Sears Holdings (Nasdaq:SHLD) delivered another brutal quarter May 23. CEO and majority owner Edward Lampert has his hands full trying to revive a truly broken department store. Rumor has Neiman Marcus and Saks (NYSE:SKS) looking at merging, which got me to thinking about Sears and JCPenney (NYSE:JCP) doing the same thing. While it sounds crazy to think two down-on-their-luck department stores would have any chance of survival as a merged entity, stranger things have happened.
Read on and I'll argue why a merger of Sears and JCPenney makes sense.
Neiman Marcus/Saks Merger
There are two big reason KKR (NYSE:KKR) would be interested in Saks: The first is Saks is a public company. By acquiring the New York-based department store it could avoid the IPO process by merging Neiman Marcus into Saks. Secondly, the combination of the two would give the combined businesses a tremendous amount of clout with vendors. Although the two firms explored a merger once before, this appears like a real possibility for KKR, who've owned Neiman Marcus for eight years. It's time to move on.
Benefits of a Sears/JCPenney Merger
Sears has 788 full-line stores averaging 136,000 square feet per store. It also has 1,196 Kmart stores at 96,000 square feet and another 25 at 168,000. There's other stuff but these are what matter the most. JCPenney has 1,104 stores across the U.S. averaging 101,000 square feet per store. It's questionable how many of the Kmart locations would work in a merger although they are similar size to JCPenney stores is helpful. Sears Holdings owns 15% and 63% of its Kmart and Sears locations respectively. JCPenney owns 39% of its stores. A combined entity would own 36% of its real estate making it very attractive to REIT investors.
The merged retailers would have 375.5 million square feet of floor space, 45% greater than Macy's (NYSE:M), Kohl's (NYSE:KSS) and Nordstrom (NYSE:JWN) combined. Assuming it cut its square footage by two-thirds and went with a standardized 100,000 square foot store, it would require 1,239 locations, about 60% fewer than it currently has. Given the value of its real estate, the task at hand would be to identify the best 1,239 locations across the country that gives it geographic coverage in all 50 states along with above-average performance. Where two stores are under consideration and one is leased and one owned, it should go with the leased location opting to sell the other.
Eliminate the overlap in distribution. JC Penney has 24 facilities, most of which are distribution centers or warehouses. Sears has a total of 38, some of which are for Kmart, others are for Sears and a handful are for both. That's a total of 62 for both companies. You could easily cut that by half and still be able to service the reduced network of stores. There's plenty of excess. Heck, Sears even owns an 86,000 square foot office building in Troy, Michigan. I'm not sure why it's there but a sale/leaseback would make sense in this situation.
Although Sears doesn't break out its sales per square foot for its stores, a rough calculation suggests it was around $197 for its 788 full-line stores in 2012. Kmart's was about half that. JCPenney's 2012 gross sales per square foot dropped considerably to $116 and that includes its e-commerce revenue. Nordstrom, by comparison, had sales per square foot in 2012 of $470. Combining the two businesses with each leading with their strengths could make the merged entity a better retailer.
JCPenney's brought in some new brands over the past year and despite the controversy of Ron Johnson's ouster, they've been very well received. Its shops-within-a-shop concept isn't a bad thing; abandoning its promotional sales and coupons was and shareholders paid the price. Sears on the other hand seems unable to do anything right except market its Craftsman, Die Hard and Kenmore brands along with building an online presence. In the first quarter of 2013 its online sales increased 20% year-over-year. Online sales would be very important to a considerably smaller version of Sears and JCPenney.
- Lastly, and probably most important, is increased buying power and reduced overhead. The merged entity despite all its warts would be purchasing a significant amount of product on an annual basis. At an estimated $150 per square foot and a gross margin of 30%, it would purchase something to the tune of $13 billion in merchandise each year. While that's less the two businesses on their own, it's still a huge amount of product. Add to this you have one public company instead of two, etc., and you have the potential for actually making money.
Ed Lampert has tried everything under the sun to boost Sears' fortunes and nothing seems to work. Mike Ullman is only in the CEO position at JCPenney long enough to right the ship financially. If Lampert and Ullman were to come together for the common good of both businesses, it might be their best and only chance for long-term survival.
At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.