Discounter Kmart Holding Corp. yesterday said it will buy department store rival Sears, Roebuck and Co., one of the most venerable names in U.S. retailing, in an $11 billion deal that would create the nation's third-largest retail chain.
The two chains would operate under their current names, but executives said the companies would swap major product lines, giving Kmart shoppers access to Sears's higher-end merchandise and giving Sears's shoppers the convenience of Kmart's locations outside of the mall.
The combined company would have $55 billion in annual revenue, about 3,500 stores and a broad product lineup including Martha Stewart Everyday and Jaclyn Smith from Kmart and Craftsman and Kenmore from Sears. In total sales, it would trail only Wal-Mart Stores Inc. and Home Depot Inc.
By combining Kmart and Sears, executives hope to challenge bigger rivals such as Wal-Mart and Target Corp., which have battered the two chains with rapid growth, lower prices and technology-driven efficiencies. But analysts say the combined stores, whose sales growth has been lackluster, must dramatically change to succeed.
Both Kmart and Sears have become casualties of a hyper-competitive retail landscape, dotted not just by discounters but niche stores, from home improvement giant Home Depot to electronics titan Best Buy, that have swallowed entire categories of goods and whittled away consumer loyalty to a single retailer.
Sears and Kmart are pioneers of American retailing. Hoffman Estates, Ill.-based Sears, Roebuck and Co., founded by Richard W. Sears and Alvah C. Roebuck, opened in 1893 as the country's first national catalogue operation. Soon it launched stores, selling a wide range of consumer products.
Troy, Mich.-based Kmart is a direct descendant of the S.S. Kresge Co., one of the first of what came to be known as the five-and-dime stores. When the first Kmart store opened in 1962, it was considered an innovative retail phenomenon with its big-box stores, with vast rows of moderately priced merchandise on a single floor.
Both chains' fortunes have fallen since then. Kmart slipped into bankruptcy protection in 2002, recovering only after selling off hundreds of underperforming stores. The chain emerged from Chapter 11 in 2003.
The new company would be called Sears Holding Corp. -- a nod, retail industry analysts said, to the 111-year-old department store's greater prestige.
No immediate store closings are expected, but several hundred Kmart stores would convert into Sears stores as early as March, when executives predict the merger will be complete. Shareholders for both retailers must still approve the deal.
At the center of the merger is a single executive: Kmart Chairman Edward S. Lampert, the largest shareholder in both Kmart and Sears through his ESL Investments Inc., a hedge fund that holds more than half of Kmart's stock and nearly 15 percent of Sears shares.
Lampert's firm purchased a controlling share of Kmart while it was in bankruptcy protection, and analysts credit him with salvaging the chain's finances by selling off unprofitable stores -- in some cases, to Sears -- and reducing Kmart's reliance on clearance sales. The company has about $2.6 billion in cash on hand.
In a conference call with investors yesterday, Lambert said that for the chain to succeed, it must try to match the size of its biggest competitors. "I think it's pretty obvious that scale is very important to compete effectively," he said.
Lambert said that by putting Sears products, such as Lands' End clothes, inside Kmart, they will reach more consumers. Of Sears's 2,300 stores, only 870 are full department stores. Kmart has 1,484 stores, and most are free-standing big-box stores, which are increasingly popular with consumers. He also said that by stocking some of Sears's unique brands, Kmart can differentiate itself from competitors.
Industry analysts expressed approval of the proposed merger, arguing the combined company can use its heightened buying power to negotiate lower product prices from manufacturers. "There is a lot of financial strength here," said David E. Griffith, an analyst at Tradition Asiel Securities Inc., a brokerage house in New York.
But analysts cautioned that a combined Kmart and Sears would not succeed unless both chains dramatically improve their merchandise and store appearance at the same pace as their competitors -- retailers such as J.C. Penney Co. and Lowe's Cos.
Linda Bolton Weiser, a retail analyst at Oppenheimer & Co., said the combined companies' success hinges on how well the chains run their stores, "which neither Kmart nor Sears has been adept at doing."
At Goldman Sachs & Co., analyst George Strachan wrote in a research report that he did not believe that "combining two failed retailers will make a viable challenger to Wal-Mart."
"These are two weak consumer franchises that are coming together for economic reasons and real estate reasons," said Adam Hanft, chief executive of Hanft Unlimited, a branding and marketing firm. "The fundamental problems both chains have, image and consumer perception, aren't going to go away."
Sears, which over the years had evolved into a massive conglomerate that included insurance, real estate and financial services businesses, saw its retail operation wither as the growth of suburban regional malls slowed. And Kmart, rather than invest heavily in expanding its discount general merchandise stores in the 1980s, bought a slew of smaller, specialty retailers in the pursuit of diversification.
Kmart lost $3.2 billion in its fiscal 2003, but reported its fourth consecutive profitable quarter yesterday. Sears reported a 2003 profit of $3.4 billion, but a loss of $867 million for the first nine months of this year.
Both chains have reported sluggish same-store sales, an important measure of retail success that reflects sales growth within stores open for more than a year.
Neither chain is regarded as a leader in its retail territory -- department stores for Sears and discounters for Kmart -- but industry analysts say the two chains can fill each other's gaps. Kmart, for example, has proved successful in apparel and home goods, driven by the success of its exclusive Martha Stewart Everyday line, said Anne Brouwer, a partner at McMillan Doolittle LLP, a New York retail consulting firm.
Both of those areas are relatively weak at Sears, Brouwer said. At the same time, Sears has a strong reputation for appliances and tools, a weakness for Kmart.
Company executives said they expect the combined companies to generate $500 million in "synergies," or cost savings, within three years, through cross-selling brands, converting some Kmarts to Sears stores and selling off underperforming stores.
For Sears, which has 870 mall-based stores, the merger would create an opportunity to migrate into locations now held by Kmart. Mall attendance is flagging across the country, analysts say, but suburban strip malls are thriving -- driven by the growth of companies like Wal-Mart, Target and Home Depot.
There are 30 Sears specialty and department stores and 10 Kmarts in the Washington region.
Executives said they plan to initially convert several hundred Kmart stores into Sears formats, but they did not rule out converting more.
Under the terms of the merger, Lambert, chairman of Kmart, would be the chairman of Sears Holdings. Alan J. Lacy, chairman and chief executive of Sears, would be vice chairman and chief executive officer of the new entity.
As approved by both firms' boards of directors, Kmart shareholders would receive one share of Sears Holding common stock, valued at $50.61 by the company as of Tuesday, for each share of Kmart stock. Sears shareholders would have a choice of either $50 in cash per share or 0.5 share of Sears Holding.
Yesterday, Sears stock jumped $7.79, up 17 percent, to $52.99. Kmart shares rose $7.78, or 8 percent, to $109.
Washington Post staff writer Neil Irwin and researcher Richard Drezen contributed to this report.