Monday, November 22, 2004

Why Eddie Lampert should talk to Carly Fiorina

Most tech investors remember the HP & Compaq merger, which was announced in September 2001. The recently announced KMRT and S merger have some similarities and differences with the HP/Compaq merger. I believe HPQ and DELL rivalry is similar to KMRT/S and WMT rivalry. DELL (just like WMT) at the basic level is nothing more than a very efficient supply-chain which both HPQ and KMRT/S are striving to become. WMT and DELL both have tremendous buying power and technology prowess to adapt to changing needs of consumers. DELL even has the ability to price items real-time depending on various factors such as demand for certain features/models and supply of components. Like DELL gained market share after HP/Compaq deal was announced WMT has the ability to gain on any missteps by KMRT/S.

The HP/Compaq was a stock-swap deal worth about $25 Billion when announced versus the $11Billion price tag for this merger. The HPQ deal was suppose to change the PC industry, unfortunately if you bought into that spin you have been on the shorter end of the stick. Since the deal was announced HPQ has gained 10.9%, DELL has outperformed that performance 7 times over with gains of 79.6% and even the Nasdaq has gained 18.5%. The two companies had high degree of customer and product overlap. DELL gained market share while HPQ was too busy in integration (wholesale head count reduction), streamlining product lines, supply-chain management and customer transitions. Compaq jewels’ like high-end servers and storage systems which had a commanding market lead were left in the dirt of integration shuffle. HPQ wanted to take on IBM and other companies which were offering everything from servers, storage, services and even software.


HPQ
was inheriting a complex and diverse product lines in addition to the services effort at both firms were in their infancy which made achieving even mediocre success a stretch. Very similar to what the KMRT/S will be dealing with new apparel efforts at KMRT and general branding/positioning overall for combined entity. HPQ wanted to be everything to everyone and did not "reinvent" itself fast enough to compete with the super efficient, marketing machine powered by DELL. Like KMRT, HPQ worked on improving its free cash flow by selling off business, cutting back on inventory and capital expenditure. Eddie Lampert is using the KMRT real-estate to generate cash and looking to invest that cash in other companies such as S. That would be fine if you were an investor in Eddies' ESL Investment Fund which gets to buy growth and more free cash flow by this cash. But when you invest in KMRT or S stock you hope you are buying an operating company for its ability to grow profitably and generate cash not for asset liquidation.


HPQ
and KMRT both suffered from revenue growth as KMRT saw same store sales drop by 13% in the most recent quarter. KMRT executives say they are less interested in increasing sales than improving profits. Falling same-store sales reflect on where the consumers are spending their dollars and it is not at KMRT. This is an unsustainable trend in the long-run since WMT just like DELL can grow sales and do it profitably. Similar to Compaq and HP prior to their merger, both KMRT and S have conflicting customer demographics and target markets in everything from apparel, appliances, tools, grocery. KMRT plans to let the "market place decide" what merchandise customers want in which store, something that WMT already knows very well thanks to its state-of-the-art IT systems. Shuffling inventory in 2400+ stores is no easy task which could affect the generous free cash flow generation and profitability of the merged entity.

Some of the differences between the HP/Compaq deal and the KMRT/S deals are that KMRT stock carries a rich valuation which makes it a good currency to buy others with such as S. KMRT generates enough free cash flow that the merger disturbance might not matter immediately. Another difference in KMRT & S deal is that S shareholders were at least given a 11% premium where as the Compaq shareholders did not receive much of a premium at the time of announcement by HPQ. But S will have to pay a hefty $400M in "Break-up fee" if it decides to end this merger.

Is the KMRT/S merger another in a long list of "merger of losers" or can putting together two struggling retailers create enough synergies and cost savings to make them into a good retailer? Only time will tell. But history does have a tendency to repeat itself.

P.S: I do not profess to have much retail industry knowledge.
Eddie Lampert is the Chairman of Kmart Holdings, Carly Fiorina is the Chairman & CEO of HPQ.

6 Comments:

Blogger Roger Nusbaum said...

This is hardly damaging or controversial. Stock market history is littered with mergers that under delivered. Compaq bought Digital Equipment and that woefully let investors down. I believe it would be fair to question whether LDDS's purchase of MCI was the beggining of the end of Worldcom. There are more too. I did not know that KMRT and S target (exuse the choice of words) different customers? I am inclined to think that efficiencies can be gained for the retailing business, but I do not know if any effciency gained will be enough to allow them to compete with WMT.

6:09 AM  
Anonymous Anonymous said...

The only reason people are drinking the kool-aid on this is that Eddie Lampert is behind it and he was on the cover of businessweek that same week. If Sears had decided to merge with Kmart on its own without Lampert's involvement, would we be having the same conversation?

9:15 PM  
Anonymous Anonymous said...

First, Carly's continued refusal to convert its non-performing product lines into liquid assets makes her completely different from Eddie.

Second, her vision to be a giant technology service provider, to compete with IBM by being another IBM, is so far different a strategy as Eddie's competing with Walmart by not being another Walmart.

I do have my own reservations on the K-Mart/Sears merger. But Daniel Pike is probably right in describing Eddie as being "obsessed with protecting his downside."

6:59 AM  
Blogger Slash said...

Agree with you. I am just concerned the personalities might be similar and definitely the challenge of surviving in a tough market is/was similar in both situations.

5:40 PM  
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