[PDF] Competing for Survival: A Turnaround of Department Store J.C.

Caroline)BaierJensenEmma)Caroline)JakslandMadelon)K.)Grandjean)PoulsenMikkelHolst)SchouHansenMarc)FaarborgToftColumbia)Business)SchoolTurnaround)ManagementFinal)ProjectProfessor)Doug)SquasoniDecember)15,)2017Competing for Survival: A Turnaround of Department Store J.C. Penney

Key)industry)metric)EBITDA)ImprovementCostsCosts)related)to )physical)spaceInventory)managementRevenueDistributionServiceProductsTurnaround)strategyTurnaroundstrategyaimedatincreasingJ.C.Penney'sbottomQandtoplinegrowth121)224)198498)Sales)per)retail)sq.)feetJCPrankssignificantlybelowitspeersintermsofsalesperretailsquarefeetemphasizingtheneedforstoreclosurestoimprovethismetric050100150200250Stock)price)developmentCompeting for Survival: A Turnaround of Department Store J. C. PenneyThispaperiscenteredaroundJ.C.Penney,anAmericanretaileroperatingmorethan1,000departmentstoresacrossthecountry.Morespecifically,thefocusisonthefinancialandoperationalissuesfacingthecompanywhichhasledtodecliningrevenuesandtheincurrenceoflossesoverthepastfiveyears.Theanalysisbeginswithanoverviewofthecompanyandtheindustrywithinwhichitoperates.Itisevidentthattheentireindustryhasbeenunderpressureduetochangingdynamicssuchasthegrowingpopularityofonlineshoppingaswellasageneralincreaseincompetition,consequentlyerodingmarginsandprofitability.Toimprovethequalityofanysuggestedrecommendations,bothqualitativeandquantitativetoolsareusedinthepaper.Inthefinancialanalysisitisdiscoveredthatalthoughmostretailershavefeltagrowingpressureontheiroperations,J.C.Penneyseemstohavebeenaffectedthemost.Thecompanytherebyunderperformsinrelationtoitsmainpeersbothintermsofefficiencyandprofitability,whilesimultaneouslyfacingagrowingdebtburdenthatcannotbesustainedinthelongrun.Thecausesforthisdecliningperformancearesoughtthroughanexaminationofthecompany'soperationalandstrategicactivities,wheremanagementturbulenceandwrongfulstrategicinitiativesarehighlightedascontributingfactorstoJ.C.Penney'sdecliningperformance.AturnaroundstrategyisproposedwithhighlightsbeingstoreclosuresandagrowingonlinepresencetoensurebothbottomQandtoplinegrowthgoingforward.Finally,severalvaluationsareconductedtoexaminewhetherthecompanyshouldi)beliquidated,ii)besoldinanM&Aprocess,oriii)continueasagoingconcern.ThemostvalueQcreatingoptiontodebtandequityholdersistokeepthecompanyasagoingconcernwhileimplementingnecessaryturnaroundinitiativestoplaceJ.C.Penneyonatrajectoryofgrowthandprofitability.Executive)summary2007))))))))2009))))))))2011))))))))2013))))))))2015))))))2017Generalindustrydeclineevidentfromstockpriceperformanceoffourplayers.J.C.Penneyisclearlyperformingtheworst,approachingindex7inDecember2017Index)100)in)2007

11.IntroductionTheretaillandscapeisprojectedtochangemorewithinthenextfiveyearsthanithasdoneoverthepastcentury(MacKenzie,etal.,2013).Lookingnotonlyatdepartmentstores,butattheretailspaceingeneral,thefirstsevenmonthsof2017saw19bankruptcies,surpassingtherecordof18filingsduring2009(Thomas,2017).Someattributethedecliningperformanceofretailerstothegrowingimportanceofonlineshoppingwhileothersviewitasamarketcorrectionforthosechainsthatwerenotproperlyequippedtocompeteintheindustryintoday'scompetitiveenvironment.All,however,agreethattheconceptofadepartmentstoreasweknowit,isabouttochange(Cohen,2017).Thedepartmentstoreindustryhasbeenindeclineforthepastfiveyears,andthistrendisexpectedtocontinuewithrevenueprojectedtofallatarateof4%annuallyto$156.4billionin2017(Cohen,2017).Annualgrowthbetween2017and2020isfurthermoreexpectedtofall-2.6%(Statista,2017a).Cohen(2017)projectsthattheaverageindustryprofitmarginwillbe2.6%in2017,adeclineof1.4percentagepointsfrom2012.Inadditiontodecliningsales,brick-and-mortarstoresincurhighoperationalcost,relativetoonlinecompetitors,primarilyduetosalariesandretailspace.Trendsamongphysicaldepartmentstoresarelowerprices,higherfrequencyofpromotionsandmorefundsallocatedtomarketingandadvertising.Inthepastdecade,brick-and-mortarstoreshavefollowedthegrowthformulaofopeningstorestoacquireandservicemorecustomers(MacKenzie,etal.,2013).Thisgrowthstrategy,however,isnolongervalidasconsumerpurchasingdecisionshavechangeddramatically.Previously,acustomer'spurchasedecisionprocessstartedwithchoosingastoreandthenselectingaproductinthatstore.Thisisinlinewiththedesignofdepartmentstores,whochoosebrandsrelevanttotheirtargetcustomergroup.However,consumersnowresearchonlinebeforegoingtothestoresreducingtheneedforassistanceintheshoppingprocess.Customersaretherebytakingchargeoftheinitialscreeningofbrands,makingthevaluepropositionofdepartmentstoresobsoletetoacertainextent.Departmentstoresalsofacethechallengeofshiftingconsumerpreferences,asshoppersde-selecttraditionalbrandsinfavorofnon-traditional,startupbrands,whicharerarelypresentinlargedepartmentstores(Roeder&Rupp,2017).Inaddition,customersareusingtheirsmartphonestobenchmarkprices,getinputfromsocialmediaandfriendsandfamily-andwhentheyarereadytobuy;numerousonlineretailerscreateandincreasepricetransparencyinthemarket,tothedetrimentofphysicalstores(Baird,2017).Inaddition,onlineretailersdeliverproductsdirectlytotheendconsumer,oftenwithinthesameday.Goingforward,fivetrendsareconsideredsignificantinwinningadominantpositionintheretailmarket,in cludingdemographicchanges,multichanneland mobilecommerce,perso nalized

