The Merger of Kmart & Sears As the engineer of the $11.5 billion planned purchas

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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 highprofile 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 hedgefund 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 oneday return given that market interest rates were 6%. Shortsellers 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 rebranded 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 WalMart. Consumers think that when they want price they go to WalMart. 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.   

Questions you should consider in reviewing the case:

1. Which firm is most liquid?

2. What is the return to shareholders?

3. What is the NPV of buying Sears?

4. What is the PV of Mr. Lacy’s pay package?

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

Income Statements – January 31, 2004 (All numbers in thousands)

Balance Sheets as at January 31, 2004 (All numbers in thousands)

Walmart Kmart Sears Target Sales 258681000 23253000 41124000 48163000 Costof Sales 198747000 17846000 26231000 31790000 Gross Profit 59934000 5407000 14893000 16373000 Administrative Expenses 44909000 4998000 9111000 11534000 EBIT 15025000 409000 5782000 4839000 Interest 996000 162000 1025000 559000 Taxes (@35%) 4910150 86450 1664950 1498000 Net Income 9118850 160550 3092050 2782000

Explanation / Answer

1. Firm with most liquidity

      Walmart Kmart sears

Liquidity ratio 6453000/37418000 2389000/2822000 12454000/12776000

=0.17 =0.85 = 0.97

   sears has most liquidity

Note:- liquidity ratio = (current assets - inventory) / short term liability

2. return to shareholders = net income / (retained earning + commonstockholder )

Walmart Kmart    sears  

return to shareholder 9118850/40157000 160550/781000 3092050/7991000

   =22.71% =20.56% =38.69%

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