Investor Bill Ackman's decision to take a $400+ million haircut and sell out of troubled retailer J. C. Penney is likely the best outcome for all parties, at least in the short-term. Ackman's position as the largest shareholder (through his Pershing Square hedge fund), and his presence on the board, were a source of too much distraction for both Penney's management , and likely for Ackman himself.
Now that Ackman has moved on, it's worth reevaluating Penney and seeing if this changes the story.
One less distraction
Since taking his role on the board following the initiation of a nearly 18% stake in the company back in 2010, Ackman was right in the middle of driving change at Penney. Starting with the ouster of former-come-again CEO Mike Ullman, and his replacement with Ron Johnson after successful retail stretches at Target and Apple, Ackman pushed hard to remake the company in the image that he thought it needed. And while we can argue all day whether or not Johnson's marketing and merchandising strategy would have eventually worked, the short-term pain--to the tune of billions of dollars in losses and a more than 60% drop in the share price--was just too much for management and the board of directors to take.
The end result, besides that mountain of lost cash?
- An alienated customer base
- Nearly two years of lost ground to competitors
- A management team and board in disarray
And Ackman's decision to not just resign from the board, but to exit his position in the company, will probably help Penney to move forward. So what does management do now?
That's the $64,000 question. The more important question is, "what should investors do?" Let's dig into some of Penney's peers for a little context.
Not a value play
Sears Holdings is often mentioned in conversations regarding Penney. It's hard not to draw similar conclusions with two old retail behemoths that didn't really do much to stay relevant in a changing world. However, where Sears has significant value is in its real estate holdings, which are worth maybe as much as four times the company's current market capitalization. Unfortunately, J.C. Penney investors can't count on this same value play.
Per Reuters, Penney's real estate value is around $4 billion. However, the company also has $2.9 billion in long-term debt, greater than the company's $2.8 billion market cap, meaning that the asset value doesn't create upside from today's share price for Penney as it does for Sears.
However, there are still plenty of parallels to draw between the two when it comes to retail execution. As Fool Rick Munarriz recently described, Sears is failing to get any traction, even with its key Kenmore and Craftsman brands, which should be performing well on the back of the housing recovery. But same store sales at both Sears and KMart stores continue to fall.
But CEO Eddie Lampert's background is one of leveraging asset plays like Sears, not as a retailer, so don't count on a strong turnaround. Luckily, you don't have to with Sears to make money, with Lampert having shown in the past a willingness to strip a company apart and sell off the assets if that was the best way to leverage its value.
The wrong side of bankruptcy for a turnaround play
In 1992, Macy's filed for bankruptcy, before being acquired by Federated Department Stores in 1994. The power of the Macy's brand would lead the company to formally change its name to Macy's in 2007. As of today, the only name remaining are Macy's and Bloomingdales, from what had been Robinson's-May, Filenes, and Marshall Fields among many in it's "federation" of stores.
The point? Retail is a constantly evolving, changing landscape, and this was true before the advent of web commerce, as the evidenced by the fact that the Macy's that investors own today was actually Federated or May before 2005. Taken to the next step, investors in any of these companies have been wiped out by bankruptcy at least once. And therein lies the risk with Penney today.
It could very well take a bankruptcy and reorganization for Penney to have a shot at becoming more like Macy's for investors--that is, a solidly profitable retailer with a clear marketing message and brand, as evidenced by its quarterly earnings, 2.3% dividend, and aggressive share buyback program.
Ackman's decision to exit Penney should be a cautionary tale for investors. While his absence will surely help management formulate a strategy and determine a direction, there is just too much risk that it's too little, too late. And without strong asset value to underpin the share price, plus massive debt obligations that come before shareholders, the potential for a turnaround just doesn't outweigh the risk of total loss.