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Why Things Are Worse Than J.C. Penney's Letting On

By Steve Symington - Sep 28, 2013 at 12:00PM

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Few are surprised J.C. Penney is raising more cash to stay afloat, but here's why things could be worse than management claims.

To say this week has been brutal for J.C. Penney (JCPN.Q) shareholders seems a massive understatement.

The stock has lost more than 30% since Monday, when I pointed out that the struggling retailer was said to be in talks with banks and institutional investors to raise more capital to finance its faltering turnaround.

Incidentally, I also noted that the news was especially troubling considering that it came less than four months after J.C. Penney not only secured a $2.25 billion five-year term loan with Goldman Sachs (GS 0.14%) to stay afloat but also was left with $1.535 billion in cash at the end of last quarter after burning through more than $1.1 billion between capital expenditures, inventory restocking, and debt repurchases.

Here's what J.C. Penney said
But then, shortly after a plunge on Thursday, when a Goldman Sachs bond analyst raised eyebrows by recommending investors buy J.C. Penney credit default swaps (which pay off if a company defaults on its debt), J.C. Penney issued a press release stating it was "pleased with its progress thus far in the Company's turnaround efforts and the traction of its initiatives are starting to achieve."

In addition, the company said, it was "encouraged by improvements in purchase conversion both in store and on," primarily because of "being back in stock in key items and sizes the customer expects to find at JCPenney." It continued: "Overall sales on continue to trend double digits ahead of last year."

Here's what it didn't say
But J.C. Penney was also notably absent regarding its core bricks-and-mortar comparable sales, which makes you wonder just how bad the its next quarterly results will be.

And yes, I understand the company had to start somewhere to turn the business around, but if J.C. Penney's primary reason for seeing improvements in purchase conversion is simply restocking the same old stuff people expected them to have in the first place ... well, to me it seems a celebration of mediocrity, at best. 

Perhaps we shouldn't have been surprised, then, when shares of J.C. Penney plunged more than 13% on Friday, after the company announced plans to sell 84 million shares of common stock at $9.65 per share -- that's a 7.3% discount to Thursday's closing price of $10.42 per share -- with Goldman Sachs serving as the sole book-running manager for the offering.

All told, that would bring in around $811 million, not including an option granting underwriters the right to purchase up to an additional 12.6 million shares of common stock over the next 30 days.

But that brings up another question: If Monday's reports were true, and J.C. Penney was indeed undergoing talks with banks and institutional investors to raise more capital, why did it have to make the seemingly desperate move of trying to talk investors into buying 84 million new shares at below-market prices?

Assuming those talks weren't with Goldman Sachs about this particular offering, something tells me J.C. Penney simply couldn't convince any outside source of capital that it was worth risking more money by issuing another term loan or revolving credit line.

As a result, I think Friday's dilutive move was one of last resort from a company that knows its huge losses won't end anytime in the near future. When all's said and done, even if you thought J.C. Penney's harrowing decline so far has been impressive, that's why I'm convinced we haven't seen anything yet.

Fool contributor Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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