JCP - JC Penney

[onyx1]

Language from September 4, 2012 10-Q:

 

"For the remainder of 2012, we believe that our expected cash flow generated from operations, combined with our existing cash and cash equivalents and the savings resulting from the elimination of the dividend will be adequate to fund our capital expenditures and working capital needs."

 

Language from the just-released December 4, 2012 10-Q:

 

"For the remainder of 2012, we believe that our expected cash flow generated from operations, combined with our existing cash and cash equivalents, the savings resulting from the elimination of the dividend and the access to our credit facility will be adequate to fund our capital expenditures and working capital needs."

 

 

 

[BG2008]

A few updates:

 

1) Noticed a lot more clearance signs in the men's section at the 2 stores that visited.  Virtually all the men's Izod products and JCP Men's clothing were heavily discounted.  I guess those bright JCP Men's color isn't really working out.  Surprised that men's IZOD is being heavily discounted as well.  I thought that Izod is doing well. 

 

2) Saw the heaviest traffic when they ran their 20% off friends and family promotion about a week ago

 

3) Apparently Target has been promoting a shops concept for sometime:

 

http://www.youtube.com/watch?feature=player_embedded&v=4CxwY6blXuw

http://www.youtube.com/watch?v=MZ34plvb8tU

And a not so nice review on Target's candy offering

 

 

[BG2008]

New Insights - Would Like Some Feedback

 

I believe I've stumbled upon a revelation on why JCP will eventually wind up becoming the most fashion forward retailer, how JCP will actually "arbitrage" $4 rent vs $40 mall based inline rent

 

The premise goes like this:

 

1) In order to become the dominant retailer, you have to offer products that are truly differentiated and must change your offering with ever changing fashion trends

2) In order to offer good products, you must attract good vendors

 

How do you attract good vendors?  Why will vendors sell at JCP over Walmart, Target, Costco, Kohl's, Macy's, Nordstrom, Dillards, Bloomingdale, or go rent space from Simon's, GGP, or Macerich? 

 

At Walmart, Costco, Kohl's, Target, your products are likely displayed in a way that will make most vendors cringe - But these channels offer quick ramp and almost guaranteed profitability vs operating your own stores.  But you risk diluting your brand. 

Macy's setup is probably the most similar to JCP, but Macy's, Dillards, likely have a full array of brands already.  It's likely very difficult to gain shelf space at these channels

Simon, GGP, or Macerich requires 10 year leases and a long ramp time.  It took Abercrombie and Fitch 10 years to get to 500 stores and cost them around $500mm of cap ex as well. The mall concepts are great when you're Abercrombie and SSS grows over time.  But, if you're a mediocre brand like PacSun or Bebe, growing via the mall route can bankrupt you if your offerings falls out of line with fashion and SSS drops YOY.  When rental expense exceeds 15%, you as a brand retailer really starts to gasp for air. 

 

I went to visit Joe Fresh on Fifth Avenue, Jon Adler and Giggle in Soho.  I can see why JCP picked those vendors.  They seem to bring a very unique offering to JCP.  Yet these business have limited scale in the US.  Joe Fresh has 3 stores in NYC.  Jon Adler and Giggle both have around a dozen locations I believe.  But with JCP, they can ramp up to 700 locations in under 12 months.  They can have their shop build out the way they want and convey the message that they intend to.  Their profitability is virtually guaranteed, because they are not paying $40 per square foot a year.  If their sales are poor, the consequence is that they get dropped from JCP's line up. 

 

Joe Fresh is one of the most exciting retailers in Canada and very fashion forward at affordable prices.  Jon Adlers reminds me of Ron Johnson's interaction with Michael Grave while he was at Target.  Everything in the store was over $200 for a small chic product.  I'm pretty sure JCP is working with them to design an affordable line to the masses.  Giggles is valued by JCP for its registry business.  The new JCP is really big on getting to know its customers via data acquisition.  The buttons weren't just an enticement, you had to enter an e-mail to redeem the buttons.  Giggle's registry will help to notify JCP when a mother is pregnant.  Pregnancy is one of the most important in the turning point of a woman's shopping behavior, when a woman becomes pregnant, her needs/wants becomes drastically different than before.  Why would Disney want to sell in over 500 of the JCP stores?  Disney wants to be in JCP because it a) offers quick ramp and b) virtually guarantees profitability. 

 

I view JCP currently as a goodco/badco.  The goodco is the square footage represented by the shops and the badco is the square footage represented by the traditional business.  As they convert the badco into the goodco, $/sqft will go up and so will gross margin along with these shop square footage. 

