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How COVID-19 Might Derail Penney’s Bankruptcy Plans

How soon retailers can fully reopen their doors could dictate J. C. Penney’s ultimate fate.

The mass merchant filed a Chapter 11 petition for bankruptcy court protection on Friday in a Corpus Christi, Texas, federal bankruptcy court, listing total assets at $8.57 billion while tallying $8.03 billion in liabilities. Estimates show the company has more than 100,000 creditors, the bulk of whom hold unsecured claims. The case includes 17 affiliated Penney’s debtors.

Investment firm BlackRock Inc. hold a 13.85 percent stake in Penney’s common stock, while The Vanguard Group has a 5.02 percent stake. Among its 50 largest creditors holding unsecured trade claims, the fashion firms high up on the list include: Nike Inc., Beaverton, Ore., $32.1 million; Alfred Dunner Inc., New York, N.Y., $14.2 million; Byer California, San Francisco, Calif., $12.6 million; Adidas Distributing, Portland, Ore., $7.1 million; Haggar Clothing Co., Farmers Branch, Tex., $6.1 million; The Lee Co., Greensboro, N.C., $6.1 million; Van Heusen Sportswear, New York, N.Y., $5.7 million; Supreme Int’l, Miami, Fla., $5.0 million, and Kasper Group, New York, N.Y., $4.8 million.

Court documents indicate the retailer plans to split into two publicly traded entities upon exiting from Chapter 11. One would be a real estate investment trust holding some of the retailer’s property, while the other would consist of its retail operating business. Penney’s operates 846 stores, with 387 of those locations owned by the company. Some of those assets would be placed into the REIT, which could sell up to a 35 percent stake to outside investors to generate cash. It’s been speculated that mall REITS could take a stake, help with funding and preserve their own portfolios due to co-tenancy clauses.

But the catch is that the operating component has two key deadlines—plan-related milestones—for the entire plan to work.

“JCPenney must move swiftly towards consummation of a transaction that allows it to emerge before the critical holiday season,” Bill Wafford, executive vice president and chief financial officer, said in a declaratory statement filed with the bankruptcy court. What he didn’t say was what would happen if most stores continue to remain closed due to the ongoing coronavirus pandemic.

Wafford said Penney’s is analyzing the best and most viable option for it to emerge from Chapter 11, which means it will gauge potential investors interest in debt or equity financing. And it has to consider a sale of the company as one option.

Penney’s would be forced to pursue the sale option if it fails to meet the milestones and obligations laid out in its bankruptcy plan. First, Penney’s must reach an agreement with its first-lien lenders on an “acceptable business plan by July 14,” Wafford said. Presuming Penney’s meets that hurdle, the company then needs to secure commitments for exit financing by Aug. 15. If neither one is met, it must put itself up for sale. This means it must consider, and maybe even negotiate, the sale component sooner than later if reasonable going-concern offers surface, even if it doesn’t yet have to decide on that option right away. Waiting until the last minute to see whether a milestone gets unmet is an almost certain path to liquidation.

Penney’s was seeing green shoots in its turnaround effort up until the virus reared its ugly head, Wafford said.

“Before the pandemic, the company had a substantial liquidity cushion, was improving its operations, and was proactively engaging with creditors to deleverage its capital structure and extend its debt maturities to build a healthier balance sheet,” he said. “Unfortunately, that progress was wiped out with the onset of COVID-19.”

CEO Jill Soltau’s Plan for Renewal strategy calls for across-the-board changes, from revitalizing the merchandise assortment and engaging customers with a compelling experience, to reviving digital and physical traffic, fueling growth and fostering a results-oriented culture. But by mid-March, any signs the plan was working evaporated when all nonessential retailers shut down to curb the spread of the coronavirus. Two months later, COVID-19 is still impacting discretionary merchants, though many retailers have laid out their reopening strategies and begun welcoming shoppers in line with government guidelines and social distancing protocols.

Penney’s, meanwhile, has reopened 41 stores, plus an additional seven are fulfilling buy online, pickup in store orders with curbside delivery.

But what happens with the rate of reopenings and potential rise in infections could impact the course of Penney’s bankruptcy.

“The continued existence of the coronavirus will delay the usual reopenings, and a rise in local infections could scare people away from newly reopened malls because of fears that they could get infected,” said Walter Loeb, a former retail analyst who now works as a consultant.

