J.C. Penney: A Hedge Fund’s Plaything
I have, until now, steered clear of J.C. Penney (JCP). It was obvious that the retailer was struggling, with losses piling up following the doomed strategy of former CEO Ron Johnson. On the other hand, bulls were ever present, pointing out that said strategy could easily be changed and the company remained a household name with significant real estate holdings. Over the last couple of weeks we have learned that Bill Ackman’s fund, Pershing Square gave up and sold their 18% stake, and that Perry Capital, Hayman Capital and Glenview Capital have significant holdings of JCP stock.
It is tempting to conclude that when Richard Perry, Kyle Bass and Larry Robbins (the heads of Perry, Hayman and Glenview respectively) all agree on an investment, then we should be looking to buy in also. It is hard to go against some of Wall Street’s most successful investors, but I am still not convinced that JCP is a good investment. Part of the reason is the very fact that these three prominent hedge funds have significant stakes.
Hedge funds in general aren’t known for their patience. The funds have to do what’s right for their investors, and holding on blindly to a falling stock doesn’t fit that bill. It is quite possible that there is still some upside to the stock from its current level just below $13, but any significant move down, even as the result of a general market decline, could see them departing as quickly as they arrived. Whatever the direction of the next move, significant volatility is on the cards, so an options straddle may be a good play, but, as you would expect with something that obvious, it looks a little pricey.
Bill Ackman believed he could force changes on the board to make the company more successful, and there is some evidence that the current big investors feel the same way. This is, of course, one of the legitimate reasons to hold a large share of a company, but it reminds me of some marriages that I have witnessed; where one partner marries the person they believe is perfect, while the other is marrying somebody they believe they can make perfect. They rarely end well.
Glenview’s increased holding, declared in a filing released yesterday, could be the result of long term confidence in JCP, but it could also just be an attempt to average a losing position with a view to exiting when break even or a small profit looks possible. There is no way of knowing if this is the case or not, but the uncertainty that comes with hedge funds owning significant stakes in any company is part of what leads me to conclude that JCP is not for me.
But, the bulls maintain, just the real estate holdings of the company put a value of around $17 on the shares. If the company had no bonds outstanding that would be fine, but as losses have piled up, so has the debt. The future issuance of secured debt is limited by the terms of some earlier loans, but at that time, estimates of the liquidation value of JCP, such as here, resulted in a significantly lower figure of around $7 per share.
J.C. Penney’s total debt is not excessive by industry standards, but as the stock price has fallen dramatically, so the debt to equity ratio has risen to historical highs around 2.5. Obviously, when you are struggling to return to profitability, servicing a significant amount of debt is an impediment.
In some ways, JCP is just the type of stock that I like to recommend. It has been under severe pressure, partly from short sellers, and has a history of profitability. It has recovered somewhat from a low around $12, which sets up the possibility of buying with a logical stop loss level not too far away, but the up-side also looks limited in the short term. There is likely to be some resistance in the event of the $14 level being reached again, so the up-side looks to be about equal to the down-side. I prefer the risk reward ratio to be in my favor.
On balance, I don’t believe JCP is a good investment at these levels. It has become a plaything of the Wall Street hedge fund gods and that should be seen by us mere mortals as more of a curse than a blessing.