 

Obviously, most of us can put together some financials and see that if you increase gross margin by this much and reduce SG&A by this much and voila you've got a massively profitable company going forward.  What I'm trying to answer is "Why will JCP offer good products going forward?  Why will customers want to shop at JCP?"  I believe the answer lies in the fact that JCP is essentially a platform that offers 1) Quick Ramp 2) profitability guaranteed 3) ability for brands to convey/impart their brand images 

 

Think about his - GGP, Simon and Macerich offer tenant improvements that could be as much as 1 year rent to entice tenants to take their space.  Vendors are supposedly funding JCP with the shop build outs.  Ron Johnson had mentioned this a few times on the calls.  Clearly, JCP is offering the vendors economics that are extremely attractive in order for the vendors to help fund the build out. 

 

Lastly, does JCP have enough cash to fund the build out?  I've put together a model and I think that it's a close call.  They need to get back to postive EBITDA first.  But the $1bn of cash at year end, another $200mm of non-core assets, and the $1.5bn in credit facility would be helpful.  My model assumes no vendor support in the build out and a $1bn in cap ex per year.  The conclusion is that, it could be tight if gross margin and $/sqft doesn't improve. 

 

Would love feedback from people regarding my assumptions.  Would love to know if my logic is flawed.  I am more than happy to provide further detail on the points above. 

 

 

 

[hyten1]

BG2008

 

i don't want to burst your bubble, but this is nothing new. bill ackman spoke about this during his cnbc interview, this is one of the thesis for the bull case.

 

i agree with everything you said, at the end of the day, its show me time.

 

hy

[BG2008]

No bubble bursting.  We are all very aware of the possibility that JCP will go broke before they can convert all their space into shops.  I think JCP is all about handicapping the probability of this turnaround.  Which is why the company is trading where it's trading at.  Bill Ackman certainly mentioned the goodco/badco.  I don't think that Ron Johnson or Bill Ackman went into the specifics of the attractiveness of the JCP/Mall arbitrage.  After crunching the numbers, it's very black and white which is the preferred route for vendors.  Most of the assumptions I used came from working on an attempted sale of a 3 mm square foot mall portfolio back in 2008 and following a couple mall based retailer's attempt to ramp their business.  The revelation here is that the vendors likely will NOT abandon the shop buildout strategy.   

 

If this is show me time, then anyone care to analyze the cashburn and how feasible JCP can get to 40, 70, 100%% build out?  Also, has anyone compare side by side the economics of a build out via the regular mall based stores vs selling through JCP? 

 

It's one thing to say "this ship is sinking fast", it's another to say "X gallon of water is leaking in, but our pumps can handle 1.5x of that and we're working on plugging the hole"   

[Kraven]

I've been meaning for a long time to take a walk around a JC Penney and see what it looks like.  I found myself right by one in Northern Virginia and decided to spend a few minutes and look around.

 

I am not sure what I expected, but after seeing some of the pictures of the prototypes and so forth I can say that this store at least definitively did not look a thing like that.  It was like a department store museum.  It reminds me of exactly what a department store looked like in 1981.  That being said, there was a lot of traffic there although the mall was pretty busy today. 

 

I was definitely excited to see the stores within the stores.  This one had the usual - Sephora, Izod, Levi's, Arizona Jeans, etc.  Again, I'm not sure what I expected, but this wasn't it.  Other than maybe Sephora, I had no real sense that these areas were actually "stores" within the store.  They looked like nice displays, no different from any other department store that dedicates some space to a brand.  I didn't see much traffic in these areas.  There were a couple people in the Levi's space. 

 

I think I expected that each area would be a clearly defined space.  As I said, it just seemed like a display area.  The Levi's section had nice wood floors and some random wooden benches.  I think there may have been some Ipads there, but if so they were turned off and looked well used and smudged.  The Izod area and the JCP area were nicely lit.  I was somewhat confused in that Arizona Jeans, which I thought was one of the "stores" was in at least 3 different places (maybe men, women and children?  I'm not sure, I didn't look closely enough).  Sephora was nice and big and did clearly seem like a separate space.

 

I think I had an image in my head that each "store" would be closed off in some way to give the feeling of an actual, small store.  I don't know if that was just in my head or what the prototypes show.  In any case, this store gave no sense that there was anything other than a display area.  In fact, walking around the store, without some major overhaul I actually can not see people just staying in that one store and doing all their shopping there as opposed to venturing out into the mall. 

 

As to the rest of the store, it was incredibly dated.  There did seem to be plenty of employees helping people.  Every few feet there was a big sign hanging from the ceiling that said "30-60% Off".  By the door where I walked in there were toy helicopters with a big discount on a few shelves that hadn't been restocked, next to the optical department, the hair salon and men's underwear.  Very random.

