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Retail’s Changing World: Federated Opts to Put Lord & Taylor on Block

Federated Department Stores said it plans to divest its Lord & Taylor division and expects to complete a transaction prior to the end of the year.

NEW YORK — Federated Department Stores Inc. has put Lord & Taylor up for sale after months of analyzing whether to retain it, pare it down or liquidate it.

After a board meeting Thursday, Federated finally concluded the $1.56 billion, 55-unit Lord & Taylor didn’t fit into its strategy to build up its Macy’s and Bloomingdale’s divisions into more powerful national brands. Federated believes that reviving L&T would be a costly distraction, and that selling it was the best option. At least one analyst estimated that L&T could fetch $745.3 million after tax.

There was some speculation Thursday that a prospective buyer recently expressed interest in L&T, prompting Federated’s announcement that day. Federated acquired Lord & Taylor through its $17 billion purchase of May Department Stores last year.

There are plenty of cash-rich hedge funds and private equity firms with stakes in retailing that could take a look at Lord & Taylor, including Cerberus, Texas Pacific Group, Apax Partners, Kohlberg Kravis Roberts, The Blackstone Group, and Bain Capital.

In addition, a few retailers, such as Nordstrom and Kohl’s, are likely to examine the chain, as well some real estate companies. Vornado Realty Trust last year teamed up with KKR and Bain to buy Toys ‘R’ Us, and has a stake in Sears Holdings, the entity that emerged from Kmart’s purchase of Sears, Roebuck.

It’s possible that Federated ends up selling off Lord & Taylor’s real estate, which is valuable, in the event that efforts to sell the chain as an ongoing operation are not successful.

Terry J. Lundgren, chairman, president and chief executive officer of Federated, said in an interview Thursday, “My intent is to sell Lord & Taylor as an ongoing business. That’s what I think will be appealing and that’s how we are going to market this. I personally think it will continue as Lord & Taylor. That would be my preference.”

Lundgren said Federated spent months analyzing L&T, and added: “I was just trying to look at the overall idea of Lord & Taylor as a third brand,” for Federated. “The more we looked at it, the more it didn’t make strategic sense. The store sizes are different. The positioning is different. It really needed to be a stand-alone business.”

Lundgren said Federated considered many elements, including how much L&T would add to Federated’s value over the next three years, the investment of management’s time in beefing up the business, and what to do with the cash from the sale.

“If we had the time and the additional capital to put into it, it would have been something we would have considered. We would have definitely kept it as a third brand, but based on our priorities, it wouldn’t be a strategic fit,” Lundgren said.

Those priorities include the huge task of converting May stores into Macy’s, selling off about 80 May stores, as previously announced, and using cash from asset sales to pay down debt and buy back stock.

Lundgren said that while he prefers to see L&T continue to exist, Federated is willing to talk to companies that might consider converting the business to another nameplate, even a competitor like Nordstrom. Recently, reports have heated up that Nordstrom is extremely interested in opening a Manhattan store.

“You never know,” Lundgren said, though he downplayed Nordstrom as a potential buyer, explaining that the average L&T store is about half the size of an average Nordstrom. “We would be willing to talk to anybody about buying the portfolio, even them,” he added.

“Nordstrom wants 38th Street [L&T’s New York flagship]. A lot of consumers would go there to check out Nordstrom,” said a former May executive. Nordstrom stores range from 120,000 to 200,000 square feet, with most around 160,000 square feet. L&T units average 100,000 to 120,000 square feet and are more comparable to Parisian, the department store unit this week put up for sale by Saks Inc.

Lundgren said he expects lots of inquiries about buying L&T over the next few weeks and for the sale process to last six to eight months and be completed before the end of 2006. He said no talks with prospective buyers have been held yet. Goldman Sachs and J.P. Morgan Chase are advising Federated on the sale.

In the meantime, Federated will be challenged to keep Lord & Taylor operating smoothly during the sale process and keep key executives on board. According to one individual close to the division, “Everyone has been told what their severance would be. There are a lot of people with tenure. They are not going to jump ship quickly. Everybody expected this. This is not anything new. Jane [Elfers, L&T’s ceo] will make Lord & Taylor as viable as possible and that means everybody will have to work hard.”

One former retail ceo said that “stay bonuses” are likely to be offered down to the buyer level. The merchandisers are more at risk to lose their jobs, compared with store associates considering a strategic buyer would merge the central merchandising.

