An Analysis of J.C. Penney
Value Investing Congress
October 18, 2011
T2 Partners Management L.P.
Manages Hedge Funds and Mutual Funds
and is a Registered Investment Advisor
The General Motors Building
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Info@T2PartnersLLC.com www.T2PartnersLLC.com
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PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND
FUTURE RETURNS ARE NOT GUARANTEED.
-3-
Summary of Investment Thesis
• A decent business that has underperformed
– But this is NOT Sears/K-Mart
• A fairly valued stock based on current performance
– 5.6x EV/EBITDA; 18.1x P/E
• An extraordinary combination of people, covering the key value
drivers, have come together to bring about change – and you get
this for free
– New top management: Ron Johnson and Michael Francis
– Real estate: Steve Roth, Vornado
– Capital allocation: Bill Ackman, Pershing Square
• The business has been undermanaged, so there are many areas
for improvement that can drive enormous value creation
–
–
–
–
Increase sales/sq. foot
Cut costs
Unlock real estate value
Optimize capital structure
-4-
The Basics
• Stock price (10/17/11): $29.99
• Shares outstanding: 213.3 million
• Options and warrants: 24.8 million
• Market cap: $6.4 billion
• Enterprise Value: $7.9 billion
• Book value per share (7/31/11): $22
• Sales: $17.7 billion
• P/E (LTM): 18.1x
• EV/EBITDA (LTM): 5.6x
• P/S: 0.36x
-5-
JCP’s Stock Has Done Little Over
the Past Decade
-6-
JCP’s Stock Since Activists’
Investments
JCP reports May SSS -1%
JCP reports June SSS +2% (vs. KSS
+7.5%, M +6.7%); lowers EPS guidance
JCP reports July SSS +3.3%
JCP announces Ron
Johnson as next CEO
Pershing Sq. and Vornado
investment announced
JCP reports Aug SSS -1.9%
-7-
JCP Valuation vs. Peers
JCP Com p group
Mkt Cap
EV
TEV/EBITDA
P/E (LTM)
LTM
Dillard's Inc. (NYSE:DDS)
Kohl's Corp. (NYSE:KSS)
Macy's, Inc. (NYSE:M)
Nordstrom Inc. (NYSE:JWN)
Target Corp. (NYSE:TGT)
The TJX Com panies (NYSE:TJX)
2,575
13,593
12,497
10,681
35,753
21,986
3,353
16,118
18,078
12,393
52,448
21,715
Average
J. C. Penney (NYSE:JCP)
6,408
7,956
5.1x
5.9x
5.5x
7.9x
7.1x
7.9x
13.9x
12.7x
12.0x
16.8x
12.6x
17.3x
6.6x
14.2x
5.7x
18.1x
-8-
JCP’s History
James Cash Penney opens The
Golden Rule, a dry goods and clothing
store, in Kemmerer, Wyoming
Incorporated in Utah
as the J.C. Penney
Corporation
1902
1913
1914
Company launches
jcpenney.com, its
online store
Myron Ullman III joins
as company’s 9th
Chairman and CEO
J.C. Penney issues its
first catalogue
1951
1963
Moved headquarters
to NYC
Store sales exceed $1B
for first time
1992
1994
Moved headquarters
to Plano, Texas
2004
Exits catalogue
business
2006
2010
2011
Announces
Sephora inside
jcpenney concept
Ron Johnson to begin
as 10th CEO 11/1/11
-9-
JCP’s Broad Footprint
• JCP operates 1,106 department stores in 49 states and PR
• JCP owns 426 of its 1,106 stores (38.5% of stores, ~42mm sq. ft.)
and 17 of its 26 distribution/warehouse centers (~12m sq. ft.)
• JCP’s real estate alone could be worth over $3b (total EV of $7.9b)
-10-
Revenues Over the Past Decade
-11-
Revenue Growth Has Been a Zero
Sum Game
-12-
EBIT Over the Past Decade
-13-
EBITDARP Over the Last Decade
* Earnings before interest, taxes, depreciation, amortization, rent and pension expense;
assumes $302mm LTM rent expense
-14-
A Diverse Business Mix
Fine jewelry, 4%
Services and other,
4%
Footwear, 7%
Women’s apparel,
24%
Children’s
apparel, 11%
Men’s
apparel/accessories,
20%
Women’s
accessories,
12%
Home, 18%
-15-
Private Brands
49% of revenue comes from private brands developed,
designed, and sourced in-house
Billion
dollar
brand
Billion
dollar
brand
-16-
National Brands
45% of revenue comes from national brands
-17-
Exclusive Brands
6% of revenue comes from exclusive brands/concepts –
a major opportunity
-18-
Investment Thesis
• New management team & active Board of Directors
• Opportunity for operational improvement
• Significant real estate value
• Capital structure optimization
-19-
Investment Thesis
• New management team & active Board of Directors
• Opportunity for operational improvement
• Significant real estate value
• Capital structure optimization
-20-
Ron Johnson Left Apple for JCP
• Ron Johnson, 52, beings as new CEO on Nov. 1st
• After graduating from Harvard Business School,
was one of only a few of his classmates to go into
retailing, at Mervyn’s
• Mervyns was acquired by Target, where Johnson
rose to become senior vice president of
merchandising
– “During his 15 years there, Target got hip, went
national, and crushed sales records…[His track
record is nuts.” – The Atlantic
• In 2000, Steve Jobs hired him to lead Apple’s retail
stores
– Today: More than 350 stores worldwide, generating
sales of over $4,000/sq. ft.
