Kmart, Sears plan mega-merger but no debt issue

By Paul Deckelman

New York, Nov. 17 - Kmart Holding Corp. and Sears Roebuck & Co., two of America's largest retailers, announced plans Wednesday to unite in one of the biggest corporate mergers ever. But unlike many such combinations recently, the mostly stock deal is not expected to result in a big new debt issue to fund the transaction.

Instead, senior executives of the two companies said on a conference call for analysts and portfolio managers after release of the merger news that Kmart and Sears "expect that the combined cash of the two companies will be sufficient to finance the merger," in the words of Kmart chairman - and big Sears stockholder - Edward Lampert, who added that "clearly, the financing capability of the combined company is significant as well."

Under the terms of the nearly $11 billion deal - which caught many participants in the financial markets totally by surprise, even though the companies had obviously been working on details of the planned marriage for weeks - Kmart and Sears will combine to form a new company, to be called Sears Holding Corp. Kmart shareholders will receive one share of new Sears Holdings stock for each Kmart share. Sears, Roebuck shareholders can choose to receive either $50 in cash or half a share of Sears Holdings stock. Lampert estimated that the final deal would turn out to be 55% stock and 45% cash.

The executives explained the rationale for the merger: that while Sears was a great retailing company, it simply was not in enough locations to be able to effectively compete with retailing juggernaut Wal-Mart Stores or such other, larger retailers as Home Depot - which competes with Sears' long-established Craftsman line of power tools, lawn mowers and other "hard" goods - Target Corp. and the like.

Not only was it a question of getting into new markets and more locations within existing markets - Wal-Mart, Home Depot and Target all are, for the most part, successful stand-alone "big box" retailers, usually located in their own very large stores adjacent to regional shopping malls where there is frequently, though not always, a Sears.

While not dismissing the importance of the malls - Sears chairman and chief executive officer Alan Lacy said that his company was in "870 of the best malls in the country" - the venerable Chicago-based retailer clearly wants to move into big-box retailing as well, particularly as it rolls out its new, larger "Sears Grand" superstore concept.

Enter Kmart, which has some 1,500 stores, even after its bankruptcy earlier in the decade, when it shed several hundred of its least productive locations. Many of its stores are off-mall stand-alone locations of the type that Sears craves.

Kmart, meantime, is looking to differentiate itself from larger discount rivals Wal-Mart and Target, and looks to beef up its already formidable line of brand names that include Martha Stewart and Joe Boxer with some of Sears' product lines - Craftsman, Kenmore, Jaclyn Smith and Kathy Ireland clothes and the like.

"We're going to trade up," declared Lacy. "We sell better things than Wal-Mart and Target."

"Sears in a Kmart box"

The plan as outlined, calls for the combined companies to continue to operate stores under both nameplates; however, a number of Kmart off-mall locations are likely to be converted to Sears stores, while Sears brands will start showing up in the Kmarts that remain Kmarts.

Lampert, in answer to an analyst's question, said he has "no preconceived notion" of which stores might become which. While acknowledging that theoretically, even some Sears stores could conceivably be switched over to Kmart, he said that "the opportunities for Kmart stores to become Sears are far greater."

"Sears in a Kmart box ought to do very well," said Kmart president and chief executive officer Alwyn Lewis. "We're going to try all different kinds of things. We'll have a flexible culture."

Started from Kmart store sales

The genesis of the merger was the deal that Sears made earlier in the year to buy several dozen locations from Kmart, which was in the process of monetizing unwanted properties by selling them to other retailers. Sears found it easy and relatively inexpensive to switch those stores over and began to sound Kmart out about doing more.

Lampert - a billionaire hedge fund operator before he took over Kmart several years ago and brought it out of bankruptcy - began working with Sears chief Lacy on the possibility of a combination. Fortuitously, Lampert's company, ESL, not only controlled Kmart - it was also the largest single shareholder in Sears as well.

Besides the advantages to Sears in gaining additional locations and to Kmart in gaining a better class of merchandise that will distinguish it from rival discounters, the executives of the two companies also foresaw synergies totaling about $500 million annually - found money that it expects to mostly plow back into the business.

No change of control for bonds

In answer to an analysts' question about whether the transaction would trigger any change-of-control situations in the debt of either company, Lewis insisted that it would not.

An analyst asked whether the ruling troika of Lampert, Lewis and Sears chairman and Lacy was comfortable with the company's proposed leverage levels, and whether they anticipated any share buybacks, or would any free cash flows be reinvested in the company.

"Strong" balance sheet

Lampert said that it was his belief that at least through the transition period as the two companies carry out their mergers and try to mesh their operations and corporate cultures, it is important that the combined entity "has a very, very strong balance sheet.

"Kmart went through a period where it had a weak balance sheet and we built up undeniable strength. Once Sears sold its credit-card business, its balance sheet was very significantly strengthened, and I think on a combined basis, if you look at the combined cash flow, we feel obviously very comfortable coming out of the box."

As to whether there might be stock buybacks ahead, he said: "I do think that at different stages of opportunity, you have different capital structures - and it's something that we will critically review on an ongoing basis."

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