 

I own a little stock, but can say that if I had seen this store before I bought it, I may not have.  I'll hold on and see what happens.  At the end of the day, whatever they are trying to achieve, this store at least is very far from that goal.  Just thought I would share my experience.

[BG2008]

Kraven,

 

I'm not surprised at all by your description.  Admittedly, the total "shop" square footage is only 10% across the board.  I happen to live on Long Island and visit the Roosevelt Field Mall JCP and that locations gives me a better image of what a build out ultimately will look like.  I agree with you that Sephora, Levi, Liz Clairborne (big yellow doors), MNG by Mango, JCP women, men, and Izod, obviously stand out as "shops" at the Roosevelt location.  I've visited a few other lesser locations and the new "shops" are certainly an  upgrade over what used to very dated selling space.  I agree that they also cheapen a bit on the Arizona shops, it's really just shelves re-arranged, it doesn't stand out that much. 

 

Anyone still following this name? It seems that the posts here have diminished significantly lately when 2013 is truly the make-or-break year for JCP.  The next upcoming events are release of 10-K and we get a sense of their cash balance.  In February, the judge will decide whether JCP can sell Martha Stewart products (although, it won't be branded as Martha Stewart b/c of the Macy's lawsuit).  I wonder if JCP knew that was going to be the case when they did the strategic deal with MSLO.  I spoke with Martha's IR today and she told me that JCP will likely sell the Martha designed products under a JCP private label brand.  If you can't slap the Martha Stewart brand on it, why spend close to $30mm a year on the merchandising?  Is Martha's design really that appealing on its own?  We'll get to see.  You'll have Joe Fresh launching in March of this year I believe.  Went with my wife lately to the Joe Fresh store.  I can't figure out why ppl will want to buy the Joe Fresh stuff.  My wife seems to think that because the items are low price point and can be easily mixed and much with other outfits, there are natural buyers for the budget conscious who wants to exude high fashion, but can only afford so much.  I think that we'll know in the next 9 month whether JCP was a giant waste of time or whether they can really entice Americans to shop there.  At some point this year, they'll add Giggle, Carter, Disney, and a slew of other stores.  Let's wait and see if they fan out. 

 

People have been so fixated on the pricing missteps.  I feel like they are really missing the new brands that are coming and what kind of impact they may have.  With an anticipated 40% build out by Sep, JCP will be halfway to what it ultimate will look like. 

 

BTW, does anyone know how much on a $/SQFT does it cost to build out these shops?  Does anyone have contacts in the merchandising space?  Friends who are buyers for Macy's, Kohl's, Carters? etc

 

[Kraven]

Kraven,

 

I'm not surprised at all by your description.  Admittedly, the total "shop" square footage is only 10% across the board.  I happen to live on Long Island and visit the Roosevelt Field Mall JCP and that locations gives me a better image of what a build out ultimately will look like.  I agree with you that Sephora, Levi, Liz Clairborne (big yellow doors), MNG by Mango, JCP women, men, and Izod, obviously stand out as "shops" at the Roosevelt location.  I've visited a few other lesser locations and the new "shops" are certainly an  upgrade over what used to very dated selling space.  I agree that they also cheapen a bit on the Arizona shops, it's really just shelves re-arranged, it doesn't stand out that much. 

 

BG2008, my point was that other than Sephora none of the "shops" actually stood out.  They all seemed like display areas.  In fact, if I didn't know they were supposed to be shops, it would never have occurred to me that it was anything other than a nice display area.  It looked exactly the same as any display area really at a Macy's or wherever.  I am not sure too that it looked like such an upgrade over other space.  Yes, it was nicer, but to be honest it really just blended in.

 

It's kind of funny, I like the story behind JCP, but after actually being in the confined space of the store I have a hard time seeing it as a destination in an of itself.  I don't doubt that it could be transformed, but there is something intangible to walking around a mall and I don't know that that experience can be captured in the relatively smaller space of a department store.  We'll see soon enough.

[luck]

here are somewhat random observations:

 

- walking around a jcp in a bay area burb, it seemed like at least the inventory is not shabby and disarrayed a la the sears next door. 

- when i asked the customer service reps about opinions on ron johnson, they said people can't stand him.  they say customer traffic is improving. 

- i generally compare traffic to both macy's and jcp when i walk through and all three stores seemed about the same in terms of traffic.

- my issue is that jcp is marking down things dramatically.  shirts for $3, etc. to the point where it seems like they're solely focused on revenue and not focused on the bottom line at all as they fight to recover. 

