores in the U.S. and Canada.

The firm opened its first store in 1925 and soon became the nation’s top retailer.

That distinction was eventually lost to Wal-Mart. The merger would make Sears Holdings the national’s third largest retailer after Wal-Mart and Home Depot Inc.

The surprising $11 billion gamble was done to help the two firms compete with Wal-Mart and other big-box retailers.

Lampert and Lacy, in announcing the deal, promised up to $500 million a year in savings within three years from store conversions, back-office job cuts, more efficient buying of goods and possible store closings.

Shares of both Kmart and Sears, Roebuck and Co. surged on the news, but some analysts are skeptical that it amounts to a home run.

“Both have been broken in some sense,” said Dan Hess, president and chief executive of Merchant Forecast, a New York-based independent research company. “Kmart has to learn to survive in a Wal-Mart world, and Sears needs to learn to survive in a world of Home Depot and Lowe’s.”

Lampert, 42, was as an assistant to Robert Rubin at Goldman Sachs & Co. before leaving to form a hedge fund at the age of 25. He orchestrated the deal and will lead a new board that will be dominated by Kmart directors.

“We need to have a very low cost structure in order to compete with our biggest competitors,” said Lampert, whose Greenwich, Conn.-based investment firm controls Kmart and is Sears largest individual shareholder, with a 15.8 percent stake.

Lacy said he and Lampert have known each other for four years. The idea for a combined company first arose when they were in talks about Sears purchase of 50 Kmart stores earlier this year, he said.

The new company is expected to have $55 billion in annual revenues and 3,500 outlets.

It will be headquartered in the northwestern Chicago suburb of Hoffman Estates, where Sears has its headquarters, but will maintain a “significant presence” in Troy, Mich., where Kmart is based.

Lampert gained control of Kmart when the retailer emerged from bankruptcy in May 2003, through the conversion of his debt holdings into equity. In March, Kmart posted its first profitable quarter in three years.

While same-store sales have continued to decline, Lampert has maximized cash flow in part by selling off some of the stores to Sears and Home Depot.

On Wednesday, Kmart said it earned $553 million, or $5.45 per share, in the third quarter ended Oct. 27, compared with a loss of $23 million, or 26 cents per share, for the same period a year ago. Its stock price has risen more than sevenfold from $15 a share when it emerged from bankruptcy.

Mired in a retail slump, Sears had long fallen out of favor on Wall Street after losing ground to competitors and enduring sluggish sales for years. The company last fall introduced its Sears Grand stores, which offer grocery and convenience items besides traditional Sears fare such as clothing, home appliances and tools. The concept had delivered promising results for the retailer at its first three stores in metropolitan Salt Lake City, Las Vegas and in the Chicago suburb of Gurnee.

Lampert said the goal for the combined company is to achieve a 10 percent operating profit margin, a level that’s generated by such retailers as Gap Inc. and Target Inc. But he noted that in the meantime, the financial operations will be “lumpy” as it digests the two companies.

A key part of increasing productivity at the stores will be in the cross selling of the brands, though company officials declined to be specific on which they would overlap. Besides Craftsman tools and Kenmore appliances, Sears’ exclusive brands include Lands’ End clothing. Kmart’s brands include Martha Stewart, Jaclyn Smith and Joe Boxer. Lampert said that Sears could also benefit from Kmart’s expertise in its pharmaceutical department and health and beauty products.

Sears shares soared $7.79, or 17 percent, to close at $52.99 Wednesday on the New York Stock Exchange, and Kmart shares climbed $7.78, or 7.7 percent, to close at $109 on the Nasdaq Stock Market.

Shares of Martha Stewart Living Omnimedia Inc. also rose more than 6 percent on the belief among investors that the deal could bring a larger-scale merchandising agreement with Sears. Currently, Martha Stewart Everyday brand is sold exclusively at Kmart in the United States and at Sears Canada.

Under Wednesday’s agreement, which was unanimously approved by both companies’ boards of directors, Kmart shareholders would receive one share of new Sears Holdings stock for each Kmart share. Sears shareholders can choose $50 in cash or half a share of Sears Holdings stock. That portion of the deal values Sears shares at $11 billion, a 10.6 percent premium over its value at Tuesday’s close.

The merger, expected to close by the end of March 2005, is subject to approval by Kmart and Sears shareholders, regulatory approvals and customary closing conditions.

Sears Holding also created the office of the chairmanship, which consists of Lampert, Lacy and Aylwin B. Lewis, who was named president of Sears Holding Corp., CEO of Sears Retail. Last month, Lewis, formerly an executive at restaurant operator Yum Brands Inc., was named chief executive and president of Kmart.

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