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Federated-May Merger: With a Deal Imminent Market Weighs Fallout

Merger talks between Federated and May continued over the weekend, with both boards in New York. The firms are said to be close to a deal.

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Photo By WWD Staff

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Federated’s Macy’s division is likely to take over May’s nameplates

Federated’s Macy’s division is likely to take over May’s nameplates.

Photo By Meredith Derby, Kyle Samperton and Ed Mackinnon

NEW YORK — The Federated-May nuptials appear to be set.

The boards of Federated Department Stores and May Department Stores hashed out remaining differences over the weekend, and barring any last-minute hitches, an announcement of the merger is expected today, according to sources.

The merger will reshape the American department store landscape, creating a $30 billion giant with about 1,000 stores. It’s also likely to accelerate the rush to greater scale among Federated’s competitors and suppliers, spurring further mergers further mergers or deals between stores and vendors. The ripples are likely to be felt for years to come, from the store floor to factories in the Far East.

Large job losses are likely, certainly within May, and Federated’s management will face the challenge of turning around a May operation that has stagnated for years.

For weeks, the price of a deal has been the sticking point between the two companies, with Wall Street analysts and investment bankers indicating late last week that Federated should not pay much above the May stock price, which closed at $35.35 on the New York Stock Exchange on Friday. Although, details of the deal could not be learned, if Federated paid between $35 and $36 a share the deal would be worth $10 billion to $11 billion, excluding debt.

Wall Street analysts argued that Federated wouldn’t pay much of a premium, considering May is in a weak bargaining position. It’s already highly leveraged, having bought Marshall Field’s for $3.2 billion last year from Target Corp.; profits and comparable-store sales over the last several years have been weak, and there’s literally a lack of leadership following the resignation of Gene Kahn last month as May’s chairman and chief executive.

Other issues negotiated this weekend could have included the composition of a combined board, the fate of May’s St. Louis headquarters, severances and contracts of key executives, and store dispositions. There is a 20 to 25 percent overlap in locations between Federated and May, and retail analysts predict that as many as 100 to 150 May units might be sold off.

“If both boards are in town, they’ve got to have some sort of understanding already,” said retail analyst and consultant Walter Loeb. “May has not shown the ability lately to grow, or put the numbers together, but the leadership of Federated will help May. It’s also difficult for them in this environment to find new management.” 

Despite its woes, May still operates efficiently, with a 16 percent SG&A, whereas Federated is about 27 percent. EBITDA rates of the two retailers are close, in the 14 percent range.

Investment bankers said that at a $36 price and a 100 percent stock transaction, there would be a 16 percent dilution, excluding the impact of synergies. A 50 percent stock and 50 percent cash transaction would have a 6.4 percent dilution, but with more impact on the balance sheet.

However, by combining both companies, plenty of synergies would be attained through the elimination of May’s St. Louis corporate headquarters, as well as regional headquarters for May’s divisions, and increased buying power. One former Federated executive said Field’s has been operated poorly for some time and that’s where Federated would have plenty of room for improvement with sales and margins.

“The problem is the higher the premium that Federated pays, the higher the dilution is going to be for Federated shareholders, and more debt will be on the balance sheet,” said Gilbert Harrison, chairman of Financo Inc. “The price depends on the synergies Federated expects to realize in this transaction, but certainly the merger would give the combined company a national presence and ability to stamp the Macy’s and Bloomingdale’s nameplates on stores nationwide.

“Of the 458 department stores that Federated operates and the 444 stores operated by May, May has 129 in the Midwest, whereas Federated has 30 stores there. That would be a major benefit for Federated. Another major benefit would be in the central states, where May has 21 stores and Federated has one.”

Harrison speculated that Federated would let Lord & Taylor continue to stand alone, and convert the rest of May’s stores, including Marshall Field’s, to Macy’s and Bloomingdale’s. “If you believe the vision that Terry Lundgren [Federated’s chairman, president and ceo] has for Federated, as much as he believes that Marshall Field’s is a good name, he has to be convinced that the Macy’s imprint is best for the combined companies, especially given the strength in national advertising and the nearly 100 percent geographic presence in all states that comes out of it.”

Some earlier reports placed Federated’s offer to be close to $40 a share, but Larry Leeds, chairman of Buckingham Capital Management, said, “I’m somewhat surprised that Federated would be interested in May at the rumored price, if you look at where May’s shares sold before Kahn left the company, and if you look at May’s earnings. If Federated were to step away, the price of May’s shares would decline precipitously.”

According to the former Federated executive, Field’s, being upscale compared with other May units, would be easier to blend into Macy’s. May’s other divisions, such as Hecht’s and Foley’s, generally attract a more moderate customer than Federated’s stores and therefore there would require plenty of work to upgrade to Federated’s level. Federated then runs the risk of losing customers of those stores, and would have to try to convert them to shopping higher-priced assortments.

