The Future of Kmart
With Eric Beder
Senior Retail Analyst, Ladenburg Thalmann
Friday, Jan. 25, 2002; 1 p.m. EST

On Tuesday, discount retailer Kmart Corp. filed for bankruptcy protection.

"The Troy, Mich.-based chain hopes to emerge from bankruptcy in 2003 as a leaner, more viable operation in part by closing unprofitable stores this year, laying off some of its 240,000 employees and terminating the leases of about 350 stores it no longer occupies but for which it remains responsible." Read the full story.

Eric Beder, Ladenburg Thalmann's senior retail analyst, on Friday, Jan. 25 at 1 p.m. EST, talked about the future of Kmart, Corp.

Beder has been with Ladenburg Thalmann since 1999. At Ladenburg, Beder focuses on the discount department store, luxury goods and teen retailing sectors. Some of those companies he investigates are Coach, Kohl's, Neiman Marcus, Oakley, Saks, Spiegel, Target and ValueVision International.

Beder has covered the retail industry for over 5 years. Prior to joining Ladenburg Thalmann, Beder was an equity analyst at HD Brous & Co., a Long Island-based NYSE member broker-dealer, where he covered retailers. Before this, he was head of financial analysis and research at Colliers ABR. He also served as a senior financial analyst at Paribas Capital Markets Group and as an options specialist at Citibank Investments.

Beder holds an MBA from the University of California at Berkeley and a B.S. from the Wharton School at the University of Pennsylvania.

Below is the transcript.

Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.

Eric Beder: Good afternoon...I look forward to your quessions on retailing in general and Kmart in particular...as way of background I have been a retailing research analsyt for 2+ years and have covered the discounters for over 4 years...

Dallas, Texas: How fast do you think notifacation of which stores will be closing will be made public? How many stores do you think will be elimanated? Will Martha Stewart look elsewhere for her line of merchandise since Chapter 11?

Eric Beder: I believe Kmart will close 200-400 stores, primarily in the South and other rural markets that compete directly with Wal-Mart...hopefully the notificiation will be in 3-4 months (it destroys store morale for employs to be hanging around waiting for notification)..unfortunately, I think the store shopping experience will get worse during this period of uncertainty.

Technically, Martha Stewart could opt out of her contract with Kmart...this would be a major disaster for the chain. However, I am not sure where she would go...I do not beleive either Target or Wal-Mart would be able to give her as much exposure as Kmart. That said, I believe Martha will look to improve her contract terms at Kmart (if she stays).

Washington, D.C.: Frankly, I'm not surprised that Kmart is struggling--their stores have been a disaster for years. Target has successfully introduced hip designers, and Walmart has embraced a middle American folksiness--both stores make it "cool" to find neat things at low prices.

Kmart stores are just a mess. Their merchandise is cheap. And I don't mean inexpensive -- I'm talking about quality. I can't imagine anyone ever boasting about finding something at Kmart the same way that I'll say to my friends "And can you believe it's from Target!".

Eric Beder: You bring up a number of points:

1) One of the key probelms of Kmart is that they have not created a niche outside of pricing...the only major positive difference between Kmart and their competitors is Martha Stewart, Sesame Street and some of the other private label apparel products..unfortunately, in slowing economic times sales of apparel lag (even at Wal-Mart).
2) The store shopping experience, while improved, definitely still reflected 10+ years of neglect under prior management...while Wal-Mart and Target spend billions building up thier store infrastructure, Kmart fell further and further behind. Prior to new management, the cash registers at Kmart were, many times, older than the people running them.
3)Does anyone actually say "I can't believe it is from Wal-Mart?"...the Wal-Mart shopper is tremendously price driven...without the infrastructure, Kmart could not offer competitive prices and remain profitable....

Arlington, Va.: It seems to me that all the old retail stores (like Macys, Sears, JCPenny, and Kmart) all have a tough time making money. In boom years they lag in profits, and in lean times they operate at a loss. Do you think this is due to the nature of retail, and that customers have permanently shifted to smaller, newer stores, or do you think it is just uninspired management at many of these chains?

Eric Beder: Their are a number of trends in retail that hurt many of the older line stores:

1) The suburbanization of America draws traffic from city centres, hurting the old line department stores that remain there due to sunk in real estate costs.
2) For the department store group in general, a lack of different fashion looks drives consumers to specialty chains that are focused on only one specific niche...what used to be a large positive (the ability to satisfy all customers) now has become a negative.
3) New concepts have taken the best of department stores and made the shopping experience easier...the success of both Kohl's and (to a lesser extent) Target can be traced with dissatisfaction with shopping in crowded and poorly services department stores and mall outlets in favor of lower priced and more convenient discounters.
4) With large built in costs, it is very hard for older stores to react and change...it is also very expensive....

