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The Sears-Kmart Deal: Will Ed Lampert Drive Rollouts or Roll-ups?

Edward Lampert, engineer of the Sears-Kmart merger, is more likely to build shareholder value by selling assets than building a viable retailer.

NEW YORK — He may not have fully tipped his hand yet, but veteran players are predicting that Edward Lampert, engineer of the Sears-Kmart megamerger that is set to close today, will look to maximize shareholder value by selling assets rather than by building a viable long-term retailer.

Retail observers and analysts are betting on Lampert the investor, instead of Lampert the retailer.

Lampert, founder of ESL Investments, is the financial guru who bailed out Kmart from bankruptcy. He has publicly cited Warren Buffett as a role model, but some see him more as an asset stripper, who, unlike Buffet, is deeply involved in the management of Kmart, and will be in the merged company, as well.

“The comparison with Warren Buffett involves some pretty dramatic comparisons,” said Howard Davidowitz, chairman of Davidowitz & Associates Inc., a national retail consulting and investment banking firm. “Buffett, who has a concentrated portfolio, has a theory that no matter how many billions you have, you should only invest in a few companies. Lampert did that, and he buys undervalued firms, something that Buffett also does. They’re both what you call value investors.”

But the comparison ends there.

When the $11 billion merger was announced last November, Lampert acknowledged the challenge of the undertaking at a news conference and gave a broad outline of his vision for the combined $55 billion company.

“This is going to be an enormous undertaking,’’ he said. “We’re going to need really the best of us, but the best of both the Kmart team as well as the Sears team. I think that there is going to be a lot of work to do in converting Sears stores, where appropriate, bringing Sears products into Kmart stores….We want to make sure that everybody stays focused on running the stores and stays focused on the customers….We really want it to be very much customer-focused and store-focused.”

And Sears chief executive officer Alan Lacy, in a video shown to employee shareholders this month, urged them to vote for the merger, and said the retailer’s management is “absolutely committed and believes that Sears Holdings can be both a great company and a great retailer.”

This story first appeared in the March 24, 2005 issue of WWD.  Subscribe Today.

But analysts and bankers in the industry said they think the Kmart nameplate eventually will fade away, while Sears, Roebuck & Co. could someday encounter the same fate.

The Yale-educated Lampert is considered a brilliant investor who has multiplied the return on investment for ESL shareholders. And while there isn’t consensus on the Buffett comparison, there is agreement that the merged entity faces an uphill climb.

“Lampert has diverged from Buffett on one very important principle,” Davidowitz said. “Buffett always invested in management. He buys great companies with great managers and lets them run the companies. Lampert has gone out and bought the Titanic. He bought Kmart cheap and made a lot of money for his investors. But retailing is very management-intensive, and now Lampert is involved in management. Buffet has never done this.”

A spokesman at Sears declined to comment for this story, as did the spokesman for ESL. Officials at Kmart didn’t return phone calls requesting comment.

While Davidowitz used the phrase “financial engineering” to describe Lampert’s brilliance at creating ROI, he said the steps used to get there don’t necessarily equate with what’s best for the company, the retail industry or for consumers.

“When Lampert took over Kmart, he made [Kmart and ESL] shareholders very wealthy. That’s good. He fulfilled his fiduciary duty to them,” Davidowitz said. “But as for the retail operation, he didn’t reinvest one penny into the company. He didn’t build any stores, while Wal-Mart and Target are building all over America. Lampert closed stores and sold some good ones to Home Depot and Sears.”

Retail analyst Ulysses Yannas of Buckman, Buckman & Reid also voiced concerns about the merger and the course of evolution for the new Sears Holdings Corp. He also cited concerns involving management issues.

“I don’t think this is a good deal for the Kmart shareholder. I thought that Kmart was in the process of straightening itself out. Now it wants to merge with Sears, which has had problems over the last 20 years. Sears has had a horrible time in softlines, and the profile of the two retail customers are not the same.

“On the [Sears] management front, Alan Lacy as chief executive officer, how successful was he at Sears? Not successful at all,” concluded Yannas.

Davidowitz said Lampert has raised price points and cut customer service at Kmart. “Kmart has posted some of the biggest negative [same-store sales] that I’ve ever seen,” the banker said. “That’s his performance and at the end of three years, you won’t see the Kmart nameplate.”

Davidowitz expects a similar fate for the Sears nameplate. “Sears is expecting to compete off the mall. But if you go into the mall, you can get Sears’ famous brands there, and you can’t get it anywhere else in the mall,” the banker said. “Sears doesn’t have any competition there. Now, Sears goes off the mall and it sells consumables, food, hard goods. It also competes against Wal-Mart, Target, Home Depot, Lowes and Best Buy. It is right in the teeth of the toughest power retailers in America.”

Following the merger, Lacy will serve as vice chairman and ceo of Sears Holdings Corp., the new company. Lampert takes the helm as chairman of the merged company, and Aylwin Lewis, ceo of Kmart and a former Yum Brands executive, will become president of Sears Holdings as well as ceo of the Sears Retail division.

Yannas noted that AutoZone, the automotive accessories and parts retailer that ESL also has a stake in, is without a chief executive. “Lampert has to try to straighten that out and deal with the merger. I think he’s got too much on his plate,” he said. Yannas also scoffed at the idea that the merger is a great real estate play, helping Sears move more quickly on its off-the-mall strategy. “Was the problem really in the mall? J.C. Penney is there. Why are they doing so well?”

Yannas, who said he holds Lampert in high regard, described Lampert’s financial moves as “brilliant,” but added that there are too many unanswered questions, such as who will be the chief merchant at the merged company, to gauge the success of Sears Holdings as a retail operation.

A former Kmart executive, who requested anonymity, predicted that the Kmart nameplate would end up in the retail graveyard in three to five years, calling the merger a marriage of two old, tired American icons.

The former executive is not sure if Lampert has been good for Kmart’s employees or retail operation, noting, however, that “investors seem enamored of him, particularly institutional investors who hold large positions [in Lampert’s hedge fund].”

While the former Kmart executive felt the Buffett comparison was public-relations hype, the individual said many of the remaining Kmart stores are in “locations that are not that great.”

Meanwhile, there is at least one group against the merger, The National Association of Retired Sears Employees. Kmart reportedly pays little in the way of benefits to employees, the organization claims. The group representing Sears retirees are concerned about potential loss of benefits.

In a NARSE poll, 88.4 percent said they were opposed to the merger. NARSE, referring to the merger as a takeover, said the proposed combined entity “will not result in a competitive, powerful, merchandising organization accepted by the shopping public.”

Shares of Kmart closed Wednesday down 1.8 percent to $124.83. Sears closed down 1.6 percent to $56.80.