Question

The Merger of Kmart & Sears

As the engineer of the $11.5 billion planned purchase of Sears, Roebuck & Co. by Kmart Holding Corp.,

Edward Lampert is stepping out of the shadows of Wall Street to make a high‐profile bet that the

fortunes of not just one but two retailing giants can be turned around. He keeps his strategy close to the

vest, and his fortune is uncertain, though it was estimated at $2 billion ahead of the acquisition news.

Mr. Lampert’s hedge‐fund firm, ESL Investments inc., which owns 43 million shares of Kmart, and 31

million shares of Sears, recorded paper gains of nearly $600 million in the wake of the takeover news.

He knew that was a spectacular one‐day return given that market interest rates were 6%.

Short‐sellers have been wary of Kmart ever since it emerged from bankruptcy in early May 2003. After

Mr. Lampert bought up some $1 billion of Kmart’s distressed debt in 2002, he kicked off an aggressive

restructuring campaign that included closing stores and selling off real estate to competitors. Investors

were so enamored of his results that they helped to double Kmart’s stock price in the past 18 months

from $58 per share to the current value of $120 per share.

The SEC filing also included a new employment contract for Sears chief executive Alan Lacy, who is

slated to be CEO and vice chairman of the combined company, Sears Holdings Corp. Under the

employment pact, which runs for 5 years after the merger’s effective date, Lacy is entitled to a minimum

base salary of $1.5 million a year and a target annual bonus of 150% of the base salary.

An acquirer’s brand typically is the one that goes forward, but companies have been known to flout the

rule based on whose brand is stronger in the marketplace. When Nations Bank bought Bank of America,

the merged company took the Bank of America name and re‐branded all the Nations Bank branches.

Asked to comment on the Kmart / Sears deal, an analyst said “I don’t think the combined company will

be a much more significant challenge to Wal‐Mart. Consumers think that when they want price they go

to Wal‐Mart. When they want value – a little fashion – they go to Target.” After hearing this, Mr.

Lampert began to wonder if he had made the correct decision. “I wonder,” he thought to himself,

“would I have been better off buying Target instead?” Although it was too late, he began to look at the

financials for Target to see if he would have been better off buying Target.

Income Statements – January 31, 2004
	Wal-Mart	Kmart	Sears	Target
Sales	258,681,000	23,253,000	41,124,000	48,163,000
Cost of Sales	198,747,000	17,846,000	26,231,000	31,790,000
Gross_Profit	59,934,000	5,407,000	14,893,000	16,373,000
Administrative_Expenses	44,909,000	4,998,000	9,111,000	11,534,000
EBIT	15,025,000	409,000	5,782,000	4,839,000
Interest	996,000	162,000	1,025,000	559,000
Taxes (@ 35 %)	4,910,150	86,450	1,664,950	1,498,000
Net Income	9,118,850	160,550	3,092,050	2,782,000
Balance Sheets as at January 31, 2004
	Wal-Mart	Kmart	Sears	Target
Cash_and_cash_equivalents	5,199,000	2,088,000	9,057,000	816,000
Receivables	1,254,000	301,000	3,397,000	5,776,000
Inventory	26,612,000	3,238,000	5,335,000	5,373,000
Total_Current_Assets	33,065,000	5,627,000	17,789,000	11,965,000
Property,_Plant_&_Equip.	58,530,000	153,000	6,788,000	16,969,000
Other_Assets	6,079,000	120,000	908,000	1,495,000
Total_Assets	97,674,000	5,900,000	25,485,000	30,429,000
Accounts_Payable	31,051,000	1,772,000	7,582,000	7,448,000
Other_current_Liabilities	6,367,000	1,050,000	5,194,000	866,000
Total_current_liabilities	37,418,000	2,822,000	12,776,000	8,314,000
Long_term_Debt	20,099,000	2,297,000	4,718,000	10,217,000
Common_stock	431,000	208,000	823,000	96,000
Retained_Earnings	39,726,000	573,000	7,168,000	11,802,000
Total_Liabilities_&_Equity	97,674,000	5,900,000	25,485,000	30,429,000

Questions you should consider in reviewing the case:

1. How could we find the greatest underperforming area for any of the firms?

Answer 1