– Credited with the Genius Bar concept
-21-
Ron Johnson’s Motivation, Incentives
and Alignment With Shareholders
• "I've always dreamed of leading a major retail
company as CEO, and I am thrilled to have the
opportunity to help J. C. Penney re-imagine what I
believe to be the single greatest opportunity in
American retailing today, the Department Store.” –
Ron Johnson, 6/14/11
• Johnson forfeited150k AAPL restricted stock units
(“RSUs) granted in 2008 (that vest in 2012) and
100k RSUs granted in 2010 (that vest in 2014) with
a market value of $73 million
• In return, he only received 1.7m JCP RSUs that
vest 1/27/12, worth roughly $50 million
• In addition, Johnson personally invested $50m to
buy warrants to acquire 7.3m JCP shares at
$29.92. They expire 7.5 years and Johnson cannot
sell or hedge them for six years
-22-
Michael Francis Left Target for
JCP
• Michael Francis, 48, begins as JCP’s President on
Nov. 1
• Francis will be responsible for merchandising,
marketing, product development and sourcing
• 21 years at Target (1990-2011)
– 2011: Led Target’s expansion into Canada
– Chief Marketing Officer (Aug ‘08- Sept ‘11)
– EVP Marketing (Feb ’03 – Aug ‘08)
• Francis began his merchandising and marketing career
as an executive trainee on the sales floor of Marshall
Field’s in Chicago in 1986
-23-
Pershing Square’s Involvement
As of 9/22/11 13-D filing:
• Pershing Square owns 39.1m shares (18.3%) and
has economic exposure to 16.6m shares (7.8%)
through total return swaps for total economic
exposure of 55.6m shares or 26.1% of shares
outstanding
• Pershing Square gave up some voting rights to
increase ownership
• The 8/19/11 stockholders agreement limits
Pershing Square from exceeding 26.1% ownership
Bill Ackman
joined JCP
board Feb 2011
-24-
Vornado’s Involvement
As of 10/8/11 13-D filing:
• Vornado owns 23.4m shares (9.9%)
• The 9/16/11 stockholders agreement allows
Vornado to buy up to 15.4% of common stock
• Steven Roth has extensive real estate expertise and
an extraordinary history of value-creation
Steven Roth
joined JCP
board Feb 2011
-25-
Current Equity Price: $30 per share
Market
value of
equity
-26-
Investment Thesis
• New management team & active Board of Directors
• Opportunity for operational improvement
• Significant real estate value
• Capital structure optimization
-27-
Opportunity for Sales Improvement
Sales per sq. ft. are below peers and remain -14%
below 2007 peak levels vs. peer average of -8%
$177/sq. ft.
in FY 2007
$153/sq. ft.
in FY 2010
-28-
JCP’s Net Promoter Score Has Been
Rising Steadily, Outpacing Peers
Dramatic
improvement
since 2003
Note: Net promoter score is percent of people who answer 9 or 10 minus those who answer 0-6 when asked, on a scale
of 0-10, “How likely is it that you would recommend our company to a friend or colleague?”
Source: JCP 2010 investor day, pp 93 of 120
-29-
Initiative #1: Sephora Inside JC Penney
Expected to have ~30% store
base penetration by YE 2011
-30-
Sephora Brand Awareness Is Rising and
Should Drive Increased JCP Traffic
Google Trends indicates “Sephora” search
traffic is up roughly +50% YTD in 2011
-31-
Initiative #2: Liz Claiborne
“Liz Claiborne is one of the most recognized brands in the history of
American apparel retailing with a deeply loyal following, and our
research shows that it is among the most desired by the J.C. Penney
customer.” – CEO Myron Ullman
October 2011: “J.C. Penney acquires worldwide rights for the Liz Claiborne
family of brands as well as the U.S. and Puerto Rico rights for the
Monet brand for $267.5 million.”
