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Endangered Species? Dept. Store Woes Spur Merger Rumors

<CS:BOLD>NEW YORK -- Will there be another wave of mega-mergers to ultimately save the department store?<BR><BR>Industry observers say there is nothing in the works at the moment, but big deals could happen in the future. There recently has been a...

NEW YORK — Will there be another wave of mega-mergers to ultimately save the department store?

Industry observers say there is nothing in the works at the moment, but big deals could happen in the future. There recently has been a stream of rumors about different permutations — some more believable than others. The latest, as reported, is that Federated and May Co. might want to buy Dillard’s, but the consensus is that the Dillard family is a long way from wanting to sell.

That doesn’t mean Dillard’s — or Elder-Beerman, Bon-Ton and some Saks Inc. chains — might not be snapped up eventually — or that Federated and May Co. wouldn’t look for a mega-merger with the likes of Nordstrom, Marshall Field’s or even each other. “In order to be effective, the department stores need a bigger base on which to operate,” said Gil Harrison, chairman of Financo Inc. “There is no question there will be continued consolidations.”

Federated and May Co. are antsy for greater growth after experiencing several years of poor comp-store performance, and have been opening just a handful of stores annually. Most importantly, they’ve seen market share declines due to the rise of the likes of Wal-Mart, Target and Kohl’s as well as specialty chains like Talbots. Retailing is increasingly becoming a game of scale, and the department stores will need to be big to better compete. Consolidation also seems likely since there is so much idle space and landlords are more flexible with deals. As retail analyst Walter Loeb said: “I believe there are some department stores in the U.S. that are irrelevant for the future.”

But while the speculation on potential mergers runs amok, the reports remain unsubstantiated. Aside from the Dillard’s rumors, there have been rumors about Federated and May Co. getting together, foreign companies such as Carrefour or Metro coming into the market or H&M purchasing a retailer to speed its U.S. expansion. Nordstrom takeover rumors have come and gone; like Dillard’s, it’s believed Nordstrom family members still take pride in controlling the Nordstrom business. Speculation on a Neiman Marcus-Saks Fifth Avenue combination, or Gucci or LVMH Moet Hennessy Louis Vuitton buying one of them, has run hot and cold for years.

There’s even some chatter about J. C. Penney Co. combining with another retailer years from now after it turns itself around — and signs of improved performance are emerging. Penney’s chairman and chief executive officer Allen Questrom has a big picture perspective and a track record of mega-mergers. As chairman and ceo of Federated, he led the strategy to take over Macy’s and The Broadway.

But, for now, mega-mergers don’t appear to be in the cards any time soon, despite financing availability and the allure of market-share gains and cost-cutting opportunities, such as eliminating corporate offices. But since the Eighties and early Nineties, when mergers proliferated — and bankruptcies resulted — retailers are more aware of the debt risks and difficulties of assimilating stores and banks are more cautious.

“There is not that much to consolidate other than a few regional department stores,” Carl Steidtmann, chief economist of Deloitte Research. “All the big mergers already happened.”

Rather, Steidtmann said, in order to revive sales and profits, department stores could look to diversify their real estate portfolio risk, perhaps by going off-the-mall, similar to mega book store chains, or Kohl’s and Target.

Similarly, Ferris, Baker Watts equity analyst David Lamer said he did not believe there is really any low-lying fruit to pick. “It doesn’t make sense since we are talking about three to six major players right now,” he said, referring to May Co., Federated, Dillard’s, Saks Inc. and Marshall Field’s.

He said Federated and May Co., if they pursue other department stores, should only pursue those with the right formula at driving top-line sales and earnings. “Quite frankly, right now, no one has the formula,” he said. Lamer suggested department stores work on how they buy and sell merchandise and innovate.

“I don’t know of anything cooking,” said Stephanie Shern, chief executive officer of Stephanie Shern Associates, a consultant to retail and consumer products firms, when asked about retail mergers. “It’s a bad environment to think about a major transaction, though there is a lot of money sitting on the sidelines waiting to be invested, and bankers prefer retailing more than technology now. I know of no transaction that is for real, though I’ve heard a lot of discussion about these combinations, and there will be some.”

She said Saks Inc. has to do something to separate the upscale Saks Fifth Avenue from the Saks Inc. department store group, May Co. must figure out ways to grow, as does Federated — which has been focusing more on home and new formats — and Neiman Marcus has to think about getting back on a growth track, since it’s been pulled down by the worldwide luxury downturn.

“Every one of these companies has a reason for doing a transaction,” she said. “The question is who will combine with whom, or will there be somebody from overseas, like Metro, Carrefour or one of the big department store chains coming to the U.S.? To be truly global, they have to, and the price could be right for them now.”

Within luxury retailing, “it may be wild speculation, but conceivably Gucci Group could come in and buy one,” meaning Saks or Neiman’s, Shern said. She said she thought it was less likely that LVMH would seek to buy Neiman’s or Saks, suggesting it’s not the strategic orientation of chairman Bernard Arnault and members of his management.

However, all department stores, including Saks and Neiman’s, are struggling in some way, Shern said. “The solution has to be to shuffle the deck somehow, but a major transaction would be very difficult, even though the price may be inexpensive, you would be buying something that needs a lot of fixing and creating a management team is complicated. I could see the possibilities, but I don’t see anyone taking the chance.” Instead, department stores must think about reinventing the model, she concluded.

Others aren’t so sure. “The acquisition track has been the way to go since malls are not being built very much,” said Isaac Lagnado, president of Tactical Retail Solutions.

Could a Federated-Dillard’s combination work? “My hunch is that it would be a struggle,” said Lagnado, of Tactical. “Dillard’s is a bottom fisher. They bought very shrewdly, pieces of such chains as Mercantile and Ward’s, creating a hodgepodge of stores of different sizes, different metro areas, different advertising targets, but Dillard’s can make what it has work because the company has low costs.”

Asked if Federated could assimilate Dillard’s hodgepodge into it’s own retail portfolio, Lagnado replied: “I don’t know. My hunch is that it would be a struggle.”

That’s if Federated — or May Co. — can ever buy it. The consensus is the company isn’t for sale. “They are perfectly happy running their company,” said one top retail executive. “They are troubled by their performance, but they are quality people. They work hard and there has been no decision to sell it.”

Said another source: “It’s much too early for anything, in terms of his [William Dillard Sr.] passing. Things financially would have to change. It’s still a family business that’s run like a family business, and Bill Dillard 2nd [ceo] is even more conservative than his father was.” Since the death of Dillard Sr. on Feb. 8, Dillard stock price gains have sparked rumors that the family would consider selling. Any deal would require the approval of the Dillard family, since the family controls the voting stock, the board and the management.

May Co. and Federated, hungry for new retail properties and with the cash for major deals, will have to take their money elsewhere.

Larry Leeds, chairman of Buckingham Capital Management, believes Federated would even be more interested in Marshall Field’s than Dillard’s, and that Field’s would more likely one day be sold since the parent Target Corp. has been rapidly growing its Target division, while Field’s has been staying put in the Midwest.

“When you are looking at how do you grow, sometimes you have to take a difficult course,” said Arnold Aronson, director of retail strategies at Kurt Salmon Associates. “These type of mega-mergers at best provide a short-term expense savings, economies of scale and so-called synergies, but don’t address the fundamental problem of same-store growth.”

“The department store model is going to have to change to get the consumer to pay the proper price and right now an acquisition is not going to address the core problem, which is how do department stores motivate the consumer to pay full margin when they [the consumer] are focused on discounted product prices,” said Emanuel Weintraub, president of the self-named consulting group.