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Consolidation Fever: Which Store Logos Could Vanish Next?

With earnings reports trickling in this month, rumors of retail consolidation have resurfaced. The latest: a merger of Federated and May Co.

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NEW YORK — How to compete with Wal-Mart and Target.

That is the modern retail conundrum that stores from Macy’s to Gap have to deal with. No wonder that, with earnings reports trickling in this month and the stock market sinking to new lows, retail consolidation is in the air once again.

The goal is one of scale. While once considered giants, $15 billion retailers are no longer kings of the block at a time when Wal-Mart has sales almost 15 times that and even Kmart is almost three times bigger. Economies in purchasing, staff, back office and logistics are now the holy grails retailers chase as they cope with flat or barely-rising comp-store sales.

So the latest rumblings come as no surprise: Federated Department Stores and May Department Stores could still be considering a merger at some point, after failed talks last year, although no deal is imminent. Meanwhile, something could crack at Sears, Roebuck & Co., which is widely described as "a house of cards," but which is rolling out its Lands’ End brand this spring into more Sears stores. The future of an independent Sears’ is all about execution of a renewed store presentation.

In addition, Target Corp. may be rethinking its position on the Marshall Field’s and Mervyn’s divisions, though Target has long denied those chains are up for sale. According to one insider, "May has been pursuing Marshall Field’s for years." Field’s is dominant in Chicago, Detroit and Minneapolis, where neither May Co. nor Federated have much of a presence. Target also operates Mervyn’s in California, another possible disposition and a chain due to come under increasing pressure from the invasion into that market by Kohl’s. Target Corp. could use the money to further fuel the Target chain.

There also has been talk about Metro, Tesco or Carrefour, the big European retailers, coming to the U.S. To be truly global, they have to, and the price for entry could be right for them now — especially if any of them wanted to make a run at the bankrupt Kmart and take on the challenge of carving out a niche for the long-struggling retailer. But such moves could be delayed if there is a war against Iraq, or by the increasing tensions in other parts of the world.
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In the U.S., no other major bankruptcies are seen this year after Kmart’s filing in 2002. There will be a lot of trimming, though, with all the major chains re-examining individual store performances, preparing to shut weak units and cut staff. Regional operators, such as Gottschalks, Bon Ton, Elder-Beerman and Boscov’s, are considered takeover targets or restructuring candidates.

Each year around this time, the rumor mill grinds it out. But this year, due to the spate of high-profile executive departures since January following the difficult Christmas season, and the sense of urgency purveying the industry, it’s reached a feverish pitch. Everyone is asking, "Who’s getting the next pink slip?" and, "Who’s next to merge?" The more troubled the company, the hotter the rumors.

As far as May and Federated merging, it could be some time off. "There have been conversations on and off," said one source. "There could be antitrust problems, and there are always problems with some egos, and deciding who ends up running the business."

Though Federated is outperforming May Co., May has more cash, and could be the acquirer. The company has been very open to purchases, having bought a string of bridal businesses in the last few years, including David’s Bridal. Forecasting May’s eighth quarter of year-over-year declines in a row, Shari Schwartzman Ebert, analyst at J.P. Morgan Securities, said in a research note that she is looking for the group to report a drop of 11.4 percent in fourth-quarter earnings to $1.20 a share. May is expected to report fourth-quarter earnings on Thursday.

Retailers do a lot of wheeling and dealing over individual units, so they’re always watching each other. Just last week, Federated said it is buying two stores in Hawaii from J.C. Penney, which will be remodeled and opened as Macy’s next fall. However, retailers are now more aware of the debt risks and difficulties of assimilating stores on a bigger scale, and banks are more cautious than they were in the high-flying Eighties and early Nineties.

Nevertheless, "retail consolidations have to continue. The only way to survive is to become bigger," said Gil Harrison, chairman of Financo Inc. "It’s becoming harder and harder to earn a buck because unit prices are down. Just to break even, you have to sell more units."
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Peter J. Solomon, chairman of the investment banking firm that bears his name, said he’d heard reports of a Federated-May merger on several occasions in recent years. "They should merge," he said. "The problem with department stores has been the same for 50 years — the absence of top-line growth," he said. "In the absence of that, they need bottom-line growth, and they’ve accomplished some of that by merging divisions and internal consolidation, as Federated just did in Atlanta. A merger wouldn’t solve the top-line issue any more than consolidation has, but it will help give them a more efficient cost structure and maybe help them buy better.

"Department stores’ great strength was as providers of credit, but that hasn’t been the case since the introduction of the walk-around credit card 50 years ago. Even when revenues were steady or growing, they’ve been losing market share, giving up about one-third of it in the Eighties alone. They’re great institutions that no longer have the importance they once had.