Like all retailers, Penney’s ended up in a crippling liquidity crunch when temporary store closures choked off the lion’s share of its revenue. But the pandemic-induced problem, like that of fellow bankrupt retailers J. Crew Group and Neiman Marcus Group, was exacerbated by a high debt leverage, squeezing Penney’s to the point that it elected to skip an interest payment.

Now, Penney’s hope of avoiding a sale hinges on whether state and local guidelines permit it to open stores quickly enough. One retail expert speculated that the company probably would need to open at least 350 stores by mid- to late June in order to gauge consumers’ propensity to spend in brick and mortar, which will aid in estimating a sales projection for a business plan. Whether it can get to even close to that number of reopenings remains unclear.

In the meantime, Penney’s will also need to determine a plan for fall merchandise orders. Before COVID-19, it employed nearly 85,000 associates, although most are now on furlough. The company has a massive supply chain network with nearly 3,000 vendors and 11 domestic shipping facilities, Wafford told the court. Of Penney’s merchandise assortment, men’s apparel represents 21.0 percent, women’s apparel is 13.3 percent, home and leisure is 12.7 percent, and footwear, handbags and accessories are 12 percent. The balance is comprised of jewelry and watches, children’s apparel, cosmetics and women’s specialty apparel, such as swimsuits.

While net sales in 2019 totaled $10.7 billion, that’s just slightly over half of 2007’s $20 billion tally.

Presuming Penney’s is able to emerge from Chapter 11, there’s no guarantee that it will survive for the long haul. While it will be in a better financial position after eliminating nearly $5 billion in debt, there’s the risk of a second wave in infections come fall and winter. Will retail, even in a new normal, have to shut down again? It’s a possibility, but no one knows for sure. But it does mean that some creditors will likely push hard for a liquidation figuring they’ll get more value now from Penney’s assets before they depreciate in a steeper downturn.

Many unsecured creditors in the Sears Holdings Corp. bankruptcy made a similar agrument, but Sears ultimately prevailed and the bankruptcy judge in the case gave his nod for the company to be sold to its former chairman, Edward S. Lampert. Even though it’s closed nearly another 100 doors since filing for bankruptcy, the company is still in business and provides jobs for the stores it still operates, as well as another venue for vendors who have goods to sell.

The thinking behind that could give Penney’s the advantage if it can finalize an agreement with its first lien lenders on a business plan by July 14. When given a choice between second chances and liquidation, most bankruptcy judges lean toward the second chance provided a debtor can reasonably execute on its reorganization plan. After all, the concerns over a second wave round of COVID-19 infections is speculation at this point, and allowing Penney’s to exit will keep the bulk of its employees working, as well as those supporting its extensive supply chain.

Approval on interim financing is still pending in bankruptcy court. Half of its $900 million in debtor-in-possession financing will repay secured pre-petition lenders, and $450 million will be split into two parts. The first $225 million will be accessible by Penney’s, and it will be able to access the balance of $225 million provided it meet certain financial metrics.

The company is set to close at least 20 doors, although there’s speculation that as many as 200 locations might be targeted for closure.

Penney’s was founded in 1902 by James Cash Penney. He is also given credit for wanting to offer higher quality goods at better prices through the creation of private label brands, first in 1914 with Marathon Hats and then later for work apparel, fabric goods and lingerie. Today, Worthington, St. John’s Bay, Arizona jeans and JCPenney Home are among its best-known private brands, a business that drives about 46 percent of total sales. The company also launched the first catalog in 1963, and by 1993 became the largest catalog retailer in the country. It followed with the launch of its website in 1996, which hit $1 billion in online sales by 2005.

Penney’s problems began when activist investor William A. Ackman of Pershing Square took a major stake in the retailer and later, after joining the board, pushed to have Ron Johnson, a former retail chief at Apple, join the company as its new CEO. Johnson, who became CEO in 2011, tried to transform the retailer into a series of boutiques located within a “town square” setup. However, Johnson never tested the concept and in the process eliminated many of the retailer’s well-loved private brands, which in turn alienated existing customers.

After his departure, Penney’s churned through a number of CEOs, each with their own plan to turn things around. Its most recent former CEO was Marvin Ellison, who joined Penney’s from Home Depot and then left in 2018 to become CEO at Lowe’s. While he’s gone on to become a great CEO at Lowe’s, he didn’t have the soft goods experience needed at Penney’s, which was always best known for its higher-margin apparel and home goods softlines categories. Soltau was named CEO in October 2018.

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