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Kmart files Chapter 11
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January 22, 2002: 12:28 p.m. ET
Struggling discount retailer ends speculation, files for bankruptcy protection.
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NEW YORK (CNN/Money) - Kmart Corp., the second largest discount retailer in the United States, filed for Chapter 11 bankruptcy protection Tuesday, ending weeks of speculation about the company's financial health.
Kmart's filing, the biggest retail bankruptcy ever in the United States, had been widely expected, but company officials had for several weeks declined to comment.
The filing came a day after Fleming Companies Inc., Kmart's biggest food distributor, halted shipments to Kmart after the retailer failed to make its regular weekly payments. Fleming's move may have been the last straw for Kmart, which has struggled for months with sluggish sales and strong competition from Wal-Mart Stores Inc. (WMT: up $1.87 to $58.22, Research, Estimates), the No. 1 discounter in terms of annual revenue.
In recent weeks, ratings agencies had downgraded Kmart's credit, its stock plunged and the company was removed from Standard & Poor's benchmark index of 500 leading stocks.
Kmart's bankruptcy filing, with $17 billion in assets, is the biggest ever for a U.S. retailer, according to Bankruptcydata.com. Federated Department Stores Inc. (FD: up $0.52 to $41.03, Research, Estimates), which filed in January 1990, was second with $7.9 billion in assets. Montgomery Ward Holding Corp., which filed in July 1997, was third with $4.9 billion.
Kmart, which has about $37 billion in annual revenue, said it had secured $2 billion in debtor financing to pay its $1.6 billion in debt and expected to emerge from bankruptcy in about a year. A company in Chapter 11 is protected from creditors while it reorganizes and tries to work out a plan to pay its debts.
"We are determined to complete our reorganization as quickly and smoothly as possible, while taking full advantage of this chance to make a fresh start and reposition Kmart for the future," CEO Charles Conaway said in a statement.
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Kmart said all of its 2,114 stores were open for business and that all credit cards, gift certificates and store credits would be honored as usual. It also said its pension and savings plans are independent of the company and would be administered as usual.
But the Troy, Mich.-based company also said it would review the performance of each of its stores, with a goal to close unprofitable locations. Analysts have speculated that the company could close up to 500 stores, on top of the 350 closed last year.
Kmart said it would not discuss plans for store closings, but the company said in its press release it hopes to cut about $350 million in annual expenses through reorganization and job cuts.
Wall Street analysts thought the move was good for Kmart, as it ended weeks of speculation and enabled the company to repair its relationships with vendors and make itself more competitive.
"Within the past 24 hours, they've opened a number of different options that weren't available 24 hours ago," said Wayne Hood, retail analyst at Prudential Financial. "They could reemerge as a smaller, more competitive company with stable cash flow. If I were Wal-Mart, I would be more concerned now than if Kmart hadn't filed."
Investors were less pleased, and Kmart (KM: down $1.00 to $0.74, Research, Estimates) shares lost nearly 60 percent of their value, slipping below $1 Tuesday.
And Standard & Poor's, which had already cut Kmart's debt rating to "CCC," or "low junk" status, cut it to a "D" rating after Kmart's announcement. Moody's Investors Services and Fitch also rated Kmart's debt "low junk."
In addition to Fleming Cos. (FLM: up $0.88 to $18.15, Research, Estimates), other vendors, including Scotts Co. (SMG: down $0.24 to $43.29, Research, Estimates), also have suspended shipments.
While observers have speculated for months that Martha Stewart Living Omnimedia Inc. (MSO: down $0.08 to $17.23, Research, Estimates) will be the next to pull out, a Martha Stewart representative told CNNfn its relationship with Kmart hasn't changed.
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Another Kmart vendor, CSS Industries Inc. (CSS: down $0.30 to $27.45, Research, Estimates), which makes gift wrap, greeting cards and similar items, said its difficulty in collecting from Kmart would weigh down its earnings growth in 2002. For its part, Fleming said Kmart's filing would have no impact on its business.
"Kmart's debtor-in-possession financing gives it the critical liquidity needed to fund its operations during the reorganization process, a necessary first step in resuming our relationship," Fleming CEO Mark Hansen said.
"Additionally, Kmart's reorganization can be an opportunity to close underperforming, high-cost-to-serve stores and redirect capital toward efficient, highly productive discount stores and supercenters," Hansen added.
Of greater concern to Kmart is what it will do in the future to avoid the troubles that led to its bankruptcy. During an economic downturn that led consumers to tighten their purse strings, the discount retailer floundered even as its competitors flourished.
Wayne Hood of Prudential Financial pointed out that Kmart was cutting back on promotions even as other retailers such as Wal-Mart and Target Corp. (TGT: up $1.35 to $42.01, Research, Estimates) were expanding them in an effort to lure shoppers.
A long-time effort to compete with Wal-Mart and Target on similar brand names was especially disastrous for Kmart, analysts said.
"Competing on price with Wal-Mart doesn't work," said Kurt Barnard, president of Barnard's Retail Trend Report. "Hopefully they will never do it again. It was a bloody experience for them."
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Kmart would benefit more from creating its own unique brands, enabling it to build its own identity and avoiding price competition, analysts said.
"The key for them is the marketing of a new and totally different identity from Wal-Mart or Target or anybody else," Barnard said. "They have to create their own distinctive identity. The kind that will make you and me wake up in the morning and say, 'I need a new pair of pajamas -- I think I'll go to Kmart.'"
Other alternatives for Kmart, analysts said, include possibly merging with Fleming to form a retail/grocery "supercenter" or being acquired by an overseas retailer such as Dutch supermarket chain Koninklijke Ahold NV or U.K. retailer Kingfisher. Both are said to be looking for ways to expand in the United States.
Leading Kmart's reorganization will be Ronald Hutchison, the first occupant of the newly created position of chief restructuring officer, and new chairman James Adamson.
"[Kmart has] a very aggressive timetable," Hood said. "It will be interesting to see if they can pull it off." 
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