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.

Income Statements - January 31, 2004

(All numbers in thousands)

Walmart

Kmart

Sears

Target

Sales

258,681,000

23,253,000

41,124,000

48,163,000

Cost of Sales

198,747,000

17,846,000

26,231,000

31,790,000

Gross Profit

59,934,000

5,407,000

14,893,000

16,373,000

Administrative Expenses

44,909,000

4,998,000

9,111,000

11,534,000

EBIT

15,025,000

409,000

5,782,000

4,839,000

Interest

996,000

162,000

1,025,000

559,000

Taxes (@35%)

4,910,150

86,450

1,664,950

1,498,000

Net Income

9,118,850

160,550

3,092,050

2,782,000

Balance Sheets as at January 31, 2004

(All numbers in thousands)

Walmart

Kmart

Sears

Target

Cash and Cash equivalents

5,199,000

2,088,000

9,057,000

816,000

Receivables

1,254,000

301,000

3,397,000

5,776,000

Inventory

26,612,000

3,238,000

5,335,000

5,373,000

Total Current Assets

33,065,000

5,627,000

17,789,000

11,965,000

Property, Plant, and Equip.

58,530,000

153,000

6,788,000

16,969,000

Other Assets

6,079,000

120,000

908,000

1,495,000

Total Assets

97,674,000

5,900,000

25,485,000

30,429,000

Account Payables

31,051,000

1,772,000

7,582,000

7,448,000

Other current Liabilities

6,367,000

1,050,000

5,194,000

866,000

Total current liabilities

37,418,000

2,822,000

12,776,000

8,314,000

Long term debt

20,099,000

2,297,000

4,718,000

10,217,000

Common Stock

431,000

208,000

823,000

96,000

Retained Earnings

39,726,000

573,000

7,168,000

11,802,000

Total Liabilities and Equity

97,674,000

5,900,000

25,485,000

30,429,000

3. What is the NPV of buying Sears? 5. How could we find the greatest underperforming area for any of the firms?