Another source pointed out that there are not that many retail jobs around, so many employees will stay on board as long as possible. L&T employs about 12,000 workers, including 1,275 in Manhattan

Elfers could not be reached for comment, but sources said she held a management meeting Thursday to discuss the announcement.

“My guess is that the potential buyer would consider the talent pool. We very much like the management at Lord & Taylor, including Jane and management beyond Jane,” Lundgren said.

What complicates a transaction is the fact that Federated owns about 60 percent of Lord & Taylor’s real estate, and 55 percent of the total real estate of May. There are some excellent L&T locations that are owned, including the 610,000-square-foot Fifth Avenue flagship, as well as the Stamford, Conn., and Westchester, N.Y., stores. Federated said it will account for Lord & Taylor as a discontinued operation in its monthly sales and quarterly earnings reports. This is expected to reduce fourth-quarter 2005 earnings from continuing operations by about 10 cents per share, the company said.

Lord & Taylor is considered a victim of some regrettable May strategies. It has never been able to retain the luster it had up until the Eighties when it embarked on an ill-fated expansion across the country.

In July 2003, May reversed Lord & Taylor’s expansion strategy and decided to pull out of the Sun Belt, closing 32 stores. Today, the business is concentrated in the Northeast, Mid-Atlantic and Midwest regions, but has long depended on older customers, aggressive price promoting and coupons to generate business. Four years ago, the chain embarked on a campaign to upgrade its stores and product, focusing on bridge, better and contemporary brands, eliminating moderate lines, and enlivening its image through new types of special events, windows and catalogues.

“This is a tough sale,” said a former May executive. “There are too many uneconomic stores, maybe 15 to 20 that are unproductive. As you go through the roster, a lot of them need capital infusions.” Among them is the Chicago unit in Water Tower Place, which has “tiny floors,” as well as a unit in Boston. However, stores in the New York metro area are more productive and the Westchester; Stamford; Garden City, N.Y., and Ridgewood, N.J., stores are among some renovated branches.

“In terms of Jane’s strategy, you can’t fault it. She has tried to upgrade the goods,” focusing on better, contemporary and bridge labels and a younger audience, the source said.

Another source close to the store said about $400 million in moderate brands have been shed over the past few years, and this spring, the company expects to get a valid read on the viability of the restructured business, considering the chain would have anniversaried several discontinued vendors at that point, and the division would be looking for some single-digit comp-store sales gains.

With the Lord & Taylor flagship, “Every major developer will be interested,” said Peter Ripka, a founder and partner in Ripco Real Estate Corp. “It’s almost definitely going to be a mixed-use building because of the strength of the residential and office markets. That area of Fifth Avenue has gotten much better with stores such as Best Buy and Barnes & Noble opening. It used to be a no-man’s land from 34th Street to 50th Street.”

Another real estate executive said a Lord & Taylor transaction could be a real play. “There’s definitely great value in the real estate. There’s a lot of good locations. However, it could be run as a smaller, more nimble independent chain, with some capital infusion.”

“We believe there is the potential for the Lord & Taylor division (including the New York flagship) to be sold in a single transaction, which we value to be $745.3 million after tax,” Debra Weinswig, a retail analyst at Citigroup, said in a research note. “Our valuation includes the Lord & Taylor flagship located in Manhattan, valued at $384.9 million (excluding air rights) and the remaining Lord & Taylor stores, excluding the two L&T stores that will be divested, at $360.4 million.”

Weinswig predicted that Saks Fifth Avenue will be taken private and be combined with Lord & Taylor. “We believe that a private equity buyer could purchase Saks Fifth Avenue and buy Lord & Taylor stores to rebrand them under the Saks Fifth Avenue name. We view this outcome as a possibility because the Lord & Taylor stores which Federated could divest are in markets in which Saks is underpenetrated.”

Robert K. Futterman, founder of Robert K. Futterman & Associates, called the Lord & Taylor flagship “probably the most valuable piece of real estate left [for redevelopment] in New York City. There’s so much residential development going on there. All the retailers around L&T do extremely well. It’s such an opportunity for mixed use because it has huge floor plates, great visibility and great accessibility.”

A real estate play would be logical for L&T, he said. “There’s a trend with Toys ‘R’ Us, Mervyns and Kmart where real estate ends up becoming even more valuable than the business.” And while it’s possible that a retailer like Target or Nordstrom’s could take over the space, another scenario could involve subdividing it into a combination of specialty stores and restaurants. “It works for all of the above,” Futterman said.