Bankrupt J.C. Penney walked away from Monday’s marathon hearing with long-awaited court approval on its sale to first-lien lenders and landlords.
Witness testimony emphasized the “economic reality” of Penney’s precarious financial position if the proposed sale failed to garner the court’s green light.
“Our goal from the beginning of this process has been to ensure J.C. Penney will continue to serve customers for decades to come and this court approval accomplishes that objective,” Penney’s CEO Jill Soltau said Monday after the court granted its sale approval. “With the 2020 holiday season in full swing, we are excited to operate under the new ownership of Brookfield and Simon outside of Chapter 11 and under the J.C. Penney banner.
“We appreciate the efforts of the court and the support of our creditors in this process and putting us in a strong position to build on J.C. Penney’s long track record of taking care of our associates, customers, vendor partners and communities,” she added.
Under the sale terms, ownership of 160 stores and six distribution centers will go to the majority-group lenders via two separate real estate investment trusts, and the operating company, known at OpCo, will be sold to Simon Property Group and Brookfield Asset Management.
The master lease agreement between the OpCo and PropCo owners is expected to be finalized in the coming days while many expect the sale to close later this month. A confirmation hearing on the reorganization plan is set for Nov. 24.
Penney’s bankruptcy saga
Much of Monday’s court testimony debated possible alternatives to a Penney’s sale, like the ad-hoc equity committee’s proposed reorganization that would have vacated debtor-in-possession financing. A reorg, though unorthodox, would have returned some of the equity shareholders’ investment, though the proposal was untenable from the start and simply allowed the bankruptcy process to leave no stone unturned.
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By contrast, Judge David Jones branded the OpCo-PropCo proposal as a viable plan with approval from both sides that would preserve Penney’s 60,000 vulnerable jobs—and marked the best financial offer benefiting landlords and vendors with a vested interest in keeping the mass merchant as a going concern.
Addressing the ad-hoc plan, Judge Jones said it “would take a lot” to vacate the DIP order and there was little reason to opt for such a “drastic measure.” And while he empathized with equity shareholders and their losses, the value in their investments was “already gone” a long time ago.
Court testimony painted a stark picture of Penney’s finances. Its DIP financing is set to expire Monday without an extension, and even that funding hasn’t given Penney’s sufficient bandwidth to flow inventory into stores.
Penney’s bankruptcy counsel Jonathan Sussberg of Kirkland & Ellis told the court that after 178 days in bankruptcy, “Our singular focus and goal was making sure J.C. Penney survived…as a going concern.”
Sussberg also said settlements are in place with the minority group of lenders and the Committee of Unsecured Creditors, with the Ad Hoc Committee of Equity Holders dispute the sole exception.
“This company has outstanding claims of more than $7 billion [and] unless all are satisfied in full or in cash [or other treatment], there’s no economic reality for equity,” Sussberg said.
Given Penney’s calamitous cash position, the sale must proceed as “time is of the essence for these debtors to move forward on an expedited basis,” he said. “We do not have enough unencumbered cash to repay the DIP. We do not have it unless the [asset-based loan] is paid down in full.
“Our vendors are hanging on by a string,” Sussberg said. “Unless an order is entered, in short order, we will not return to normalcy.”
Many of Penney’s vendors have either short-shipped, deferred shipments, or suspended orders, Sussberg said.
“Absent approval of a sale, I fear this company will move to a liquidation,” he added.
Penney’s finances
How dire is it?
While the DIP provides for cash on delivery, roughly “70 percent” of vendors “have us on cash in advance. We have to prepay for those willing to ship goods,” James Mesterharm, managing director and head of the restructuring group at Penney’s financial advisor AlixPartners, said in court testimony Monday.
If a deal doesn’t close by Nov. 20, then the buyers have the right to walk away when the DIP facility expires next week, Mesterharm said. “Those factors are working against us the longer the company stays in bankruptcy,” he added.
Mesterharm told the court that many private-label suppliers do not plan to ship for 2021 under current conditions, and though Penney’s had nearly $700 million in factoring support in 2019, “Right now, we have zero.”
Chapter 11, he added, “is not a healthy place for companies to stay,” noting the expenses related to the court process. Plus, vendors demanding cash on delivery or in advance drains liquidity, and Penney’s asset-based loan formula hinders its ability to pay for needed goods.
“It’s not a healthy sign for a retailer that we are unable to get inventory,” Mesterharm said, noting that Penney’s hasn’t been able to tap into some of its DIP financing.
If the court failed to approve the OpCo-PropCo deal, then Penney’s has “no wherewithal to pay that DIP,” David S. Kurtz, head of the global restructuring practice at investment banking firm and Penney’s banker Lazard Frères & Co., testified Monday. In such an instance, lenders would likely push to liquidate.
“I just don’t know how we will be able to pull this together,” he said, describing the bankruptcy case as a “melting ice cube.”
What happened in the sale process
Kurtz said Simon and Brookfield plan to “make a lot of money” and return Penney’s to profitability. He debunked the idea that majority lender group member H/2 had controlled the sale strategy, noting that “they wanted us to try” to find a buyer for Penney’s real estate assets and would have been willing to walk away if no suitor materialized.
Lazard had spoken with private-equity firm Sycamore Partners, which wasn’t “willing to put any skin into the game” and instead was looking to be hired to run the business, Kurtz said. Richard Baker’s Hudson’s Bay had been in dialogue with the company throughout August, but also seemed more interested in running the business than acquiring it. In the end, only Simon and Brookfield were willing to put $300 million in equity into a deal.
Chief financial officer Bill Wafford stressed the importance of finalizing “the sale of the company now instead of at the confirmation hearing,” which would offer vendors, employees and landlords a measure of certainty just weeks before Black Friday.
The OpCo sale represents the “highest and best bid” for Penney’s, Wafford added. “We presented the company to over 100 potential acquirers and this was the highest and best offer that arose out of that.”