It may seem like a strange idea to compare the situations of a retail chain and a legacy airline, but today's J.C. Penney (OTC:JCPN.Q) and the pre-bankruptcy version of AMR (NASDAQOTH: AAMRQ), parent company of American Airlines, have more in common than investors may think. Let's examine whether J.C. Penney should take AMR's approach to reorganization.
"Bankruptcy" is often tossed around as a single term. However, bankruptcies take many forms, the best known of which are Chapter 11 and Chapter 7. A company with no realistic chance of restructuring, or one that lacks the financing to do so, may end up with a Chapter 7 bankruptcy. Under this situation, the assets are liquidated and stakeholders often receive only a small fraction of what they're owed.
By contrast, a Chapter 11 bankruptcy allows the company to continue operating while working out a restructuring plan. Companies in this situation can shed burdensome costs and may emerge from bankruptcy able to list new stock that's then used to make up much of what various stakeholders are owed.
But bankruptcy is bad!
No one likes to hear that the company he or she is invested in is going bankrupt. In a typical bankruptcy, in which a company is insolvent, common shareholders are wiped out, since all available funds are used to pay higher-ranking stakeholders.
But another approach to bankruptcy exists -- one where common shareholders can see some investment return. As difficult as this approach is, it can happen, and AMR is a prime example.
A new approach on a bankrupt airline
Unlike so many other bankrupt companies, AMR was solvent going into bankruptcy. It expected to be able to meet payroll and continue to pay suppliers, had no soon-to-be-maturing debt, and had around $4 billion in cash on hand.
However, AMR also had a cost structure rendered uncompetitive, as it was forced to compete with the cost structures of more efficient previously reorganized airlines. When AMR filed for bankruptcy protection, the market expected it would end like the other airline bankruptcies, in which common shareholders get nothing and other stakeholders take losses.
But AMR declared bankruptcy before it had run out of cash, and the restructuring of the airline now has the merger plan calling for common shareholders to get a part of the new American Airlines Group. The bankruptcy plan calls for AMR common shareholders to get what they are due, thanks to a collection of factors including the airline's comparatively healthy state going in and the merger with US Airways (NYSE: LCC).
The Department of Justice is challenging this merger in a lawsuit that will go before a judge in November. A centerpiece of AMR's restructuring rests on this merger, including the likelihood that AMR common shareholders would recover value.
But the whole AMR saga shows that declaring bankruptcy in a more solvent condition has a higher chance of recovering value for common shareholders than if a company burns through all its cash before declaring. In the case of AMR, not only was there more to divide up in reorganization, but the more solvent nature of AMR also made the airline more attractive to the buyout offer from US Airways.
Could Penney do it?
J.C. Penney is trying to turn its business around and has done a less than spectacular job so far. But the recent announcement of an equity raise will give the retail giant one more shot to recover. The usage of this money will be critical to the fate of J.C. Penney investors. If things have changed at the company and this latest cash infusion does result in real turnaround, investors at this stage could see significant returns.
However, if J.C. Penney burns through this cash without being able to show a solid turnaround, the equity and debt markets will be less likely to invest more money on reasonable terms. At that point, the company should give real thought to an AMR-style bankruptcy, in which a reorganization is done even while the company is solvent. After all, the J C. Penney name, the company's real estate, and its connections with suppliers all still have value. A J.C. Penney with a slimmed-down cost structure and less debt may even be attractive for a takeover, whether by another retailer or by private equity.
I would not recommend J.C. Penney reorganize right now, since it still has another chance with the fresh cash it expects to raise. But if this cash doesn't produce a meaningful turnaround, investors should be aware that the company may opt for a bankruptcy while it's still solvent. And looking at the situation at AMR, the same investors should realize that a solvent and bankrupt J.C. Penney is not necessarily the end.