If a merger is agreed, the Bush administration is not expected to raise many antitrust concerns, especially given the heft of Wal-Mart, Target and even J.C. Penney. “It’s a slight issue,” said the source. Federated’s primary interests lies in May’s Field’s chain in the Midwest, Foley’s in Texas, and Hecht’s in the Washington D.C area.

J.C. Penney is seen as a potential buyer of some May locations, though Penney’s has been expanding in off-the-mall locations, which May doesn’t have, and May stores tend to have about 50,000 square feet more than Penney’s, which average around 120,000 to 130,000 square feet. May’s Lord & Taylor division, which operates smaller units, could be appealing to Penney’s, as well as to Nordstrom. Only last week, Penney’s senior executives said in a conference about its year-end results that the retailer had $2.5 billion in cash on hand and was prepared to act on any attractive real estate opportunities that presented themselves.

There has been speculation circulating that Nordstrom would be interested in the Lord & Taylor flagship on Fifth Avenue and 39th Street, though the location is not as fashionable or as trafficked as Fifth Avenue in the Fifties, or 34th Street.

“Lord & Taylor is a division that doesn’t make sense in the mix, so that whole business could just go away,” said one vendor. “Their buyers are totally skittish.”

Saks Inc., Dillard’s and Belk could be interested in individual store locations. Sell-offs could also include May’s credit operation, and May’s 700-unit bridal specialty retail group. Federated already has indicated it will consider selling its credit-card operation and the disposals of the two businesses would raise significant cash for Federated to pay for the May acquisition.

As far as cost-cutting opportunities, May’s St. Louis corporate office, which has financial, credit, personnel, merchandising and other functions, would likely be the first to go, though enormous local opposition is inevitable.

“It will be gone within six to eight months,” speculated a source from outside May. The company employs a total of about 110,000 people, including about 6,000 at the St. Louis headquarters. Over 1,000 of the headquarters employees work at May Department Store International and May Merchandising. MDSI handles private label development largely through imports, and is said to have a team of at least 600 people. The president of MDSI, Carol Williams, reports to Jay Levitt, ceo of May Merchandising Corp. The May Merchandising domestic team has roughly 500 staffers, according to a source, and they mainly work on the domestic scene.

After eliminating the headquarters, it’s likely that Federated would start to convert May’s nameplates to mostly Macy’s stores. Each division also has its own headquarters, with buying teams, which would also likely be eliminated over time. Federated also has regional headquarters, which all will operate under the Macy’s name by next month. Federated’s Burdines operation in Miami could take on May’s Foley’s division, based in Houston, for example. Macy’s East, based here, could absorb Hecht’s, based in Washington D.C., and Macy’s West in San Francisco could absorb Robinsons-May in Los Angeles.

“There are going to be a lot of people looking for jobs in a very restricted job market,” said Hank Sinkel, executive vice president of sales and marketing at sweater producer Hampshire Designers.

Federated and May have in the past two decades conducted serious, but unsuccessful, merger negotiations on at least two occasions. May came close to buying Federated in 1988, but instead Campeau, the Canadian developer, swept up Federated and drove it to bankruptcy. Federated emerged from bankruptcy in 1992 and bought Macy’s two years later.

Around 1999-2000, serious discussions were held again to the point where a leadership scenario was devised. James Zimmerman, former Federated chairman and chief executive, would have run the combined entity for over a year, and upon his retirement, Kahn would have stepped up. Lundgren, who had not yet established his reputation, would have been on the sidelines in that situation. However, Lundgren is now widely regarded as a retail star, and will run the combined Federated-May business.

But just as the two retailers’ boards spent the weekend nailing down a deal, their respective vendors and real estate partners probably spent the weekend charting the fallout of a bigger Federated. With greater size will come greater bargaining power for Federated, including which sites in malls to keep and terms for markdown money and promotional funding. Suddenly what had been two competing department store chains will now become one, halving overnight the distribution channels available to many companies.

“It’s uncertain [to comment on changes] without knowing what the landscape would be post-merger,” said William Lauder, president and ceo of the Estée Lauder Cos. “The two organizations have a lot of overlap in at least four significant regions, and would likely shed a number of units if this merger were to happen. Federated and May go head to head in the Northeast, in the West Pennsylvania-Ohio Valley area, in the D.C. metro area and in Southern California, among other areas. In many areas, particularly in Southern California and from Philadelphia to D.C., they match themselves up mall by mall — I’d be hard-pressed to name a mall there where they both aren’t major players. A deal like this would significantly change the operating model. It’s a daunting task, but that doesn’t mean that the management of both companies couldn’t make it work.”