2marketing,thedistributionrevolution,andemergingretailbusinessmodels(MacKenzie,etal.,2013).Alloftheabo veeleme ntspresen ttraditionaldepartm entstoreretailerssuchas J.C.Penney(hereinafter,JCP)withasignificantchallenge.MajorplayersintheindustryareKroger,Macy´s,Nordstrom,Kohl's,andJCP,thelatterbeingthesubjectofanalysisinthispaper.ThefollowingsectionwillgiveanintroductiontoJCPandthechallengesitisfacingintheseturbulenttimesinachallengingindustry.2.CompanyOverview2.1KeyCompanyFactsJamesCashPenneyandWilliamHenryMcManusfoundedJCPin1902,andithassincethenbecomeoneofthelargestdepartmentstorechainsintheUS,operating1,013locationsacrossthecountryandemploying106,000people.Currently,JCP'sheadquartersarelocatedinPlano,TexaswherethecompanyisledbyCEO MarvinEll ison.JCPtargetslow-andmid-incomehouseholdssellingmerchandisewithinthefollowingsegments:clothing,cosmetics,electronics,footwear,furniture,housewares,jewelryandappliances.Asapartofarecentgrowthstrategy,thecompanyhasdividedkeyoperationsintothreepillarsi)beauty,ii)homerefresh,andiii)specialsizes.Thecompanyholdsbothnational-andprivate-labelbrands.Asof2016,private-labelbrandsaccountedfor44%ofsales(J.C.Penney10K,2016).Overthepastcoupleofyears,JCPhasexperiencedfinancialproblems.Priorto2011,thegrowthofJCPwasstagnatingfortwodecades,whichmadetheboardhireRonJohnsonfromAppleasthecompany'snewCEO.RonJohnsontriedtoimplementradicalchangesbygoingawayfromcoupons,salesanddiscounts,andmoretowardseveryday"fairandsquare"lowprices.However,thiswasnotreceivedwellbycustomers.After16months,withRonJohnsonasCEO,saleshaddeclinedmorethan25%,andthestockpricehaddecreasedbyalmost50%.Thisfurtherresultedinaroundoflayoffs,with19,000peoplelosingtheirjobs.From2011to2015JCPexperiencedfivestraightlosingyears,whichamountedtoa$3.5bnlossintheperiod(Isidore,2017).Thecompanystillfacesseveralchallenges;revenueisdeclining,debtobligationsamounttonearly$3,6billion,andthecompanyhashighoperationalcostrelativetoe-commercecompetitorswhocontinuetowinmarketshare.Becauseofaliquidationofpoorlysellinginventory,especiallyintheappareldivision,andtheclosingof127oftheleastprofitablestores,JCPmanagedtogeneratea$1millionadjustedEBITDAin2016,whichisthefirstshadowofprofitabilityinsixyears.Thiswas,amongotherelements,aresultofthegrowingfocusonprivatelabels,allwithahighergrossmarginthanbrandsnotapartoftheJCPumbrella.This,combinedwiththecompany´shighbrandawarenessandalargeproductportfolio,posesopportunities fortheorganizationgoingforw ard.Foracomplete listofstrengths,weaknesses,opportunitiesandthreatscf.SWOT-analysisinExhibit1.

33.PeerComparison3.1Non-FinancialPeerAnalysisAlthoughmultipledepartmentstoresareappropriateforcomparison,includingSears,Target,andWal-Mart,thepeerreviewisnarroweddowntofocusonKohl's,Macy's,andNordstrom,sincethesearethemostsimilartoJCPandfrequentlycitedaspeersinbrokerresearch.JCPconsidersKohl'sitsclosestcompetitor(Ofek,etal.,2016).However,asChiefInformationOfficerTheraceRischnotes,"ourcustomerstendtobemoresimilartothoseofothermid-tierdepartmentstores,butanyonethatsellsthesamestuffwedoisathreat"(Ibid).Kohl's,Macy's,andNordstromarethemostrelevantforJCP,sincetheyoffersimilarproducts,theircustomersareinfluencedbysimilarbroadeconomictrends,andtheiroperationsaremostlydomestic.Therefore,thesethreepeerswillprovideanindicationofJCP'sabilitytotacklethechallengesofthebusinessinwhichtheyoperate.ComparingJCPtothethreepeersintermsofqualitativemeasuresshowsthatJCPscoresatthebottomofthepeergroup,exceptinshoppersatisfaction.Table1summarizesthecomparisononfourparameters;over allexperience,e-commerceexperience,shopp ersatisfaction,andbrandreputation(additionalparametersarefoundinExhibit2.Table1:QualitativepeercomparisonSources:TheHarrisPoll,Foresee,andAmericanCustomerSatisfactionIndex(ACSI)inRetailBusinessMarketResearchHandbook2017-2018(Miller&Washington,2017).Nordstromperformsthebestinthepeergroup,rankingfirstonallfourparameters.ItisinterestingthatJCPidentifiesKohl'satitsclosestcompetitor,whenKohl'sseemstoperformbetterthanJCPinallfourmeasures,indicatingalackofcompetitivenessfromJCPinitsappealtocustomers.Forbusinessesfacingextensivecompetitionfromsubstitutecompanies,customerloyaltyarguablybecomesincreasinglyimportant.Furthermore,withthemarketdecreasingthereisahighlikelihoodofconsolidationintheindustryeitherthroughmergersortheclosingofcompaniesassupplybeingstoexceeddemand.Beingthepreferredcustomerchoicethereforeincreasesthelikelihoodofsurvival.Assuch,JCPisatriskofbecomingredundantunlessitcanmanagetoturnitscustomerexperiencearound.3.2FinancialComparisonAshighlightedintheindustryanalysis,retailersarefacingseveraldisruptionswhichhaveputthefinancialperformanceofcompaniesunderincreasedpressure.ThequestionisthenifthedecliningOverall'ExperienceE.commerce'ExperienceShopper'SatisfactionBrand'ReputationNordstrom81828275.58Kohl's80797775.04Macy's78797372.4JC

4performanceofJCPcanbeattributedtoindustry-ratherthanfirm-specificeffects?ThiswillbeexaminedinthefollowingsectionthroughananalysisofthefinancialperformanceofJCPanditspeers.3.2.1OperationalAnalysisTable2illustratesthedevelopmentinthenetincomeofJCPanditspeersandyieldsseveralinsights.AllpeershaveexperienceddecliningprofitsevidentfromanegativeCAGRofaround13%to17%intheperiod2012to2016thussupportingthethesisthattheentireindustryisfacingchallenges.However,whiletheothercompanieshavemanagedtogenerateprofits,JCPhasincurredlossesthroughoutmostofthe periodon lyturningaslightpro fitin2016of$ 1million.Table2:Developmentinnetincome(USDmillion)Toexamine potentialsourcesofth isnegativeanddeclini ngnetincomeitisusefu ltobreak profitabilityintoitssubcomponentsillustratedintable3.Table3:ProfitabilityratiosProfitabilityratiosJCPKohl'sMacy'sNordstromAverageGrossmargin35.67%36.08%39.40%40.40%37.89%EBITDAmargin7.36%12.35%10.63%11.08%10.36%EBITmargin2.51%7.33%6.53%6.71%5.77%Profitmargin0.01%2.98%2.40%2.40%1.95%JCPperformstheworstoutofallitspeersonallfourprofitabilityratiosthusindicatingthatthecompanyeitherhastoohighcostsorfailstochargesufficientlyhighprices.Fromtable4itisevidentthatJCPhasacost/saleslevelaboveaverageinallfourcategorieswhichimpliesthatonesourceofdecliningprofitabilityisthecompany'scosts.Table4:CostratiosNetincome20122013201420152016CAGR

J.C.Penney(985)(1,388)(771)(513)1n.m.