- free wi fi signs everywhere.  this is good when it points to the future and the town center/aisle lounge area with iPads, etc. 

- after they convert all the stores, perhaps they should have a theatrical display in front of the jcp's in the mall to indicate that it really is a new jc penney catering to a new generation.  i don't think younger generations see it as a hip place to be yet.  i didn't see any twenty somethings or teens in any of my store visits even though they were frequenting smaller stores right outside the jcp.

 

i am not long this and won't be for awhile, but if i were to play it today, i'd sell a cash covered february put at $15.  collect the 23 cents and hope you don't get exercised and then repeat the action.  if you do get exercised, at least you're long at a dollar lower than the two million dollars javier teruel buys at around $16 on november 19 and you have some downside protection if you believe that the replacement value of JCP's real estate is near $11 billion as ackman claims.  just my opinion. 

 

at any rate, jcp definitely makes the mallgoing experience more interesting now that i'm looking at the stock.

 

 

[luck]

to add to the previous post, after reading buffett/munger's admonitions against retailers and the airline industry, i definitely feel like an investment in jcp would require a massive amount of due diligence - great perspectives on this thread.  after borders, i also take everything ackman says with a grain of salt.

 

also, i think an assessment would have to be made about jcp's plan online versus amazon, boutiques, etc.  ron johnson might be able to upgrade to various small brand shops within stores, but by the time he does, much may shift to online buying.  therefore, jcp would need to build a clear and effective online strategy simultaneously.

 

i do think the concept of the "store hangout" is interesting.  in the malls i've been to, the common seating area in the center is generally populated with a bunch of older folks keeping to themselves.  the apple store is pretty much the hangout for the younger generation in these malls to get free internet, etc. and there's no central lounge in any of the other anchors.  if johnson throws in a bunch of iPads, etc. and makes his lounge idea somewhat theatrical, he might have an opportunity with the younger demographic & their parents and this may turn things a little in jcp's favor.

[ItsAValueTrap]

to add to the previous post, after reading buffett/munger's admonitions against retailers and the airline industry

I'm curious... where do they say that they don't like retailers?

 

Berkshire, as far as I know, owns multiple retailers (WMT, Dollar General, Nebraska Furniture Mart, various jewelers like Borsheim's, See's Candies has some retail outlets, etc.) and zero airlines.

[PlanMaestro]

I'm curious... where do they say that they don't like retailers?

 

Many places, but is more that they don't like marginal retailers or old formats… like department stores. This is one place:

 

http://variantperceptions.wordpress.com/2012/12/04/buffett-on-the-imperfect-turnaround/

[luck]

yeah, sorry about that, itsavaluetrap.  as soon as i typed that, i thought about Walmart.  pretty much what plan linked to.  the snowball goes into some munger/buffett department store adventures/frustrations to add more perspective.  also, a great read overall in my opinion.

[ItsAValueTrap]

Got it, thanks.

 

I think Buffett is very much interested in taking concentrated positions in quality businesses.  Usually over time it's the quality businesses that make most/all of the overall shareholder return.  That point comes across stronger in Carol Loomis' book than Alice Schroeder's I think?  (Maybe I should re-read The Snowball.)

[BG2008]

I'm a real estate guy, so IMHO

 

Real Estate Value as Downside Protection is a bit misleading for JCP - If JCP can't turn the ship around, the real estate is not worth $11bn.  The truth is that Macy's, Sears, and most of large anchor stores tend to own ~50% of their real estate and have the rest lease to them at $2-4 per square food.  Just pull up the filings for Macy's etc and look at the properties section and look at their operating lease cost divided by the leased square footage.  I believe that the JCP real estate is worth $11bn after JCP turns around the ship and JCP generates say $2-3bn of EBITDA a year.  With Ackman steering the wheel, he will likely do something similar to Penn National.  BTW, Penn National gaming is separating it's OpCo and PropCo.  Penn National can do this because they have relatively good cashflow and low debt balance.  So, Ackman down the road structures the deal where JCP's PropCo assumes the majority of the current debt (lenders are willing to do this because they have the real estate as collateral).  Propco gets paid $1bn in rent, minus the $250mm in interest and $50mm in SG&A, the shareholders get $700mm in dividends.  Slap a 5-8% dividend yield on that and you monetize the real estate at a $8.8bn to $14bn valuation. 