“Fundamentally, I believe that more choice is better for consumers, both in terms of brands and retail opportunities,” said Edgar Huber, president of the Luxury Products Division of L’Oréal USA. “Having just one or two retailers would represent a severe limitation of choice for consumers. Another risk I see is that roughly 100 stores between the two are in direct competition, and would either have to be sold — to another retailer or even to someone not operating in the luxury arena currently — or closed if the merger happens. But if it happens, we are prepared to deal with it. We will simply be faced with the task of increasing sales in a smaller number of doors. It does seem that this type of megamerger is becoming more and more prevalent in the U.S. — whether it’s with retailers, banks or cell phone providers.”

“Both May Co. and Federated are very strong partners for Liz Claiborne Cosmetics and we would expect that the partnership would continue should there be a merger,” said Art Spiro, president of Liz Claiborne Cosmetics. “In the event of a merger, we would not foresee any change in our business relationship.”

The impact on the market of a merger depends on the strategy taken by the combined company, said Hal Upbin, chairman and ceo of Kellwood Co. One possibility is a good-better-best approach, with three sets of stores focusing on different price points. “Under that scenario, it’s conceivable that we could wind up being a more important player,” said Upbin. Kellwood, which has an emphasis on lower-priced brands such as Sag Harbor, also produces the better-priced Calvin Klein sportswear line and other higher end lines such as David Meister.

A good-better-best positioning could break out with stores such as Strawbridge’s in the good category, Macy’s in the better and Bloomingdale’s and Marshall Field’s in the best. However, vendors like Upbin suggested retailers gain clout over vendors in markdown money and negotiating prices, after these kinds of mergers occur. “At the end of the day, we certainly don’t become any stronger.”

“These kinds of situations always tend to have the effect of consolidating the buying decisions in a smaller base,” said Michael Delaney, ceo of Ralsey, a division of sourcing giant Li & Fung. “It’s just one less customer,” he said. “I don’t think it’s good for the overall market.”

“The markdown conversation is going to be very, very difficult going forward,” said one vendor executive.

Large vendors such as Jones Apparel Group have worked hard to limit their exposure to traditional department stores and have even become retailers themselves, as exemplified by Jones’ December acquisition of Barneys New York, and Liz Claiborne’s acquisition of Mexx, the European fashion business that has just begun to open U.S. stores. Still, department stores under the May and Federated umbrellas remain very important to the large vendors. In its 2004 annual report, Jones noted that about 14 percent of its sales last year were to May; Federated accounted for roughly 12 percent of the pie. That adds up to approximately $1.2 billion of Jones’ $4.65 billion top line.

“I think this merger would be a disaster. It is going to empower Federated and give it even more leverage over vendors than they currently have, which is already tremendous,” Allan Ellinger, partner at Marketing Management Group, said. “What you’ll see are the same brands in all the stores, which mean less options for the consumer, as well as one less retail organization to sell to for the vendor. I’m afraid that the consumer will drown in a sea of sameness.”

Kurt Barnard of Barnard’s Retail Consulting Group also believes the merger wouldn’t be good for vendors, with fewer buyers buying more. But it would give Federated the downscale segment of the market that it doesn’t have, and expand its presence in the upscale market via Field’s, Barnard said. “The deal would also give Federated a stranglehold in the U.S. in the bridal business and the tuxedo-rental business,” assuming Federated decides to hang on to May’s bridal group.

Wendy Liebmann, partner at WSL Strategic Retail, doesn’t expect consumers to be necessarily impacted by the merger of the two chains. “There’s already so much sameness in the midlevel department store sector. There’s not much choice now, and for shoppers it is really more about convenience and location,” she said. 

For Liebmann, it would mean consolidation on many fronts, from store closures to less business for vendors, all of which translate to a trickle-down effect on its employees and professional advisers.

“While it’s an opportunity for Federated to take doors and put on the Macy’s banner, it could also represent the possibility of Federated moving [more] into the top tier” of department stores with Field’s. “I don’t think the merger is solely about real estate and clout, but an opportunity in select markets to do prestige department stores,” Liebmann said.

Mall owners have been through the consolidation wave before, and at least one is looking forward to the possibility of good retail space becoming available. Rehabilitating vacant department stores is something they had to face when Lord & Taylor, Mervyn’s and Montgomery Ward closed stores. L&T has closed 25 of the 32 units it said would be darkened.

“We see the consolidation that is probably going to happen as very positive for us because there is a lot we can do with those spaces [that are given back to us],” said Robert Michaels, president and chief operating officer of General Growth Properties Inc., in a company conference call earlier this month when the firm discussed fourth-quarter results.

— With contributions from Evan Clark, Vicki M. Young and Amy S. Choi

 

 

See related article, "May's Whirlwind Year"