Kkr And Kmart? This Kould Be Kismet

The Street seems to largely like this takeover idea

Is the nation's No.2 retailer about to becomeKKRmart? That was the word on Wall Street on Nov. 19, when Kmart Corp. shares shot up 17%, to $11.25, on rumors of a takeover by leveraged-buyout giant Kohlberg Kravis Roberts & Co. Neither Kmart or KKR will talk. But KKR has good reason to look at the chain.

On the surface, Kmart seems like anything but a blue-light special. Rivals Wal-Mart Stores Inc. and Target Stores boast newer stores and better customer loyalty while Kmart struggles to modernize. And even though Kmart Chairman Floyd Hall has stemmed the flow of red ink, Kmart's profits are measly. In its third quarter, ended on Sept. 30, Kmart earned just $9 million on sales of $7.8 billion.

Still, Kmart could be a diamond in the rough. Hall has pruned $370 million in overhead expenses this year, and the chain reported a 22.6% gross margin in the third quarter, compared with 21.2% a year earlier. While it still lugs $4.6 billion in debt, better margins would provide cash to service debt from an LBO. "If they could increase their margins even slightly, it would throw off a ton of cash," says one major Kmart shareholder.

KKR has dabbled in retail with previous buyouts of food retailers Safeway Inc. and Stop & Shop Co. And it recently raised $5 billion. A takeover of Kmart at, say, $12 a share would cost about $5.8 billion. And while Kmart has already sold off its nondiscount store subsidiaries except for Builders Square Inc., it has some potentially valuable assets in its 2,143 U.S. store locations. "There's an awful lot you can do with 80,000 square-foot cinderblocks with acres of parking in developed suburban locations," says analyst Ronald Petrie of Roney & Co.

Would Hall consider a KKR buyout? "My board might. We're not closed to any concept that could be in the best interest of shareholders," he said at a Nov. 20 news conference.

Attention, Kmart shoppers: Those pin-striped billionaires roaming the aisles might be Henry R. Kravis and George R. Roberts looking for a bargain.

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