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Macy’s Coast-to-Coast: Federated-May Deal

Federated Stores ended the speculation and said it would buy May Co. for $10.35 billion to create the largest U.S. department store chain.

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NEW YORK — Now the tough part.

Federated Department Stores confirmed Monday it will buy May Department Stores for a total of $17 billion in equity and debt, embarking on one of the most dramatic reshapings of the American retail landscape in history. Federated will now have a foothold in 64 of the nation’s top 65 markets, meaning those with more than 1 million in population, as it sets out to truly turn its Macy’s nameplate into “America’s department store.”

But while the deal may turn Federated chairman, president and chief executive Terry Lundgren into the alpha male of department stores, it also presents him with the challenge of turning around the struggling May by making them Macy’s. Even he acknowledged that the path Macy’s blazes will be rife with challenges, including “integration headaches.”

In addition, layoffs will happen soon. “I won’t hide from that subject,” Lundgren said at a press conference Monday outlining the terms of the deal. Asked the extent of the foreseen layoffs, he replied: “I don’t know how many.”

While Lundgren provided few details on combining Federated and May, he outlined a few points, including:

  • The acquisition should be completed by the third quarter.

  • May’s St. Louis headquarters will close this year, with significant job losses among its 6,000 employees.

  • Most, if not all, of May’s nameplates are likely to disappear in 2006 and 2007 as Federated rebrands them as Macy’s or, in some cases, Bloomingdale’s.

  • Federated will implement its “reinvent” program in May stores in the drive to turn around their performance.
A key to the new company will be the rollout of Macy’s as a nationwide, and far more competitive, chain. That’s been the vision of Federated’s management for years. Macy’s has primarily an East Coast-West Coast presence, with few stores in between, but with the merger, it’s headed for the heartland, planting its name on approximately 300 or more doors formerly owned by May, and parading into 15 states for the first time.

Macy’s revved-up marketing and strengthened national media are certainties for the future, but far more is expected to be seen as a result of a combined Federated-May, according to Lundgren.

At the press conference, Lundgren said the $17 billion deal includes $11 billion in equity and $6 billion in May debt. Each share in May can be converted into $17.75 in cash and 0.3115 in Federated stock. The price is equivalent to $35.50 per May share. Lundgren also cited the potential for higher comp-store gains and cash flows to help pay down the debt burden.

He also cited greater exclusivity of merchandise by distributing such successful Federated private brands as INC and Charter Club to more doors, and possibly broadening the distribution of certain May private labels and some of its moderate merchandise.

As for Federated’s “reinvent” program, it involves retrofitting stores with wider aisles, reducing clutter; improved signage and amenities; fancier fitting rooms; simplified pricing, and assortments that better reflect local demographics and style preferences. Younger shoppers are targeted through new juniors’ shops and streetwear departments. Planning, allocating and markdown systems, which May has lacked, play a big role in the merchandising.

Also, as Lundgren, stressed, Macy’s buyers focus on four customer types — traditional, neotraditional, updated and contemporary. He wants that strategy to spill over to May stores, to sell more goods. May has several sites that can be traded up, and many of its sites already trade at a level comparable to Macy’s West, which is considered more fashionable than Macy’s East, he noted.

Later, he told WWD that getting greater productivity from existing Federated and May doors, even though mall traffic isn’t growing, is crucial. “I think mall traffic is steady. In our case, it’s a matter of getting more business out of that traffic.”

As far as closures this year, May’s St. Louis corporate headquarters is likely to be history. The headquarters employs roughly 6,000 people and is the site of May Merchandising and May Department Stores International, the domestic and private label buying arms, respectively. Lundgren said May’s corporate operations, including credit, logistics and systems, will get folded into Federated’s Cincinnati and New York corporate operations. However, St. Louis will still be the site of a “major operating division,” he added. The Famous-Barr division already operates there.

The acquisition is subject to shareholder and government approval. Federated will work with government regulators to figure out how many stores must be shed to avoid monopolizing the malls. Analysts estimate Federated could dispose of around 150 May stores, but Lundgren gave no estimate. Major real estate players are expected to be J.C. Penney, Kohl’s and Sears, as well as Saks Inc. and Nordstrom on a smaller scale. Even Neiman Marcus could get in on the action in a few locations.

