Martha Stewart's everyday troubles: as Kmart files for bankruptcy, retail partner Martha Stewart Living Omnimedia could experience an unwelcome brake on the fastest growing part of its business

Folio: The Magazine for Magazine Management, Feb, 2002 by Jillian S. Ambroz

What's a doyenne to do? Martha Stewart's company was one of the few media outfits to post gains during a misfortune-plagued 2001. But this is no time to plan a celebration. Despite an estimated 5.4 percent increase in profits last year, Martha Stewart Living Omnimedia began 2002 facing increasing investor concern over the financial woes of her exclusive mass-market retailing partner.

MSLO's deal with the Kmart Corporation has been a lucrative one for both sides. Last year, Kmart sold $1.5 billion worth of Martha Stewart Everyday housewares (everything from bed linens to gardening tools), and those licensing fees accounted for nearly 25 percent of MSLO's profits.

But since Kmart filed for bankruptcy on January 22, MSLO finds its fastest growing segment-merchandising--in jeopardy. "The worst part of the Kmart situation for Martha Stewart is that [it] had been fundamentally the strongest, looking over the four business segments for Martha Stewart [in 2001]," says Laura Richardson, vice president, equity research for Adams, Harkness & Hill. (Publishing, television and direct business are the others.)

Kmart's woes have depressed MSLO's stock, and the investment community is seeking guidance from Stewart's company about its contingency plans, says Kevin Gruneich, publishing and information services analyst, Bear Stearns. In a statement released by MSLO on the day of Kmart's bankruptcy filing, Stewart, the company's chairman and CEO said, "We remain optimistic that Kmart... will ultimately emerge from this situation as a stronger, more competitive company in keeping with its proud heritage. Going forward, Kmart will continue to sell Martha Stewart Everyday brand products under the terms of our contract for the foreseeable future." The statement also acknowledged that Kmart owed MSLO $13 million in outstanding royalties, ads in the company's media and cost-reimbursement arrangements.

MSLO can extricate itself from the alliance now that Kmart has filed for Chapter 11, but a bankruptcy judge may have the final word. Even if the marriage remains intact, there will likely be fewer Kmart stores selling less Martha Stewart Everyday merchandise--which in turn will place a drag on what was a key driver of MSLO's revenue growth.

A BEAUTIFUL PARTNERSHIP

When in MSLO renewed its relationship with Kmart, one that had begun 10 years earlier, the newly independent media company got itself one of the most favorable deals in retail history. Kmart, which had just sidestepped bankruptcy, gave MSLO $16 million upfront, hefty licensing fees and complete control over the look of the products, the suppliers and any overseas ventures.

It's paid off on the bottom line. Revenues from Kmart represented 13 percent of MSLO's overall sales last year, but 27 percent of its $101 million in core EBITDA (earnings before interest, taxes, depreciation and amortization before corporate overhead and after backing out Internet losses), according to Bear Steams.

And it looked like the numbers were going to get even better. Last August, the contract was extended through 2008, promising yearly increases through performance guarantees and higher royalties.

Now, however, all bets are off. Kmart, which has increasingly lost ground to competitors like Wal-Mart and Target because of ill-advised price-cutting strategies and a mismanaged supply chain, is expected to close between 250 and 350 of its 2,100 stores. And that means MSLO is likely to take a hit. "If they cut square footage by 5 to 10 percent, you can assume the Martha Stewart stuff would sell down about that much," says Mike Porter, a retail analyst for Morningstar.

The contractual performance guarantees provide some revenue security; says a MSLO spokesperson. But a hurting Kmart will keep MSLO from the upside it had anticipated.

BLUELIGHT BANKRUPTCY

Kmart's bankruptcy may, in fact, deliver the best outcome for MSLO. The contract provides for an escape hatch from the Kmart deal, and that could make MSLO a free agent to be courted by the likes of Target, Wal-Mart, Kohl's, J.C Penney and even Home Depot. The media company owns all its product designs and related materials, says a MSLO spokesperson. Despite a hiccup in sales as the products change hands, a move might serve the brand well, says Bear Steams' Gruneich. "Going with a new distributor might be quite good for the brand, actually," he says. "Kmart has lagged behind Wal-Mart and Target in that sector, and if you saw this product line go into Target stores, it could actually accelerate sales."

Some analysts predict that Kmart will do anything to hold on to its high-profile partner, and could even go to court to contest Martha's departure. "If the company is in bankruptcy and they're trying to turn around, they don't want to lose one of their core product lines," says Kathleen Heaney, senior vice president of Brean Murray Institutional Research. Kmart gives the Everyday products plenty of shelf space and high royalty fees, perhaps better than what competitors could provide," she says.