October 07, 2013 - 1:53pm EST by
2013 2014
Price: 70.00 EPS na na
Shares Out. (in M): 304 P/E na na
Market Cap (in $M): 2,371 P/FCF na na
Net Debt (in $M): 3,500 EBIT 0 0
TEV ($): 5,871 TEV/EBIT na na

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  • Retail
  • Distressed
  • Bill Ackman (Pershing Square)
  • margin expansion


I am recommeding buying JCP 5.65% bonds due June 1st 2020 for $70 (I am just focusing on this issue but there are many other ways to play this capital structure).  If the company stabilizes over the next 12 months or so and the bonds should trade to a 9% yield or better (about $84), the all in return would be in the mid to high 20s.  Post the equity raise, the Company has bought time to manage a turnaround.  The overwheling point of view in the news media and even in the analyst community is that they are going Chapter 11 soon after this Christmas. That is just not likely now that they have about $2.3 billion of liquidity post the raise and the ablity to raise more liquidity via a second lein piece of debt, drawing on the accordian and selling non core real estate. Some combination of these actions could raise another $500-1000m.  My thesis is that the company most likely muddles along which should eventually provide par for the bonds (about a 12% return from here). For those who want an equity kicker for this investment, invest about one year's worth of interest per 1000 bonds or about 7,000 shares and buy the stock at $8. How the equity does depends on the speed and magnitude of the turnaround but a year's worth of interest, which seems like a reasonable amount of return to risk if you believe bankruptcy is not the most likely scenario.
There have been so many good discussions on the equity board of JCP here that I won't repeat too many of them. The crux of the bear case is that Ackman brought in Johnson to fix up a dowdy retailer and he attempted to make changes to the stores that probably should have been done over 10 years and not 1. The result was the mess we have today and a sales decline to $12 billion from $17 billion and massive losses and the customer is gone forever and that bankruptcy is inevitable.  Bulls argue that JCP can get halfway back to about $14.5 billion in top line through couponing and bringing old vendors back.  There is a lot of debate about how much gross margin will come back and how much of Johnson's SGA cuts are permanent (I am modeling about $4.5billion of SGA). I assume that they can comp about 5% next year and 10% the following year and do a 36% gross margin next year and a 39% margin the following year. I put CapX at $450mm for the next few years (again reasonable people can disagree on this number) and interest expense in the mid 300s. This exercise burns through roughly $800mm of cash next year (essentially all the money just raised) and gets to slightly positve cash flow the following year.  Given the $2.3 billion of cash on hand and $500mm-1000m of other sources of liquidity (accordian, real estate sales, 2nd lien), the company comes nowhere near bankruptcy. For those who believe in the common, you need more like $14.5 billion in sales and a 10% EBITDA margin which is not impossible either but my focus is on the bonds. My proposed structure gives you a mezzanine way of playing the capital structure - though I believe a high20s return on the bonds is ample. If gross margins only settle in the mid 30s, you get to about $500mm of EBITDA in two years. The Company would sill have enough liquidity to muddle along for another year. In 2016, If sales can recover another 5% (to about $14.5 billion) and gross margins stay about 36%, EBITDA grows to about $700-800mm which should be enough to keep out of bankruptcy and eventually get to par on the bonds. Other than the non essential real estate sales that have been widely talked about as a source of liquidity, I am not assuming any kind of real estate (SHLD like) slow liquidation. I am assuming that a small part of the sales damage from the RJ era can be recovered and the liquidity available will give the company time to get a muddle along scenario for the bonds.  The mid 30s gross margins are essentially what Bon-Ton generates and they are in many of the same locations (see my write-up of BONT around $12 with an exit around $18) and have many of the same type of customers and JCP used to generate high 30s gross margins.
The real risk is a continued implosion of same store sales.  The company claims to be generating positive comp store sales but they also claimed not to "need" equity or at least let that story sit out there while they raised common.  There are rumors of hedge funds buying up term loan and CDS to force put the screws to the Company should they not hit Revenue and EBITDA targets. It is hard to handicap how that plays out but $800mm of equity should give the bonds enough room to make it through my muddle scenarios.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


A stabilization of sales and a return to mid 30s gross margins.  There is an old saying that with stocks someone else has to think you are right but with bonds only you have to be right.
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