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What Does J.C. Penney’s Secondary Offering Mean for You?

Daniel Jones
September 27, 2013

Greetings Fools! In my last article on J.C. Penney Company (NYSE: JCP), I discussed the fundamental health of the big retailer, and compared it to some of its peers. What I concluded was that matters were bad and getting worse and that any turnaround seemed unlikely to occur, but not impossible. Toward the conclusion, I did mention that investors should not underestimate an attempt by the company to issue additional equity as it sought what appears to be some much needed funding.

Predictions Do Come True
True to form, J.C. Penney released news yesterday of its intention to raise a substantial amount of equity capital. This came as a shock to the market, especially after statements made by CEO Mike Ullman on Wednesday that the company had sufficient liquidity to meet its operations, and that it expected to report gains in comparable store sales for the current quarter. As a result, J.C. Penney's shares declined in price, due to fear from investors that the company could be more distressed than initially thought.

However, the reason for the discord might be well rationalized. As opposed to a small stock offering, J.C. Penney is issuing as much as 84 million shares to the public. On top of that, they are granting the underwriters of the issue, Goldman Sachs Group (NYSE: GS) the right to acquire 12.6 million shares within 30 days of the offering, for a total issuance of 96.6 million shares. At yesterday's closing price of $10.42 per share, this would imply a total offering of almost $1.007 billion.

Shareholder Implications
When placed next to the company's current market capitalization of $2.3 billion, such a large offering would mean a substantial dilution for shareholders. As an extreme example, for instance, a shareholder who owns, say 10% of the company prior to the completion of the offering would, after a full issuance of the 96.6 million shares, only control roughly 6.95% of the company's common shares. In some cases, if a company can grow rapidly with equity capital, the expected increase in profitability can push shares higher. In the case of J.C. Penney, the opposite will likely be true, as the company's fundamentals have rapidly deteriorated over the past few years.

As shown in the table above, J.C. Penney's return on equity has fallen precipitously from a high of 13.8% in 2009 to -31.1% in 2013. The company's net profit margin has seen a similar decline, while its free cash flow margin has followed suit.

In comparison, companies like Kohl's Corp. (NYSE: KSS) and Macy's (NYSE: M) have performed considerably better.  For instance, Kohl's Corp. has seen its return on equity increase yearly from -71.3% in 2009 to 22.1%, while its net profit margin has been on the rise, and its free cash flow margin has hovered around its five-year average of 4.6%.  Meanwhile, Macy's has experienced a gradual increase in its return on equity from 13.1% in 2009 to 16.3% in 2013, while its net profit margin has consistently stayed around 5.7%.  On the other hand, the company's free cash flow margin has been somewhat volatile, going from a five-year high of 9.4% in 2010 to a five-year low of 2.5% in 2013, but with no definitive trend.

All these factors, when added to a crippling debt load of $4.921 billion (which is more than tw