J.C. Penney (OTC:JCPN.Q) may be the poster child for the collapse of the department store.

For nearly a decade, the business has been spiraling through a series of sputtering turnaround attempts and new CEOs, none of whom could do much more than hold the line in the company's long decline. The retailer never recovered from former CEO Ron Johnson's disastrous rebrand attempt in 2012, and when the coronavirus pandemic hit, bankruptcy seemed inevitable for J.C. Penney. Indeed, the company filed for Chapter 11 on May 15, and it now plans to close 242 out of its approximately 850 stores. 

However, the brand may get a second lease on life.

Simon Property Group (NYSE:SPG), the largest mall operator in the U.S., is partnering with fellow mall REIT Brookfield Property Partners (NASDAQ:BPY) to explore taking over J.C. Penney out of bankruptcy, according to The Wall Street Journal.

Both Simon and Brookfield count on Penney as an anchor tenant at dozens of malls. Simon owns 63 properties with J.C. Penney locations, while Brookfield owns another 99. 

On paper, a bid for the department store chain could make sense, at least if the price was right, as acquiring Penney would could keep a valuable revenue stream in place, avoid the need to find a new anchor tenant, and prevent an activation of cotenancy rules that allow other tenants to pay less rent in the event of an anchor closing. Similarly, it would help also help alleviate any potential blight at its malls.

It wouldn't be the first time Simon and Brookfield pulled such a move, as they previously acquired Forever 21 and Aeropostale out of bankruptcy, but Penney, as an anchor, would be a much bigger move by the property managers. It also seems to be a more a sign of desperation in the midst of a crisis than getting a good value.

Store closing signs hanging from a ceiling of a store

Image source: Getty Images.

A downward spiral

The COVID-19 pandemic has devastated shopping malls and nonessential retailers , forcing several weeks of shutdowns from which the industry is only just starting to recover. Even now, malls seem to be the worst format for shopping right now as they're largely enclosed structures with little ventilation. They also can't easily provide things like curbside pickup, which has became a lifeline for retailers during the pandemic, as most mall stores have no exterior access.

Even before the pandemic, malls were struggling, as were many of their tenants, and few were worse off than J.C. Penney. In fiscal 2019, comparable sales fell 7.7%, and the company posted an adjusted loss of $257 million, or $0.80 per share. Penney did eke out positive free cash flow of $145 million, showing its ability to generate some cash in pre-pandemic times.

The department store chain hasn't released first-quarter results, but revenue likely fell by around half, given that its stores were closed for about half of the quarter. With losses piling up during the quarter and billions in debt, J.C. Penney was forced into bankruptcy after missing an interest payment.

Is this the end of malls?

Keeping alive zombie businesses like J.C. Penney may be in the best interest for landlords like Simon and Brookfield in the near term as the company needs the revenue stream and occupancy, but such a decision signals that malls are on the precipice of a collapse. J.C. Penney is far from the only mall-based retailer in such a precarious position.

Macy's (NYSE:M), another common anchor, posted an adjusted loss of $630 million in the first quarter as revenue plunged 45%, and the pandemic seems likely to accelerate store closures for the department store chain. Meanwhile, a number of mall-based chains have either filed for bankruptcy already or are teetering on the brink of insolvency, including Neiman Marcus, Francesca's, Ann Taylor-parent Ascena Retail, and Tailored Brands, the parent of Men's Wearhouse and Jos. A. Bank, among others.

The longer the coronavirus crisis goes on, the more pressure it will put on mall-based retailers and their landlords.

Simon Property Group finished the first quarter with a 94% occupancy rate and strong profits, and the impact of the pandemic may only show up gradually in its results over the next few quarters as it wrestles over rent collections with retailers like Gap, which Simon and Brookfield both recently sued. But the coronavirus crisis is rapidly accelerating a transition away from malls to e-commerce and brick-and-mortar chains that are more accessible, like big-box stores and off-price retailers, which tend to be found in strip malls, and that spells long-term challenges for mall REITs like Simon and Brookfield.

Acquiring J.C. Penney may help keep the gravy train rolling for these landlords, but zombie businesses have a way of taking down the living as well.