Next year and in 2007, “we are likely to change the name of many May stores to Macy’s and Bloomingdale’s,” Lundgren said. He didn’t specify which divisions, but it’s likely all of May’s department store divisions will get converted, even possibly Marshall Field’s, to achieve maximum national advertising for Macy’s.

Converting Field’s to Macy’s is a very difficult decision, considering Field’s is a strong, beloved institution in Chicago. But planting a Macy’s or two in downtown Chicago would be undeniably appealing to Federated, and without doing so, the national rollout of Macy’s would seem incomplete. Field’s on State Street, the most architecturally dramatic flagship in the country, would be hard to resist for Macy’s. Two May sources said Monday they expect Field’s to become Macy’s.

Another tough decision will be what to do with May’s more specialized chains. Lord & Taylor is another venerable retail institution that’s been sharpening its focus and upgrading its assortments for the past three years with Jane Elfers at its helm. As Lundgren told WWD, “Lord & Taylor is a terrific name. However, we have been looking at May on a macro basis. We need to look at Lord & Taylor as a standalone and try to understand it.”

As far as May’s bridal group, including David’s Bridal and Priscilla of Boston, “I don’t really understand it enough. We need to get in and look at it,” Lundgren said. “May management has spoken positively about that business.” 

Market sources believe that Federated is likely to try to sell both Lord & Taylor and the bridal business. Lord & Taylor has some very valuable real estate, including its flagship on Fifth Avenue and 39th Street.

May’s credit operation is also likely to be sold.

On the financial side of the acquisition, Lundgren said the transaction is expected to be accretive to earnings per share in 2007, and that Federated will realize about $450 million in cost savings by 2007 due to the consolidation of central functions, division integrations and the adoption of best practices across the combined company. Lundgren told WWD that he considers May’s ability to operate efficiently, (it has a lower SG&A rate than Federated) as well as its knowledge of moderate merchandise and certain private brands, to be best practices.

Most of the hard work won’t begin until next year but through it all, there will be pressure on Federated to lift store productivities, consolidate and cut costs, in light of the debt burden it will assume through the deal and Wall Street pressures on Federated to quickly show the benefits of the acquisition.

“We are in a very competitive business. It’s a very challenging, very competitive industry,” Lundgren said. “Discounters, moderate stores, luxury stores, all of them compete with us. Just about everyone competes for our customer.”

There’s been some speculation that Federated could pursue a three-tier merchandising strategy of good, better, best — meaning May stores, Macy’s and Bloomingdale’s — but Lundgren said, “That’s not our going-in strategy.”

He described Federated and May as being “complimentary” and without significant overlap. With the deal, Federated will double its store count and volume to about 1,000 units and $30 billion in annual sales.

With a 20 to 25 percent overlap of stores, anticompetitive questions are expected to be raised by regulators. Antitrust queries involve examining the geographic locations where merging companies would compete as well as similarities in product lines being sold and their availability elsewhere, including catalogue, Internet and mass market retail sales. Antitrust concerns could arise in Maryland, where Hecht’s and Lord & Taylor compete against Macy’s and Bloomingdale’s.

At the minimum, the proposed Federated-May entity by law must meet approval from federal antitrust officials, either at the Federal Trade Commission or the Department of Justice, depending on which agency takes the case. In any event, regulators will weigh whether competition among department stores in markets where the two chains operate — like in Maryland, Pennsylvania, Massachusetts and New York — would be lessened by the marriage and cause prices to increase.

It’s a hurdle that wasn’t met in 1998 when the FTC, joined by several states, refused to allow Office Depot and Staples to merge. When Exxon and Mobil decided to merge in 1999, the agency feared anticompetitive results at gas stations on the East Coast and ordered the divestiture of Mobil stations above Virginia and of Exxon stations below the state, according to FTC spokesman Mitch Katz.

Federal regulators on Jan. 28 gave the antitrust go-ahead for the pending Kmart Corp.-Sears, Roebuck merger, however.

Ellen Cooper, the assistant attorney general for antitrust in Maryland, said the Federated-May merger was “something we plan to look at, but we really haven’t formulated any specific theories or plans for going forward at this point.”

