Kmart dives on analyst's bankruptcy warning, primary back to business with Paxson

By Paul Deckelman and Paul Harris

New York, Jan. 2 - Attention Kmart investors . . . watch out.

That was the word from Prudential Securities, which downgraded the giant discount retailer's shares to a "sell" from a "hold" Wednesday and raised the specter of a possible bankruptcy filing, triggering a slide in both its equity and its bonds, even though the company tried to reassure the financial markets that everything is OK. Activity was otherwise quiet on the first trading day of 2002, and the first full session this week, after Monday's half-day and Tuesday's holiday.

In the primary sphere, the market wasted no time getting back to business with a new deal emerging on the first trading day of 2002.

Paxson Communications Corp. announced it will sell $310 million (proceeds) of senior subordinated discount notes due 2009 (existing: B3/B-), with Salomon Smith Barney running the books.

A source told Prospect News that the zero-coupon notes from Paxson would price late this week or early in the week of Jan. 7.

The offering is the first zero-coupon high-yield deal since August of last year.

Meanwhile another sell-side source intimated that a cable company - "a very recognizable name" - will announce an offering of $500 million or more in the next seven to 10 days.

This syndicate official told Prospect News that the fundamentals are in place for considerable January business in the high yield primary market.

"I've been a big believer for some time that the new year's going to be off to a very heavy start like we saw last year," the source said. "The beginning of every year always has some positive tone to it.

"You have insurance companies and pension funds who have very predictable cash flows that have to be invested. And they always want to get started early in the year.

"There have been rumors of pension funds that are looking to target $8 billion towards this asset class, this year. All those things, I think, point to some good times if the economy continues to improve.

"The thing that still hangs over our head is 'When are defaults going to slow down?'"

This official believes that the default rate could peak in the "10%-11% range, before the end of the first quarter, unless the economy does not recover."

The softness which took hold of the high yield primary in the waning days of 2001 - with several deals pricing wide of their price talk - will likely not carry over into the new year, according to this sell-side source.

"I think the reason it softened is because it was at year end," the source said. "I think there were deals trying to get done later in the year than you normally see. And I think that had some impact.

"Let's not forget that October and November actually were not bad months in terms of volume. And I think people were saying 'Listen, if you want my money before year end you're going to have to pay me for it.'

"I'm not sure that necessarily carries over into softness at the beginning of the year."

On the secondary side, Kmart bondholders and shareholders were singing the Blue Light Blues, after Prudential equity analyst Wayne Hood predicted disappointing fourth-quarter, full-year 2001 and 2002 earnings, and warned that unless things improved, the Troy, Mich.-based retailer might find itself in bankruptcy court this year.

Kmart shares slid 72 cents, or 13.19%, to $4.74 on the New York Stock Exchange. Volume of 24.3 million shares was more than five times the usual 4.5 million-share daily turnover.

On the debt side, Kmart bonds "hung in there for a few minutes in the morning, but then got beat up out of the gate," a trader said.

He quoted Kmart's 8 3/8% notes due 2004, which opened at the 82 bid/84 offered level, as going home in the 74 bid/78 offered area. Its 9 3/8% notes due 2006 "were under even more pressure," he said, falling to 70 bid/73 offered from late Monday. He quoted the 8 1/8% notes due 2006 as having fallen to 68 bid/71 offered from prior levels around 75 bid/78 offered.

Among longer-dated Kmart issues, the fall was just as pronounced, although the activity level was considerably lighter, with the company's 7.95% debentures due 2023 dropping to a wide 55 bid/60 offered from prior levels around 62 bid/63 offered.

In a research note, Prudential's Hood, citing softening sales, slashed his earnings estimates for the discount department store chain, projecting fourth-quarter earnings of just 20 cents per share, down from his previous estimate of 43 cents per share. For the full 2001 year, the analyst opined that Kmart would likely lose 15 cents a share, versus the earlier estimate of a 15-cent-per share profit. For 2002, Hood reduced his earnings per-share estimate to 25 cents from 35 cents previously .

Even more ominously, he cautioned that Kmart's cash-flow generation would lag, making a bankruptcy filing a distinct possibility. The next six months would be "a critical time" for Kmart, the analyst wrote. "We don't believe a Chapter 11 filing is imminent - but we wouldn't rule it out if the first half of 2002 is disappointing."

Kmart, in response to the Prudential assessment, said it has sufficient funds and available lines of credit to continue to carry out its strategies. But the trader said the company response "didn't do much for its bonds."

Another trader said that Kmart "was down considerably" on the fears raised by Hood's comments, quoting them off at least five points across the board.

"A lot of paper came out of the woodwork," he noted, "as people who had stashed it away all of a sudden decided it was time to see what it was worth." He didn't see that much actual activity in the credit, but rather saw a lot of bids wanted.

Likewise, he noted, Fleming Cos. - which has a major long-term contract to supply grocery items to Kmart - was lower on Hood's prediction that Kmart's money woes may force it to cut spending, which in turn could put a damper on the company's plans to add grocery aisles - to be stocked by Fleming - to many of its 2,100 store locations.

The Dallas-based food wholesale distributor's 10½% notes due 2004 dipped two points to 96 bid/98 offered, but the trader noted "there were a lot of offerings in the Street and very few bids." Its 10 5/8% notes due 2007 were down two points at 94. Fleming shares meantime retreated $1.71, or 9.24% Wednesday on the NYSE, to $16.79. Volume of 3.9 million shares was about three times the usual daily handle.

Apart from Kmart and Fleming, which he said were easily the two major names of the day, the trader saw "a little interest" in Delta Airlines paper - although with no real price movement from recent levels "as retail accounts coming back from the holidays finally stepped up to the plate." Delta's 7.90% notes due 2009, for instance, were quoted around 90.5 bid.

Also in the airline area, Continental Airlines' 7.73% pass-through notes due 2012 were seen around 70 bid, down from recent levels around 75. There was no movement Wednesday, but a market source said the Houston-based air carrier's bonds had been weakening ever since a Dec. 21 Moody's Investors Service downgrade, which dropped its senior implied rating to B2 from B1, with a negative outlook. Continental was among a number of major air carriers whose bonds were downgraded by the ratings agency last month in the face of a slower-than-hoped for rebound in passenger traffic in the aftermath of Sept. 11 and in the teeth of the recession.

There was more evidence of the continued problems of the airline industry Wednesday, as Continental announced that its domestic traffic for December was 2.9 billion revenue passenger miles, down 10.3% from a year ago, and domestic capacity was 4 billion available seat miles, down 11.3% from last year.

Elsewhere, some of the recently beleaguered European cable names firmed in light dealings. NTL's zero-coupon notes due 2008 went from 24.5 bid to 26, while Telewest's 9 5/8% notes closed at 69 bid/71 offered, up two points.

Also in communications, a trader saw a little activity in telecom names, quoting Nextel Communications Inc.'s 9 3/8% notes up two points to around 81 bid/82 offered. Global Crossing bonds hung in around the 12.5 mark to which they had moved in very light dealings Monday on news that the troubled Bermuda-based international telecommer had been granted a waiver through mid-February of potential cerdit agreement violations, giving it more time in which to negotiate with its lenders and try to line up possible equity investors. Aside from that, though, he declared that it was "still a quiet day, with not a ton of activity."

Another trader wryly suggested that "those back from the holiday may have all been dealing with hangovers, so it was just pretty quiet."

End

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