Unfortunately, the picture's not pretty for



shareholders if the company doesn't manage to make good on its turnaround plans.

After weeks of speculation, Kmart

filed for bankruptcy protection Tuesday, citing a rapid decline in liquidity resulting from its weak fourth-quarter sales and earnings, the evaporation of the surety bond market and an erosion of supplier confidence.

Bill Kelleher,
Cohen & Grigsby

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If the company doesn't emerge from bankruptcy as planned in 2003, shareholders will be last in line when it comes to recovering assets from the company.

But bankruptcy lawyer Bill Kelleher of Pittsburgh firm Cohen & Grigsby says the company should be able to survive. Armed with its secured $2 billion in debtor-in-possession financing, Kmart said it hopes to reorganize on a fast-track basis, and Kelleher says the company should have no trouble staying in business.

Still, investors slammed shares of Kmart on Tuesday, sending the stock down 60% to 69 cents. The stock has been in a free fall for several weeks now, having lost 86% of its value since the start of the year.

Here Kelleher gives his take on Kmart's bankruptcy and the effect this will have on shareholders and other stakeholders in the company.

TSC: Some people felt that by securing financing, Kmart could stave off bankruptcy, but that didn't happen. Why not?


Sometimes lenders get better protection in a bankruptcy, so

Kmart might not have been able to get financing outside of bankruptcy. That's speculation, but sometimes that's the case.

If you're a lender, you don't want them to file bankruptcy on you, so you're better off waiting till they file and then making the loan. You get more protection that way. Getting this financing early on was critical to enable Kmart to not only satisfy its obligations but to send the message to people dealing with them that they intend to stay in business.

TSC: What does this bankruptcy filing mean for Kmart, and how will it help them get back on their feet?


Typically, a retail bankruptcy gives a company time to sort out its financial problems and evaluate all of its leaseholds for various stores throughout the country.

If the company decides that any given store is underperforming, bankruptcy provides a vehicle for them shutting down that facility and minimizing or avoiding other long-term lease agreements or other commitments they might have.

TSC: Kmart said it hopes to emerge from bankruptcy next year. Is this realistic?

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It depends on what they're trying to do. If they're trying to solve operational problems -- for example, if they're going to shut down a substantial portion of their 2,000 stores and walk away from leases -- and that's the way they're going to get back on their feet by fixing their debt and cost structure, that can take a lot of time.

If they have a specific goal in mind -- for example, if there's some bond debt or some type of secured bank financing and they think they can use bankruptcy to get a restructuring on that, and they're not addressing a whole host of other problems -- then maybe they can do it very quickly. It depends on what they're using the bankruptcy for.

TSC: Kmart's stock is now sitting at a 38-year low. What do you believe will happen to shareholder equity at this point?


Bankruptcy provides that distributions get paid in accordance with legal priorities. At the top of the ladder is secured creditors, banks or financial institutions. Unfortunately, at the bottom of the ladder are equity and shareholders.

Under strict bankruptcy rules, shareholders are not entitled to get anything, including the ability to continue holding their stock, unless all of the priority levels ahead of them get paid in full. There are very few bankruptcies where all creditor groups get paid in full.

There are many large corporate reorganizations where a negotiated plan is put into place that will provide some return to shareholders, but it's not usually significant.

TSC: Kmart's bonds already trade at junk status. What's in store for bondholders?


There may still be a market for their bonds. It's obviously a highly speculative investment for someone at this point, but it depends on what type of bond it is.

If it's secured and there is some collateral backing it up, they may be entitled to get that based on the value of the collateral. Otherwise, they'll just have to wait like all the other creditors for the bankruptcy process to run its course and find out what, if anything, they can get at the end of the day.

TSC: Do you expect a lot of shareholder lawsuits as a result of this?


Bankruptcy prevents anyone from filing a lawsuit against the company. So there can't be any shareholder lawsuits unless someone feels they have a right to sue someone who's not in bankruptcy, like a director or an officer. If people think there were problems with the stock or reporting prior to that, there may be shareholder action.

TSC: What effect will this have on the company's credibility and how long will it take Kmart to recover from the stigma of having gone bankrupt?


The $2 billion debtor-in-possession financing presumably is sufficient to enable them to maintain a reasonable relationship with suppliers. Most of these suppliers are sophisticated and understand Chapter 11 and this type of financing, and my guess is that with perhaps only minor bumps in the road, Kmart will have no trouble remaining in business.

I think if Kmart continues to maintain a reasonable level of inventory in its store and continues to have the same sort of customer treatment it has had in the past, most of the public won't notice any difference at all.

TSC: So you think they're definitely going to survive this?


Well, I'd be surprised if they don't survive.