Kohl's986889867673556-13.3%

Macy's1,3351,4861,5261,072619-17.5%

Nordstrom735734720600354-16.7%

D&A/Sales4.85%5.02%4.10%4.37%4.59%0.27%

5Akeymetricusedintheretailindustryissalesgeneratedperretailsquarefeetandasevidentbyfigure1,JCPrankssignificantlybelowallpeersonthisparameter.Figure1:KeyindustrymetricsSource:Factset(2017)Thecompanygenerated$121perretailsquarefeetin2016comparedtoKohl'sandNordstromwhogenerated$224and$498respectively.ThisimpliesthatJCPdoesnotgeneratesufficientrevenuetojustifythe1,013storesitiscurrentlyoperating,makingitimperativetoclosedownthosethatfailtogeneratesufficientrevenueandprofits.Thecompanyisalreadyintheprocessofclosingdownstoresbutthelowrevenuepersqftimpliesthatadditionalclosuresarenecessarytofurtherimproveprofitabilitybeyondtheminimal$1million.IntermsoftheefficiencyofJCP'sactivitiesthefocusisonthecompany'sassetturnoveraswellasitsinventorymanagement.Theretendstobeatrade-offbetweenefficiencyandprofitabilityascompaniesareeitherhigh-margin,low-volumebusinessesor theopposite.DuetothelowermarginsofJCP,onewouldexpectthefirmtooutperformitspeersintermsofefficiency.JCP,however,ranksbelowaverageintermsofassetturnoverwhichisthesalesgeneratedperunitofassets.Thisisinlinewiththelowrevenueperstore,andthecompanycouldthereforeimproveitsefficiencybyclosingdowninefficientshops.Intermsofinventorymanagementthecompanyhas112daysinventoryoutstandingwhichisbelowthatofMacy'sbutaboveitstwootherpeers,NordstromandKohl's.Thedecisiontoremovesalesandimplement'fairandsquare'lowpriceshadanegativeeffectonthecompany'ssalesandmighthaveresultedinthefirmbeingleftwithobsoleteinventory.Table5:EfficiencyratiosEfficiencyratiosJ.C.PenneyKohl'sMacy'sNordstromAverage

Assetturnover1.261.331.231.741.39

Inventoryturnover3.233.283.035.133.67

Currentratio1.791.931.451.441.65

Quickratio0.480.390.390.700.49

Interestcoverage0.904.404.598.114.50

LTdebtratio(LTD/TA)51%33%34%35%38%

D/Eratio3.110.801.481.791.80

TA/TL1.195.031.301.242.19

7contrast,uponexaminationoftheothercashratios,JCPappearstohaveahighlevelofcashonitsbalancesheetwithahighercashasapercentageofassetsandliabilitiesthanallitspeers.AkeytakeawayfromthefinancialanalysisofJCPisthatalthoughthecompanycurrentlyhasareasonableassetbaseandasubstantiallevelofcashtoserviceinterestpayments,thehighlevelofleverageandcorrespondinglyhighinterestpayments,almostexceedingthecompany'sEBIT,arenotsustainableinthelongrun.4.CausesofDecline4.1ManagementFailureMikeUllmanheadedthecompanyfrom2004to2011(Ofek,etal.,2016).Towardstheendofhistenure,JCPwasunderp erformingmateriallyrelativetoitspeers.Thecompan yperformedsignificantlybelowallpeersintermsofROA,ROE,EBITDAmargin,profitmargin,andinterestcoverageratioin2011asillustratedinExhibit3.ActivisthedgefundmanagersBillAckmanandStevenRothacquired27%ofthecompanyin2010.BothweregivenseatsonJCP'sboard,andAckmanpromptedthefiringoflong-timeCEOMikeUllman(Subramanian,2015).Heendorsedhisreplacement,RonJohnson,in2011,tothenre-hireUllmansixteenmonthslaterandthen,again,pushforhisreplacement.ThefollowingpresentsananalysisoftheleadershipofJCPstartingwiththearrivalofRonJohnson.WithinayearoftakingoverasCEO,RonJohnsonhadreplacedthechieffinancialofficer,chiefoperatingofficer,chieftechnologyofficer,chiefmarketingofficer,andchieftalentofficer(Bhasin,2012).Itiscertainlyadvisableforaturnaroundmanagertoscantheexistingmanagementteamformemberswhounceasinglyworkagainstthenewagenda,butacompleteswitch-upoftheC-suitecouldeliminatevaluableexperienceandinsight,andfeedalienationbetweenthenewstrategyandtheremainderoftheexistingorganization.OneofJohnson'sstrategicfiascoswasthereplacementoffrequentpricediscountsandpromotionswithoutpriortestingonhowtheexistingcustomerbasewouldrespond.In2012,theaveragediscountonsoldproductsreached60percent(Ofek,etal.,2016)Discountswerereplacedwitheverydaylowpricingthroughthe'FairandSquare'campaign,andhigher-endproductlinesanddesignercollaborationswereadded.Johnsonremovedsalescommissionswiththeintentionofincreasingcustomerfocusanddecreasingfocusonsales(and,onecouldspeculate,toincreasethedistressedbottomline),astepwhichfrustratedmanyemployees(Ibid).Despitedouble-digitdecreasesinsales,storeswhichhadbeenupdatedaccordingtoJohnson'sstrategyperformedrelativelybetterthanthosewhichhadnot.Somehavesincearguedthatthestrategicoverhaul,whichcateredtoaratherdifferentcustomer,wasnotgivenenoughtimetocultivateproperly(Ofek,etal.,2016).Ackman,whohiredJohnsontoreplaceUllman,cited'too