"This Federated-May thing has been pretty much an annual rumor, but I attach importance to every rumor, and this one would make a lot of sense. Even when you look at the two companies’ overlap geographically, it’s not as serious as you might think — just a few markets, including southern California."

Federated is strong on the East and West Coasts and in the Southeast, while May is strong on the West Coast, in Texas and parts of the Northeast and Midwest.

Illustrating Solomon’s point about market share, retail consultant Jack Schafer, of Jack Schafer Associates in San Francisco, cited U.S. Commerce Department statistics that showed department stores losing market share, as a percentage of nonautomobile sales, for seven straight years through 2001, the last full year for which figures were available. Department stores peaked with a 12.8 percent share in 1993 and 1994 but have since declined steadily, to 10.2 percent in 2001.

Most analysts don’t see any major bankruptcies on the horizon, though they do see plenty of store closings, with retailers weeding out unprofitable units. Simultaneously, retailing increasingly becomes a game of scale, making consolidation likely.
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"I think we are still at a zero sum game," said Kathy Yohalem, principal of Tait Advisory Services LLC. "Retail just came off a year that was not that good. Secondary and tertiary stores in key cities are having a real tough go of it. What are their reasons for being? You are going to see more consolidation. They have got to be looking at their doors and seeing how profitable each is."

According to Arnold Aronson, managing director of retail strategies, Kurt Salmon Associates: "Consumers are not being stimulated to buy enough to keep all the retail square footage and infrastructure costs manageable. Logically speaking, mergers and acquisitions is a rational vehicle for matching waning consumer demand with existing retail capacity, and the stock prices are fairly depressed, which might make things easier to buy. However, questions about who acquires who, who gets what job — those human things — sometimes create bottlenecks."

Aronson suggested a major merger is unlikely in the immediate future. "There will be more consolidation and major consolidations in the next two years. Most of the incremental profitability that department stores have comes from one-time, nonrecurring mergers, either acquiring outside companies or merging internal divisions. That path will probably be continued."

The most recent consolidations include Kaufmann’s into Filene’s at May Co., and Macy’s and Rich’s at Federated.

Dillard’s, which has been pruning locations, would be a good buy for Federated, considering there isn’t too much geographic overlap. Dillard’s strength is in Texas, Arkansas, Mississippi, Louisiana and Alabama, whereas Federated’s strengths are on the East and West Coasts.

However, at Dillard’s, a family-run business, pride runs high, lessening the possibility of a sale of the business. The same is true at Belk’s and Nordstrom. All three chains have recently been struggling with sagging sales and stock prices. "While their stocks are really low, they don’t want to capitulate," said one market observer. "And why would anyone want to take on their problems?"

Ross Nussbaum, retail real estate analyst for Salomon Smith Barney, gave another good reason for further consolidation. "Having four or five department stores at a mall that essentially sell the same thing, over time, they just will not be able to compete against each other and it’s survival of the fittest."
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Department stores also are competing against specialty stores in the mall, which offer the same merchandise in a "friendly, more energetic environment," he said.

And they’re fighting a war of attrition. The sector will contract through the closure of stores, said Nussbaum, which leaves spaces in the malls to be filled by stronger competitors or category killers such as Best Buy or Barnes & Noble.

Retail consultant Walter Loeb doubted whether the largest two department store operators would get together soon. "There are too many overlapping properties," he said. "This is not something that either company would like to see happen and while Federated is certainly stronger at this point, I don’t expect it to happen at this point. I do see a future consolidation among department stores in the U.S., but smaller ones, not the big ones."

Midwest Research analyst Jeff Stinson said consolidation in the sector "makes a lot of sense. The challenge is finding the right valuations." Stock valuations of the department stores, he said, were not high enough to compel owners to sell.

But another type of consolidation is seen — more of the vertical one. Said Salomon Smith Barney broadline analyst Deborah Weinswig: "It makes sense for either Federated or May to acquire a strong brand with retail outlets," similar to the Sears’ purchase of Lands’ End last year. Penney’s, which bought the Bisou Bisou brand last year, has already said it’s close to announcing another brand acquisition.

Candace Corlett, a principal of WSL Strategic Retail, said consolidations are "terrific in terms of consolidating buying and efficiencies," and saving chains that could have disappeared. However, they also strip chains of personality, she said. "It comes back to painting everything with the same brush," she noted. "This is an era when shoppers have many retailers to choose from, including the Internet, and at no time has it ever been more important to have a personality that shines through."
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