Federated Snaps Up Fingerhut in a Bid to Build Online Presence

The move underscores increasing pressure faced by traditional retailers.
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Federated Department Stores

(FD)

is betting big that more and more consumers want to shop in less conventional ways.

In a push beyond its traditional department-store roots, the Cincinnati-based company agreed to acquire direct marketer

Fingerhut

(FHT)

for $1.4 billion in cash, or $25 a share, plus the assumption of about $300 million in debt.

The move underscores the pressure faced by traditional retailers that don't want to be left behind in a pile of bricks and mortar as customers discover the ease of shopping on the Internet. Although slow to the table, traditional retailers are finally beginning to develop online strategies.

Dayton Hudson

(DH)

recently bought

Rivertown Trading

, a direct mail company with Internet experience. And

Saks

(SKS)

, which has a thriving catalog business under the

Folio

name, is expected to log onto the Internet in coming months.

Selling directly to consumers through catalogs and the Internet allows department stores to add another leg of growth to a mature industry. It also gives them a way to combat a host of Net start-ups, many of which offer apparel similar to merchandise found in department stores but at cheaper prices.

"If you look at the Internet, it's hard to put your finger on how much growth there is and in which areas," says Jeff Stinson, an analyst with

Midwest Research

, who rates Federated a market perform. (His firm hasn't performed any underwriting for the company.) "Federated is putting itself in a position if that growth is there, they can reap the return. It's a big strategic move."

Still, skepticism about the synergy between the two companies abounds. Critics note that Fingerhut's customers, with household incomes typically below $30,000, are unlikely to shop at any Federated properties, which cater to more upscale consumers. And the deal will reduce Federated's earnings for at least the current fiscal year by as much as 10%, say analysts.

These worries pushed Federated shares down 6.6% at Thursday's close, off 2 13/16 to 39 11/16, while Fingerhut shares closed up 30%, rising 5 9/16 to 24 3/8.

"The fact that it's dilutive isn't great," says Jennifer Blachford, an analyst with

Suffolk Capital Management

, which owned 372,000 Federated shares as of Sept. 30, according to datatracker

Technimetrics

. "Initially, I didn't feel it made any sense, because Fingerhut has such a different customer."

Federated already sells $150 million worth of goods a year through its

Bloomingdale's by Mail

catalog as well as an undisclosed amount through the

Macy's by Mail

catalog and

Macys.Com

, an e-commerce division established last year. Still, these businesses represent a fraction of the company's $15.8 billion in annual sales. Fingerhut has about $2 billion in annual sales.

Even though Federated operates some 400 department stores under the

Bloomingdale's

,

Bon Marche

,

Burdines

,

Goldsmith's

,

Lazarus

,

Macy's

,

Rich's

and

Stern's

names, there are still pockets of the country that remain beyond its reach.

"We don't have stores in 14 states," says a Federated spokesman. "Direct selling lets us make our customer base truly national."

But growing this avenue requires costly infrastructure -- everything from merchandise fulfillment centers where orders are processed to credit facilities. In buying Minneapolis-based Fingerhut, Federated adds these facilities in one swoop.

"It was more efficient, less costly and much faster" to buy than to build, says the Federated spokesman.

For Fingerhut, the deal implements its strategy to transform itself from a company selling to low-income consumers through its catalogs to a marketing firm with a stronghold on the Internet. Investors applauded Fingerhut's move last fall to divest itself of its 83% stake in

Metris

(MTRS)

, a consumer credit card company.

And Fingerhut's new president, William Lansing, who hails from

General Electric

(GE) - Get Report

and

Prodigy

(PRGY:Nasdaq), has gone on a buying spree since joining the company last May. He's folded Internet and catalog companies into the mix while building a fulfillment business that handles everything from developing a Web site to filling online and catalog orders. It's largely for these capabilities and for Fingerhut's data-mining techniques that Federated is paying $25 a share for the company. This price is a long way from $5 a share, where Fingerhut traded at just two years ago.

Fingerhut also will gain access to the funds necessary to continue its acquisition strategy.

"Federated pushes beyond its roots into nonstore retailing," says Lansing. "And Fingerhut gets the resources to continue our roll-up strategy." Lansing adds that Federated now has brands that reach from the retailing cradle to the grave. He says about 30% of Fingerhut customers stop buying from the company once they improve their financial standing. "It'll be nice to offer them more upscale brands," he says.