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Credit Claims Endanger Kmart Chapter 11 Exit

NEW YORK — Ongoing creditor negotiations have left Kmart Corp. unsure of whether, as expected, it will file its plan of reorganization with the Chicago bankruptcy court today.<br><br>Jack Ferry, spokesman for Kmart, said Thursday there was an...

NEW YORK — Ongoing creditor negotiations have left Kmart Corp. unsure of whether, as expected, it will file its plan of reorganization with the Chicago bankruptcy court today.

Jack Ferry, spokesman for Kmart, said Thursday there was an outside chance that the planned filing might not take place until Monday. “We’ve said that we would file on or about Jan. 24,” he noted.

According to Ferry, even if the filing takes place late today, it wouldn’t necessarily detail the discounter’s final game plan. “We can file it Friday even if no consensual agreement is reached [among the creditors], and then file an amended plan,” he said.

The latest hurdle to the planned filing — which led to the last-minute, round-the-clock negotiations among creditor groups — stemmed from a pullback on the amount that hedge fund ESL Investments was willing to put into a bank-debt buyout.

Little is known about ESL, although its principal, Edward Lampert, made headlines of another sort with his Jan. 10 kidnapping in Greenwich, Conn. Following his release on Jan. 12, Lampert and his ESL-led group had second thoughts about a $280 million, or 40 cents on the dollar, buyout plan for Kmart’s bank creditors.

Since 2001, ESL’s focus has been on the automobile industry, in firms such as AutoZone and AutoNation. That changed in the fall of 2002 when ESL purchased Kmart’s pre-petition bank and bond debt, then trading in the mid-20 cent range. Also purchasing Kmart bank, bond and trade debt at the time was Third Avenue Value Fund, a so-called vulture fund. Kmart’s pre-petition bank debt this week was trading in the 30 cent range, with bonds at between 16 and 17 cents and a spread of 7.5 to 10 cents on the trade claims.

Both ESL and Third Avenue, sources said, have been instrumental in pushing the bankrupt retailer to move faster in its reorganization. An analyst at a competing vulture fund observed, “There is a general belief that the longer a company stays in bankruptcy, the less there will be in the pot for creditors.”

ESL is probably the largest Kmart creditor, owning about $1 billion in bank and bond debt, and would likely sit on the board of a reorganized Kmart. The original plan was for Kmart to reorganize and swap equity in the reorganized firm for pre-petition claims, with ESL and its partners to fund the bank-debt buyout. ESL reportedly is still willing to partially fund the buyout, just not as much as initially planned.

A straight equity swap tends to be a relatively easy transaction. In this case, however, the banks in the Kmart bankruptcy are unsecured and want more up front.

According to another vulture fund source: “The issue now is how do you carve up the value of Kmart? Who will get what? Banks don’t want equity. They want the cash.”

Much of the negotiating is likely to center on subsidiary guarantees in the financial instruments that are part of the pre-petition bank debt. The same vulture fund source said some of those subsidiaries have value, such as real estate assets.

So far, it seems that creditors such as ESL and Third Avenue have been winning the ongoing creditor battles. In recent weeks, factions within Kmart and its constituents have hotly contested what Kmart’s store count should be, according to sources from the financial, retail and apparel industries.

As reported, Kmart on Jan. 14 said it will shutter 326 stores, including 60 of its 117 Kmart SuperCenters.

James Adamson, who until last Sunday was Kmart’s chief executive officer and now is its interim nonexecutive chairman, wanted to close more stores. According to sources, his preference was to close the Super K business altogether.

Julian Day, named as Adamson’s successor as ceo this past weekend, was in charge of supervising the day-to-day operations in his previous position of president and chief operating officer. Day’s preference was to keep some of the Super Ks and close fewer stores.

According to a real estate source close to the company, the question of which stores to shed was so hotly disputed that the final tally kept changing “day by day” up until the announcement was made. ESL and Third Avenue, sources said, pushed to keep more stores open, the point of view that ultimately prevailed.

Even if a reorganization plan is filed shortly, there’s still a likelihood of more changes in the works for Kmart. Fleming Cos., the distributor of goods for Kmart’s Pantry section and supplier for the retailer’s remaining Super Ks, said Thursday that the company was still in negotiations with Kmart over its distribution agreement. One real estate investment trust analyst said he is “expecting more Super Ks to close.”

Jim Harris, president of Seneca Financial Group, was involved in the restructurings of Allied Department Stores and Federated Department Stores. He observed: “Kmart is no closer now to reorganizing than it was the day it filed,” Jan. 22, 2002. The restructuring and recovery expert believes that Kmart would stand a better chance of survival if it was much smaller, in the range of 500 to 700 stores.

However, one retail executive who just returned from a trip to Hong Kong said, “The factories are jittery about continuing to ship Kmart. But, for many, business is so bad in general that they are willing to take the gamble.”