Kmart Crumbles Amid Bankruptcy Talk - TheStreet

Kmart Crumbles Amid Bankruptcy Talk

The stock drops 13.7% as Wall Street speculates that a Chapter 11 filing beckons.
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Wall Street expects

Kmart

(KM)

to die a death of a thousand cuts. Debt-rating cuts, to be precise.

With Kmart's stock plunging for a fifth straight day Tuesday -- the retailer's shares dropped almost 13.7% to $2.45, putting them at mid-1960s levels -- a growing number of people now say bankruptcy may be Kmart's only way out. Heightening the suspense, the company's board was meeting Tuesday to consider its options, raising the prospect that Kmart could declare its intentions as soon as this afternoon.

"I think a Chapter 11 filing is definitely imminent," says Seth Freeman, managing director of EM Capital, a consulting firm that specializes in advising retailers in financial distress. A bankruptcy filing could allow the company to renegotiate leases on money-losing stores and move aggressively to cut costs, analysts say -- two things the red ink-stained company clearly needs to do.

Jack Ferry, a Kmart spokesman, didn't immediately return calls seeking comment. Kmart has said that it is seeking supplemental financing, and that it has at least $300 million of cash on hand.

Attention Getters

The New Year has been nothing if not eventful for the Troy, Mich., discount retailer. The company released disappointing holiday sales figures on Jan. 10, saying it would review its liquidity position and business plans for 2002 and 2003. Even so, at the time many observers agreed that while Kmart would need to cut costs and probably close a substantial number of stores, the prospect of a bankruptcy filing remained a long shot.

Suppliers like

Fleming

have since said they were continuing to deliver goods to Kmart and that the company was current in its payments, which seemed to mitigate the chances of a bankruptcy filing. Industry observers say it's unusual for a company that's receiving goods and keeping up with its bills to seek Chapter 11 protection.

But the repeated cuts at the hands of credit rating agencies S&P and Moody's appear to have gotten Wall Street's attention. Ratings cuts make it more expensive for the company to borrow money.

"Once the bond rating agencies chop a company's ratings," Freeman says, "it really becomes a spiraling effect, where bankruptcy becomes the only alternative."

Code Blue

Kmart shares have paid the price for that brand of speculation. Since Prudential Securities analyst Wayne Hood published a bearish report Jan. 2, shares have dropped 55%. Kmart is now 82% off its 52-week high, set last August, as Wall Street has all but given up on the stock. In the long run, however, a bankruptcy filing could help the company while leaving current shareholders with nothing.

"Chapter 11 for retailers offers special ability to improve cash flow by terminating unprofitable leases," says Randy Klein, a principal at the Chicago law firm Goldberg Kohn Bell Black Rosenbloom & Moritz, who specializes in representing creditors in bankruptcy proceedings.

Analysts expect Kmart to seek to close about 250 underperforming stores in a bid to boost cash flow and earnings. A bankruptcy filing could also make it easier for Kmart to secure financing. Chapter 11 filers often receive what is known as debtor-in-possession financing, which is often secured by company assets such as inventory and puts the lending banks ahead of other creditors.

These types of arrangements are typically negotiated ahead of a bankruptcy filing, Freeman says.

Kmart recently said it has about $900 million remaining on $1.5 billion in revolving credit lines. But it also has about $4 billion in debt, and worries over whether the company can service that load have increased in recent days. While retailers can emerge from bankruptcy and remain in business, two high-profile cases in recent years suggest that outcome is far from certain. Both Service Merchandise and Montgomery Ward, two large department store chains, have filed for Chapter 11 in recent years and both eventually went out of business under crippling debt loads.

Kmart still has some believers, despite a poor holiday performance that looked especially bad considering that rivals such as

Target

(TGT) - Get Report

and

Wal-Mart

(WMT) - Get Report

did well.

But "Chapter 11 can provide a refuge to restructure," says Klein, the Chicago lawyer.