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Can Anybody Spare $1 Billion for J.C. Penney?

By Adam Levine-Weinberg - Apr 16, 2013 at 12:19PM

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J.C. Penney has already drawn $850 million on its revolving credit line, and it's apparently looking for another $1 billion in long-term financing. The company's rapid cash burn serves as a warning flag for investors.

There was no shortage of bad news for troubled retailer J.C. Penney (JCPN.Q) last week. On Monday afternoon, the company parted ways with embattled CEO Ron Johnson, bringing back his predecessor, Mike Ullman: a man they had pushed out less than two years before. By the end of the week, several other top executives recruited by Johnson had left the company. Later in the week, news outlets reported that -- despite the return of coupons and other discounts -- same-store sales were on pace to decline by double digits for the fifth straight quarter.

Most important, The Wall Street Journal broke the news last Thursday that J.C. Penney was working with Blackstone Group (BX) to raise $1 billion to improve liquidity. Moreover, J.C. Penney stated early this week that it had drawn $850 million on its credit line to fund inventory purchases and capex. The rapid deterioration of J.C. Penney's credit metrics and share price will make it very difficult for the company to secure more permanent financing on reasonable terms. Furthermore, the company is burning cash so quickly that another $1 billion will only buy it a year or two to recover from the Ron Johnson era. As a result, I think investors would be wise to continue to stay far away from J.C. Penney stock.

Bleeding cash
While J.C. Penney ended the fourth quarter with $930 million of cash and cash equivalents on its balance sheet, I wrote last month that the company was likely to burn through most of this cushion in the first quarter. Since J.C. Penney is already drawing $850 million on its credit line to fund working capital needs, it appears that I understated the severity of the problem.

New CEO Mike Ullman may want to save money by cutting back on capex (which is being used to build out mini-shops within many J.C. Penney stores), but he has limited flexibility to do so. Due to Ron Johnson's gung-ho attitude, many J.C. Penney stores are in the middle of major renovations to build out the new Home section. Of three J.C. Penney stores I visited several weeks ago, two had significant ongoing construction. In one case, nearly a quarter of the store's total floor space was closed off with plastic tarps.

Ullman probably has no choice but to finish the renovations that have already begun, even though that has meant tapping into the company's credit line. More broadly, he faces a long-term strategic problem. Ron Johnson's vision for J.C. Penney involved breaking up every large (100,000 square feet and up) store into shops, but the company is only a quarter of the way through that transformation. With some stores being 30% to 40% shops, others having a few shops, and some having no shops at all, Ullman and his team may have trouble crafting a coherent message to customers. However, J.C. Penney would need to invest even more money to complete the transformation -- or to undo it. One thing is certain: J.C. Penney needs cash to resurrect itself.

Sources of cash
J.C. Penney and Blackstone have apparently been in touch with banks and private equity firms, with the goal of raising $1 billion through a combination of a five-year term loan and the sale of a minority stake in the company. Top J.C. Penney shareholder Bill Ackman claims that he and other major shareholders would be willing to put up more capital as well. However, each of these options comes with major drawbacks. Private equity firms will demand very good terms, which would dilute the holdings of other investors. Bank loans would saddle J.C. Penney with higher interest payments, damaging profitability even further. Last, while I could imagine major shareholders investing some additional money in J.C. Penney, even $500 million seems like a stretch. It simply does not make sense for these investors to throw good money after bad.

I think J.C. Penney's best bet for generating cash is selling off a few of its most desirable stores. This is not a palatable strategy, as it means losing some of the highest-potential stores, but it could produce cash without severely diluting the interests of J.C. Penney shareholders or adding interest expense that J.C. Penney cannot afford. For example, Sears Holdings, another struggling department store giant, was able to sell 11 stores to General Growth Properties (GGP) for $270 million last year. Bill Ackman's Pershing Square hedge fund happens to be a major shareholder in General Growth.  This could open up an opportunity for J.C. Penney to pursue a similar deal -- if any of its real estate would be sufficiently valuable to General Growth.

Foolish conclusion
J.C. Penney will have trouble raising $1 billion on acceptable terms. The best-case scenario is probably a sale of the most valuable store locations, but this depends on buyers being interested in the real estate. Even if J.C. Penney does raise $1 billion or more, there is no guarantee that a turnaround will take hold, making the company a potentially dangerous place for investors right now.

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