While Wall Street analysts favor the merger, shares of Federated and May lost some ground Monday due to market concerns over higher prices and inflation fears. Federated on Monday closed at $56.45, down 60 cents, in trading on the New York Stock Exchange. Shares of May closed at $34.51, losing $2.38, in Big Board trading.

Retail analysts at Merrill Lynch, Stacy L. Turnoff and Daniel Barry, wrote in a research note, “We are pleased with the transaction and believe that there are a multitude of cross-synergies between the two retailers.”

The analysts pointed to certain key financial metrics that made the merger compelling: Federated’s superior merchandising capabilities, a national presence for Federated as well a national advertising campaign through its conversions of May’s regional nameplates to the Macy’s brand and May’s expertise in cost-cutting, which, at 14 percent, establishes it as a leader on an earnings before interest, taxes, depreciation and amortization basis.

Deborah Weinswig, retail analyst at Citigroup Global Markets, observed, “Do I think May could have held out for a little more? Could May have gotten another $1 or $2 per share? Maybe, but in the end it’s not that much of a difference. When you look at this transaction, what you see is that Federated, buying May at 8.9 times EBITDA, was fairly disciplined in their approach.” Weinswig’s 12-month price target for shares of Federated is $70.

“I think this saves department store retailing,” said Frederick Schmitt, a vice president at the investment banking firm Sage Group. “What we see is retailing at the traditional department store level will be kept alive. There’s so much pressure at the higher end from Neiman Marcus and Saks Fifth Avenue and at the lower end from Wal-Mart and Kohl’s.”

Retail analyst Walter Loeb believes that the big differentiator for Federated will be its ability to leverage private brands in all stores and further emphasize the Macy’s nameplate as a national brand.

Indeed, during his conference call Monday morning, Lundgren played up product differentiation. “Many of you have expressed concern that May Co. stores are too moderate and won’t fit within the Macy’s strategy. That’s just not true. I mean, as a retailer, I study the competition and I can tell you it is just not the case. May Co. has many locations whose demographics are higher than what their current assortments would indicate, and we believe we will add considerable value there….The key will be utilizing our plan of distribution function, which currently May Co. does not have, to make sure that we tailor the assortments to individual locations as we do at Federated today.”

Lundgren emphasized that Federated will increase its dividend by 85 percent to $1 a share from 54 cents. “That speaks [to] our confidence in the cash-flow generation potential of this combined company,” the ceo said.

Karen Hoguet, chief financial officer of Federated, said it’s too early to know whether Federated will first hyphenate May stores with the Macy’s name before changing them to straight Macy’s, as Macy’s did last year with its regional operations. All of those regional names will be dropped by early March.

Onetime costs will total $1 billion in cash spread out over three years. The costs are anticipated to include severance, markdowns and facility shutdown costs.

While Ed Nakfoor, a retail consultant in Detroit, was pleased to see Federated get Marshall Field’s, he wasn’t sure yet if the merger is good for customers. “When Target Corp. first put Marshall Field’s on the block, it was my thought from the get-go that Federated would have been a better fit than May since Federated is more skilled at operating big-city department stores.

“In Detroit, where the beloved Hudson’s gave way to Marshall Field’s, residents are sure to welcome the cachet that Macy’s brings and even more exciting is the prospect of finding themselves within a Bloomingdale’s banner,” he said. “Much of that is because here many people still refer to the renamed store as Hudson’s, and don’t really have a personal attachment to the Marshall Field’s brand in metro Detroit. Of course, the situation will be different in Chicago.”

Emmanuel Weintraub, a retail consultant at the firm that bears his name, said the merger makes Federated the “Wal-Mart of the department store sector — they are big, they are dominant.”

Britt Beamer, founder and chairman of America’s Research Group, said Federated’s ability to now advertise its Macy’s nameplate nationally will allow Macy’s to be able to fully reach the coveted under-35-year-old shopper. “That shopper is TV driven,” Beamer said. He added that Macy’s “cannot effectively advertise to that person now” because it is more of a regional department store chain. Leaving  Field’s as it is would minimize the effectiveness of a national Macy’s advertising campaign, said Beamer. He’s expecting Federated to turn Field’s into one of its other nameplates, Bloomingdale’s or Macy’s, where appropriate.

