Retailers Shop -- or They'll Drop?

The Federated-May deal is the latest among department-store chains forced by the tough market to merge. Dillard's and Saks may be next

By Pallavi Gogoi

The big holiday shopping season is long over, but now it's the department store themselves that are doing the looking -- and buying.

On Feb. 28, Federated Department Stores (FD ) announced it will acquire May Department Stores (MAY ) for $11 billion. The deal, expected to close in the third quarter, boosts the recent wave of consolidation that started with Kmart's (KMRT ) November purchase of Sears (S ), which is likely to close next month. The latest announcement could also spur a deal between the Dillard's chain (DDS ) and the department-store division of Saks Inc. (SKS ) -- they're among the last big chains left that have yet to make a move in this round of consolidation.


  The Federated-May merger announcement comes as no huge surprise since these department-store chains have long suffered slow growth and faced intense price competition from discounters Wal-Mart (WMT ) and Target (TGT ) as well as warehouse clubs like Costco (COST ). At the same time, these chains have failed to attract affluent customers the way upscale retailers Neiman Marcus (NMGA ) and Nordstrom (JWM ) have.

"The American economy is like an hourglass -- 40% don't have much disposable income, and the other half has a lot to spend," says Milton Pedraza, CEO of the Luxury Institute, a business consulting firm. "You just can't sit in the middle like these department stores."

The combination of Federated and May creates a giant chain of 1,000 department stores, which includes such well-known names as Macy's, Bloomingdale's, Lord & Taylor, and Filene's. May CEO John Dunham acknowledged the tough retail environment's role in the deal. "To succeed, we have to operate more efficiently and compete more effectively against players at all levels of the retail demographic," he said in a release.


  The merger will likely give the larger entity the clout to cut better deals with suppliers and vendors and save on advertising. "A customer of that magnitude would be able to squeeze manufacturers on terms," Prudential analyst Lizabeth Dunn wrote in a research note on Feb. 28. Also, the new behemoth will likely close some stores, resulting in cost savings, and raise money by selling off some real estate.

As much sense as the Federated-May deal may make, there's no guarantee of success. Witness the merger of Saks with various department-store chains, including Profitt's, during the mid-1990s. Saks Inc. now wants to separate the upscale Saks Fifth Avenue division -- which includes the flagship Manhattan store, other luxury Saks stores around the country, and Saks Off Fifth -- and the department-store unit. "The track record is so abysmally poor that it's hard for me to believe that these [deals] will be any different," says Pam Danziger, president of Unity Marketing and author of Why People Buy Things They Don't Need.

However, the sheer size and power of the joined Federated and May companies will put pressure on both Dillard's and Saks to improve their performances or unite to compete. Many industry watchers are betting on the latter. "That combination would be highly complementary given that both have a strong store base in the South, says Burt P. Flickinger III, managing director at retail consultant Strategic Resource Group.


  According to Denise Kramp, a partner at Korn/Ferry International in Philadelphia, "To compete against a 1,000-store gorilla, they have to get more scale." Neither Saks nor Dillard's returned calls seeking comment. Nervous investors sent shares of Dillard's down 4.7%, to close at $23.30 on Feb. 28, and Saks shares fell 1.87%, to $15.19.

Meanwhile, Neiman Marcus is said to be shopping for a buyer, albeit for completely different reasons. The high-end luxury retailer has been among the best performers in its segment, and Chairman Richard A. Smith, 81, whose family controls the company, has made no secret of his plans to sell his stock. Rumors are that Smith will sell to a private investment firm able to commit the financial resources Neiman needs to serve its upscale clientele.

While Smith might hope to ensure such commitments from a buyer, he certainly doesn't want to wait too long. "It's better to trade a year too early than too late," says Strategic Resources' Flickinger. Neiman didn't return a call asking for comment.

With retailers' flurry of activity, it looks like the most interesting buys right now may not be in the stores -- but the stores themselves.

Gogoi is a reporter for BusinessWeek Online in New York

Edited by Patricia O'Connell

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