8muchchangetooquicklywithoutadequatetestingonwhattheimpactwouldbe'asthereasonbehindthefailureofJohnson'sstrategy,whichAckmandescribedas'veryclosetoadisaster'(Wapner,2013).StrategicfailureunderJohnsonappearstohavebeenanissueofinhabitingthewrongfocus:whileJohnsoncertainlyshowedexceedingcompetenceinpastendeavours,hewassteel-setonafocusonthewrongcustomer-amove,whichculminatedinconfusionamongexistingcustomersaboutwhatJCPstoodfor.WhilestrategicfailuremayhavecontributedgreatlytoJCP'sdemiseunderJohnson,severalsourcessuggestthatalackofbuy-infromtheorganizationalsoaffectedtheturnaroundprocessadversely.Johnsonhadaverycleargroupofafewexecutiveswhomheconfidedin.EmployeescomplainedaboutlackofcommunicationandtransparencyfromRonJohnson'smanagementteam.Asanexample,storemanagersonl yhadaccesstoth eirownsalesnumberswhereasrelativestoreperformancewaskeptunderwraps.Bhasin(2013a)pointstowardsJohnson'spastatApple,acompanywhereconfiden tialityiskeyforverysen siblereasons,asa potentialpartofthe explanation.ButatJCP,themovetowardsopac ityresultedinlossoftrustin management. AccordingtoCovert(2013),JohnsonandeightotherexecutivescontinuedUllman'spracticeandcommutedfromtheirhomesinotherstatestoJCP'sheadquartersbycorporatejet.Johnsonwasrarelyintownfortheentireworkweek,andstayedattheRitz-Carltonhotelonthecompany'sbillwhenhewas.Theuseofcorporatejetsandluxuryhotelsduringtimesofcutbacksandlay-offscreatesavividcontrastandmaysignalthattopmanagementhasnointerestin"sharingthepain".Theperceiveddistancecreatedasaresultlikelyhurtbuy-infromtherestoftheorganizationwhich,duetotheiss ueso flacking transparency,werealread ysubject toastarkcommunicational hierarchy.Therapidspreadofrumors(surrounding,amongotherthings,newroundsoflay-offs,eliminationsofcertainpositions,andshut-downsofdivisionsandstores)alsoultimatelycreatedanenvironmentofuncertainty,distrust,andinsecurity.Lastly,Tuttle(2013)notesthatJohnsonhaddifficultiesrelatingtoandappearedtohavelittlerespectforJCP'sexistingcustomerbase.Forexample,hepublicallysuggestedthatcustomersneededtobe'educated'whentheydidnotrespondwelltothenew'fairandsquare'pricingstrategy.MikeKramerwascarriedoverfromApplebyRonJohnson,takingthepositionasCOOatJCP.KramerwasquotedinintheWallStreetJournalin2013,describingtheJCPcultureatthebeginningofhistenure:'IhatedtheJCPenneyculture,itwaspathetic'suggestingthatJCP'sheadquarterswere'overstaffedandunderproductive'(Bhasin,2013b).ThedemeaningrhetoricwithwhichthenewC-suitedescribedtheJCPculturewasanotherlikelysourceofalienationbetween"old"and"new".WhenUllmanreturnedin2013,hemovedthefocusbacktotheprecedingJCPcustomerandreinstatedheftydiscounts. Largelosseswe reincurredagainin2013,when HomeStores,asoverhauledbyJohnsonathigherpricepoints,wereestablishedanddidnotresonatewellwithcustomers(Ofek,etal.,2016).In2015,UllmanhandedoverthereinstocurrentCEOMarvinEllisonmarkingthetransitiontowardsbettermanagementpractices.EllisonmakesapointoutofvisitingJCPstoresasoftenaspossible,andallseniormanagementisexpectedtodothesame.Whenvisiting

9stores,theyarerequiredtodressinthecompany'sclothinglinestoeliminatevisualcultureclashes(Ibid).Ellisontellsthetaleofhischildhoodinablue-collarfamily,wherethebi-annualvisittoJCPwassomethingtheentirefamilylookedforwardto(Wahba,2016).EllisonappearstorelatetoandtargetthepresentJCPcustomer,whilemakingaclearpointofattemptingtoelicitbuy-infromalllevelsoftheorganizationbybeingpresentandavailableandcompellingalltopmanagementtodothesame.OnJuly10th,itwasannouncedthatJCP'sCFOEdwardRecordwouldstepdown(Rupp,2017).CFOresignationisoftenaredflagindistressedcompanies,takentoimplythatthingsmaybeheadedfortheworse.Hisreplacement,JefferyDavis,istheseventhpersoninhabitingtheCFOrole(includinginterim)inthepastsixyears.Figure2:CEOandCFOturnover,2000-20174.2CorporateGovernancePastboardmemberandactivisthedgefundmanagerBillAckmanlargelyreceivedtheblameascatalystforthedeclinethatfollowedtheimplementationofRonJohnson'sstrategy.Butina60-Minutesinterview,hehighlightedthatallotherboardmemberswereunavoidablycomplicit,too.WhenRonJohnsontookoverin2011,thecompositionofJCP'sboardcertainlyhadroomforimprovementintermsoftherelevan ceofthei rcompetencies. Withanov erweightw ithinelectronics,technology,andlogistics,nonehadextensivedirectexperiencewithintheretailsector(JCP,2011).Narrowvisionontheirareasofexpertisecouldbetoblamefortheirinactionandlimitedinvolvement.Undertheabsenceofapoisonpill,RothandAckmanwereonlyrequiredtodisclosetheiracquisitionof27%ofthecompanyin2010within10daysoftheacquisitionasperSECrules(Subramanian,2015).In2013,thecompanyinstitutedapoisonpillwitha10%threshold,whichwasextendedandloweredto4.9%in2014.T hemove wasintendedtopreve nthostiletake oversandensure preservationofthecompany'snetoperatinglosscarryforwards(NOLs)of$2.2billion(Wahba&Michael(Dastugue20002004201120132015Allen(QuestromMike(UllmanRon(JohnsonMarvin(EllisonRobert(CavanaughEdward(RecordCEOCFO20122014Ken(Hannah20172016Jeffrey(Davis(Interim(CFO:(Mike(KramerInterim(CFO:(Andrew(S.(Drexler

10Cavale,2014;JCP,2016).Ifthecompany'sbestshotatsurvivalturnsouttoinvolveputtingitselfupforsale,thepoisonpillwouldofcoursehavetobealtered.PotentiallossofNOLsisanimportantconsiderationinanyscenariowhereachangeofcontrolmayoccur.4.3OrganizationalDistressCurveOftenacatalystfortheinitialdeclineofacompanyisthesimultaneousoccurrenceofnegativeinternalandexternalforces.Inth ecase ofJCP,thei nternalfactorslargelyrevolvearoundmanagementfailureconsistingofhighCEOturnoverandfaultystrategicinitiativescoupledwithdecliningfinancialperformance,ultimatelyleadingtoacompanysplitintoseparatelayersthatdonotworktogether.ThenegativeexternalimpactonJCPisattributedtotheincreasedpressureonalldepartmentstoresbecauseoffiercecompetitionandthegrowthinonlineretail.Theshiftingbusinessdynamicshaveaffecteddepartmentstoresacrosstheindustry,however,itisJCP'sinabilitytoadjusttothisexternalpressurethathasresultedinitsdecline,whichothershavemitigatedthroughswiftandefficientstrategicresponses.TheorganizationaldistresscurveisausefultoolforhighlightingdifferentstagesofJCP's lifecycleandemphasizingthos efactorsthatpush edthecompanyanotherstagedownthecurve.Figure3:OrganizationalDistressCurveAshighlightedpreviously,itwasageneraldeclineandpressureontheentireindustrythatinitiatedJCP'smovedownthedistresscurve.Failuretoadaptproperlytoexternalshocks(inaction)therebyresultedindeterioratingprofitability,whiletheappointmentofnewmanagement,i.e.action,ledtotheimplementationofvaluedistortingstrategieswhichcanbeinterpretedasfaultyaction.Todaythecompanyistosomeextentinastageofcrisiswithextensiveleverageandlowprofitability.Toprevententeringthestageofdissolutionseveralstepsareneeded,includingthedefinitionofafeasiblecorporatestrategy, appropriateorganizationalarrang ementsaswellasanadeq uatefinancialstructurewhichcanbolste racceptancefromcapitalmarkets.Th efollowingsections

