This is my first article on J.C. Penney (OTCPK:JCPNQ) the historic retailer that filed Bankruptcy on May 15, 2020 with $500 Million dollars in cash, and $1.4 Billion dollars in unencumbered real estate.
I have over 20 years experience consulting in large complex Bankruptcy cases for Law firms, large creditors and Debtors. This is the strangest case I have ever seen.
This article will make the case that J.C. Penney is not “Hopelessly insolvent” and in fact has plenty of money left for unsecured creditors and shareholders if the right actions are taken and the right plan is implemented.
It’s interesting to note, the debtor stressed two main points at the hearing for approval of the Debtor in Possession Loan in May 2020:
A. They predicted that unless they received a $450 Million dollar DIP Loan, they would run out of money in late June/July.
B. The Bankruptcy needed to move fast in order to keep the support of the 1st Lien holders.
From the beginning of the Bankruptcy, the projections made by the debtors advisors were very pessimistic, which was understandable due to the shut down of all of their stores during the quarantine. However, 300 stores opened sooner than expected, so the revenue projections which were based on a total shut down for many more months, were off by a long shot.
As shown in the chart below (Doc 1268) as of July 18th, 2020 their total available cash exceeded the June 4th projections by approximately $400 Million dollars (and exceeded the the projections in the interim cash flow projections by over $500 Million dollars)
This large increase in revenue gave shareholders a reason to celebrate as the Current Restructuring Support Agreement, wipes them about but was based on much lower revenue numbers.
However, after failing to run out of cash in June or July as they predicted, the Debtors’ advisors predicted a liquidity crisis would now happen sometime in mid August, but instead they have amassed over $1.48 Billion in cash as of the writing of this article.
Because of the increasing revenue, J.C. Penney has a $450 Million dollar (DIP) Debtor in possession loan they have not had drawn on. Despite their earlier projections In May and June being off by hundreds of millions of dollars, they still have not adjusted their recovery projections for unsecured creditors and shareholders. This is further proof that an official equity committee needs to be appointed.
Does a company with $1.48 Billion in cash and no bond debt due until 2023, earning over $300 Million a year in Credit card royalties (which cost less than 1 Million in expenses to generate) sound like a company that is insolvent to you?
Regardless of how much money JCP earns, or how positive the numbers continue to be, JCP advisors haven’t changed their recovery projections, the Debtors net cash flow exceeded it’s interim Budget Projection by 229.4% and the Debtors had accumulated $721 Million more in short-term investment funds than projected.
Why should the Bankruptcy Court trust the future projections presented by the JCP advisors, when so far they have been off my literally hundreds of millions dollars?
Many shareholders predicted this revenue windfall and filed letters and motions accusing the JCP Management of filing the Bankruptcy in Bad Faith, some don’t go that far but just accuse them of gross undervaluation of assets, some cite financials and appraisals based on SEC disclosures made by management just a few months earlier (See Docs 294, 319,333, 389, 518, 555, 529, 575, 576, 577 484) and many others. These letters are quite convincing, especially since the numbers presented to shareholders have been more in line with the shareholder letters than the JCP advisors.
Nick Celentano, the Chairman of the ad hoc equity Committee recently said”
We’ve been working with counsel and our financial advisors for two months now analyzing data and putting together a true valuation of JCP. The results confirmed what we knew from the start, JCP is worth much more than the Debtors believe. We see a recovery in all models for equity we’ve ran. Let me make one thing clear to all parties involved. We will not accept any plan that does not give equity it’s fair share.
The Ad Hoc shareholders committee has filed a motion to have an official equity committee appointed (Doc 1268) I fully support this motion and Pandemic or not, the numbers don’t lie, even if the real estate and inventory are worth much less than appraised value, the Online Business and Credit Card royalty revenue are not valued at close to ZERO.
J.C. Penney Bankruptcy vs. Sears Holdings Bankruptcy
J.C. Penney is a different animal than the Sears Holdings, Inc. (OTCPK:SHLDQ) Bankruptcy, in that case which I have covered in multiple articles, the debt and common stock is majority owned and controlled by Eddie Lampert and his investment vehicle ESL Investments. The REIT made up of former Sears real estate is controlled by ESL, and so is the spin-off Lands’ End (LE) and the old Sears Transform Holdco.
