A Federated Foul Up?

Its acquisition of Fingerhut is running into serious problems

When Federated Department Stores Inc. announced its $1.7 billion acquisition of catalog retailer Fingerhut Corp. 17 months ago, it extolled the access the deal would give it to the Internet. Fingerhut's vast order-fulfillment capability and marketing prowess were just what Federated needed to ramp up its Bloomingdale's and Macy's e-commerce sites. Federated also saw a chance to provide fulfillment services to other online ventures. What Federated didn't mention, however, was that most of Fingerhut's business had nothing to do with the Net. The low-end catalog specialist was as far from Federated's business as a bargain-basement outfit is from a Fifth Avenue boutique.

That difference can't be ignored now. On July 6, Federated's stock plunged 15%, to around 29, after the retailer disclosed that it was "concerned" about rising delinquencies in Fingerhut's credit business. Federated's management has compounded the problem by giving no indication of how much the rise in bad debt could affect earnings. Prudential Securities' analyst L. Wayne Hood estimates that the delinquencies could reduce this year's net income by as much as $27 million, to $836 million, compared with $794 million last year.

Federated execs declined to comment. But the slipup has some critics questioning whether the Fingerhut deal will pay off anytime soon. Some argue that Federated's management, caught up in the Internet euphoria, didn't do its homework. Says Brian James, a retail analyst at Loomis, Sayles & Co., a Boston investment firm that holds 900,000 Federated shares. "They bought this thing for strategic reasons and did not understand from an operational standpoint what they were getting into."

The reason: Nearly 75% of the outfit's estimated $2 billion in sales comes from its Fingerhut catalog, which targets low-income shoppers with workaday items such as appliances and furniture. To drive sales, it offers easy credit; high prices and stiff interest rates offset the higher default risks. "It can be very treacherous," says Mark Alpert, a credit analyst at Deutsche Banc Alex. Brown.

CREDIT TROUBLE. That it can. A person close to the situation says Fingerhut's problems stem from a decision to change from offering installment credit to a riskier revolving credit program involving a proprietary credit card. Fingerhut also aggressively boosted its credit-card customer rolls early last year to increase sales. The efforts, launched before Federated bought Fingerhut in March, brought on more bad debtors than expected. Analyst Hood estimates delinquencies have risen from 18% of Fingerhut's $2 billion in credit receivables in 1999 to as much as 22.5% this year. Management changes after the Federated deal may have worsened things. Fingerhut's CEO left, as did a key credit officer.

Federated may also be running into trouble developing the fulfillment business for e-tailers. This year, Merrill Lynch & Co. estimates that business will generate just $80 million of Federated's $18.8 billion in total sales, up from $17.7 billion a year ago. Fingerhut's online retailing will add $100 million. Although Federated's largest customer, Wal-Mart Stores Inc., has signed a three-year fulfillment contract, it is expected to develop its own fulfillment services by the contract's end. Another of its largest clients, eToys Inc., recently left. A Federated spokeswoman said the parting was mutual and that Fingerhut will improve profitability by focusing on online retailers whose business is less seasonal. Federated may yet find a way to make the deal work. For now, however, it got more than it bargained for.

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