Federated

(FD)

got its

Fingerhut

slammed in the door.

Earlier this month, the parent of

Macy's

and

Bloomingdale's

said credit delinquencies at Fingerhut, the direct marketing company it bought last year to help bolster its Internet operations, were rising.

Thursday, it unveiled the gory details: Credit problems likely will hack off $150 million from second-quarter earnings before interest and taxes, resulting in an earnings haircut of 43 cents a share. In the third quarter, earnings before interest and taxes could be hit by an additional $200 million to $250 million.

That announcement provided fuel to the skeptics who remain unconvinced that Federated had any business buying Fingerhut -- whose customers are less well-off than the crew that troops through Bloomies -- in the first place. And even fans of the purchase admit that Thursday's announcement means someone was asleep at the wheel. Federated shares, already down about 50% from their 52-week highs, fell 3 3/8, or 13%, to close at 23 1/2.

Anatomy of a Debacle

Federated said several factors caused the credit debacle. Analysts said two -- inadequate provision for write-offs of late fees and slower economic growth -- were less significant. The biggies, they said, were Fingerhut's switch from installment credit to revolving credit (which allows customers to carry a balance and make only minimum monthly payments), and its end-of-the-year deferred-payment specials.

Federated Falls
Internet continues to elude Macy's owner

Source: BigCharts

One money manager who is long the stock and wants to remain anonymous said Federated didn't adequately keep tabs on the credit situation at Fingerhut. "This problem has just emerged over the last six weeks," responds Federated spokeswoman Carol Sanger. Delinquencies jumped from 16% in May to 18% in June and then to 21% in July, she said. "Whether we should have recognized the

need for supervision -- maybe we should have," she says. "But Fingerhut is expert at running its own business." What it wasn't so expert at, she says, was making the transition to offering revolving credit to its customers.

In its announcement Thursday, Federated said it would increase collections activity, lower credit lines and tighten policies, including deferred credit, and more aggressively verify addresses. It also will move responsibility for Fingerhut's credit operations to Federated's own credit group.

Shock Waves

While some analysts had predicted Federated would drop a bomb of this magnitude, the market reaction shows that others were shocked. "This is about twice as bad as my worst-case scenario," says the money manager. (One who got it right:

Credit Suisse First Boston's

Michael Exstein, who theorized a worst-case scenario of a 47 cent-a-share hit back on July 6.)

Most pooh-poohed the idea that broader economic conditions -- slower growth following the

Fed's

interest rate increases, along with higher gas prices -- were contributing much to Federated's trouble. "This is 95% Federated-only," insists the money manager. Others were less sanguine: One hedge fund manager wondered if other retailers also relying on lower-income customers (likely to be the first to be cash-strapped if the economy really does take a tumble) might face similar troubles.

A spokeswoman for

Target

(TGT) - Get Report

-- whose average customer earns about $50,000 a year, compared with Fingerhut's less than $30,000 -- said the company's credit business was humming along just fine and that there absolutely were no signs of any problems.

Finger-Pointing

Despite the problems revealed Thursday, it's too early to say that Federated shouldn't have bought Fingerhut, says Jeff Feiner, an analyst with

Lehman Brothers

, who maintained his buy rating on the stock. (His firm hasn't done any recent underwriting for Federated.) From the beginning, there have been plenty of skeptics arguing that Federated got swept away in Internet fever when it paid $1.4 billion in cash (plus the assumption of $300 million in debt) for what was essentially a catalog company targeting a completely new customer demographic. At the time, Federated said it was more efficient to buy order-fulfillment and credit facilities than to build them from scratch.

The market isn't persuaded; Federated's shares have fallen about 34% since the acquisition was announced in early February 1999. In part, it has been caught in the middle, between shareholders who would like to see it aggressively spend to develop its Internet properties, and those who prefer the more conservative capital spending of a department store retailer. (

TheStreet.com

examined Federated's Internet Catch-22 in a previous story.) The credit worries and continued questions about Fingerhut mean Federated's stock will continue to ail, say analysts.

Thursday's grim news shows that Federated can't just use Fingerhut for its Internet expertise and forget the rest; it's got to hunker down and pay close attention, even to the parts of the business it wasn't excited about in the first place.

"They've got a much wilder animal on their hands than the tame little kitten that they thought they bought," says the money manager.