Unlike J.C. Penney, Mr. Lampert refused to fire sale the Sears real estate, in fact years prior to the Bankruptcy, ALL Sears shareholders were provided the opportunity to purchase 266 prime real estate assets from the company on a parri passu basis, this entity became Seritage Growth Properties (SRG) As stated later in this article, if you are going to sell the real estate, why not offer it to shareholders FIRST. Why favor the first lien holders?
Why not offer the opportunity to shareholder and unsecured bondholders?
J.C. Penney’s management owns little or no equity in J.C. Penney and have a different plan than Sears Holdings had for their Real Estate, they plan to essentially allow the First lien holders to foreclose on it at a depressed price during a once in a hundred year pandemic (See the Reconstructing Support agreement Doc 25 page 48)
J.C. Penney’s side of the Story
J.C. Penney in it’s earlier pleadings, alleged that due to the pandemic their first lien holders are essentially unsecured and most or all of the real estate assets of the company must be sold and/or foreclosed on by them and turned into a REIT, the operating retail business would be sold with shareholders receiving nothing and unsecured creditors getting an undisclosed amount.
J.C. Penney asserts that the COVID-19 Pandemic has reduced the value of ALL their assets so much that the only class of creditors in the money are the 1st lien holders, even though J.C. Penney had $1.4 Billion in unencumbered real estate prior to the filing pf the Bankruptcy. (that real estate is now a part of the DIP loan collateral, see Doc 333 Page 15)
In all of the pleadings addressing the stock holders the actual value of the assets (Pandemic or not) are not provided via appraisal or a market test, they simple point to the trading price of the debt and stock allege that this is why shareholders are out of the money.
In their objection to the motion for an official equity committee (Doc 1300) the debtors assert:
The Motion also ignores market realities, reflected in the trading prices for the Debtors’ debt and equity securities that place shareholders near the money, where (as here) nearly $2 Billion of the first lien debt is trading at 38 cents on the dollar, $400 Million of second lien debt is trading at a penny on the dollar, and $1.3 Billion of unsecured debt is trading at a penny on the dollar, it seems highly unlikely that shareholders will end up in the money.
J.C. Penney’s listed $8.467 Billion in assets in the Initial Bankruptcy filing but now they say those assets are worth less than $3.9 Billion dollars. Perhaps the real estate has declined some or even a lot, but the e-commerce business and credit card revenue has done substantially better, and these assets and revenue are totally unaccounted for, or grossly undervalued at best.
The credit card royalty stream is a totally separate business from the retail business and e-commerce business and must be appraised and sold separately for this very reason. It should not be “gifted” to whoever buys the brick and mortar retailer.
In the Motion for an official equity committee (Doc 1268) the Ad Hoc equity committee lawyers/advisors made points that were not properly addressed in the objection to the motion (Doc 1300)
To be clear, JCP has an extra $700 Million dollars they didn’t expect to have but they still filed an objection to approval of an official equity committee. I estimate this committee would cost less than 2-3 Million dollars depending upon how amiable other constituencies are. Page 23 of this motion shows that plenty of value is left for Shareholders.
As shown below on a Discounted cash flow analysis and an Orderly Liquidation Analysis the equity committee lawyers make a compelling case for value being left for the equity (See Doc 1268 Page 25 Below)
THE MOORE PLAN FOR SHAREHOLDER RECOVERY
The Debtors’ original bankruptcy petition stated assets of $8.6 Billion, and debts of $8.2 Billion, with no unsecured Bond until 2023. The issue they have promoted has been the refinancing of the 1st Lien Debt.
The funded debt totals $4.9 Billion dollars (See Below)
JCP themselves asserted their assets were worth $8.6 Billion in their own Bankruptcy filing but based on the fact that their other projections have been so far off, can we trust this number?
The JCP advisors have continued to assert that the first lien holders are impaired, meaning ALL the J.C. Penney the assets are worth close to or less than less than $3.6 Billion. Even after exceeding revenue projections by more than $500 Million dollars they have not made any adjustments to the Restructuring Support agreement. (See Doc 25 page 48) (If they have they have not been disclosed to the shareholders)
The JCP Credit Card Royalty Revenue is Significant
The largest undervaluation of assets that JCP has made is that they value the credit card royalty revenue at essentially ZERO, I value this income at $1.5-$3 Billion dollars.