-32-
Initiative #3: Grow Online Sales
Online sales have been
flat for 4+ years
Source: Credit Suisse, 10/4/11
-33-
JCP Sales Opportunity Could Add
$8/share in Value
$38
$8
15% improvement in sales
per sq. ft. = $8 to equity
Current
stock
price
-34-
There Is Significant Opportunity for
Margin Improvement
EBITDAR margins are 380 bps below peak levels vs.
peers on avg. at or above former peak levels
13.1% in
FY 2007
9.3% in
FY 2010
-35-
EBITDARP Margins Have Also
Been Weak
EBITDARP margins are 280 bps below peak levels
while peers are hitting new highs
13.8% in
FY 2006
11.0% in
FY 2010
-36-
J.C. Penney Spends Much More on
Advertising Than Its Peers
“Penney Dumps Big Book Catalog” – ChiefMarketer Network, 11/18/09
“Retailer J.C. Penney is discontinuing its traditional catalog
business in favor of “look books,” which refer consumers to the
company's e-commerce site.” – Direct Marketing News, 9/28/10
-37-
Margin Improvement Could Add
$15 in Value
$53
Sales per sq. ft.
improvement
$8
300 bps EBITDA
improvement =
$15 to equity
$8
Current
stock
price
-38-
Investment Thesis
• New management team & active Board of Directors
• Opportunity for operational improvement
• Significant real estate value
• Capital structure optimization
-39-
JCP Real Estate Portfolio (1)
JCP real estate is worth $12 - $15 per share
-40-
JCP Real Estate Portfolio (2)
$20/share in gross book value of buildings
Property and Equipment, Net
($ in millions)
Land
Buildings
Furniture and equipment
Leasehold improvements
Accumulated depreciation
Property and equipment, net
Estimated
Useful Lives
(Years)
N/A
50
3-20
2010
2009
$
315
4,434
2,271
1,065
(2,854)
$
308
4,276
2,356
1,118
(2,701)
$
5,231
$
5,357
Source: JCP 2010 10-K
-41-
JCP Real Estate Portfolio (3)
• JCP spends ~$300m/yr to rent the 62% of stores it does
not own
• JCP pays itself ~$180mm in “synthetic rent” for the 38%
of company-owned stores
• $2.3b of owned real estate value (owned stores, ground
leased stores, owned distribution centers) implies 8%
cap rate on the “synthetic rent”
-42-
Valuation Based on Separate Retailer
and Real Estate Earnings Stream
Sale-Leaseback & Implied EBITDAP Multiple
Low Case
Value of Real Estate
Mid Case
High Case
$2,058
$2,339
$2,620
Assumed Cap Rate
8.0%
8.0%
8.0%
Implied NOI of Real Estate
$165
$187
$210
$1,584
$1,584
$1,584
Current LTM EBITDAP
Rent Expense Impact to EBITDAP
(165)
(187)
(210)
Pro Forma LTM EBITDAP
$1,419
$1,397
$1,374
Current TEV
$7,689
$7,689
$7,689
Less: Real Estate Value
(2,058)
(2,339)
(2,620)
Implied Firm Value
$5,631
$5,350
$5,069
4.0x
3.8x
3.7x
Implied EBITDAP Multiple
JCP trades at 3.8x LTM EV/EBITDAP, adjusting for real estate value
-43-
JCP’s Real Estate Could Be
Worth $13/share
$65
Margin
improvement
$8
Sales per sq. ft.
improvement
$8
Current
stock
price
$8
$13
Real
estate
value
Base value
of retail
business
-44-
Investment Thesis
• New management team & active Board of Directors
• Opportunity for operational improvement
• Significant real estate value
• Capital structure optimization
-45-
Share buyback: $900m Spent in 1H11
•
•
•
•
•
Feb. 2011: Board authorized up to $900m repurchase
Q1 ‘11: JCP bought back 21m shares for $787m
Q2 ‘11: JCP bought back 3m shares for $113m
Completed program on 5/6/11
Average price of $36.98
-46-
Debt Ratios
Source: Capital IQ
-47-
Additional REIT Assets
Value of REIT Assets
REIT assets valued 7/30/11 at $300m = $1.40/share
-48-
JCP’s Total Value Could Exceed $70,
More Than Double Today’s Price
Capital structure
optimization
$70+…?