CashOnly887100%887

Inventories2,85435%998.9

OtherCurrentAssets35630%106.8

TotalCurrentAssets4,0971992.7

TotalInvestmentsandAdvances137%0.91

IntangibleAssets54010%54

OtherAssets655%3.25

TotalPPE,IntagiblesandOthers5,2172127.71

TotalAssets9,3144,120

13Table8:CreditorOverviewandWaterfallAnalysisIntheliquidationsimulation,firstlien-andsecondliencreditorsaresatisfied.Seniorsubordinateddebtorswill,however,onlyretrieve48%ofthefacevalueoftheirinvestment.Onlyequityholderswouldbeleftcomp letelywith outrecovery.Nevertheless, onewouldexpectthatseniorsubordinateddebtorswouldpushforarestructuringbeforealiquidation,asretrievinglessthan50%wouldnotanoptimalsolutionforanyonewhoperceivesthatthecompanycouldpotentiallybesaved.5.2Chapter11FilingWhenacompanyisindistresstherearestrategicconsiderationsinvolvedinfilingforvoluntaryChapter11.Thethreatofabankruptcyalonecanbeeffective:the'takeitorgetnothing'threatcanbeaneffectivebargainingtoolforwhencreditors,suppliersandemployeesthreatentoexercisetheirclaims(George,etal.,2012).Whileanin-courtrestructuringhasmultiplenegativeimplicationsforacompany,therecanbesignificantbenefitstogainfromtheabilitytorestoreoperatingcashflowstosustainablelevels.SinceanynewobligationsaregivensuperioritytoallotherdebtobligationsunderaChapter11,JCPwouldhaveeasieraccesstocredit.ThiscashboostcanhavesignificantimpactontheabilitytoturnCreditorsRecoveryrateRecoveryValueAssetsLeft

FirstlienDebt

2016TermLoanFacility1,667$100%1,667$

Seondliendebt

5.75%SeniorNotesDue2018265$100%265$

8.125%SeniorNotesDue2019400$100%400$

5.65%SeniorNotesDue2020400$100%400$

6.375%SeniorNotesdue2036388$100%388$

SeniorSubordinatedDebt

7.95%DebenturesDue2017222$48%106$

7.125%DebenturesDue202310$48%5$

6.9%NotesDue20262$48%1$

7.4%DebenturesDue2037313$48%150$

7.625%NotesDue2097500$48%239$

Totaldebt4,667$500$0$

LesscashandEquivalants887$

Netdebt3,780$

EquityMarketValue1,354$

TotalEnterpriseValue5,134

14operationsaround(George,etal.,2012).Howev er,managementactionsmaybe remarkablyconstrainedduetocourtscrutiny,despitethetimegainedtomakedecisionsandproposeasolution(Ibid).Besideshighcosts,lackofcontrol,andthepotentialofpublicizingsensitiveinformationofanin-courtrestructurin g,whatmakesaChapter11filinglessattractiv eforJCPistheaffi liatedreputationalriskthatgivesrisetoskepticismfrombothdownstreamandupstreamstakeholders.Vendorsarelikelytobecomereluctanttosupplyproductsormaterialsinthefearofnotgettingpaid,whileconsumersmaybelessinclinedtobuyproductsthatpotentiallycannotbereturnedorservicedinthefuture.Expensiveproductswithlongexpectedliveswhichhaveafter-salesserviceandembeddedguaranteesattachedwillbeparticularlyaffectedbythisreputationalrisk.Customerslookingforproductssuchashomeapplianceswhicharemeanttobeusedforyearswilllikelybeacutelyreluctanttobuyfromafirmindistress,whichwouldbeexpectedtohaveadiscouragingeffectonsales.AnexaminationofthefinancialsofJCPwillfacilitateansweringthequestionofwhetherthefirm'slevelofdistressindeedqualifiesabankruptcyfilingasabsolutelynecessary.Theessentialquestionstoaskarewhetherthecompanyfacesliquidityproblems,andifso,whenitwillbeunabletoserviceitsdebt.Thenextthreerepaymentsdebtincludeadebentureof$220millionin2017,$265millionofSeniorNotesin2018,and$400millionofSeniorNotesin2019.AquicklookatthecashsituationconsideringthedebtlevelsandperformanceprojectionssuggeststhatJCPmaybeunabletoservicetheSenior Notesin2019.However,JCPhasalreadymitigatedthethreatthrougharecentrenegotiationoftheWellsFargorevolverof$4billion,whichprovidesJCPwithatemporaryoptiontouseitscashholdingstofinancematuringdebt,andtherevolvertofinanceoperations.Butfinancingoperationsthroughincurringmoredebtiscertainlynotasustainablesolutioninthelongterm.JCPmustbeabletoorganicallyfinancetheiroperationsthroughnetincomegrowth.Insummary,astrategicChapter11filingwouldbemoreappropriateinasituationwherecashwassignificantlyandurgentlyconstrained.DuetotheinherentreputationalrisksbankruptcycouldposetotheJCPbrand,bankruptcyshouldbealastresort.JCP'scurrentfinancialsituationdoesnotyetmeritthedrasticmeasure.Thecompanyshouldinsteadassesstheprobabilityofasuccessfulout-of-courtturnaroundstrategy.Ifthecompanyconcludesthatanotherturnaroundisunlikelytosucceed,orthatindustrydeteriorationisultimatelylikelytodrivethecompanyintodissolution,liquidationunderChapter7maybemorerelevant.5.3TurnaroundStrategyToconvertJCPfromafirmindistressintoawell-performingentity,threeingredientsareneeded:i)afeasiblecorporatestrategy,ii)appropriateorganizationalarrangements,andiii)acceptanceby

