Kmart Shoppers Find a 'Bargain'

Zilch, zero, nada. That's what shareholders typically get when companies reorganizing under Chapter 11 emerge from bankruptcy.

Yet one of the hottest stocks the past few days has been discount retailer Kmart (KM), which only a week ago became the largest-ever retail bankruptcy and the nation's second-biggest Chapter 11 case. Kmart has more than doubled since the filing, trading at $1.57 around early afternoon Wednesday.

Even as the Dow Jones Industrial Average fell almost 250 points Tuesday, Kmart shares jumped 33%. The run-up came after the company, based in Troy, Mich., said that vendors had resumed shipping goods and a judge had approved a $2 billion rescue package from a group of banks. And it came a week after Wall Street firms, noting the steep odds against the stock retaining any value, stopped covering Kmart.

"There are a group of investors that trade on this," says Stanley Kershman, a bankruptcy attorney in Ontario who has testified before Canada's Senate Banking Committee and the U.S. National Bankruptcy Review Commission. "And they've made money doing it."

Time on My Side

Kmart has said it hopes to emerge from Chapter 11 in 2003, so that it doesn't squander two Christmas selling seasons reorganizing. Most retailers make much of their yearly profits over the holiday season. Analysts expect Kmart to close stores and reorganize its crushing debt in an effort to reduce costs.

But even if Kmart successfully slims down its operations and restructures its bloated balance sheet, current shareholders aren't likely to receive any value for their holdings, experts say. That's because in a bankruptcy proceeding, claims by creditors take priority over those of shareholders. With Kmart staggering under $4.7 billion in debt ahead of its filing, the stock is almost certain to be rendered worthless in the company's reorganization plan.

"It's very rare" for shareholders to receive substantial value in bankruptcy proceedings, says Chris Stuttard, editor of BankruptcyData.com. Most of the time, he says, the common stock is canceled and new equity is issued to creditors and new court-approved investors. Sometimes, the old shareholders get a small handout -- perhaps one new share for every 100 old ones, says Stuttard. "It's more of a token -- 'Like, thanks a lot,' " he says.

Bad Karma?

Moreover, with competitors like Wal-Mart (WMT) and Target (TGT) breathing down its neck, Kmart has little room to maneuver competitively, as it found during an ill-fated price war that led in part to the company's demise. And even in the best of times, a bankrupt company faces a steep road to recovery.

"The statistics are that most bankruptcies fail," says Randy Klein, a principal at the Chicago law firm Goldberg Kohn Bell Black Rosenbloom & Moritz, who specializes in representing creditors in bankruptcy proceedings. "A successful Chapter 11 is a rare event, but they will try."

Indeed, the retail scene is littered with Chapter 11 cases that ended up in parking lot fire sales, rather than a turnaround. Service Merchandise and Montgomery Ward are two recent cases of big department store chains that planned to reorganize around a core group of stores but failed. Kmart shares plunged 90% in the months leading up to its insolvency as investors noted the company's eroding sales and failing profitability.

But apparently, that won't keep people from buying Kmart stock as long as it stays listed. Stocks must typically trade under a buck for 30 days before they get sent to the pink sheets. Kmart's recent foray above $1 will keep that clock ticking a while longer.

And seeing opportunity, some people are behind the stock. "I would buy more," said Chris Castaldo, publisher of StockTradersPress.com, an online research outfit, shortly after Kmart filed for bankruptcy. "I think this is a great opportunity." In his view, Kmart will emerge from bankruptcy a stronger company after shutting money-losing stores.

But remember this: Buying Kmart stock now isn't a bet the company will emerge healthy -- it's a wager that you'll find someone even more gullible to take it off your hands before the shares go to zero, which they almost inevitably will.

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