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Stewart Locked Out of Sears: Negotiations With Lampert to Modify Contract Key to Whether Products Expand Beyond Kmart

Posted on: Sunday, 1 January 2006, 15:00 CST

By Susan Chandler, Chicago Tribune, Chicago Tribune

Jan. 1--It was supposed to be one of the biggest synergies to come out of the merger of Kmart and Sears: the opportunity to pump Martha Stewart's stylish line of housewares--currently sold exclusively at Kmart--through Sears' network of almost 1,000 stores.

But nine months after Kmart's acquisition of Sears closed, Martha is nowhere to be seen in Sears' U.S. stores, and there's no sign she will be making an appearance anytime soon.

Stewart and Edward Lampert, the chairman of Sears Holdings Corp., are negotiating over a modified contract that would allow the Martha Stewart Everyday line to be sold in Sears, sources close to both sides say.

Lampert, the hard-nosed hedge fund operator who brought Kmart out of bankruptcy, wants to pay Stewart less than she is entitled to under the current agreement, according to a source familiar with the talks. Stewart is pushing for an extension of her current contract, which carries large financial guarantees.

A spokesman for Sears Holdings declined to comment on the state of negotiations as did a spokeswoman for Martha Stewart Living Omnimedia.

As the talks drag on, investors and others are getting impatient to see how Sears Holdings deploys the various brands at its disposal.

"People expected to see more of the cross-pollination going both ways between the brands," said Neil Stern, a retail consultant with Chicago's McMillan/Doolittle. "We're seeing DieHard and Kenmore in Kmart, and you'd expect to see Kmart brands in Sears as well, with no brand being more prominent than Martha."

The absence of Martha Stewart products is particularly awkward for Sears Essentials, the hybrid stores that were once touted as the future of the new company.

Sears Essentials was supposed to combine the best of Sears and Kmart in former Kmart sites that are outside mall settings and therefore easier for shoppers to negotiate. But so far, the stores have turned out to be Sears merchandise combined with a pharmacy and a convenience food department.

Kmart brands are no-shows, including Martha Stewart Everyday housewares, Route 66 denim, Joe Boxer casual wear and Jaclyn Smith women's apparel.

That's particularly confusing for Kmart shoppers who used to frequent the 50 locations that have been converted to Sears Essentials. They now find Martex towels in the housewares department Martha Stewart goods formerly occupied, and they likely were disappointed to discover that Martha Stewart's popular Christmas shop was missing this year.

"We don't have any Kmart brands at Sears at this point," confirmed Chris Brathwaite, a Sears Holdings spokesman. "We're currently looking at the best way to leverage the brands of both companies, and that work continues right now."

The early results on Sears Essentials have not been encouraging, and Sears is pulling back on the concept, Lampert said in his third-quarter letter to Sears shareholders. Instead, the company is focusing on a strategy called "Sears Inside of Kmart," which involves putting Kenmore appliances and Craftsman tools in more of Kmart's nearly 1,500 stores. Kenmore and Craftsman already are available in 88 Kmart stores.

Lampert didn't mention the logical counterpoint of that strategy, which would be "Kmart Inside Sears."

Stewart's home goods would be the centerpiece of such a strategy, and her notoriety is higher ever since she emerged triumphantly from prison in March after serving five months for lying to investigators about a stock sale.

NBC made a movie about her life starring Cybill Shepherd that aired in May. Stewart starred in her own reality show version of "The Apprentice" this fall. A Martha Stewart line of upscale furniture is doing well for Bernhardt Furniture Co., and more than 3,000 people in suburban Raleigh, N.C., have expressed interest in a Stewart-designed house being marketed by KB Home.

Sears' home departments could use a lift.

Before he departed in October, Luis Padilla, Sears' head merchant, was trying to give them one by bringing new merchandise inspired by Sears' Great Indoors home remodeling and decorating chain to Sears department stores.

The new home department would have featured bedding, pillows, lighting and home decor items such as vases, frames and candles created by the same vendors that supply the Great Indoors. There also would be a culinary department with small electric appliances, cookware, place mats and napkins.

The items would have been priced a little above Sears' current offerings but would have been less expensive than those found at the Great Indoors. The home department in the Sears store in Vernon Hills was being remodeled as a prototype for the new approach.

But the departure of key merchants after the Kmart/Sears merger closed in March has left the strategy in limbo.

"There is so much turmoil going on," said one former Sears executive who asked not to be named. "There is nobody who is leading the initiative, and much of that has fallen by the wayside. There will be a minimal amount of new merchandise."

Brathwaite declined to comment, saying the company doesn't comment on its business strategies going forward.

Back in the late 1980s, when Stewart first signed on with Kmart, many retail experts thought her image was too upscale for the discount chain. Sears, J.C. Penney or Kohl's, stores that were a cut above, would have been a better match, they said.

Yet Stewart proved adept at translating her understated style and color palette into budget-priced items for Kmart shoppers, who found the Martha Stewart Everyday department front and center in many Kmart stores. The line has expanded over the years to include outdoor furniture, dishes, glassware, holiday decorations, cookware and even baby gifts. In earlier times, Stewart also appeared in Kmart's TV spots.

But the relationship suffered after Kmart was forced to seek bankruptcy protection in 2002.

Stewart was concerned about being tied exclusively to a chain that was rapidly shrinking through store closings, while Kmart was unhappy with the guaranteed royalty amounts it had to pay Stewart even as its sales contracted. Kmart sued Martha Stewart Living Omnimedia in February 2004 over contract language that provided royalty guarantees for individual product lines.

Just two months later, things appeared to be patched up.

Kmart and Stewart announced they had reached a revised agreement that "better aligns the two companies' mutual business interests."

As part of the deal, Stewart gave up the product line royalty guarantees. Kmart dropped its lawsuit and agreed to extend its contract with Stewart through the end of 2009. The deal is heavily weighted in her favor, industry sources say, because, at the time, Kmart needed Stewart more than she needed Kmart.

Under the agreement, Kmart will pay Stewart an aggregate minimum royalty of $54 million for 2005; $59 million for 2006 and $65 million for 2007. The payment then drops to $20 million for 2008 and $15 million for 2009 or 50 percent of the earned royalty in either of those years. Kmart also is allowed to defer up to $10 million in royalties to the last two years of the contract.

Stewart's products have never sold in enough quantity to hit the guaranteed royalty payment, says a knowledgeable source, so in theory, a certain amount of her products could be sold in Sears without costing the combined company anything extra.

Lampert's pitch to Stewart is that she can make more money long-term by having her products sold in more outlets, but Sears Holdings won't expand the distribution unless she accepts Lampert's modifications. Stewart has an additional reason to work something out with Sears Holdings. Her products are sold exclusively in Canada through Sears' stores in that country.

But Stewart and Lampert are both known to be tough negotiators who don't give much ground. It's entirely possible the two sides will reach an impasse and no new agreement will be reached, sources said.

Stewart might be better off if that happens, according to retail consultant George Whalin.

"She is going to make more money in the long-term when she is away from Kmart and Sears. Tomorrow she could sell that product to Federated, J.C. Penney, Linens 'n Things and Bed Bath and Beyond. She would be foolish not to, and nobody has called her a fool."

schandler@tribune.com

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Source: Chicago Tribune

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