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CINCINNATI, NEW YORK AND ST. LOUIS -- Consolidation fever is spreading, and its latest victim is the turbulent department stores sector.

In a move whose timing took some by surprise--but shocked no one--Federated Department Stores acquired longtime rival May Co. to create a new $30 billion company with greater breadth and leverage to compete in today's mass-driven retail economy.

The deal, whose $17 billion in total valuation includes $11 billion in cash and stock and $6 billion in May Co. debt, was the initiative--some might even say the obsession--of Federated president, chairman and ceo Terry Lundgren. And the reasons are many.

As a new company, Federated will now have a nationwide presence with stores in 49 states (excluding Alaska) and the territories of Guam, Puerto Rico and the District of Columbia. What's more, the Federated and May properties create a chain with 950 stores in 64 of the 65 top markets in the country (excluding Jacksonville, Fla.) prior to anticipated closings where there is market overlap (see page 28).

While this new Federated is still dwarfed by retail chains including Sears/Kmart and Wal-Mart, which each have approximately 3,500 units, it effectively has doubled in size, making it one of the nation's 10th largest retailers in terms of sales.

"We have taken the first step toward combining two of the best department store companies in America, creating a new retail company with a truly national scope and presence," said Lundgren.

As most observers have noted, the reinvention of Federated involves modernizing an outdated retail model. Like the new Sears/Kmart hybrid, the combination of Federated and May by sheer merit of size will allow for dramatically improved economies of scale--critical to today's direct sourcing-focused retail model that is a world apart from the origins of the vendor-driven department store channel, which relied on countless middlemen and was virtually devoid of a centralized buying format.

The past five years undoubtedly have been challenging for America's department stores. Industry analysts have been challenging the concept of America's department stores. Analysts have questioned whether or not there is still a place for them. Due to the maturity of most department store chains, expansion has become difficult both in terms of opening new units and driving stock increases--and other channels have taken share.

"In today's retail environment, competition comes from every conceivable retail format," said John Dunham, president, ceo and acting chairman of May. "To succeed, we have to operate more efficiently and compete more effectively against players at all levels of the retail demographic."

While consumers keep buying more of the categories traditionally associated with department stores--including home and apparel--at mass, there is also increased head-to-head competition coming from mid-tier competitors. JCPenney and Kohl's both had strong annual results in 2004. Kohl's stores have popped up in high-traffic strip malls across the country and the company now engages in national advertising--a brand-building strategy Lundgren hopes to apply to Macy's.

Under the new deal, Macy's will become the dominant retail nameplate, though no consolidations or store name changes are planned prior to 2006. Federated already successfully converted its Stern's chain to Macy's and Bloomingdale's stores three years ago, a strategy that Lundgren plans to apply to the bulk of May's department stores.

"We have had considerable success in re-branding our own regional stores as Macy's, so obviously we anticipate continuing this strategy to some extent with our new stores," added Lundgren.

The other nameplate under Federated that has been undergoing recent growth is Bloomingdale's, which opened its second Manhattan store in SoHo last year and has been expanding its Bloomingdale's Home chain. However, Macy's brands and price points are more approachable for the majority of consumers.

"Strategically it makes all the sense in the world: it gives Macy's the opportunity to truly become a national factor in what I consider the mid-tier department store channel," said Stuart Kessler, partner and president of retail/consumer products consultants Clear Thinking Group, LLC. Kessler has served as president of Food Locker Outlet Division and coo of Champs Sports in his retail career.

While May has some well-established names under its umbrella, including its premium Lord & Taylor brand, there are questions if even the strongest nameplates are worth keeping versus building up one nationally known brand. Most regional chains, such as Gimble's, have disappeared as national chains have expanded.

Popular regionals such as Marshall Fields may end up converted by a few units or reduced to flagships where customer loyalty is strongest. May had acquired Marshall Field's in July 2004 for $3.8 billion from Target Inc., which had combined the Dayton and Hudson divisions under the Marshall Field's name back in 1990.

"May has been struggling to absorb Marshall Field's," said Kessler. "It's a great brand, particularly in the Midwest, and very strong in apparel, but it remains to be seen what happens, because it was never fully integrated."

Whether or not May's 210-unit David's Bridal specialty chain, which May purchased in 2000, will remain a part of the business also remains to be seen; likewise, its After Hours Formalwear and Pricilla of Boston divisions. There are few formalwear specialty competitors, which led to The Men's Wearhouse opening its first Bride & Joy formal stores in Q4 quarter 2005. Lundgren acknowledged it to be one of May's stronger businesses, but as with the rest of May's brands, its future is indeterminate.

"I don't see Hecht's or Foley's surviving or even quite frankly the Lord & Taylors; it remains to be seen what happens with Filene's and Marshall Field's. I think it will become a strategic real estate decision," added Kessler.

According to a JP Morgan report, there are "about 94 overlapping stores--about 10% of the store base. Using even conservative assumptions, we can see store sales fetching $1 billion to $2 billion," which could be invested in debt or operations. Citigroup Smith Barney concurred that there is potential for real estate disposition, and has modeled 30 store closures though its analysis indicates that there are "only 16 malls where Federated and May have three or more locations. We believe that these 16 locations at a minimum, will be divested."

Companywide, Lundgren anticipates that the deal will accelerate comps growth due to a host of synergies including private label expansion of lines from both retailers and the ability to offer customer loyalty programs and bridal and gift registries nationally.

"Currently, private brands account for approximately 17.4% of Federated's sales and the company's long-term goal is for private label penetration north of 20%," noted Deborah Weinswig, Citigroup Smith Barney analyst. Private label stands at about 13% of May's current mix, according to Federated.

The company expects to realize an anticipated $450 million in cost synergies by 2007, based on "the consolidation of central functions, division integrations and the adoption of best practices across the combined company."

There are also the requisite merger-related costs, which will total approximately $1 billon amortized over a three-year time frame beginning in 2005.

Reaction from Wall St. has been generally optimistic based on already-positive stock trends. According to a March 1, 2005, Citigroup Smith Barney report, May's shares appreciated 24% since the resignation of former May chairman Gene Kahn, which expedited the merger. Analysts are also bullish on the potential sale of Federated/May's credit card business, which may occur as soon as Q2 according to a Merrill Lynch report.

If Lundgren's plan takes hold, reports of the death of the department store have been greatly exaggerated. Apparently, it is not the channel but the business model that is ready for retirement.