J.C. Penney’s bleak future

I have followed the failures of J.C. Penney, the giant American retailer, over the past year with a kind of morbid fascination. The hiring – and then firing – of former Apple marketing whiz Ron Johnson only added to the titillating storyline associated with the company: a one-time retail champion fallen on hard times that makes one bold, last-ditch effort to right the ship.

As early as last summer, JCP’s Altman z-score, an academic measure of solvency often used for its predictive power of future bankruptcies, fell well within the distressed category, and around 80% of such companies file for bankruptcy within 24 months. Johnson’s ill-fated turnaround strategy put further pressure on the company, as revenues fell precipitously as a result of Penney’s move away from coupons and discount racks, alienating its already diminished customer base. In short, the company’s base retail operations are a train wreck, not a good sign for a retailer that has entered the dreaded zone of uncertainty.

For Penney, it’s not really a matter of hoping the cash reserves hold out. Without some signs of operational improvement, the company is doomed. It will continue to burn through cash until the inevitable reckoning occurs, and hiring on the man that Johnson replaced – former CEO Myron Ullman – is not really the answer investors were looking for. If Ullman was the answer, he wouldn’t have been shunted aside in the first place.

Bankruptcy seems an obvious destination; however, I’m not quite sure what Penney would gain from Chapter 11. Lightening the debt load certainly wouldn’t hurt, but with total debt to equity standing at 94.04, it’s not the debt that is crushing the company. After all, other retailers (Macys comes to mind) carry more debt, but are thriving nonetheless. What’s crushing the company is that no one wants to shop at its stores, and that is something that bankruptcy won’t solve.

Factor in as well the presence of shareholder William Ackman, whose Pershing Square Capital holds roughly 18% of the company. It was Ackman who was chiefly responsible for the Ron Johnson debacle. As JCP’s options begin to narrow, you can rest assured that Ackman’s attention will shift from saving the company to saving himself. A bankruptcy would surely put Ackman’s equity stake at risk, and as The Deal noted earlier in the week, one can safely assume that Ackman will try to avoid that eventuality at all costs.

But it’s hard to see an alternative to bankruptcy at this point. Some believe that the company has enough “brand equity” to court outside investors once the stock begins its inevitable descent; however, such a concept is fraught with uncertainty. Given the way the term is used, I often feel that folks confuse “brand equity” with something more neutral, “name recognition.”

The fact is that JCP’s current brand positioning skews into the negative; it is more likely to be a place where people actively avoid shopping. I would wager that JCP could adopt a defunct retailer’s brand name (like Thalheimer’s), re-brand its operations, and be ahead of where it is now – that’s how little goodwill and esteem the brand holds. If such a state can be considered “equity,” then the whole concept of brand equity needs to be rethought.

So what can be done?

It’s really a tough predicament for JCP. At this point, the first step is to admit that the company is not viable in its current configuration. Embracing that reality should create the necessary appetite for radical change. The easiest path that I can see is for JCP to greatly decrease its footprint by selling off all marginal properties in order to raise cash and improve operating performance. Once that process is under way and generating cash, the company should throw its remaining resources behind a web-based strategy to push its private brands, using the successful online retailing platforms of Amazon and others to augment the remaining JCP store locations and its own website. So, in a sense, I guess I am advocating that JCP transform itself into a direct-to-consumer retailer cum middle-brow fashion house, while retaining only the profitable rump of its current retail stores. Rather than trying to remake itself in the mold of a Macys or Target, JCP should look to Fifth & Pacific (formerly Liz Claiborne Inc.) for inspiration.