In a New York Times Article Published on May 11 2017, it was reported that the money from the Macy’s branded credit cards accounted for 39 percent of the company’s total profit of $1.9 billion last year in 2014, up from 26 percent in 2013, according to an analysis by Morgan Stanley. At Kohl’s, the profit from plastic totaled 35 percent, up from 23 percent, over that same period. At Target, it made up 13 percent of total earnings, up from 11 percent in 2013. Now, let’s take a look at the J.C. Penney credit card royalties.
J.C. Penney has two credit cards, a J.C. Penney Store card and a J.C. Penney MasterCard (Which can be used everywhere MasterCard is accepted) the royalty numbers since 2014 are listed below:
2014- $313 Million
2015- $367 Million
* This year was higher due to the change in reserves
More than Four years prior to the filing Bankruptcy, Sears Holdings converted ALL their Sears Store Cards to Shop Your Way MasterCards, this way the credit card royalty revenue is not dependent upon the survival of the brick and mortar retailer (among other reasons)
The Moore Plan converts all JCP store cards to a JCP General MasterCard that can be accepted anywhere MasterCard is accepted.
The Moore Plan would offer all shareholders an equal opportunity to buy into the JCP REIT (Like Sears Holdings did with Seritage Growth Properties) If shareholders do not purchase all the units of the REIT, other constituencies would be provided the opportunity to buy the Surplus.
The Moore Plan provides that the Retail Business would be sold separately without the credit card revenue, so that at least $1.5 -$3 Billion more in value is available to all stakeholders, below are a few options:
Option 1: Have JCP to issue Secured Bonds backed by this revenue, (similar to the Bowie Bonds Back by David Bowie’s song royalties) these funds can be used to refinance the 1st lien debt and develop the Real Estate to be transferred into the REIT.
* Shareholders and creditors could exchange some or all of their debt for these Bonds and be offered the first opportunity to buy any surplus
Option 2: Sell the royalty stream a Minimum of $1.5 Billion-$2 dollars to an outside party and use the funds to refinance the first lien debt, tender for unsecured bonds and develop the real estate internally.
Option 3: Spin-off the credit card royalties into a separate company with shareholders and unsecured creditors getting a piece of the company on a pro rata basis with the surplus going to refinance the first lien debt or replace them altogether.
Option 4: Request an advance on this royalty stream from Synchrony (the Card portfolio owner) of no less than $1 Billion dollars (about 3.3 years revenue) and perhaps renegotiate for a higher royalty and refinance the first lien debt, then tender for the unsecured Bonds and/or convert them to PIK (Paid In Kind) Bonds with an extension of 3-5 or years and offer 25-50 cents on the dollar in cash for those that don’t want to convert to PIK.
Because their is no unsecured debt due until 2023, using the credit card royalty revenue to significantly pay down down and/or refinance the 1st lien debt makes sense, this plan makes cash interest an option of the company and/or pays off the debt at a discount. The credit card royalty advance or securitization would be recouped from the royalties generated from the credit card portfolio not other revenue of J.C. Penney.
Any of these options raises $1-$3 Billion Dollars from an unencumbered asset that is listed at close to ZERO value by J.C. Penney, again, the royalties would be recouped first and only from that source of revenue, this revenue stream is mostly unaffected by COVID 19, which the debtors blame for devaluing all the other assets, and it has nothing to do with real estate appraisals and isn’t connected to the survival of the brick and mortar retailer.
All shareholders should buy unsecured bonds as a way to hedge, even when value is available for shareholders the wrong plan and lack of incentive from management can cause the stock to be wiped out, so hedging is essential. ALL shareholders should own unsecured bonds as they are worth par plus interest under the Moore Plan.
J.C. Penney’s management has no skin in the game and in Bankruptcy, unsecured bondholders are higher in priority than shareholders, these Bonds currently cost 1 cents on the dollar. In my opinion, it is irrational not to own unsecured bonds if you believe their is value left for stockholders. Under the absolute priority rule, unsecured Bondholders get paid BEFORE stockholders.
For new investors, It’s possible to make 25-100X your investment on the unsecured Bonds, for stockholders you can protect yourself from receiving no recovery but owning the unsecured bonds. All this is contingent upon the equity committee becoming official and the Moore Plan or a variation of it is implemented.
Disclosure: I am/we are long JCPNQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own unsecured bonds and common stock