NEW YORK (CNN/Money) - Federated Department Stores agreed Monday to buy rival May Department Stores in a deal worth about $11 billion.

The deal, approved by the boards of both companies, would combine two of the most storied names in department store retailing. Federated, based in Cincinnati, owns Bloomingdales, Macy's and other chains. May, based in St. Louis, owns Lord & Taylor's and Marshall Field's, among other stores.

Although rumors about their impending merger had been swirling around for a while, talks accelerated last month after May chief executive Gene Kahn abruptly resigned.

Industry observers said the deal makes sense given that department stores have struggled to expand sales in a retail world dominated by discount chains, especially Wal-Mart and Target, and mall-based specialty stores. Last November, Kmart agreed to buy Sears, Roebuck & Co. in a deal also valued at about $11 billion.

Federated and May together would have about 1,000 stores and annual sales of about $30 billion, making it the third-biggest general merchandise retailer in the country, behind Wal-Mart and Sears, in terms of total sales

Under the deal, Federated (Research) will pay $35.50 in cash and stock for each May share, or about $11 billion, the companies said in a statement. May shareholders will receive $17.75 in cash and 0.3115 share of Federated stock per May share.

In addition, Federated will assume about $6 billion in May (Research) debt.

Federated stock rose about 1 percent in the early going while May stock fell more than 1 percent. As part of the transaction, Federated said it would increase its annual dividend to $1 a share from the current 54 cents a share.

Federated said it expects a one-time cost of $1 billion related to the acquisition but expects to realize $450 million in cost savings by 2007. The merger is expected to add to Federated's earnings in 2007.

The companies said no division consolidations or store name changes are planned before 2006. But Federated said most of May's regional department stores will probably be converted to Macy's and Bloomingdales eventually.

Federated also said it intends to make St. Louis the headquarters of one of the major operating divisions.

"For the customers of both companies, joining together means we will be better able to offer value and an improved retail experience, from better assortments and merchandise selections to more competitive pricing and service," Federated CEO Terry Lundgren, said in press conference Monday.

While Lundgren talked up the deal to reporters, some industry observers were more skeptical about its success. [For more, click here]

He also expects the combination to help accelerate sales at stores open at least year-- a close-watched retail measure known as same-store sales.

"By acquiring May, Federated now becomes a truly national brand. It will become a much bigger, improved and price-savvy retailer. With its sheer size, it will be able to squeeze better deals from its vendors," said Marshal Cohen, chief retail analyst with market research firm NPD Group.

Wendy Liebmann of WSL Strategic Retail thinks the merger, particularly the acquisition of the upscale Marshall Field's, could strengthen Federated's foothold in the upscale retailing arena.

"Here's an interesting thought about what might result: a good-better-best approach, with Macy's the 'good', Bloomingdales the 'better' and Marshall Field's the 'best,'" said Liebmann.

"That would mean, all of a sudden, Federated could put itself into a competitive league with Neiman Marcus, Bergdorf Goodman and Saks Fifth Avenue, something the company has not been able to do in spite of all its efforts to take Bloomingdales back to chic days of old," she said.

The companies said the deal was expected to close in the third quarter of 2005. It needs approval from regulators and shareholders.

Given that Federated and May both operate mall-anchor stores, the merger is likely to create an overlap in a number of markets. Lundgren, however, didn't offer details about potential store closings, or layoffs, but indicated that the company would undertake a strategic reviews of all the markets where both companies currently operate.