While potentially gaining more fans from the under-35 crowd, the combined Federated-May entity, to be sure, runs the chance of alienating slightly older customers who are used to shopping at a Strawbridge’s, Filene’s or Hecht’s, which the company will likely convert to Macy’s nameplates. Weintraub also thinks Field’s could be headed for name changes — either Macy’s or Bloomingdale’s, depending on the location — while some Lord & Taylor locations might become Bloomingdale’s.

However, Denise Kramp, senior client partner at Korn/Ferry International search firm, said, “I can’t imagine a Marshall Field’s customer accepting Macy’s.”

Kim Picciola, an analyst at Morningstar, wrote in a research note Monday, “If the companies can successfully integrate their operations and leverage Federated’s merchandising capabilities and May’s operating efficiencies, we think this move will provide them with some short-term relief from the challenging retail environment faced by traditional department stores.”

She added, though, that a bigger department store chain won’t necessarily mean a better, more competitive one in the long run. “This new [Federated-May] combination will continue to experience intense pressure from specialty retailers, discounters and high-end retailers, which have been steadily stealing share from midtier department stores. We expect this trend to continue.”

From a vendor perspective, the Federated-May merger impact will have a varying affect on suppliers such as Liz Claiborne, Ralph Lauren and Coach, “depending on how astute the supplier has been,” Goldman Sachs analyst Margaret Mager wrote in a Monday research report.

“The combined May-Fed entity will capture roughly 30 to 45 percent of sales for the branded apparel companies that have pursued diversification strategies….We see Federated-May merging as a defensive move, given the [department store] channel has been losing share and its suppliers have been moving beyond its channel, as well. Smart suppliers began shifting their business mix away from the department store channel years ago and have been emphasizing profits over sales for some time through reduced door count and tight inventories,” Mager wrote.

— With contributions from Vicki M. Young and Meredith Derby, New York, and Joanna Ramey, Washington

Federated’s New Retail Landscape

Federated Department Stores Inc.
May Department Stores Co.
New Markets
Overlap Total
Alabama
2
Alaska
Arizona
6
9
15
Arkansas
California
113
47
160
Colorado
11
11
Connecticut
4
13
17
Delaware
1
4
5
Florida
66
Georgia
27
Hawaii
19
Idaho
9
Illinois
4
29
33
Indiana
4
15
19
Kansas
5
5
Kentucky
6
2
8
Louisiana
2
4
6
Maine
1
2
3
Maryland
4
24
28
Massachusetts
11
27
38
Michigan
24
24
Minnesota
2
12
14
Missouri
17
17
Montana
3
Nevada
8
2
10
New Hampshire
4
4
8
New Jersey
33
17
50
New Mexico
1
2
3
New York
35
30
65
North Carolina
12
12
North Dakota
3
3
Ohio
20
24
44
Oklahoma
5
5
Oregon
5
8
13
Pennsylvania
14
35
49
Rhode Island
1
2
3
South Carolina
2
South Dakota
1
1
Tennessee
5
5
10
Texas
5
47
52
Utah
8
8
Vermont
1
1
Virginia
5
24
29
Washington
33
1
34
Washington D.C.
2
2
West Virginia
1
1
2
Wisconsin
5
5
Wyoming
1
Guam
1
Puerto Rico
1

Federated Department Stores Inc. operates 458 department stores in 34 states, Guam and Puerto Rico. May Department Stores Co. operates 484 department stores in 38 states, plus 697 David’s Bridal, After Hours, and Priscilla of Boston stores in 46 states and Puerto Rico. All information as of Jan. 29, 2005. Compiled by Amy S. Choi


Top Five U.S. Department Stores

CompanyAnnual revenues
Sears, Roebuck & Co./Kmart Holding Corp.$55 billion*
Federated Dept. Stores/May Dept. Stores$30 billion*
J.C. Penney Corp.$18.4 billion
Kohl’s Corp.$11.7 billion
Dillard’s Inc.$7.5 billion

SOURCE: Company reports. *Estimated combined sales

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