Wednesday, January 23, 2002
Kmart set to file for bankruptcy
By STEPHANIE STROM and LESLIE KAUFMAN
The New York Times
Kmart Corp., the nation's third-largest discount retailer, is expected to seek bankruptcy protection as early as this morning in Michigan, where it has its headquarters, according to advisers to the company.
It would rank as the largest retail bankruptcy filing on record.
Jack Ferry, a Kmart spokesman, refused to comment on the company's plans.
But others said the board of the company, meeting into the night Monday, was putting the finishing touches on about $2 billion in debtor-in-possession financing. That money will allow it to continue its operations while under bankruptcy protection.
Kmart, which operates roughly 2,100 stores, may use bankruptcy to extricate itself from leases on about 250 of them around the country, according to retail analysts. A critical question for the retailer is whether Martha Stewart, its most important and visible supplier, will continue to supply the stores with her line of housewares.
Monday's decision by Fleming Companies Inc., a major food distributor and grocery wholesaler, to halt most of its shipments to Kmart after the retailer failed to make its weekly payment was the final straw for the company. But its woes had been mounting for some time, with holiday sales coming in at the low end of what the company expected, and a longer term strategy of low pricing that hurt revenue.
Oddly, the spectacular failure of Enron Corp., already the largest corporate bankruptcy ever, may have had as much to do with Kmart's failure as skittish suppliers and hard-nosed bankers.
Kmart relies on surety bonds, essentially agreements by insurance companies to continue financing in the event of a default, to back its workers' compensation program and to cover liabilities arising from its sales of guns and liquor, according to advisers and executives close to the company.
Enron depended on such bonds, too, and since its bankruptcy filing, leaving insurance companies to cover its liabilities, insurers have raised prices for surety bonds. In Kmart's case, insurers were requiring cash collateral for the securities.
That placed a large additional, unanticipated drain on Kmart's cash flow that, coupled with supplier demands for payment on delivery and the company's weak performance during the crucial holiday period.
''Their cash flow model for post-Christmas would have been fine - until Enron scared every last living person in finance out of their wits,'' said one adviser.
Even though Kmart drew down a $1.5 billion credit line just after the holidays, the demands on its cash were too great.
The fact that Kmart could not pay Fleming, one of its biggest and most loyal suppliers, $78 million to cover its bill shows how desperate its position has become, said Walter F. Loeb, a long-time retail consultant. ''They're now starved for food, so to speak, and that can't go on for more than two or three days,'' he said.
''They have no money, and it's hard to see what other choice they have.''
Fleming's demand for payment also demonstrates how worried one critical Kmart distributor had become. Kmart represents 27 percent of Fleming's sales, and Fleming had committed to building three warehouses to service Kmart. Suppliers hate to alienate such a major customer. ''Fleming probably shipped to Kmart longer than most,'' said one executive close to the company.
The two companies are also related through Ronald W. Burkle, an investor who holds big stakes in both Kmart and Fleming, and brokered their relationship.
But Fleming, regarded as a smart operator in the investment community, has seen its shares plummet as speculation about Kmart's problems have mounted. ''Fleming is working with Kmart as they navigate through their current financial problems, and we intend to resume delivery of food and other consumable products to Kmart upon receiving satisfactory assurance of Kmart's performance,'' Neal Rider, Fleming's chief financial officer, said in a statement. ''We are also taking the appropriate steps to protect Fleming's interest.''
Kmart has been on the ropes on and off for more than a decade, partly crushed by ferociously efficient competitors like Wal-Mart and Target, and partly a victim of its own missteps, like stocking dowdy fashions and being slow to invest in computer technologies that others, especially Wal-Mart, have cleverly exploited.
In fact, Kmart was near filing for bankruptcy in the mid-1990s. The company was losing money because its stores were outdated and its resources had been stretched by its acquisitions of unrelated businesses like Office Max and Borders books.
Under shareholder pressure, Kmart saved itself then by spinning off several units, including Borders, Sports Authority and other specialty retail units, and replacing its longtime chief executive, Joseph Antonini.
But to no avail: Competitors kept coming. Wal-Mart, which was dwarfed by Kmart in its 1970s heyday, is now nearly five times larger, and Target, regarded as having the most fashionable merchandise among the discounters, just replaced Kmart as the nation's second-largest discounter.
Kmart's board has fought hard to avoid a bankruptcy filing in recent weeks. The company's directors pressed management and its advisers last week to come up with alternatives to keep Kmart out of bankruptcy court, even though chief executive Charles C. Conaway had argued that bankruptcy was the company's best option.
Credit rating agencies have been downgrading the retailer's debt rating. Banks, including J.P. Morgan Chase and FleetBoston, as well as lenders like General Electric Capital Corp., have been negotiating with the company for the last week about various types of financing.
Kmart has secured the services of Henry S. Miller, the head of Dresdner Kleinwort Wasserstein's restructuring practice, as its bankruptcy adviser. Jack Butler, a partner at Skadden Arps Meagher Slate & Flomm who has represented the company for the last several years, will act as the company's lawyer.
Investors became increasingly worried about Kmart after the company's board held a marathon 36 hour meeting spanning Jan. 7 and Jan. 8, only to issue no public statements about the outcome of the meeting for another 48 hours. When Kmart finally did talk last Thursday, it merely announced a series of high-level executive changes and said it would review its liquidity and continue discussions about financing.
Conaway was removed as Kmart's chairman. James B. Adamson, an outside director with experience in managing distressed companies, became chairman, and Mark S. Schwartz, who had been brought in with much fanfare from rival Wal-Mart to resuscitate Kmart's fortunes even though he was credited with the failure of another large retailer, left the company.
That did little, however, to calm the fears of the company's suppliers and financiers. Adamson, who is chairman of Advantica Restaurant Group, which operates Denny's and other restaurant franchises, joined Kmart's board in 1996, and although he worked wonders to bring Revco out of bankruptcy, critics complain that he has not helped Kmart avoid it.
Adamson is expected to bring in a colleague from Advantica to be Kmart's chief restructuring officer to work alongside Conaway, according to an adviser.
While the board shuffled management last week, banks led by J.P. Morgan Chase worked feverishly to cobble together $2 billion to $3 billion in asset-backed financing for the Kmart.
One investor was told that the bank had offered Kmart two choices. It could file for court protection to secure that money, or it could stay out of bankruptcy and take a smaller loan of between $750 million and $1.2 billion.
The terms of that loan would have placed J.P. Morgan first in line to recover not only that money, but also the $1.5 billion it was owed after Kmart drew down its credit line after the holidays. In bankruptcy, however, J.P Morgan will have the same standing as bondholders, who are owed about $4.5 billion, and trade creditors, who are owed between $2 billion and $3 billion.
An executive close to the talks said Kmart had hoped to arrange financing that would keep it out of bankruptcy proceedings. ''But in a situation like this, you need to file as quickly as possible so that suppliers start shipping again,'' he said.