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Takeaway: We think that firing RJ at this juncture opens JCP up to risks that were previously not part of the equation. Ullman? Seriously???

This note was originally published April 08, 2013 at 19:41 in Retail

After being short JCP from the Ackman/Johnson $40 ‘$9-$12 in earnings power’ hype, we pulled a 180 at $19 earlier this year based on our view that liquidity concerns were overblown, and that the stock would start to turn when the better productivity from the new shops rollout improved the sales delta. Without a doubt, the call was too soon and the subsequent $4/$5 drop in the stock was painful. But the reality is that the research did not change anywhere near as much as the sentiment did, so we kept this name on our Best Ideas list.  But we were vocal several times in saying that the one thing that could make us cut bait on our call is if the Board bowed to Wall Street’s bantering and fired Johnson at this juncture (see our 3/6 Note below “Why Firing Johnson Is The Fastest Way To Ch 11) . Well…Johnson is out, and we're cutting bait. There could be more downside to come.  

This Action Raises More Questions Than It Does Answers

  1. We think that this move is either six months too late, or six months too soon, but definitely ill-timed today.  The Board should fire the guy when either a) his pricing strategies are failing miserably due to botched execution (mid 2012), or b) when the shop-in-shop strategy – the real reason why you hired him – proves to be unsuccessful (end of 2013). Unless there was a dramatic negative turn of events over the past two weeks (which is possible), it is perplexing to think of why they would get rid of him today as opposed to seeing if the shop strategy works. The Board should show a little transparency into its process and personal accountability for its actions.
  2. Mike Ullman is the new CEO, again. Seriously? The stock initially traded up nearly 15% on the announcement that RJ, America’s most hated CEO, was out. That’s about what we’d expect. But once the company disclosed that that Mike Ullman was stepping in, the stock gave up nearly 20%. What does that say about the market’s confidence in Ullman?
  3. Did anyone else even want the job? Mickey Drexler? No way. Alan Questrom? Possibly. But we think he’s smart enough to pass on the job because JCP is so stuck between a rock and a hard place – not having the financial capital to change directions, and potentially lacking the human capital to stay on the existing course set by RJ. The job bank here was really thin.
  4. Lipstick on the Pig? One potential bullish signal would be whether the Board put Ullman in place for an interim period so he can calm the troops, stabilize the business, and put enough perfume and lipstick on the pig so that it can be taken private. We wouldn’t bank on this one, nor would we invest based on it. But we can’t count it out, either.
  5. Capital Considerations: Unless JCP is prepping for a sale, the likelihood of a capital raise just went up – and it went up materially. It’s pretty easy for a new CEO to step up and say “I need money to clean-up the problems caused by my predecessor.”  The reality is that if Ullman wants to go down a new path with the strategy, he will definitely need capital.

We think that the risks we initially highlighted (below) are still very much alive.

We’ve going to let this stock breathe for a bit. After it settles, if the quantitative factors support the call, we’ll have no problem shorting it – even if it’s at a price lower than $14. Real estate value is only $7-$8. And if Ullman can’t pull a rabbit out of his hat on this sucker, there’s no reason it can’t go lower.

04/08/13 05:12 PM EDT


Conclusion: Contrary to what others are recommending today, we think that firing Ron Johnson is just about the stupidest thing that the JCP Board could do right now. If they did fire him, we think that it would be the quickest path to bankruptcy for JCP. Sentiment seems to us that the stock would go up on that news. But if we saw him ousted we’d likely short this name with impunity -- even with the sell-side capitulating at a price of $14/15. We think losing Johnson would pose significant vendor/brand risk, and would back JCP into a corner to liquidate its real estate at a discount.

A new CEO would be faced with a binary decision tree. Either A) Return to being the lowest-quality department store in America, or B) carry out Johnson’s shop-in-shop plan better than RJ could on his own. Johnson clearly blew himself up in 2012, but we don’t put blind faith in the ability for anyone to come in and implement this plan any better. Keep in mind that 75% of the problems JCP has had have little to do with changing up the shop format and upgrading the merchandise assortment – it was largely due to RJ getting the pricing/marketing/value proposition wrong on the existing merchandise. Letting RJ run with the current plan might carry more risk as 2013 unfolds – but doing it without him is riskier, with potentially more significant financial pain.

1) First off, once a cucumber becomes a pickle, you can’t reverse the process. It already has architected its square footage to new shops, chosen new partner brands, and gotten rid of hundreds of vendors to make room for what is coming down the pike. That cannot be undone, which leads us to the conclusion that a new leader would need to move forward with the current plan – or something pretty darn close to it. Unfortunately, JCP does not have the liquidity for a new CEO to shake the Etch-a-Sketch clean, start over, and create a new plan. The lack of capital deprives JCP of the oxygen needed to go down a new path.
2) Ron Johnson has spent easily a third of his time ensuring that the right brands/vendors are chosen, and then collectively working with the brands and his merchants to make sure that the right product is in the right place inside the store. Whether you like RJ or not, the reality is that the vendors still like him – a lot. They buy into the long term vision (even if no one on Wall Street does). We’re relatively certain that at least a few large vendors would balk at rolling out product inside JCP if leadership and strategy changed dramatically.  
3) If that were the case, JCP would be left half-pregnant.  It wouldn’t be able to fill the shelves quickly with legacy product (i.e. become the old, poor quality JC Penney), and the product that should ultimately drive traffic under the new plan is at risk of never becoming a reality. Then we can build to an algorithm where comps are down another 20-30%, and not only is JCP forced to use its full revolver, but to liquidate its real estate, which we estimate to be worth about $1.8bn-$2.1bn (see our note from last night “JCP: Duration Matters More Than Ever’) to fund operating losses.
4) Allen Questrom, the Godfather of retail (we mean that in a complimentary way), was on CNBC [on 3/8] talking about why RJ should be fired immediately. He said that the Board needs to admit its mistake and move on. At face value this carries a lot of weight given that Questrom is the only person to successfully turn around JC Penney. But let’s be real. When Johnson went down the path of ‘reinventing’ JCP, Questrom did not make the cut of people he leaned on to consult about a solution. Questrom likely viewed that as a snub, and also probably has little patience for anyone that is seemingly destroying something that he worked so hard to fix. Not really a shocker that Questrom is on the short list of people recommending that he’s ousted due to 2012’s failures. Also keep in mind that he’s on the short list of people that would be considered for the top job (though we have no reason to think that he’d want it).