KMART, SEARS & ESL: HOW A HEDGE FUND BECAME ONE OF THE WORLD’S LARGEST RETAILERS Case Solution & Answer

KMART, SEARS & ESL: HOW A HEDGE FUND BECAME ONE OF THE WORLD’S LARGEST RETAILERS Case Solution

As a result of these timing differences, all the bankruptcy related activities attract the financial buyers more. Therefore, the financial buyers are then able to buy the distressed or the bankrupt assets at the most attractive prices possible for them. Moreover, the weakness associated with the financial buyers is the lack of flexibility and the lack of expertise as seen for the pension plans and the mutual fund managers. Therefore, if the strategic buyers have the cash available which could be readily invested then they would be able to create synergies however, this is usually not the case and the financial buyers steal the prize and get the bid.

Question 3
Provide an adequate historical background of the problems facing Kmart and the characteristics of the distressed debt markets. What are the factors influencing an investments in a distressed company?

In the late 1970 s, Kmart was much larger in size and sales revenue as compared to the Wal-Mart which was a superstore giant at that time. The company had around 850 stores worldwide and the sales of the company were 20 times higher than the sales of Wal-Mart. Nonetheless, later on the sales of Kmart had started to slow down however, the sales of Wal-Mart were continuously on the rise and this made Wal-Mart the giant player in the market which it is today.

The main problems faced by Kmart which led to this reduced sales and market position were the unfriendly store layout and the poor supply chain and this had created a disadvantage for Kmart as compared to the other big box retailers in the market. A new strategic decision,which was actually a tragic decision for Kmart, had been made by the company in the year 2001. Under this tragic decision, the management of the company had decided to cut down the costs of the company stores to the ‘everyday low price’ of Wal-Mart. However, this strategy failed for the company and it had to sell the items below their cost and incurred huge losses.

Overall, as a result of the huge losses, the liquidity of the company was highly affected and the management of the company had filed for Chapter 11 bankruptcy. Most of the hedge funds at this time had started to take interest and study the major distressed assets of the company but they were not confident enough nor did they have the required capital to have a controlling stake in the defaulted bonds of the company. It was not possible for the bonds to be sold at the par value however, the bondholders might receive new equity in the new company or the bonds could be simply sold for cash. The time of the bankruptcy of the company was considered as the most opportunistic time for acquiring these businesses, which had greater potential for creating synergies by combining with the healthiest companies of the industry. However, when one of the sectors within the industry is struggling hard in order to stay afloat, the other companies are not ready to commit cash for the failed company and as a result the financial buyers get the opportunity.

Question 4
Compare the Kmart’s financials before and after the bankruptcy (i.e. assets, liabilities).

Kmart had filed for bankruptcy on January 22, 2002. If we look at the financial of the company before and right after the bankruptcy of the company in case exhibit 6, then it could be seen that there had been major changes to the assets and the liabilities position of the company. Based upon the balance sheets of the Kmart in exhibit 6, certain specific ratios have been calculated in excel spreadsheet. It could be seen that all the major ratios for the company had improved after the bankruptcy of the company when the company had sought for financing.
The debt to equity ratio of the company had turned to be positive 1.78 in 2003 from negative 38.34 in 2002. The debt proportion of the company had also been declined significantly after the bankruptcy from a level of 102.68% to a level of 63.97%. Finally, if we analyze the liquidity position, then it could be seen that the liquidity position for the company has also improved significantly as seen by the increase in current, quick and the cash ratio for the company.
Apart from this, if we analyze the trend of the assets and the liabilities of the company through the common size balance sheet as shown in the excel spreadsheet, then it could be seen that there have been large increases in the short term investments and the cash position of the company and the total long term debt of the company had been reduced significantly. The reduction in the value of property, plant and equipment shows that the management of Kmart had sold a lot of inefficient locations or even unused locations after the bankruptcy. The cash proceeds generated from this had been utilized by the company to build up the cash position of the company and also reduce the debt position of the company. Overall, these significant changes to the assets and the liabilities of the company had brought the company out of financial distress and showed that the restructuring and bankruptcy of Kmart was successful…………….

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