 

Details on Penn National Spin-Off https://www.dropbox.com/s/e17ebxdadc4ijbb/PENN%20Sandbar%20Investor%20Presentation%2011-15-12%20FINAL.pdf

 

If JCP can't turn the ship around.  Good luck trying to sell big box real estate when the category, i.e. Sears, K-Mart, Best Buy, is shutting down stores and inventory is building.  Just ask Eddie Lampert if anyone is dumb enough to take the Sears RE from Eddie.  I would advise against selling puts in JCP, I think that it's possible that JCP does go out of business. 

 

Borrowing a page from Joel Greenblatt, I think that the right trade here is to buy the Jan 2014 25 Call or some other strike price.  When buying a LEAP, the key elements are

 

1. Potential undervaluation - check

2. Known event date - check

3. Reasonable amount of non-recourse leverage - check (roughly 6x at $3)

 

I think that we can all agree that the JCP thesis is somewhat binary.  Either Ron Johnson is a retail genius or he was merely riding the coattail of a once in a lifetime talent in Steve Jobs.  This is the year for us to find out.  JCP will have 40% of the square footage converted into the new shops by Sep 2013.  We should know by Jan 2014 whether JCP had transformed in the right direction or if it's time to abandon ship. 

 

Three likely scenarios

 

1. JCP turns around its business and trades significantly above $25, you exercise the call and pat yourself on the back

2. JCP fundamentally turns around its business, but trades below $25.  This is what Li Lu calls back up your truck time and you load up.  How can you tell if JCP has turned its business.  I would say look at the GoodCo/BadCo analysis.  Look at the $/SQFT for the new shops/old shops, overall EBITDA, cash balance, etc.  Also, visit the shops and see if teens and moms are starting to shop there.  Ask your wives, girlfriends, boyfriends, mistresses, groupies, etc.  It's a subjective call.  But, I believe that call is a lot easier to make by Jan 2014

3. JCP flounders, you walk away and admit that you were wrong in the assessment and down $3 for the call rather than $20

 

If JCP does wind up doing $2bn in EBITDA with the PropCo trading at 13x EBITDA and the Opco trading at 6x EBITDA, then we're looking at a $19bn EV for a combined EV/EBITDA of 9.5x.  This will result in a $73 stock price.

 

So the risk/reward is $3 versus potentially 45.  I don't mind those 15 to 1 odds. 

 

You ask "aren't you just rolling the dice here?  I think that there's an edge here because JCP offers a platform for brands to grow without taking on excess risk and entering into punitive long term operating leases.  Read the press release for Joe Fresh and look at the reason they cite for partnering with JCP.  Why would Disney, a brand that is very protective of its image, want to sell in JCP?  If I were Simon Properties, I would be very pissed right now.  (See my previous post on this.  I would love for people to give me some feedback on this)  JCP is offering a go to market option for brands that is substantially superior to Simons Properties.  In the long run, JCP will be able to dictate who gets the space and who doesn't.  Shopping malls are synergistic creatures.  When you're filled with exciting retailers, people flock to the mall.  That's why you're seeing a bifurcation in the regular malls post 08/09.  The dominant malls gets more dominant while the B and C malls lose the national brands and starts leasing to restaurants and fly by night operators.  Over time, people stop shopping there.  JCP is clearly not at the point where they have curated a nice collection of shops and clearly not yet a destination for people to shop at.  By buying the Call, you gain the benefit of "hindsight" and are able to buy or pass when the picture clears up a bit.  That's why it's called an option.  Some people may say, doesn't Macy's have a shop strategy?  What's so special about JCP.  Well, if JCP can get to Macy's productivity, then we're probably looking at a $50-60 stock price for JCP. 

 

Any feedback on the Options/Leap strategy would be greatly appreciated.   

 

 

[luck]

BCG, bottom part of this article has a take on a leap strategy for JCP:  http://beta.fool.com/shamapant/2012/11/28/2-ways-play-jc-penneys-failed-turnaround/17144/

[PlanMaestro]

BG, two fold concern with a leap strategy at this stage:

 

1. Turnarounds tend to take longer than initially thought (and then happen suddenly).

2. Markets may take time to recognize their success.

 

For example, financials have been turning since the end of 2009 and by the beginning of 2011 it was clear that the turnaround has been a complete success for most of them (even AIG). We are at the beginning of 2013 with still some unbelievable prices.

 

That doesn't mean there can be some runs in between, especially if it becomes a crowded short. But I ask … wouldn't you prefer to take those leap odds when (1) is clear and only waiting for (2), when in the case of JCP it may take yet a whole year for (1) ?

