At least half a dozen big banks are working with potential bidders for Kmart Corp.'s Pay Less drugstore chain, said to be worth as much as $1 billion.

The banks appear to be looking to finance mainly leveraged buyout firms, as opposed to strategic buyers in the retail industry.

Kohlberg Kravis Roberts & Co. in New York and Freeman Spogli & Co. in West Los Angeles are among the deal firms rumored to be interested in buying Pay Less.

Both firms declined to comment.

Banks working with potential bidders are known to include Bank of America, Bankers Trust, Chase Manhattan Bank, Chemical Bank, Citibank, and NationsBank.

Multiple Clients

Some, if not all, of those banks are working with two or more clients. Within each of the banks, separate teams, divided by so-called Chinese walls, have been set up to work with the bidders.

Bank financing for a leveraged buyout of Pay Less could amount to around $500 million if the chain fetches $1 billion.

The remainder of the financing would most likely be a combination of junk bonds and equity.

For the past few years, banks have generally insisted on around 30% equity financing, but they have been easing up on that requirement in recent months.

A deep-pocketed strategic buyer with a strong credit rating probably would have little use for the banks, apart from possible backup lines, or a bridge loan.

Kmart put Pay Less on the block last month, hiring Merrill Lynch & Co. to run the auction.

Sources familiar with the process said the auction is about midway through the second phase, in which potential buyers sharpen their bids and consult with their commercial and investment bankers.

This round is expected to be completed around mid-September. It's possible a final round of bidding may follow, sources said.

Pay Less operates about 550 stores in the West. Last year, the chain had revenues of over $2 billion and operating profits of about $113 million.

One banker said the $1 billion that Kmart is believed to be seeking represents a steep price for the chain, particularly for a financial buyer.

Lenders probably would have to swallow some pretty aggressive growth projections to finance a deal at that price, the banker added.

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