Annandale, Va.: Do you think that KMart's restructuring of their debt is really for the purpose of cleaning house prior to being bought out or merged with either Walmart or Target?

Eric Beder: I think Kmart is not a potential merger partner for either one of these chains (except as a purchase of real estate)...I believe both Target and Wal-Mart are now looking on this period of weakness as a time to take further market share from Kmart via new store growth.

I could see Kmart being bought by a food store chain...one of Wal-Mart's key sales drivers has been adding grocery service...right now Kmart is a weak second in this area. Partnering with a grocery store cahin would allow them to expand into groceries very quickly.

Alexandria, Va.: I hate it that Kmart is closing stores. To me, Kmart is about nostalgia. I loved the blue light and the "attention kmart shoppers". But I never shopped there. The stores are too messy. I don't even care about old registers. I want a clean store!

Eric Beder: Frankly, your comment is one of the reasons Kmart went bankrupt...while consumers loved the "concept" of Kmart, the didnt shop there! While cleaning had improvedm the chain still had a long way to go......

Washington, D.C.: Please give us the basics about bankruptcy. Is it always the kiss of death for retailers? I seem to remember that Macy's filed a few years ago, and they are still here. Won't this status further chase customers away?

Eric Beder: A number of points about the bankruptcy process for retailers:

1) Many times, bankruptcy is not a prelude to closing an entire chain.
2) In the bankruptcy court, Kmart will be able to eliminate unecessary leases and contracts at a minimal cost...for example the company has 350 stores they have already closed but are still paying landlords approximately $250 million in annual rental payments...those have been cancelled.
3) The creditors of the company will determine its fate...if there is not enough value to satisfy thier claims, they can liquidate the chain (see Bradlees and Caldors)
4) Most customers, if they visit the stores, will not see a significant change...obviously, the fact Kmart is in bankruptcy will scare some people from even visiting the store.
5) Most retailers, if they come out of bankruptcy, come out with a stronger store base and better finances...hopefully Chapter 11 will give Kmart the opportunity to register strong returns once they emerge....

Washington, D.C.: Hello,
I'm very concerned about the effect the Kmart bankruptcy will have on the chain's plans to open a retail store here in D.C. Kmart had agreed to open a store in a redevelopment project along with Home Depot and Giant on an underutilized tract of land near a Metro station in Northeast D.C.
If they bail out, do you think Target would consider taking over? Unlike oversaturated suburban markets, we desperately need large retailers here in the city. Perhaps that's a niche Kmart could fill, where Walmart fears to tread?

Eric Beder: In general, building of new outlets is very limited in bankruptcy....however, Kmart can choose to honor its prior obligations if they make financial sense (such as opening up new stores).

On a broader level, I believe urban areas remain one of the few growth regions left for discounters...I know Target has begun to enter that market. Based on the locations of some of the strongest Kmarts stores in NYC (the Bronx) there is a very strong need for retailers in urban communities...prior to going bankrupt Kmart considered urban areas a key growth component.

Silver Spring, Md.: What impact will the closing have on the Vendors? I know that can't be happy to have the Wal-marts and Targets dictate pricing, availablity of goods and services etc.

Eric Beder: For vendors that were owed money by Kmart prior to the bankruptcy, those claims are worth very little.

On a wider scope, vendors want and need competition among retailers to not have their margins squeezed so much...as such, we believe the vendor community will be very supportive in helping Kmart vacate Chapter 11. In a similar case, Ames, the vendors have bent over backwards to help keep that chain afloat and steer it through the Chapter 11 process.

Laurel, Md.: Toward the end of the 80s economic boon, a theory was advanced by some economists that there was simply too much retail. (Partly this was due to the 80s regulatory environment that encouraged high-risk real estate use and ultimately cause the S&L implosion.)

While competition is good for consumers, I think I could easily get by with half my present shopping options. Wouldn't, in some ways, the economy be better off with fewer retailers, if we could find some other way to use the properties?

Eric Beder: For as long as I can remember economists have complained that their is too much retailing space...yet chains continue to expand. Frankly, the retailing business is one of the most competitive of any sector in the US....so when one group rises, others fall. I think the healthy competition and efficiency in the space allows consumers to enjoy a standard of living among the best in the world...the price of clothing has actually declined in the past five years....so we say if there are retailing concepts that are better done, let the numebr of retailers continue to increase!

San Francisco, Calif.: I'm a Kmart stockholder. I'm originally from Troy, MI and received shares as a gift from my grandmother. I realize I should have sold the shares before now, but since I haven't, what can I do? Should I hold onto the shares hoping that the company turns around? Or sell now?

Eric Beder: Well...