 

 

 

 

I'm a real estate guy, so IMHO

 

Real Estate Value as Downside Protection is a bit misleading for JCP - If JCP can't turn the ship around, the real estate is not worth $11bn.  The truth is that Macy's, Sears, and most of large anchor stores tend to own ~50% of their real estate and have the rest lease to them at $2-4 per square food.  Just pull up the filings for Macy's etc and look at the properties section and look at their operating lease cost divided by the leased square footage.  I believe that the JCP real estate is worth $11bn after JCP turns around the ship and JCP generates say $2-3bn of EBITDA a year.  With Ackman steering the wheel, he will likely do something similar to Penn National.  BTW, Penn National gaming is separating it's OpCo and PropCo.  Penn National can do this because they have relatively good cashflow and low debt balance.  So, Ackman down the road structures the deal where JCP's PropCo assumes the majority of the current debt (lenders are willing to do this because they have the real estate as collateral).  Propco gets paid $1bn in rent, minus the $250mm in interest and $50mm in SG&A, the shareholders get $700mm in dividends.  Slap a 5-8% dividend yield on that and you monetize the real estate at a $8.8bn to $14bn valuation. 

 

Details on Penn National Spin-Off https://www.dropbox.com/s/e17ebxdadc4ijbb/PENN%20Sandbar%20Investor%20Presentation%2011-15-12%20FINAL.pdf

 

If JCP can't turn the ship around.  Good luck trying to sell big box real estate when the category, i.e. Sears, K-Mart, Best Buy, is shutting down stores and inventory is building.  Just ask Eddie Lampert if anyone is dumb enough to take the Sears RE from Eddie.  I would advise against selling puts in JCP, I think that it's possible that JCP does go out of business. 

 

Borrowing a page from Joel Greenblatt, I think that the right trade here is to buy the Jan 2014 25 Call or some other strike price.  When buying a LEAP, the key elements are

 

1. Potential undervaluation - check

2. Known event date - check

3. Reasonable amount of non-recourse leverage - check (roughly 6x at $3)

 

I think that we can all agree that the JCP thesis is somewhat binary.  Either Ron Johnson is a retail genius or he was merely riding the coattail of a once in a lifetime talent in Steve Jobs.  This is the year for us to find out.  JCP will have 40% of the square footage converted into the new shops by Sep 2013.  We should know by Jan 2014 whether JCP had transformed in the right direction or if it's time to abandon ship. 

 

Three likely scenarios

 

1. JCP turns around its business and trades significantly above $25, you exercise the call and pat yourself on the back

2. JCP fundamentally turns around its business, but trades below $25.  This is what Li Lu calls back up your truck time and you load up.  How can you tell if JCP has turned its business.  I would say look at the GoodCo/BadCo analysis.  Look at the $/SQFT for the new shops/old shops, overall EBITDA, cash balance, etc.  Also, visit the shops and see if teens and moms are starting to shop there.  Ask your wives, girlfriends, boyfriends, mistresses, groupies, etc.  It's a subjective call.  But, I believe that call is a lot easier to make by Jan 2014

3. JCP flounders, you walk away and admit that you were wrong in the assessment and down $3 for the call rather than $20

 

If JCP does wind up doing $2bn in EBITDA with the PropCo trading at 13x EBITDA and the Opco trading at 6x EBITDA, then we're looking at a $19bn EV for a combined EV/EBITDA of 9.5x.  This will result in a $73 stock price.

 

So the risk/reward is $3 versus potentially 45.  I don't mind those 15 to 1 odds. 

 

You ask "aren't you just rolling the dice here?  I think that there's an edge here because JCP offers a platform for brands to grow without taking on excess risk and entering into punitive long term operating leases.  Read the press release for Joe Fresh and look at the reason they cite for partnering with JCP.  Why would Disney, a brand that is very protective of its image, want to sell in JCP?  If I were Simon Properties, I would be very pissed right now.  (See my previous post on this.  I would love for people to give me some feedback on this)  JCP is offering a go to market option for brands that is substantially superior to Simons Properties.  In the long run, JCP will be able to dictate who gets the space and who doesn't.  Shopping malls are synergistic creatures.  When you're filled with exciting retailers, people flock to the mall.  That's why you're seeing a bifurcation in the regular malls post 08/09.  The dominant malls gets more dominant while the B and C malls lose the national brands and starts leasing to restaurants and fly by night operators.  Over time, people stop shopping there.  JCP is clearly not at the point where they have curated a nice collection of shops and clearly not yet a destination for people to shop at.  By buying the Call, you gain the benefit of "hindsight" and are able to buy or pass when the picture clears up a bit.  That's why it's called an option.  Some people may say, doesn't Macy's have a shop strategy?  What's so special about JCP.  Well, if JCP can get to Macy's productivity, then we're probably looking at a $50-60 stock price for JCP. 

