Plans for Re-Emergence of Kmart Survive Investor's

CHICAGO (HedgeWorld.com)--Kmart Corp filed a reorganization plan that may pave the way for its reemergence from chapter 11 bankruptcy-law protection, contrary to rumors early last week that the kidnapping of hedge fund head Edward S. Lampert would result in a delay in this filing.

The plan, which has been the subject of extensive negotiations with the company's statutory committees, called for a substantial investment by two hedge fund groups, each of which has bet heavily of Kmart's bonds since its bankruptcy. The groups are managed by ESL Investments Inc., Greenwich, Conn., and Third Avenue Management LLC, New York.

Those two fund groups will invest at least US$140 million in exchange for equity in the reorganized Kmart. The investment agreement also gives Kmart a call right for up to an additional US$60 million of convertible unsecured financing from ESL, and ESL has agreed that the cash it will receive under the reorganization plan as a pre-petition lender will be used to purchase additional equity.

In anticipation of satisfactory resolution, Kmart, based in Troy, Mich., had already moved up the target date for its emergence to April, from July. Mr. Lampert and another distressed-securities hedge fund manager, Martin Whitman of Third Avenue Management had long pressed Kmart to finalize a plan.

A spokesman for Mr. Whitman recently declined to comment on the whole matter. A spokesman for Mr. Lampert said that he was "not at liberty to speak about the ongoing negotiations over Kmart."

The U.S. bankruptcy court for the northern district of Illinois, Judge Susan Pierson Sonderby presiding, will hold a hearing on this plan on Feb. 25, and will have to approve the disclosure statement and related voting solicitation procedures before the matter goes further. If the court approves, the company hopes to begin soliciting acceptances in March and to emerge from chapter 11 on or about April 30.

The Kidnapping

Mr. Lampert was abducted on the evening of Jan. 10. On Jan. 13, the day three of the abductors were arraigned in court, Kmart's board of directors approved the broad outlines of this plan of reorganization as well as a five-year business plan.

Soon after his release, his advisers reportedly delivered the message to Kmart that Mr. Lampert's corporate alter ego, ESL Investments no longer wanted to be named in any public announcement about the proposed arrangement. The Wall Street Journal, attributing the news to unnamed "people involved in the matter," said that Mr. Lampert had decided to take a pause after his ordeal before making a major commitment to pay off the creditor banks, which include J.P. Morgan Chase & Co., and Bank of New York Co.

Three of Mr. Lampert's four abductors were quickly captured. Shemone Gordon and Devon Harriswere both arraigned in federal court in Bridgeport, Conn., Jan. 13 for violating the Hobbs Act, committing extortion that could affect interstate commerce. The third person arrested is a juvenile, and accordingly, authorities have not released his name. The alleged ringleader Renaldo Rose, an ex-Marine, was subsequently arrested in Canada on an immigration charge and now awaits deportation.

Turnover in Kmart's Management Ranks

According to documents filed with the Securities and Exchange Commission, as of Jan.1, Kmart (Pink Sheets: KMRTQ) has used US$345 million of its debtor-in-possession credit line for letters of credit. Its total DIP availability as of that date was US$1.56 billion.

"We have made considerable progress over the past year in attacking many of the systemic problems that have plagued Kmart's performance for a long time. Clearly, we continue to face many challenges--both within our organization and in a difficult economic environment that has not been kind to many retailers," said James B. Adamson, chairman of the board, in a statement.

On Jan. 17, Kmart promoted Julian Day, its chief operating officer, to the post of chief executive (Mr. Adamson stepped aside as chief executive, although he remains as chair) and fired five executives, the remaining members of a group of 25 who had received retention loans before the chapter 11 filing. The company is demanding that all 25 debtors repay their loans, worth a total of $28.9 million.

The five newly terminated executives are: Janet Kelley, executive vice president, general counsel and assistant secretary; Mariana Keros, vice president, trend & product development; Douglas Meissner, division president, Western division; Paula Paquette, senior vice president, hardlines and home; and Lee Viliborghi, regional vice president.

The company has had the retention-loan program under review at least since May, and it said Jan. 17 that it had determined that the program was established "without appropriate disclosure of material information to the board of directors by former members of executive management."

The disclosure statement filed with the bankruptcy court Jan. 24 included previously undisclosed information about the results of this review. Management now alleges that there "is credible and persuasive evidence ...that certain former managers of Kmart violated their stewardship responsibilities." Accordingly, the plan includes a litigation trust for the pursuit of legal actions against the ex-managers by creditors of Kmart.

Detail of the Proposed Plan

The plan calls for a new board of directors with nine members: one a member of Kmart's senior management, four selected by the "plan investors," i.e. ESL and Third Avenue, two selected by the unsecured creditors' committee, and two selected by the financial institutions' committee.

Pre-petition lenders will receive cash in the amount of 40% of the principal amount of their claims in lieu of shares of new common stock of the reorganized Kmart.

Holders of pre-petition notes and debentures issued by Kmart in the total face amount of approximately US$2.3 billion, as well as trade creditors, service providers, and landlords with lease rejection claims will share pro rata in the stock of reorganized Kmart, other than the shares allocated to the plan investors.

Trade vendors meeting appropriate qualifications will have up to two years of a first lien on substantially all owner real estate that is developed and unencumbered, as well as a subordination provision regarding future proceeds of leasehold interests, excluding the current store closing program and new financings.

The equity of current stockholders will be cancelled without any distributions.

The disclosure document also included a five-year business plan, which assumes moderate annual increases in comparable store sales.

The business plan "is based on our expectation that we will continue to implement several key operational initiatives, including our focus on being 'the store of the neighborhood' and further testing of the 'store of the future' prototype, with the goal of achieving significant improvements in the customer experience," said Mr. Day in a statement.

CFaille@HedgeWorld.com

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