Where Will JC Penney Go From Here? Six Options for the Company
Whatever happens could decide the fate of JC Penney as a public company -- or even as a company that remains in existence.
The Ron Johnson experiment at JC Penney (NYSE:JCP) is over.
In steps former CEO Mike Ullman as an interim CEO to fill the gap until the board of directors can find a full-time replacement. Shares are tumbling as sales growth stalls and customer traffic plunges. The real question is: Where does JC Penney go from here?
Analysts at Credit Suisse commented after the announcement late Monday and said, "The key issues that Mike Ullman, the newly reappointed CEO of JC Penney will need to address in the next 60 days include: liquidity, merchandising in general (and the fourth quarter in particular), and rebuilding the management team.
"Mike Ullman was certainly not the top-of-mind candidate to replace Ron Johnson, but he does come with certain attributes. He knows his way around all JCP constituents and has a passion for the business. But he must be viewed as an interim appointment, meant to stabilize the situation. His immediate task in our opinion is to gain additional long term liquidity, something he ensured during his previous tenure at JCP."
Thus, the liquidity issue comes back to light. JC Penney is a heavily indebted company with over $2 billion in net debt as of January, compared to an enterprise value of $5.5 billion. With negative earnings and EBITDA and some analysts forecasting negative operating free cash flow for 2014, the liquidity issue could transform into one of solvency, risking bankruptcy or worse, liquidation.
Therefore, the new management team needs to quickly, efficiently, and prudently analyze any and all means to raise the company's long-term liquidity position. Right now, the company can pay its debts. Looking forward, however, the situation gets rosy and the company needs to begin to worry about these issues now. The company can do a few things to bolster its liquidity position over the next few years both internally and externally and as either a public or private entity.
Option 1: Cost-Cutting
The age-old strategy of troubled companies is to cut costs to boost the bottom line and protect cash flows. Thus, JC Penney could look to close stores, lay off workers, and shrink the size of its operations to make the company leaner and more able to withstand changes in its customers preferences. A key negative for the company has been the reduced foot traffic due to the flip-flopping in discount policies at the stores.
The Credit Suisse analysts noted that much of the senior management are protégés of Johnson, brought in to the company during his tenure. "We would expect turnover in these positions followed by the need to fill them rapidly with individuals that have experience in the middle markets of America," Credit Suisse wrote. Thus, layoffs could actually start from the top down.
A revamped marketing campaign that better targets JC Penney's customers could also help to boost the top-line.
Tom Keene, the famed anchor of Bloomberg Surveillance, said Tuesday morning that Ron Johnson was amazing at marketing a product that everyone wanted at Apple (NASDAQ:AAPL) in the iPhone; however, JC Penney is selling an entirely different product to an entirely different consumer. Better targeting this consumer could bring traffic back to stores and keep the company afloat.
Option 2: REIT Spin-Off
Another option for JC Penney would be to spin off some of its stores into a REIT, as mentioned by analysts over the past few weeks. In this scenario, JC Penney would spin off some of the company's key stores into a new Real Estate Investment Trust, raising cash quickly for the company. However, raising cash in a quick accounting move such as this creates its own set of problems.
First of all, owning your stores can be beneficial because it shields you from rent inflation. Assuming that the key properties that will be spun out are in strong real estate markets in urban areas such as New York City, JC Penney would now expose itself to the inflationary nature of rents as well as regulation such as rent control. In sum, this is a great way to raise cash quickly but can also have negative side affects in the long run.
Option 3: Leveraged Buyout
Bill Ackman, who runs Pershing Square Capital, is notoriously the largest shareholder in JC Penney, owning over 18 of the shares. Also, he has a very close relationship to the board of Vornado (NYSE:VNO), the REIT that also owns a large stake in JC Penney. Since the companies already own a large portion of JC Penney stock, the LBO would require less equity in the deal than comparable deals done in the buyout boom of 2005-2006.
However, the leveraged buyout has its own drawbacks. As mentioned, a key issue of JC Penney is its liquidity position and its debt load. An LBO requires the investment firm launching the deal to load the company's balance sheet with lots of debt, as stated in the name. Thus, an LBO will be difficult due to the company's already large debt pile. Therefore, investors can pretty much write an LBO off of the table.
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