Kmart Bankruptcy

Series: Yale School of Management
Format: Raw, online case
Topics: Finance, Accounting, Corporate Governance, Investing, Retail
Initial date of publication: October 2010
Geographic setting of case: United States
Access:  Available to educational institutions by emailing case.comments@yale.edu. Teaching note available to accredited faculty at business schools.

Overview: On January 22, 2002, Kmart became the largest retail chain in the history of the United States to file for bankruptcy. Less than 18 months later, the company emerged from Chapter 11 protection and its stocked soared. The sequence of events prompted observers to wonder why the chain entered Chapter 11 in the first place and how the bankruptcy process had allowed the company to right itself.

Kmart grew out of the Kresge dime store empire. As discount retailing became more popular after the Second World War, Kresge launched its own discount line, Kmart, in 1962. The stores proved popular and the chain grew at a furious rate during the 1960s and 1970s, becoming the nation's leading discount chain. By 1990, Kmart had become the nation's leading retailer of any kind. This rapid expansion, however, came at a price. Kmart neglected its existing stores and never invested in building an efficient supply chain. In 1991, Wal-Mart took away Kmart's lead and Target emerged as a major competitor. During the 1990s, Kmart posted lackluster earnings and fell further behind Wal-Mart.

In 2000, the Kmart board chose Charles (Chuck) Conaway to become Chairman and CEO. Conaway recruited a crew of young and brash executives who became known as “the Frat Boys” for their high living and high handed style. In 2001, Conaway and the new executives launched an aggressive pricing strategy in an effort to match Wal-Mart. This bold (and some believed foolhardy) move created a liquidity crisis. Conaway tried to manage this crisis by stretching payments to vendors and issuing upbeat and misleading statements to his board and analysts. After disappointing sales over the 2001 Christmas season, vendors and lenders abandoned the company. The company entered Chapter 11 and Conaway was fired.

In the months after bankruptcy, Edward Lampert, a hedge fund manager from Greenwich, Connecticut, managed to purchase a significant portion of Kmart’s outstanding debt. Lampert used his position to take control of the company under Chapter 11, installing a new CEO and pushing for operational efficiencies. To raise cash, the company closed or sold off a number of poorly performing stores. Lampert also pushed to have the company emerge from Chapter 11 protection as soon as possible. By May of 2003, Kmart returned to the market as a public company.

In the 18 months after emerging from Chapter 11, Kmart stock soared. Some credited the turnaround to the new management of the store and their pursuit of higher margins. Others noted that analysts had discovered that Kmart held a substantial portfolio of real estate and leases at below market prices.