Third Avenue Management

Kmart Corporation's reorganization plan

In February 2003, Kmart Corporation filed its amended reorganization plan with the United States Bankruptcy Court for the Northern District of Illinois. The corporation planned to exit from bankruptcy. For almost a year since filing bankruptcy, the corporation restructured its operations, closed many of its unprofitable stores, and revised its balance sheet. A year before, the corporation had weak average sales and negative cash flows.

Most of its suppliers were unwilling to provide essential stock of goods to the corporation (as a result of weak average sales).

Its stock price fell from $13 to 66 cents. Claims to equity also increased considerably. Leading financial institutions stopped lending capital to the corporation after the latter’s price of stocks fell considerably. Edward Lampert was the primary architect in the restructuring of the operations of the corporation.

Lampert was part of the ESL investments, one of the financial institutions that composed the creditors’ committee. The committee was tasked to determine the financial capability of the corporation as well as the responsibility to give recommendations to the operational strategies of the company (although this was not encouraged by the court).

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Lampert was seen as an invisible force in the restructuring of the corporation’s operational strategies. He was very frustrated with the current restructuring process of the corporation.

Edward Lampert's recommendations

This forced him to initiate recommendations that were accepted by the corporation’s management. In January 2003, Julian Day replaced Adamson as CEO, a move initiated by Lampert. After the restructuring of the operations of the corporation, it signed an equity investment with ESL Investments and Third Avenue.

Lampert, the founder of the ESL Investments, persuaded the corporation to sign the proposed agreement in order to recapitalize the corporation and settle its pre-petition debts.

ESL Investments and Third Avenue Management purchased significant amount of Kmart’s public bonds, bank and other debts in the secondary market at significant discounts at face value. In 2003, ESL and Third Avenue had $1. 6 billion and $178 million of Kmart unsecured debts. Both ESL and Third Avenue agreed to invest $140 million in cash as part of the agreement. In exchange for the investment, ESL and Third Avenue would receive 14 million common shares in the newly reorganized company. ESL would own 46% of Kmart’s equity and Third Avenue, 5%.

Third Avenue Management

Third Avenue Management had three general roles:

1. secure financial liability for the creditors of the corporation,
2. provide new investments to the corporation (after the corporation announced its plans to exit from bankruptcy) – in exchange for shares in the equity capital of the company,
3. provide technical recommendations to the reorganization of the corporation.

In 2003, the corporation was able to pay its bondholders $327 million in shares for a 14% recovery rate. Trade claims would receive $ 430 million for a 10% recovery. Common shares were cancelled.

ESL and Third Avenue advised the corporation to raise an additional fund to finance a $ 2 billion ‘exit facility’ that the two organizations arranged with the Bank of America, FleetBoston, and GE Capital. Claimholders who were ‘injured’ in the plan would be entitled to vote on the plan. ESL and Third Avenue were reserved the right to make recommendations, as they deemed fit. Both organizations were also reserved the right to intervene in the strategic planning of the company by appointing experts. In short, ESL and Third Avenue were very influential in the restructuring of Kmart and its exit from bankruptcy.