Updated from 2:53 p.m. EST

Ed Lampert wants you to believe he never thought of

Kmart

(KMRT)

as a stock trade, vowing Wednesday to build a retail powerhouse through the acquisition of

Sears

(S) - Get Report

.

Through his ESL Investment hedge fund, Lampert now effectively controls the third-largest retailer in the country, an entity Wall Street currently values at $22 billion based on the combined value of their shares. That's well over twice the combined market cap of the two companies when Kmart emerged from bankruptcy in May 2003.

Previously, Lampert has unlocked value in Kmart stock by de-emphasizing its operations, which have steadily deteriorated as measured by same-store sales. Instead, he has made a number of strategic sales of Kmart real estate and lifted the stock by lending his investing acumen -- or at least the perception thereof -- to its valuation.

Now he owns Sears, which languished with its own considerable operational difficulties until the

Vornado

(VNO) - Get Report

real-estate investment trust caused on a run on the shares by disclosing a 4% stake in November. Investors rushed in to capitalize on a Lampert-like pruning of Sears' real estate portfolio, further enriching ESL, which controlled about 13% of the stock at the time.

On Wednesday, Lampert said the value of the companies has been in their operations all along.

"There's been a lot of speculation about real estate strategy and real estate values, and I think there is some truth to the notion that there are certain retailers whose real estate is worth more than its operating business," Lampert told analysts on a conference call.

"While that may have been true at Kmart at one time, we've worked very, very hard to improve the profitability of each of our stores and to make those stores worth a lot more as an operating business than as real estate," he said.

Given the paucity of capital expenditures at either retailer recently, Lampert's strategy would mark a radical transformation for the hedge fund guru.

While Lampert has a public position on the board of directors at Kmart, his involvement with Sears goes back much further. He began accumulating his stake of around 31 million shares at $35 in late 2002 and now owns a reported 13.5% piece of the retailer.

His storied foray into Kmart, however, has garnered most of the attention. ESL bought a controlling stake in Kmart's debt after the struggling big-boxer plunged into bankruptcy in early 2003, falling prey to financing issues and competitive pressures from market leaders, namely

Wal-Mart

(WMT) - Get Report

and

Target

(TGT) - Get Report

.

By May of that year, Lampert's turnaround team brought Kmart out of Chapter 11 and proceeded to quintuple the new company's stock price in little more than a year. Thanks to ruthless cost-cutting measures, Kmart is now posting consistently profitable quarters. Still, the crux of the argument for its generous valuation rests with the price tag of its previously undervalued real estate assets.

Any valuation of these assets floating around Wall Street is based on speculation at this point, but in August, Kmart sold 18 stores to

Home Depot

(HD) - Get Report

for $271 million, a virtual windfall compared to its cash flows from operations.

At the time, Kmart had another deal pending to sell 54 locations for $621 million. The buyer? Lampert's other retailing arm, Sears.

With the merger announced Wednesday, Lampert appears to be buying back some of the real estate he sold to another company he owned at a premium.

With the announced merger, a previously silent Ed Lampert is trumpeting the benefits of synergies between the two companies as a basis for the combination to compete with Wal-Mart and Target. He estimated that the merger could produce $500 million annually in profit improvements and $300 million in cost savings.

Meanwhile, Standard & Poor's said ratings on Sears and the new holding company formed in the parent, Sears Holdings Corp., will likely be in the "BB" category, an upper-level junk rating.

"Despite the company's much greater size, and synergies that are estimated by management of about $500 million per year after the third year, both companies lag their peers in terms of store productivity and profitability," S&P said in a statement.

Still, the market has reacted deliriously to the deal, sending Sears up $7.79, or 17%, to $52.99, and boosting Kmart $7.78, or 7.7%, to $109. Not all of the runup was enthusiasm for Lampert's retail strategy, however.

"One of the reasons Kmart's stock took off today is because they're pulling their tax loss carryforward asset up in time," said Allen Gillespie with GNI Capital.

Gillespie estimates that its merger with Sears will allow Kmart to use its $3 billion tax loss carryforward asset, a remnant from the bankruptcy process, to enjoy roughly $400 million to $500 million a year in savings, based on his back-of-the-envelope calculation.

Others reiterate a theory that has circulated for months, speculating that Lampert could be planning to turn the retailing combo into a publicly traded, quasi-mutual fund like Warren Buffett's

Berkshire Hathaway

.

"They're sitting on boatloads of cash," said Barry Ritholtz, chief market strategist with Maxim Group. "If they start going through all the Sears and Kmart Holdings stores and start eliminating those that are either underperforming or redundant, they're going to end up sitting on a couple of billion dollars in hard cash.

"The parallels with Berkshire are definitely there," Ritholtz added. "The question becomes, what do they do with this big and growing pile of cash? Do them become some sort of an interesting holding company? We know Lampert is capable of that sort of fascinating, outside-the-box thinking."

Acknowledging that Sears and Kmart are perceived as weak retailers compared to the competition, Lampert said a combination of the Sears business model with Kmart's locations could form a retail power strong enough to compete with the best retailers in the business. He said Sears stores are generally $80 per square foot more productive than Kmart stores.

"When you talk about roughly 100 million sqare feet of real estate that Kmart has, if we could ever achieve that level of productivity in the Kmart stores, either as Sears or as Kmart, you're talking about an $8 billion opportunity," said Lampert. "I don't think any retailer should aspire to have its real estate be worth more than its operating business."

As investors were recently bidding Kmart shares up $16.13, or 15.9%, to $117.35, while Sears was up $10.12, or 22.4%, to $55.32, it isn't clear that Wall Street is taking Lampert's words at face value.