1) You can still sell your shares....they continue to trade on the NYSE (for now)...
2) You could sell them on EBay as a collectible (Their is a thriving business in selling shares of failed dotcoms)
3) You could keep them and see what happens...shareholders of bankrupt companies are last in line to recieve proceeds in a liquidation or in terms of rights in the reorganization...at best we view shares of KM as offering the risk/reward of a lottery ticket right now.

Arlington, Va: At many discount stores, I can never seem to find a sales associate to help me find what I'm looking for. Is it a trend in the industry to cut back on sales forces, or do you think it's just that it's difficult to find good (minimum wage) employees in the tight Northern Va job market?

Eric Beder: Great question....On one hand customers want low prices, but on the other retailers need to make a profit, so many times everything else (service and support) suffers. If you look at well staffed discounters, like Target, they sell much more highe-margin products to allow them to have more salespeople.

In addition, jobs at retailers such as Wal-Mart and Kmart don't pay that much and are not very exciting (turnover can be over 100%!), so if there are other alternatives, the ability to staff stores can be compromised....

Washington, D.C.:
Eric,

What about American gun owners boycotting Kmart because of their anti-gun policy? I haven't heard this reported at all but I won't shop there and neither will my cousin and his wife. Thanks.

Eric Beder: In many areas of the country Kmart never offered guns...obviously, every dollar spent somewhere else hurt them and a sales boycott obviously was not a positve. That said, the company was focusing on being the source for mom...I am not sure how carrying ammo would lead to more sales to mothers.

On a wider level, Wal-Mart is a recognized source in the discount arena for sporting goods...virtually all discounters have ceded the lions share of the market to them...

Washington, D.C.: Do you think the analysts got this one right? After all, for 2 weeks prior to Kmart's bankruptcy, there were some vocal analysts calling the stock a sell, and that Kmart had nowhere to go but Chapter 11. Was this good analysis, a reaction to the Enron debacle (where analysts kept buy ratings on the stock as it was tanking), or just being lucky?

Eric Beder: In the interests of full disclosure, I was one of the few analysts that had a buy rating on KM before they went bankrupt; in fact none of the analysts (even Wayne Hood, the Prudential analyst who cahnged his rating to sell on January) projected a bankruptcy this quickly and even many of the ones with a Hold rating did not believe the company would go bankrupt....

Many times in retailing, fear of bankruptcy can become a self fulfilling prophecy...in Kmart's case, management did a terrible job of soothing investor (and more importantly) supplier fears. We can compare Kmart's reaction to Sak's when there debt was downgraded by the ratings agencies...Saks immediately responded with a fact-filled press release which provided concrete information about their financial condition, while Kmart said nothing. As such, this vacuum of information from Kmart spooked nervous vendors and eventually lead to suppliers cutting off shipments...when suppliers and factors stop supporting a company, bankruptcy becomes the only alternative...

Laurel, Md.: Re: Urban Markets

But aren't urban store just plain too expensive to operate?

Walmarts are almost universally located where supply trucks can come in and out easily and where large parking lots can be built to increase how much a shopper can buy in one trip.

Trying to run a national chain with national prices in an urban setting would just cause another bankruptcy.

Eric Beder: Urban stores do present problems in terms of supply, but the density level of customers leads to larger sales and higher returns...if the urban area is stable, the level of competition for a discounter is relatively weak and can not offer the pricing and selection a Kmart or Target could. Urabn areas stores, if run right, offer the ability for a chain to dominate a large section of core customers...

Washington D.C.: What do you think about today's report on some possible accounting problems for Kmart? Any validity?

Thanks for taking my question!

Eric Beder: Frankly, I find this item relatively strange...the relatively straight forward nature of retailing transactions should leave little room for accounting issues. The only potential item I can see at Kmart was thier reduction of the accrual for shrinkage, which had been falling from levels reported last year and resulted in better earnings results. I do not believe Kmart will turn out to be an Enron (by a long shot).

New Paltz, N.Y.: The article I saw said that K-Mart filed for bankruptcy having "$16 billion in assets and $10 billion in liabilities." Isn't bankruptcy in this circumstance just an unethical loophole out of a lot of leases the lessee facing a financial squeeze would like to dump? And should it be allowed, instead of facing creditors manfully across a table and negotiating one's way out?

washingtonpost.com : Kmart Asks Court for Bankruptcy Protection (Post, Jan. 23, 2002)

Eric Beder: This is one way of looking at it...it is definitely true that bankruptcy does allow any company to eliminate obligations at a relatively poor cost.

That said, the U.S. bankruptcy system is designed to offer some hope of survival for the bankrupt company...in the U.K. bankruptcies are basically liquidations. Would it have been possible for Kmart to renegotiate every poor lease? And doesn't it make better sense in the long-run for the poor leases to find better uses? If we want to force companies to "manfully" take on these obligations, we have to change the bankruptcy system....

Eric Beder: Thats about all the time I have...I hope you enjoyed the forum and I will see you in the stores!

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