Kmart’s Game Plan

How was Kmart Holding Corp. (Troy, Mich.) able to pay $11 billion for Sears, Roebuck and Co. (Hoffman Estates, Ill.) only 18 months after emerging from bankruptcy protection?

A report in The Chicago Tribune says that most of Kmart’s came from the company’s stock, which soared in the summer after the retailer announced the sale of fewer than 100 Kmart stores to Sears and The Home Depot (Atlanta) for as much as $910 million. That amount exceeded the value placed on all the company’s real estate in bankruptcy court.

But a Tribune analysis of Kmart’s remaining 1400 stores indicates that Kmart’s real estate may be far less valuable than Wall Street thinks. The Kmart stores sold to Home Depot and Sears were located in more affluent communities than the average Kmart store, the Tribune analysis shows. For instance, the stores sold to Home Depot were located in areas with average household incomes of almost $65,000. Kmart’s remaining stores are found in places where the average household income is below $52,000.

In ZIP codes where Kmart stores are situated, said The Tribune, 21 percent of households earned less than $20,000 a year and almost 50 percent earned less than $40,000.

“Kmart has the oldest and poorest customers of any discount store,” Howard Davidowitz, chairman of Davidowitz & Associates (New York), a retail consulting and investment banking firm, told the newspaper. “They sold the cream [of their stores]. That’s what I tried to tell people. Never in retail history has a retailer who wanted to stay in business sold their good stores.”

A Kmart Corp. spokesman declined to comment on the Tribune’s findings.

Other retail experts say it is highly unlikely Kmart’s remaining stores would fetch anywhere near the premium of those already sold. At Kmart, more than 90 percent of its stores are leased, far more than most department store chains, which tend to own their real estate. While Kmart’s long-term leases with below-market rents may have value to others, the leases become less valuable the longer Kmart occupies the properties.

The Tribune’s analysis shows that a third of Kmart’s store leases will expire within the next two years, although it’s unclear what options to extend those leases Kmart holds. A spokesman would not comment on that issue.

“Every day that Kmart is around, the leased stores are all losing value,” said David Neff, a Piper Rudnick attorney who represented Kmart’s creditors in the bankruptcy proceedings.

Another hurdle for Kmart, said The Tribune, is that its stores aren’t a good fit for other retailers. “At 100,000 square feet, it’s a tweener size,” said Allen Joffe, principal with Baum Realty Group (Chicago). “Home Depot is much bigger and Kohl’s is much smaller.”