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Is Penney’s Valuation the Next Bankruptcy Battleground?

How much is bankrupt J. C. Penney really worth?

The math in Penney’s Chapter 11 petition just got complicated and could spur yet another delay in the chain’s exit from bankruptcy.

Penney’s was expected to file papers converting a non-binding letter of intent into an asset purchase agreement selling the operating portion of the business to a joint venture between its two largest landlords, Simon Property Group and Brookfield Properties. The planned deal valued Penney’s at $1.75 billion, including the two real estate investment trust (REIT) components consisting of the 161 properties in one post-bankruptcy company and the six distribution centers in the other. First-lien lenders, which would own the two REITs, were planning on credit bidding and wrapping up the landlord joint venture into a combined bid that would become the frontrunner, or stalking-horse bidder, for a company auction.

But here’s where things hit a billion-dollar snag.

In a document, William Snyder of financial advisory CR3 pegs Penney’s value at between $8.2 billion and $10.2 billion. Snyder, an expert retained by the ad hoc equity committee, based his conclusion on a calculation of hard assets such as real estate, cash and inventory at $6.6 billion and $7 billion of estimated debt and liabilities. The $1.4 billion in cash on Penney’s balance sheet looks attractive, but it might be the product of unpaid rent it’ll eventually have to part ways with.

There’s plenty of guesswork at play, too.

Much of the valuation stems from estimations on Snyder’s part. He extrapolated what Penney’s revenue might look like five years out from bankruptcy, based on the retailer’s projections for years three and four of a five-year plan.

Snyder projects the pre-petition equity value in the range of $1.2 billion and $3.2 billion.

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Based on that analysis, Snyder wrote in his court filing, Penney’s is not, in fact, “hopelessly insolvent.” He also emphasized his belief that the proposed $1.75 billion purchase agreement “materially undervalues the assets,” and that his valuation “indicates a return to equity interest holders is reasonable.”

Of course, Snyder’s goal is the recoup as much money as possible for the equity group, so it makes sense that he might take a rosy view of Penney’s potential valuation, while first-lien lenders or other buyers might opt for a conservative, low-end figure of any range.

In the bankruptcy totem pole, secured creditors get priority in terms of who gets paid back first. Different creditor classes follow, and then comes the group of unsecured creditors. Their claims often are paid back on a pro rata basis, presuming there are even funds left over to go around. Equity holders usually get nothing, and find their shares extinguished when the company actually emerges from bankruptcy.

Snyder is also relying on company sales estimates from a business plan and other summarized projections, based on the retail calendar, to determine Penney’s total revenues. Those estimates have revenues hitting $6.89 billion this year, climbing to $9.20 billion next year, $9.49 billion in 2022, $9.74 billion in 2023, $10.06 billion in 2024 and $10.40 billion in 2025. The bottom line estimates include a net income of $989 million in 2020, and a net loss of $29 million in 2021. Snyder projects net income in the following years of $374 million in 2022, $502 million in 2023, $589 million in 2024 and $609 million in 2025.

While those numbers look great on paper, just how realistic they are in the real world remains to be seen. Numbers on paper don’t take into account hiccups that come up in business operations, such as a pandemic, or the possibility of another lockdown, partial, or otherwise, to stave off a second wave of infections. And if the Democratic presidential nominee Joe Biden wins the November election, he’s already indicated that he would do “whatever it takes” to combat the virus, including another lockdown.

So where does this leave Penney’s?

The grossly conflicting valuations set the stage for a showdown between the ad hoc equity committee and creditor groups in the weeks ahead. This scenario is not that far off from what happened in the Neiman Marcus bankruptcy as creditors fought for a piece of the MyTheresa asset. The intellectual property and other assets had been transferred to holding company untouchable by the bankruptcy proceedings before the luxury department store filed its Chapter 11 petition. That dispute was settled and Neiman is now expected to emerge from bankruptcy in a few days. In the Penney’s bankruptcy, the parties likely will also figure out a settlement at a mutually agreed upon dollar amount for equity shareholders.

And that’s presuming nothing else pops up to cause the joint venture between the two landlords from having second thoughts on their planned purchase of Penney’s going-concern operation.