JC Penney: ‘Invalid’ Default Claim Imperils Strategic Plan

Tuesday, 05 Feb 2013 03:32 PM

 

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J.C. Penney Co., facing a potential threat to its turnaround plans, has come out swinging after debt holders claimed it technically defaulted on a bond.

On Monday the department store chain filed a lawsuit in Delaware Chancery Court seeking to block efforts by a group of bondholders to declare a default on 7.4 percent bonds due in 2037. The company also asked lawyers at Brown Rudnick LLP to identify the investors they represent. The Boston-based firm said in a letter to the company that it represents holders of more than half of the debt.

The claim exposes J.C. Penney to “imminent, irreparable harm,” the Plano, Texas-based retailer said in the complaint. The suggestion could put the company at risk of demands for payment on more than $2.8 billion in debt, increase borrowing costs and “impair its ability to effectively deploy capital to drive its strategic business plan,” according to the legal filing.

“We believe this notice of default is invalid, completely without merit and is intended to create self-interested trading opportunities in the market,” J.C. Penney Chief Financial Officer Ken Hannah said in a statement. “We will therefore vigorously defend the interests of J.C. Penney and all of our constituencies in all appropriate forums.”

J.C. Penney has had its credit ratings slashed in the past year as Chief Executive Officer Ron Johnson tries to reverse three quarters of sales declines exceeding 20 percent. Johnson’s plan is supported by activist investor Bill Ackman’s Pershing Square Capital Management LP, the largest equity stakeholder in the company, with 18 percent of the shares outstanding. Ackman, who is on the board, recruited Johnson to J.C. Penney from Apple.

Bond Yield

J.C. Penney has $325.6 million of the 7.4 percent notes outstanding, according to data compiled by Bloomberg. The debt trades at 84.25 cents on the dollar to yield 9 percent, from 96.75 cents and a 7.7 percent yield about a year ago, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Last month, “market gossip” about a default prompted Covenant Review to issue a Jan. 24 research note, in which the independent credit research firm dismissed the rumors “as greatly exaggerated.”

In a note Monday night, Carol Levenson, director of research at Chicago-based Gimme Credit LLC, wrote: “We would be very surprised if these bondholders are judged to have a valid claim of default, given the fact that such asset-based lending agreements are used frequently and investment-grade bond indentures regarding security are full of holes and loopholes.”

J.C. Penney shares were up 3.4 percent at $20 in the final half-hour of regular trading Tuesday in New York. The shares fell 44 percent in 2012, compared with a 25 percent gain for the Standard & Poor’s 500 Retailing Index.

‘Negative Development’

The situation is a “negative development and fuel for the bears on the stock,” Liz Dunn, a New York-based analyst for Macquarie Group Ltd. in New York, said in a note. The balance sheet will be the focus of J.C. Penney’s upcoming earnings report on Feb. 27, she wrote. The company has said it will end the fiscal year with $1 billion in cash and an untapped credit line of $1.75 billion.

“The restructuring attorney we consulted characterized the move as aggressive and unusual on both sides of the table,” said Dunn, who has the equivalent of a hold recommendation on the shares.

Moody’s Investors Service rates the retailer B3, six levels below investment-grade, with a “negative” outlook and S&P has an equivalent grade on the company, following three straight quarters of sales declines of at least 20 percent. The firm said Tuesday that the dispute will have no immediate impact on its ratings.

Store Transformation

J.C. Penney has lost customers as Johnson transforms most of the company’s stores into collections of 100 branded shops and reduces coupons and sale events by marketing items at an “everyday low price.”

During the company’s November earnings call, CFO Hannah said J.C. Penney’s balance sheet is “positioned to be able to fund the transformation.” The retailer doesn’t have a bond maturity until 2015, data compiled by Bloomberg show.

James Stoll, a Brown Rudnick lawyer representing J.C. Penney bondholders, didn’t return calls for comment on the retailer’s suit over the default claims. Joey Thomas, a J.C. Penney spokesman, declined to comment. J.C. Penney’s lawyers at Skadden, Arps, Slate, Meagher & Flom LLP declined to comment beyond the legal documents.

The default claim draws on bond offering documents in 1997, and contends that the company shouldn’t have been able to pledge inventory as collateral for a credit line.

Bond Restrictions

Lawyers for the retailer say restrictions on the 7.4 percent bonds don’t mean J.C. Penney is in default by signing the credit pact because the limitations don’t “encompass liens on inventory, but instead serves only to restrict liens” on principal property.

While the credit agreement has been in force for more than a year, J.C. Penney officials have only used it “to support letters of credit, none of which have been drawn upon,” the company’s attorneys said.

J.C. Penney has publicly disclosed for about 10 years that it has various undrawn credit facilities secured by inventory with no bondholder allegations of a violation, the lawyers said.

J.C. Penney had about $2.97 billion of long-term debt and $525 million cash as of Oct. 27, according to the company’s most recent quarterly filing. Fourth-quarter sales may decline 24 percent to $4.13 billion, according to a Bloomberg survey of 15 analysts.

The case is J.C. Penney Co. Inc. v. US Bank National Association as Indenture Trustee, 8276, Delaware Chancery Court (Wilmington).

© Copyright 2014 Bloomberg News. All rights reserved.

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