15capitalmarkets(Harrigan,2012).TheimpactofthefollowingstrategicelementsonthefinancialsofJCPareelaboratedinsection5.4.5.3.1CorporateStrategyTheobjectiveoftheturnaroundstrategyistobringJCPbacktoprofitabilitywithastrategythatsecuressustainableprofitsandfirmsurvivalinadynamicmarket.Includedinafeasiblecorporatestrategyareimprovementsinoperationswhichinvolvebothcostcuttingandrevenuegeneratinginitiatives.Animportantpointtokeepinmindisthatafirmcannotcutitswaytogrowth;itisinsteadnecessarytoinvestintop-linegrowthtomaketheturnaroundsustainable.ElementsthatimproveJCP'schancesofsurvivalandincreaseprofitabilitybothintheshortandlongtermaresuggested.Theturnaroundstrategyincludesactionstobothincreaserevenueanddecreasecosts,withthesharedpurposeofimprovingthecompany'sbottomline.Figure4:StrategicactionstoimproveEBITDA5.3.1.1RevenueGeneratingActionsForJCPtosecureitslong-termsurvivaltroughgrowthitshouldprioritizethreerevenuegeneratinginitiativesmovingforward,which maybuildandsustaincompe titiveadvantage;i) furtherdevelopmentofitsOmni-channel,ii)focusonprivatelabelproductlines,andiii)improvementoftheJCPcustomerexperience.First,theshiftinconsumerpreferencesfromphysicaltodigitalshoppingexperiencesemphasizestheneedforJCPtodevelopitsonlinepresence.Digitalconsumers,ande-commerceingeneral,areontheris e;USe-commercesaleshaveincreased by13.75%since 2015andUSsmartphonepenetrationis68.9%whileexpectedtohitalmost81%by2020(Statista,2017b).Astechnologywillcontinuetoincreasethesophis ticationofconsumers,JCPmustcreateaseamless sho ppingexperiencewheredigitalsolutionssupportthein-storeexperience,forinstancethroughmobilepaymentsandeaseofsearch(MacKenzie,etal.,2013).Theexpansionofitsonlinepresencehasthreeimmediateimplications:i)itrequiresinvestmentinonlineinfrastru cture,ii) itmustbeIncrease(focus(on(online(sales(and(the(omni2channel(experience(EBITDA(ImprovementCostsCosts(related(to(physical(spaceInventory(managementImproved(inventory(management(to(decrease(inventory(levels(and(ultimately(improve(net(income(through(lower(COGSClose(unprofitable(stores,(reduce(floor(space,(renegotiate(rental(price(per(square(feet,(and(increase(subleasing(rent(price(for(store2within2store(shops((ActionRevenueOnline(channelCustomer(serviceIncrease(focus(on(the(Private(Label(to(reap(higher(profit(margin(and(exploit(successful(core(segmentPrioritize(customer(service(to(compete(with(peers(through(sales(associate(training(and(optimized(incentive(structurePrivate(Label(focus

16executedsystemicallyacrosschannels,andiii)marketingeffortsmustbealignedaccordingly.First,thecapitaltoinvestinatechnology-driveninfrastructureshouldbefreedupthroughtheclosingofanu mberofcurrentstores,which willbeelaboratedbelo w.Secondly,key tothesucces sofexpandingitsonlinepresenceistoexecutesystemicallyacrosschannels.ProductsorderedonlineshouldbeavailableforpickupinthenearestJCP,tosavethecustomershippingcostsandtoencouragespontaneouspurchases.Thecompanymustalsobeconsistentintermsofthequality,priceandproductselectionitoffersin-storeandonlinetostreamlineitsoffering.Third,JCPshouldleveragephysicalstoresasamarketingtooltomaintainbrandawarenessandachievehigheronlinesalesvolumes.SomeofJCP'scurrentlocationscouldserveasstorageunitleasesforitse-commercebusinesstosupportgrowingvolumethroughthischannel.Throughitssubstantialnetworkofstorageunits,i.e.olddepartmentstores,JCPwouldpotentiallybeabletooffershippingdealscomparabletoAmazonbothinspeedandprice,whichareimportantvaluedriversforconsumers(Gulisano,2017).However,thefirmcanextractcheapersolutionsbyrentingorbuyingsquarefeetinlessattractiveshoppingareasandbycentralizingdistributioninlargerhubs.Theconversionofphysicalstorespaceshouldthereforeonlysupportonlinepurchaseswithin-storepickup,whoseneedforspacemustbeevaluatedcontinuously.Additionally,JCPshouldleveragetheimmenseamountofdataavailablethroughitsonlineplatformstopersonalizemarketing. Anenhancedfocusonprivatelabelbrandsshouldbeundertakenaswell,asthisproductlinealreadyperformswellandexhibitssignificantsalesvolumepotentialforJCP.Privatelabelproductsshowhighergrossmarginpotentialrelativetodistributedproductsduetotheabsenceofdouble-margins.ThebelowthreesegmentsarerecommendedastargetsforR&Dandpromotionaleffortsgoingforward:• Millennials,thefirstgroupwhogrewupwiththeinternet,socialmediaandmobilephones,isagedbe-tween13-30,andmakesup15%oftheUSconsumers.Thesegmentisexpectedtoaccountfor1/3oftotalspendingintheUSby2020(MacKenzie,etal.,2013).• BabyBoomers,appro ximately47mil lionhouseholdsintheUSalon e,areprojectedtoaccountforthelargestspendingproportionswithincategoriessuchashousewares(73%)andapparel (56%)inthecomin gyears.Thesheersi zeofthesegmentunderlinestheimportanceoftargetingthegroupgoingforward.However,shoppingpatternsneedtobeevaluated,asthesegmentisexpectedtospendalargerproportionoftheirincomeonexperiencesrelativetooff-the-shelf-products(MacKenzie,etal.,2013).• HispanicsspendingisexpectedtodoubleoverthenexttenyearsandaccountforonefifthoftotalspendingintheUS(MacKenzie,etal.,2013).Inadditiontogrowingbuyingpower,theirshoppingpatternsareinterestingfordepartmentstores,asthesegmentspends1.5timesmoreonchildren'sapparel,footwear,andfreshfoodthannon-Hispanicconsumers-providingsubstantialopportunitiesfordepartme ntstoresandbrandsthatsucceedintargetingthesegment.

17Asapartofaprivatelabelstrategy,storesacrossthecountryshouldbedesignedtopromoteandshowcaseprivatelabelproductsinmoreoptimalwaysrelativetodistributedbrands.Inrelationtoanincreasedfocusontheprivatelabelproductportfolio,privatebrandsnotownedbyJCPwouldandshouldnotbeditched,astheseproductsdrivetraffictoJCPstores.Byimplementingtheinitiativesabove,JCPwill'shootwheretheducksare'(Whitney,n.d.),i.e.continueitsfocusonitscorebusiness,whilealsoinitiatingtargetingofnewsegments,adaptingtothefuture.Finally,JCPshouldprioritizeanimprovementofitscustomerexperienceduetogrowingcompetitionforsurvivalintheindustrywhereexperienceisadriverofrepeatpurchases.AsshowninTable1,JCPperformsworstinoverallcustomerexperiencerelativetoitspeers,andinthelowendinrelationtoshoppersatisfactiononlybeatingMacy'swhoalsohappentohavealowernumberofemployeespersquarefeet.Twomaindriversforanimprovedcustomerexperienceshouldbeconsidered:i)thephysicalspaceandii)theserviceprovidedbyemployees.First,thetidinessofthephysicalspaceisimportantforastimulatingshoppingexperience,withmessytablesandlowin-storeinventorie scurrentlydiscouragingsales(Loeb,2016).Awayto improveefficien cyistoeliminatenarrowjobdescriptionsandtraineveryemployeeinthestoretoassistandcheckoutcustomers,torestock,andtomaintaintidystorespaces.Second,sincein-storeemployeesaretheonesinteractingwithcustomers,customerserviceconstitutesacrucialpartoftheexperience.Excellentcustomerservicecandriveimmediateandrepeatpurchases.JCPshouldstimulateintrinsicmotivationthroughi)increasedandcontinuousemployeetraining,ii)movingawayfromtaskspecializationandtowardsareaspecialization,andiii)jobadvancementopportunities.Continuoustrainingandareaspecial izationwillmakeemployeesmoreco mpetentinthepro visionof exceptionalcustomerservice,stimulatepersonallearningaspirations,andincreasethedegreetowhichtheyfeelvaluedbycompanythroughitswillingnesstoinvestinthem.JobadvancementopportunitiesshouldincreaseemployeecommitmenttoJCPandwillinthelong-runresultincostsavings,asre-trainingofexistingemployeesistypicallycheaperthantrainingnewpersonnel.Assuch,JCPshouldaimatchangingthepeople,ratherthanchangingthepeople.5.3.1.2CostCuttingActionsAlthoughacompanycannotcutitswaytogrowth,reducingunnecessarycostscandowonderstoastrategicallyviablecompany'sprofitability.ForJCP,twothingsinitsoperatingcostsstandout:i)thehighnumberofphysicalstoresandii)aneedforimprovedinventorymanagement.JCPhasalargenumberofstoresbothrelativetotheirpeergroupandinwhenconsideringthattheretailindustryisshowingaclearshiftfromphysicaltoonlineshopping.Theoveralldecliningperformanceofdepartmentstoresresultingfromshiftingconsumerpreferencesawayfromphysicalandtowardsonlineretail,meritsadiscussionoftheoutlookfordemandandanassessmentofhowJCPmaystrategicallyrepositionitselfinthealteredmarket.JCPmustacknowledgethatreaching

