JC Penney: Ackman’s Mistake

William Ackman’s Pershing Square Capital Management has dumped more money into J.C. Penney. It is a mistake, unless he has some undisclosed plan to mine assets which are not obvious or break the retail firm into pieces which would appear to have no benefit.

An SEC filing shows that Pershing and affiliates have plans to take a “synthetic long position” which could rise to 26.1% of Penney’s outstanding shares. Pershing owns 18.1% now. Pershing has agreed to reduce its voting rights to 15%, a move that is inexplicable. Pershing also cannot add to its position without permission from J.C.Penney

Ackman has made a poor deal, no matter what the terms. J.C. Penney is one of a class of older, slowly dying retailers, many of them founded decades ago. The industry’s landscape has been re-imaged over the last 25 years as firms like Walmart (NYSE: WMT), Target (NYSE: TGT), and Costco (NASDAQ: COST) have taken large market share. Penney would argue that these companies are not direct competitors. That may the case for some products. It is not true in the case for others. Penney also has a weak e-commerce presence compared to Walmart and Target. Even badly damaged Sears Holdings (NASDAQ: SHLD) has large enough bases in its K-Mart and Sears operations to further fragment the part of the industry in which Penney does business  And, the entire bricks-and-mortar retail sector is under siege by Amazon.com (NASDAQ: AMZN).

J.C.Penney’s chances to become a first tier retailer were damaged under the management of departing CEO Myron E. (Mike) Ullman, III who has run the company since 2004. Over the last five years, revenue has fallen from $19.9 billion to $17.8 billion. Operating income, over the same period, has fallen from $1.9 billion to $832 million. The S&P 500 is down 10% from five years ago. Penney is down over 60%, about the same as Sears Holdings.

The sole bright light for Penney is that Ronald B. Johnson, the former head of Apple’s (NASDAQ: AAPL) retail operations, will take over as CEO on November 1. Johnson cannot help Penney as much as investors might hope. Apple’s retailer outlets offered products that virtually sell themselves. Penney has no such advantage.

Ackman is part of a group of hedge fund managers who are viewed as “smart money”. He has made a bad bargain with his J.C. Penny investment. It is not possible to see why he believes the retailer has any good prospects.

Douglas A. McIntyre