$65
Margin
improvement
Sales per sq. ft.
improvement
$8
Current
stock
price
$8
$8
$8
$13
$13
Real estate
value
Real estate
value
Base value
of retail
business
Base value
of retail
business
-49-
Conclusion: Many Ways to Win
• Buy a decent, undermanaged business at a fair price
and get an extraordinary combination of people,
representing significant optionality, for free
-50-
Appendix
Management’s Goal is EPS of
$5 by 2014
Source: 1Q11 company presentation
-52-
Management’s Goal is EPS of
$5 by 2014 (2)
Source: 1Q11 company presentation
-53-
Management Sees Revenue Growth
from Many Sources
Source: 1Q11 company presentation
-54-
5-Year Income Statement
JC Penney Income Statement
FYE 02/03/2007
FYE 02/02/2008
FYE 1/31/2009
FYE 1/30/2010
FYE 1/29/2011
19,903
12,078
7,825
19,860
12,189
7,671
18,486
11,571
6,915
17,556
10,646
6,910
17,759
10,799
6,960
5,470
51
27
389
(35)
5,902
5,402
(45)
46
426
(37)
5,792
5,395
(90)
31
469
(36)
5,769
5,382
337
28
495
(35)
6,207
5,350
255
8
511
(23)
6,101
1,923
1,879
1,146
703
859
Interest Expense
Interest and Invest. Income
Net Interest Exp.
(270)
135
(135)
(278)
118
(160)
(268)
37
(231)
(255)
10
(245)
(223)
11
(212)
Other Non-Operating Inc. (Exp.)
EBT Excl. Unusual Item s
5
1,793
7
1,726
6
921
(15)
443
(19)
628
Restructuring Charges
Gain (Loss) On Sale Of Assets
Asset Writedow n
Other Unusual Items
EBT Incl. Unusual Item s
8
(2)
(7)
1,792
10
(1)
(12)
1,723
10
(21)
910
2
(42)
403
(32)
8
(3)
(20)
581
Income Tax Expense
Earnings from Cont. Ops.
658
1,134
618
1,105
343
567
154
249
203
378
Earnings of Discontinued Ops.
Net Incom e to Com pany
NI to Com m on Excl. Extra Item s
19
1,153
1,134
6
1,111
1,105
5
572
567
2
251
249
11
389
378
Total Revenue
Cost Of Goods Sold
Gross Profit
Selling General & Admin Exp.
Pension Expense
Pre-Opening Costs
Depreciation & Amort.
Other Operating Expense/(Income)
Other Operating Exp., Total
Operating Incom e
Per Share Item s
Basic EPS Excl. Extra Items
Weighted Avg. Basic Shares Out.
Diluted EPS Excl. Extra Items
Weighted Avg. Diluted Shares Out.
$
4.95
229.0
$
4.96
223.0
$
2.55
222.0
$
1.07
232.0
$
1.60
236.0
$
4.88
232.0
$
4.90
225.0
$
2.54
223.0
$
1.07
233.0
$
1.59
238.0
-55-
5-Year Balance Sheet
-56-
5-Year Cash Flow Statement
JC Penney Cash Flow Statement
FYE 02/03/2007
FYE 02/02/2008
FYE 1/31/2009
FYE 1/30/2010
FYE 1/29/2011
Net Incom e
Depreciation & Amort.
Depreciation & Am ort., Total
1,153.0
389.0
389.0
1,111.0
426.0
426.0
572.0
469.0
469.0
251.0
495.0
495.0
389.0
511.0
511.0
(Gain) Loss From Sale Of Assets
Asset Writedow n & Restructuring Costs
Stock-Based Compensation
Tax Benefit from Stock Options
Net Cash From Discontinued Ops.
Other Operating Activities
Change In Inventories
Change in Acc. Payable
Change in Inc. Taxes
Change in Other Net Operating Assets
Cash from Ops.