18pastrevenuelevelsmaybeimpossibleinthefuture,simplybecauseoveralldemandforphysicaldepartmentstoresisshrinki ng.Acceptingthis potentialtr uthaboutthefuturemarketwouldsuggestaneedtofollowastrategyof'shrinkingselectively'(Harrigan,1980).LookingatacompanylikeNordstrom,whichturnsaprofitwithapproximatelyathirdofthenumberofstoresJCPhasand31%feweremployees,onecouldinferthatclosingJCPstorescouldbeaningredientfortheturnaroundrecipeforprofitability.However,astrategicconsiderationtokeepinmindisthehigherexclusivityofthebrandsNordstromdistribute:Alimitednumberofstoresiswell-alignedwithanimageofexclusivity.ForJCPwhotargetsalowerincomesegmentthanNordstrom,imitatingNordstrom'sstorestrategytooextensivelycouldbackfire.WerecommendthatJCPsupplementsthedecreaseinphysicalstorespacewithanincreasedfocusonthevisibilityandqualityoftheire-commerceofferingasdiscussedaboveinsection5.3.1.1.Decreasingrentexpensescanbeachievedthroughfouractionsasillustratedinfigure5below.JCPmustdecreasetheirpricepersquarefoot,eitherthrougharenegotiationoftheirleasingcontractswithlandlordsforrentedstores,orbyincreasingtherentchargedforstore-within-storespacesuchastheirSephorastores.Sincetheoverallretailindustryisindecline,andbuildingonJCP'slargesize,thecompanyshouldhavematerialleveragetosuccessfullyrenegotiaterentterms.Additionally,JCPcandecreasetheirrentexpensethroughareductioninsquarefeet,eitherthroughareductioninthenumberorthesizeoftheirstores.Consideringtheoutlookoftheretailindustry,JCPshouldcloseanumberofstoresaltogether,bystrategicallyidentifyingunprofitableanddecliningstores,customerreach,andp roximity tootherstores.The closingof physicalstoresandlowerrentexpenseswillallowJCPtoinvestthefreedupcashinimprovementoftheremainingstoresanddevelopmentoftheironlinepresence.Figure5:DecreaseofrentexpenseNext,withmediocreperformanceoninventoryturnoveranddaysofinventorycomparedtopeers,alongwiththepr oposedincreasedfocusontheirpri vatelabeloperations, JCPhasroomf orimprovementininventorymanagement.ImprovedinventorymanagementwillresultinlowerinventorylevelsandaconsequentlylowerCOGS.Thiswillultimatelyleadtoanimprovementofthebottomline,i.e. netincome.Furthe rmore,JCPshouldleveragetheirimprovedinventorymanagementintheirpricediscountstrategy;withahistoryofanexcessivenumberofpromotionalsalesevents(Ofek,etal.,2016),JCPcouldlearnfrombrandssuchasUniqlo,whichuseinventoryRenegotiation)with)landlordSubleasing)of)floor)spaceSquare)feetPrice)per)square)feetRent)expenseNumber)of)stores:)closingSize)of)stores:)reduction

19levelstodeterminepricediscounts(Yen,2016).Withsophisticatedinventorymanagementsystemsinplace,JCPcouldquicklyrespondtoproductpopularityanddiscountslowsellingproducts.5.3.2OrganizationalArrangementsConsideringJCP'shistoryofC-suiteturnover,currentmanagementshouldbekeptstableduringtheturnaroundtopreventfurtherconfusionandalienationamongemployees.Ellisonappearsmoreadeptatmotivatingandrelatingtotheworkforcethanhispredecessor.Hiseffortstoemphasizehispresencethroughouttheorganizationandhisenforcementofheightenedtransparencytocounterinsecurityinducedbyprevious managementteamsshou ldsupportmanagement'sabilitytomaintainorganizationalcohesivenessthroughouttheturnaroundprocess.Thesecondingr edientinasuccess fulturnar oun dstrategyisappropriateorganizationalarrangements(Harrigan,2012).AninternalforceaffectingthedeclineofJCPareemployeesandtheirlevelofmotivation.Buy-infromemployeesatallorganizationallevelsandinallfunctionsiscrucialtoasuccessfulturnaround.Lookingatcompensation,JCPsalesassociatesearnaround$9anhour,indicatingthatJCPispayingin-storeemployeesclosetominimumwage,whichrangesbetween$7.25and$11anhourinUSstates(DeSilver,2017).Payingsuchalowwagecandirectlydemotivateemployees.Figure6:HourlysalarycomparisonSources:(Glassdoor,2017a;Glassdoor,2017b;Glassdoor,2017c;Glassdoor,2017d)Additionally,studi esshowthat56%ofnear minimumwagew orkers onlyhaveah ighscho oleducationorless(DeSilver,2017).Limitededucationrestrictsjobopportunitiesfortheindividual,andthekeymotivationalfactorbehindthechoicetoworkatJCPwilllikelybethepaycheckforquiteafe wemployees.ThismaymakeitevenmorechallengingforJCPmanagementtomotivateemployeesintrinsicallyandencouragethemtotakeownershipoverandresponsibilityforthecustomerexperiencetheyprovide.ThecurrentlevelofmotivationamongemployeescanbeanalyzedassalesperemployeerelativetoJCP'speers.Astable9shows,JCPhasthelowestsalesperemployee,indicatingrelativelylowemployeemotivation.Hourly'salary'comparison'PositionJC'PenneyKohl'sMacy'sNordstromAverageCashier8.9*9.18*9.04Sales'Associate9.028.749.1711.379.575

