Federated Department Stores Inc. (FD) is buying rival May Department Stores Co. (MAY) for $11 billion in cash and stock in a deal that would create a powerhouse better able to compete against discount giant Wal-Mart Stores Inc. (WMT) at one end of the retailing spectrum and specialty stores and other upscale merchants at the higher end.

The deal announced Monday would bring together the operator of Macy's (search) and Bloomingdale's (search) with May, a company known for its Marshall Field's (search) and Lord & Taylor chains, creating a company with 1,000 stores and $30 billion in annual sales.

Federated shares rose while May share slipped in early trading after the announcement of the widely anticipated deal.

"For consumers, this will create sharper price points and better fashions that will help bring back shoppers away from other full-price department stores and discounters," said Burt Flickinger III, managing director at Strategic Resources in New York.

But not everyone applauds the merger.

"Generally, it is bad for the industry, for the vendors and for the consumers," said Dan Hess, president and chief executive of Merchant Forecast, a New York-based independent research company. "Consumers will get fewer options because there will be one point of view." He noted that it will be harder for some of the smaller suppliers to break into the merged entity's new vendor structure.

He added,"Department stores will no longer be looked at for innovation and newness.. Innovation will come from specialty stores."

The boards of both companies approved the deal Sunday. It is still subject to approval by regulators and shareholders. Federated and May said they hope to close the deal in the third quarter.

Federated's merger with May will extend Federated's 34-state retail operation into a total of 49 states, along with Guam, Puerto Rico and the District of Columbia. Alaska is the only state in which they don't have a store.

"Today, we have taken the first step toward combining two of the best department store companies in America, creating a new retail company with truly national scope and presence," said Terry J. Lundgren, Federated's chairman, president and chief executive officer.

The merger is the latest consolidation to occur in the department store industry, particularly the mid-tier sector, which has been under pressure from all types of retailing and have steadily lost market share for more than a decade. Such moves reduce advertising and other costs while gaining bargaining power with suppliers. Just last November, Kmart Holding Corp. (KMRT) agreed to buy Sears, Roebuck & Co. (S) for $11.5 billion.

And there's more dealmaking in the offing.

Saks Inc. may sell or spin off its middle-market department store division in order to concentrate on its Saks Fifth Avenue unit, which targets the luxury market, one of the hottest areas in retailing. It is expected to make a decision in a few weeks. Richard A. Smith, the 81-year-old chairman of Neiman Marcus Group Inc. whose family controls the company, may be planning to sell, hoping to cash in on a white-hot luxury market.

"In today's retail environment, competition comes from every conceivable retail format," said John Dunham, May's president and acting chairman and chief executive. "To succeed, we have to operate more efficiently and compete more effectively against players at all levels of the retail demographic. There is no question that this is a bold and exciting move, and one I believe will have a positive impact on competitive retailing for American consumers in the longer term."

Federated said it expects the merger to begin contributing to the combined company's earnings per share in 2007. The company said it anticipates $450 million in cost savings by 2007 from combining purchasing and other central functions, integrating divisions and adopting best practices from both companies.

Federated said it also expects one-time merger costs of about $1 billion, to be spread out over three years starting in 2005.

Under the deal, each share of May will be converted into the right to receive $17.75 per share in cash and 0.3115 shares of Federated stock. Based on the 10-day trading average of Federated stock as of last Friday, that equates to $35.50 per share, or $11 billion.

May shares slipped 35 cents to $35 in early trading on the New York Stock Exchange (news - web sites). Its stock has been rising in recent weeks in anticipation of a deal, including a 4 percent jump on Friday. The stock has ranged in price from $23.04 to $36.48.

Federated shares rose $1.21 to $58 in early trading Monday, approaching the upper d fend of its 52-week range of $42.80 to $59.91.

Federated also said that it will assume May debt that totaled about $6 billion at the end of 2004.

The deal will double Federated's size, just as the retailer doubled its size in 1994 when it bought R.H. Macy & Co. out of Chapter 11 bankruptcy reorganization.

Federated said Monday that it plans no division consolidations or store name changes before 2006. But it ultimately will convert most of May's regional department stores to the Macy's nameplate, as it is now doing with its own regional chains including Lazarus, Rich's and Burdines.

Still uncertain is how the Federated-May deal will affect the companies' combined work force of 243,000.

Federated said it plans to merge May's St. Louis corporate headquarters functions into Federated's Cincinnati and New York corporate offices, beginning this year. But, Federated said it will make St. Louis the headquarters of one of the combined company's major operating divisions, to take advantage of the talent pool there.

Federated and St. Louis-based May have discussed a possible merger on and off for a couple of years, but speculation heated up when May's chief executive and chairman Gene Kahn abruptly left in January. That cleared the way for Federated's Lundgren to lead the combined entity.

Kahn resigned seven months after helping May acquire Target Corp.'s more than five dozen Marshall Field's stores and nine Mervyn locations for $3.24 billion — a price many analysts panned as too steep by hundreds of millions of dollars. Federated had dropped out of bidding for Marshall Field's by then, saying the price was too high.

May's performance has lagged behind competitors such as Federated and J.C. Penney Co. as it has failed to come up with a compelling merchandising vision under Kahn and has consequently resorted to aggressive price cutting to bring in customers.

May is given or its warehouse and distribution operations, while Federated has done a good job in upscaling Bloomingdale's.

Some analysts have suggested that uniting two of the nation's largest department store chains would create a more efficient operation better equipped to go up against discounters. Together, the companies also could wring savings out of their merged retail systems and buying clout, some analysts suggested.

Others questioned whether the two retailers would be a good fit, citing the belief that Federated may be more upscale and May always margin-oriented while lacking on the merchandising side.

Federated has annual sales of $15.6 billion and 111,000 employees. It operates more than 450 stores in 34 states, Guam and Puerto Rico under the names Macy's, Bloomingdale's, Bon-Macy's, Burdines-Macy's, Goldsmith's-Macy's, Lazarus-Macy's and Rich's-Macy's. The company also operates macys.com and Bloomingdale's By Mail.

May has 132,000 employees in 46 states and annual sales of $14.4 billion. The company operates about 490 department stores under the names Famous-Barr, Filene's, Foley's, Hecht's, Kaufmann's, Lord & Taylor, L.S. Ayres, Marshall Field's, Meier & Frank, Robinsons-May, Strawbridge's and The Jones Store. The company also has 229 David's Bridal stores, 458 After Hours Formalwear stores, and 11 Priscilla of Boston stores.