 

Any feedback on the Options/Leap strategy would be greatly appreciated. 

[luck]

Just reading through Ackman's from May 16th presentation again, at that point, it looks like he sees a $900 million cost opportunity from bloated cost structure in home office, stores, and advertising and views this as a form of downside protection given potential $2.50+ per share impact to eps.  Will need to look into their costcutting plans for 2013 in further detail and how feasible they are.

[BG2008]

But I ask … wouldn't you prefer to take those leap odds when (1) is clear and only waiting for (2), when in the case of JCP it may take yet a whole year for (1) ?  Buffet said " if you wait for the robins, spring will be over" Given the low rev and EBITDA basis established in 2012 and the high short interest, we may not get an opportunity to buy at $25/share when the transformation is apparent. 

 

Plan, I think that JCP trades where it trades at because they had negative EBITDA for 2012 and people are calculating that there is a chance for Ch 11.  Obviously, if JCP trades above $25 by Jan 2014, the strategy does very well.  But if JCP trades below $25, not all is lost.  By Jan 2014, JCP will have 40% of its space converted into Shops, we will know what the cost of the build out is, we'll know how much they'll need to draw from the credit line, if any, we'll know if JCP's EBITDA can turn positive with the new product offerings.  If prices has not caught up to reality by then, that's the back the truck up time and buy with conviction. 

 

I guess the counter argument is why bother risking the $3 in premium.  I think you buy the call because there are definitive catalysts in the next 12 months via the build out.  Usually, I wouldn't bother buying calls if there is no catalyst.  What you're paying for here is the privilege to have the benefit of hindsight. 

 

Luck, I think that the $2.50/share isn't really downside protection.  JCP was bleeding $200+mm of cash per quarter in 2012 because of 30% YOY revenue declines.  except for Q4 when they are expected to generate positive EBITDA.  Without ample sales, cost cuts doesn't do anything.

 

Sizing wise, I say size the trade at 2% of your AUM which extrapolate to a 14% position at $25 strike if you were to buy the common.  In terms of the bonds, the risk/reward is not attractive enough for me when the management team clearly wants to exhaust cash in order to turn around the business. 

[luck]

thanks for the perspectives bg and plan. 

 

leap play is an interesting one, but i don't think jcp is a runaway train at all.  there's plenty of time for panicky overreaction - perhaps even far lower than today.  i don't plan on doing anything with jcp at this point and will be roaming other pastures over the near term.  we'll have to see how this shakes out.  good luck with your jcp trade if you take it though bg!

[BG2008]

Luck, if you find greener pastures, please let me know. 

 

I've been hunting for the build out economics from the vendors for JCP.  Apparently, Izod's parent Philip Van Heusen paid JCP $10mm to build out 680 shops within JCP. If the average SQFT is 800 sqft, that's 544k of retail space.  So, PVH paid $20/sqft to help out. 

 

PVH mentioned in slide 71 that sales are up 40% since the shop build out and AUR up double digits.  Assuming they did $200 (according to Q3 presentation) at the retail price per SQFT, which would be $58 incremental increase in retail sales.  Assuming JCP gets 40% gross margin on its products, wholesale increase in rev dollar to PVH would be $34.8mm.  Assuming that the incremental increase results in 20% cash margin on the wholesale figure, this is a $3.78mm increase in operating profit.  38% return on invested capital seems attractive.  the qualitative effect of a shop build out is that Izod products isn't just strewn over some self in a messy fashion.  With the shops, Izod certainly conveys a more premium image.   

 

See page 67-71 of the Annual presentation for PVH

 

http://www.pvh.com/pdf/annual_reports/PVH_Analyst_Day_Oct_2012.pdf

 

I would assume that this types of economics will be attractive for brands to sell their products in JCP. 

[luck]

JCP's definitely a stock with extreme pessimism and therein lies the opportunity. 

 

BG indicates that some might be afraid of Chapter 11, but the counter to this is the $2 billion credit facility and the $500 million cash and add onto that the easier sales of non-core assets such as the ownership positions in the mall partnerships.    The counter to this sustenance argument in turn is the $800 million cap ex and so forth... 

 

To me the way to play this is not risk capital over the near term, wait to parse through February earnings (which may cause a downward shock in the stock price despite the fact much is baked in) and then keep watching things on the ground - customer service, traffic comparisons versus other anchors, observations of pricing/profitability, new JCP introductions and variances, employee interviews.  Ultimately, I think with all the folks on the board reporting their experiences, we might be able to get an idea as to whether or not this will turn through our collective observations and prior to optimism on the company or positive numbers which would pop the stock price.  At that point, I think the leap option is interesting. 

