Posted on: Saturday, January 22, 2005

Kmart holdings may be overrated

By Susan Chandler and Geoff Dougherty
Chicago Tribune

CHICAGO — It's one of the most amazing corporate comeback stories in recent history: Only 18 months out of bankruptcy, Kmart Corp. launches an $11 billion takeover offer for Sears, Roebuck and Co.

Where did Kmart get the dough?

Most of it came from the company's stock, which soared last summer after Kmart announced the sale of fewer than 100 Kmart stores to Home Depot and Sears for as much as $910 million. That amount exceeded the value placed on all the company's real estate in bankruptcy court.

Investors used that premium price to value the rest of Kmart, giving Kmart Chairman Edward Lampert the purchasing power to pull off the Sears deal.

But a Chicago Tribune analysis of Kmart's remaining 1,400 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 weren't representative of the overall portfolio because they were in more affluent communities than the average Kmart store.

For instance, the stores sold to Home Depot were 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, 21 percent of households have had an annual income of less than $20,000 and almost 50 percent earned less than $40,000.

"Kmart has the oldest and poorest customers of any discount store," said Howard Davidowitz, chairman of Davidowitz & Associates, a retail consulting and investment banking firm based in New York.

"They sold the cream (of their stores). Never in retail history has a retailer who wanted to stay in business sold their good stores."

Real estate executives who specialize in retail workouts agree that valuing a portfolio as big as Kmart's is fraught with the potential for large errors.

It's not a simple institutional investment, they say, because stores in a single retail chain may vary widely in size and have vastly different lease terms, including landlord rights.

The speculation that Lampert intended to diversify out of retailing ended Nov. 17, when Kmart announced it was acquiring Sears for $50 a share in cash and stock.

While the deal helps answer the question of what will become of hundreds of Kmart stores — they will be converted to Sears stores — it doesn't answer what will happen to most of Kmart's stores, many in less-than-attractive areas.

Kmart says the new company will operate under both the Kmart and Sears banners, but retail experts say that is inefficient.

It's more likely, they add, that the Sears deal is a way to liquidate Kmart over a longer period of time.