(8.0)
4.0
60.0
6.0
11.0
(376.0)
(190.0)
195.0
(1.0)
26.0
1,269.0
(12.0)
5.0
45.0
9.0
8.0
(124.0)
(241.0)
106.0
(66.0)
(10.0)
1,257.0
(10.0)
29.0
53.0
(5.0)
(32.0)
382.0
(278.0)
(36.0)
12.0
1,156.0
(2.0)
48.0
43.0
(2.0)
352.0
235.0
32.0
(57.0)
178.0
1,573.0
(8.0)
40.0
56.0
(11.0)
(69.0)
(189.0)
(93.0)
28.0
(62.0)
592.0
Capital Expenditure
Sale of Property, Plant, and Equipment
Other Investing Activities
Cash from Investing
(772.0)
20.0
(32.0)
(784.0)
(1,243.0)
26.0
(25.0)
(1,242.0)
(969.0)
13.0
(956.0)
(600.0)
13.0
(587.0)
(499.0)
14.0
(485.0)
(21.0)
(21.0)
980.0
980.0
(737.0)
(737.0)
(203.0)
(203.0)
(113.0)
(113.0)
392.0
392.0
(693.0)
(693.0)
Issuance of Common Stock
Repurchase of Common Stock
135.0
(750.0)
45.0
(400.0)
4.0
-
4.0
-
8.0
-
Common Dividends Paid
Total Dividends Paid
(153.0)
(153.0)
(174.0)
(174.0)
(178.0)
(178.0)
(183.0)
(183.0)
(189.0)
(189.0)
Special Dividend Paid
Other Financing Activities
Cash from Financing
38.0
(751.0)
0
(286.0)
(3.0)
(380.0)
(35.0)
(327.0)
(14.0)
(496.0)
Net Change in Cash
(266.0)
(271.0)
(180.0)
659.0
(389.0)
Short Term Debt Issued
Long-Term Debt Issued
Total Debt Issued
Short Term Debt Repaid
Long-Term Debt Repaid
Total Debt Repaid
-57-
JCP vs. Comps
JCP Com p group
Px
Shares
Mkt Cap
LTM Net
Out
EV
LTM Rev
Debt
LTM
LTM Adj
EBITDA
EPS
NTM Rev
NTM
NTM EPS
EBITDA
Dillard's Inc. (NYSE:DDS)
Kohl's Corp. (NYSE:KSS)
Macy's, Inc. (NYSE:M)
Nordstrom Inc. (NYSE:JWN)
Target Corp. (NYSE:TGT)
The TJX Com panies (NYSE:TJX)
50.03
50.45
29.26
50.7
52.95
57.71
51.5
269.4
427.1
210.7
675.2
381.0
2,575
13,593
12,497
10,681
35,753
21,986
779
2,525
5,581
1,712
16,695
(271)
3,353
16,118
18,078
12,393
52,448
21,715
6,324
18,666
25,720
10,231
68,441
22,546
657
2,754
3,293
1,563
7,402
2,744
3.59
3.97
2.43
3.01
4.21
3.34
19,554
26,505
10,754
71,327
23,708
3,007
3,304
1,655
7,488
3,129
4.76
2.76
3.35
4.21
4.19
J. C. Penney (NYSE:JCP)
30.04
213.3
6,408
1,548
7,956
17,741
1,399
1.66
17,647
1,290
1.74
TEV/EBIT
P/E (LTM)
JCP Com p set
TEV/Total TEV/EBITDA
Rev LTM
LTM
TEV/Fw d
Rev
EBITDA
Dillard's Inc. (NYSE:DDS)
Macy's, Inc. (NYSE:M)
Kohl's Corp. (NYSE:KSS)
Target Corp. (NYSE:TGT)
The TJX Com panies (NYSE:TJX)
Nordstrom Inc. (NYSE:JWN)
0.53x
0.70x
0.86x
0.77x
0.96x
1.21x
5.1x
5.5x
5.9x
7.1x
7.9x
7.9x
8.5x
8.3x
8.2x
9.9x
9.5x
10.2x
13.9x
12.0x
12.7x
12.6x
17.3x
16.8x
0.5x
0.7x
0.8x
0.7x
0.9x
1.2x
5.1x
5.5x
5.4x
7.0x
6.9x
7.5x
J. C. Penney (NYSE:JCP)
0.45x
5.7x
9.0x
18.1x
0.5x
6.2x
JCP Com p set
Dillard's Inc. (NYSE:DDS)
Kohl's Corp. (NYSE:KSS)
Macy's, Inc. (NYSE:M)
Nordstrom Inc. (NYSE:JWN)
Target Corp. (NYSE:TGT)
The TJX Com panies (NYSE:TJX)
Source: Capital IQ
LTM
TEV/Fw d
J. C. Penney (NYSE:JCP)
NTM Fw d
Gross
P/E
Mrgn (LTM)
12.2x
36.9%
10.6x
38.4%
10.6x
40.6%
12.6x
37.2%
13.8x
29.9%
15.2x
26.9%
17.3x
38.7%
EBITDA Mrgn
EBIT Mrgn
Rev grow th
EBITDA grow th
(LTM)
10.4%
14.8%
12.8%
15.3%
10.8%
12.2%
(LTM)
6.2%
10.6%
8.5%
11.9%
7.8%
10.1%
(LTM)
2.5%
4.5%
6.1%
11.1%
2.8%
6.0%
(LTM)
24.1%
2.2%
13.5%
20.9%
4.4%
1.0%
7.9%
5.0%
0.8%
9.4%
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