 

Another observation, I walked through Best Buy the other day to buy a dvd case and found it priced at $18.  On Amazon prime, this same dvd case was $11 with free shipping.  With books, Amazon Prime is 40% less.  In my opinion, what Amazon Prime hasn't been able to do is catalogue the clothing options/brands in a systematic fashion, offer the lowest price point, and ship out for free.  I think this is an opportunity for JCP if it can attract hotter brands in the future, bill itself as the lowest online price for semi-boutique items, and ship out at a low price or free.  As mallgoers become more savvy, I think the point of purchase in the future may not be right after trying something on that you like, but rather finding the right size and brand in store and then ordering it online for much less. 

[ItsAValueTrap]

JCP has actual seen its online sales go down.  Many of its retail peers have seen their online sales increase (especially the specialty apparel companies that own their own brands and stores like AEO, ANF, etc.).

 

The problem with JCP selling other people's brands is that shoppers can buy the brands online (from somebody other than JCP) after seeing the item in the store.  With private label brands (JCP has been reducing their private label) this doesn't happen.

 

I think going forward, the trend towards people being comfortable buying online will favour companies that own brands.  You don't want to be stuck with too many bricks and mortar stores... we may need less of them in the future.  (Though I could be wrong on the last point.  I haven't looked at mall traffic figures... I presume they haven't been going down.)

[BG2008]

I've noticed a lot of brands moving towards exclusive offering, i.e. William Sonoma with some of their high priced products

 

Obviously, JCP will have no future if they offered "me too" products.  But, I think JCP is actually moving towards a different direction.  Notice the Macy's, JCP, Martha Stewart Gun Fight

 

Martha Stewart signed an agreement a few years ago to provide home goods for Macy's. Macy's is now suing Martha and JCP that JCP can't sell Martha Goods (even if they don't have marth's brands on the product)  JCP is countering that as long as it doesn't say Martha Stewart on the products, they're going to be fine.  I'm looking forward to the injunction ruling as well as seeing what the products will ultimately look like.  Retailers today get that they can't simply be a show room for Amazon.  Which is why exclusive brands are so important.  What's going to pull the customers into your store?

 

JCP is now acting as a launch pad for the small brands with 10-15 locations, i.e. Jon Adler, Giggles, Candy Shack, Michael Graves, Joe Fresh etc.  I'm pretty sure that JCP will have stipulation that as long as these products are sold in JCP stores, they can't sell to Walmart, Target, Macy's etc.  If you are a 10-15 location shop, you're probably not going to be haggling over an "once in a lifetime opportunity" to ramp to 700 locations in 12 months with profitability virtually guaranteed.  Your downside is that if it doesn't work, you get kicked out of JCP.  Given the these dynamics, I think JCP will be able to continuously source exclusive brands.  They even mentioned that they expect 25% of the spaces to turn over each year versus 10% that is typical of most malls.  This is inherently a competitive advantage as it allows JCP to be more fashion forward and be with the trends.  I'm not sure what the terms with Joe Fresh are, I'm sure there are some exclusive periods.  Most likely, you're not going to be able to buy Joe Fresh aside from JCP and their flagship stores in NYC for the next 3-5 years.   

 

I can't stress enough how much of a competitive advantage JCP has over the malls in attracting brands.  In one situation, the Simon GGP malls are asking for a punitive tax to do business 10-20% in rent expenses and it takes 10 years to open up 500 locations.  JCP virtually guarantees your profitability because it's a wholesale model, ramp to 700 locations in under 1 year, and no risk of bankruptcy if you get the roll out wrong. 

 

 

[BG2008]

Luck,

 

In my model, I have $800mm in cash after Q4 versus what the company has been telling people about $1bn in cash.  In Q3, ebitda was negative 200+mm.  They generate cash in Q4 due to higher sales and working capital etc.  So, they're left with $2.3 bn of cash (including the facility).  $800mm goes to cap ex and the rest goes to sustain operating cash burn, working capital, etc.  The key is that when they put in the new shops,  the new shops generate 30-40% more $/SQFT and likely at higher margins.  Even if we use a low 30% gross margin for those square footage, the higher sales figure will get the company to positive EBITDA territory.  By Jan 2014, we'll know whether the company can fund the rest of the 60% of the build out from operating cashflow.  Everyone is afraid of JCP running out of cash etc.  But, I have not met anyone who has modeled out the cashflow.  Obviously, these things can swing wildly.  But, it's not a bad idea to look at the worst case scenario and see what that looks at.  I have a small position in the calls.  Obviously, at a lower price, I would be a lot more interested.