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Kmart chief's moves may mean merger with Sears

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An investor tied to both Sears, Roebuck and Co. and rival Kmart Holding Corp. may move to significantly increase his stake in Sears and possibly propose to merge the two struggling companies, a key source close to the negotiations said late Tuesday.

An announcement is expected from the retailers as early as Wednesday, the source said.

Widely-known investor Edward Lampert, the chairman of Kmart, who took the company out of bankruptcy and whose investment company, ESL Investments, now owns a 52.6 percent stake, holds roughly 14.6 percent of Sears' stock through his Greenwich-based investment company.

Executives at both companies couldn't be reached late Tuesday.

But a deal would surprise few. Speculation that Lampert was pushing to make a move on Sears had been growing for months as his investment stake grew and Sears' retailing picture continued to sour.

The Hoffman Estates-based company, founded in 1886, is an American icon. It has $9.5 billion in market value, $31 billion in 2003 merchandise sales and $2.7 billion in cash on hand.

Sears' heyday was the 1960s when it ruled shopping malls, selling everything from kitchen stoves to kids' apparel and power tools to a rapidly growing middle class. The Sears credit card gave many young families their first access to revolving credit. Its Allstate insurance unit, later spun off, insured their homes and autos.

Sears stock has generated a total return of 59 percent over the last 10 years, far less than Wal-Mart's 362 percent total return.

Sears' stock hit a 10-year low of about $24 a share in the fall of 2002 after new problems with its credit card portfolio arose. The stock rebounded 23 percent to about $46 earlier this month after a real estate trust bought a stake in the company. The stock closed Tuesday at $45.20, down $1.10, or about 2.4%.

On Nov. 5, when Vornado Realty Trust revealed that it had quietly amassed control of 4.3 percent of the company's stock, it highlighted a fundamental shift in the way the market values retailers. The move put heavy pressure on Sears Chairman Alan Lacy to justify the company's weak profits and outmoded merchandizing strategies.

According to interviews with retail and real estate experts, opportunistic investors like Vornado Chairman Steven Roth and Lampert might be able to make more money by selling many of Sears' poorly performing but well-located stores to more successful retailers. And Sears itself might be more viable as a smaller chain with a tighter focus.

Lacy's inability to turn Sears around after four years of trying has run smack into a powerful real estate trend that has created heavy demand for just the kinds of properties that Sears has in abundance.

That's why Sears' stock soared 23 percent after the Vornado announcement Nov. 5 and another 5 percent last Thursday when Robert Ulrich, chairman of Target Corp., told analysts his company is open to the idea of buying prime mall-based properties.

Over the last few years, new mall construction has slowed to a crawl, about 1 percent growth annually versus 5 percent a year in the 1980s. Growing retailers like Target and Nordstrom Inc. can't find enough space for new stores, especially in urban and suburban markets where property is at a premium.

Older, ailing retailers like Sears have lots of stores in attractive locations that might be used more profitably by some of these potent competitors. Pressure started building on Lacy in 2002 when Lampert, the 42-year-old chairman of Connecticut hedge fund ESL Investments, began collecting a 15 percent stake in the retailer. Lampert had proven already how hot the market is for recycled retail real estate by selling more than $1 billion worth of assets at Kmart.

Lampert took Kmart out of bankruptcy in early 2003 and began spinning out properties. Earlier this year, he sold 50 stores to Sears for $576 million and 18 others to Home Depot for $271 million.

Sears has more than 141 million square feet of retail space, according to its annual report. It owns almost 60 percent of its 871 full-line stores, which are primarily located in large shopping centers. Those stores alone total 128 million square feet. Sears also has 345 specialty stores, including 245 hardware stores and 18 focused on home decorating and remodeling.

But the real estate Sears owns is uniquely valuable in several respects. First, analysts say, many of its stores are in prime locations that have become congested over the years. The sites are often next to desirable corners and have special features like big parking lots with easy access from the street. They are also big enough to split.

Lampert has been highly active in all aspects of the Kmart investment, from dealmaking to fixing the stores.

"In a control position," Lampert told BusinessWeek magazine recently, "our ability to create value goes up exponentially."

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