20Table9:EmployeemotivationSources:(J.C.PenneyCompany,Inc.,2017;Kohl'sCorporation,2017;Macy'sInc.,2017;Nordstrom,Inc.,2017)Thisindicatorhasitsflawsduetolimitedinformationavailability;thenumbersofemployeesincludebothbackandfrontofficepeople,salesaredrivenbymorethanjustsalesassociateeffortssuchasstoredesignandinventoryonshelf,andthesalesfiguresreflectbothin-storeandonlinepurchases.However,itdoesprovidesomeindicationofemployeeefficiencyorlackthereof,particularlywhentakingJCP'sunderperformanceintoaccount.JCPshouldfocusondriversofintrinsicmotivationsuchastraininganddevelopmenttotargetemployeedrivetogeneratesales.JCPshouldfocustheadjustmentofitsorganizationalstructurearoundflatterhierarchies;aquicksearchonJCP'sonlinejobportalandonGlassdoor.comshowsthehighnumberofjobtitles,whichareallnarrowintheirjob responsi bilities.Thiswillalso haveaspillover effectoncu stomersatisfaction,sinceemployeescantakespeedyactiononcustomerrequestsinsteadreferringthecustomertoanotheremployee.Italsostimulatestheflowofinformation,whichisimportantforimplementationandintrackingthesuccessoftheturnaroundstrategy.5.3.3FinancialChangesTheturnaroundstrategyforJCPaddressesthethirdelementofasuccessfulturnaround(Harrigan,2012),i.e.acceptancefromcapitalmarketsthroughpropermanagementofdebtobligations.Thiswillalsobenefitthebottom-lineofJCPthroughadecreaseinitscurrentlyastronomicalinterestexpenses.WhenglancingoverJCP'sbalancesheet,itquicklybecomesevidentthatthecompanyisinahabitofheavilyfinancingitsassetswithdebt(seesection3.2).ComparingJCP'sdebtlevelswiththepeergroupandlookingattheinterestcoverageratiocreatesanevenbleakerpicture.Thecompany'shighlevelofindebtednessresultsinaremarkablyhighinterestexpense.Itshighleveloflong-termdebt,whichsignificantlyincreasedin2014,couldindicateanefforttoturnthecompanyaround.However,thesedebtlevelshavenotbeenjustifiedintheROAnortheROE,whereJCPhasbeenunderperformingsince2011,andincreasinglysosince2014,testifyingfurthertotheexcessivenessofitsdebtlevels.Consideringtheabovediscussiononsystemiccausesofdecline,itseemsthatJCPhastakenonexcessivedebt.Ontheotherhand,theremaybeanargumentforkeepingthemoneytheyalreadyborrowedasabufferforturbulenttimes,sincethecompany'sabilitytoborrowat

21reasonableinterestmaydeteriorateiftheirperformancedoesnotimproveinthenearfuture.However,webelievethecurrentdebtlevelisexcessiverelativetoJCP'scurrentrevenues,andwethereforerecommendthatJCPloweritsinterestexpensebydiligentlypayingdownexistinglong-termdebtandrefrainingfromtakingnewloans.5.4ValuationThefollowingsectionpresentsavaluationofJCPbasedonaprojectionofthecompany'sfuturecashflows.Twovaluationsar epresented, namelyabasecasevaluationandapost-restructuringvaluationwheretheturnaroundinitiativesareimplementedandaccountedforintheprojections.5.4.1BaseCaseAssumptionsThevaluationofJCPisconductedusinganall-equitymethodbasedoncashflowsratherthanearningsandnottakingintoaccountthecompany'scapitalstructureinthevaluation(Shefter,n.d.).TodiscountprojectedfuturecashflowsforJCP,itisnecessarytoestimatethecompany'sWACCandallthesubcomponentsusedinthecalculationillustratedinthefollowing:!"##=%&∗1-*+∗,-+/0∗1-Forthebasecaseanalysis,allcomponentsarebasedonthecompany's2016financialstatementexceptforthemarketpremium,riskfreerateandtaxratewhicharebasedonthemostrecentestimates.Thecostofdebtisestimatedbydividing2016interestpaymentswithtotalleverageyielding/&=7.2%.TheD/VandE/Vratiosarebasedonthecompany'senterprisevalueandlevelofdebtandequity.Therisk-freerateisbasedonthe10-yearUSTreasuryRate(U.S.DepartmentoftheTreasury,2017)andthemarketriskpremiumisderivedfromareportbyKPMG(2017).JCP'sbetaisobtainedfromGoogleFinance(2017)butadjustedusingtheBloombergmethodwiththeformula:adjustedbeta=2/3*rawbeta+1/3*1,inordertogeta'cleaner'beta,lesssensitivetoanyshocksormarketriseswhichcouldproducemisleadingresults(NYUStern,n.d.).Followingthisadjustment,abetaof0.7isobtained.Usingtheseinputsresultsinacostofequityof6.5%,whichyieldsaWACCof5.6%.OnemightbeinclinedtothinkthataWACCof5.6%seemstoolowforacompanyinneedofaturnaround.However,similarandevenlowerresultsfortheWACCareobtainedwhenconsultingexternalsources.Gurufocus(2017)estimatesaWACCforJCPof5.11%andbasedonthisdata,theaverageWACCamongJCPanditspeersis6.55%.TheWACCfoundusingthemethodologyabovethereforeappearstobeareasonableinputinthevaluation.Theprojectionsinthebasecasearebasedonmeanbrokerestimatesfortheperiod2017-2020forSales,COGS,SG&A,interest,Capexandnetworkingcapital(Factset,2017).Sincebrokerprojectionsareonlyavailablefortheperiod2017to2019andforsomeitems2017-2020,threeyearrollingaveragesareusedfortheremainingyears.

23average,privatelabelproductshavea25to30%highergrossmarginthanbrandedproducts(Kumar&Steenkamp,2007).Theannualgrowthrateoftheprivatelabelsegmentasapercentageoftotalsalesof5%appearsslightlyoptimistic.Tobalanceouttheoptimisticgrowthrateaconservativeassumptionconcerningthegrossmarginofprivatelabelproductsisimplemented.25%ratherthan30%isassumedtobethegrossmarginimprovement.Thecurrentgrossmarginofprivatelabelproductsis40%,asimpliedbytheoverallCOGSandusingtheassumptionofa25%grossmargin.Undertheassumptionofa5%annualgrowthofthepercentageofprivatelabelsales,thefollowingdevelopmentinthegrossmarginandCOGScanbeestimatedforthecoming10years:Table10:PrivatelabeldevelopmentSecond,sincewarehousingcostsareincludedinJCP'sCOGScalculation(JCPenneyInc.,2017),improvedinventorymanagement willaffectCOGSthroughwareh ousing.Basedonindustryinformation,warehousingcostsareestimatedtoconstitute3.4%ofCOGSanda10%improvementininventorymanagementisassumedequivalenttoa10%decreaseininventory,realizableoverthenextthreeyears.CombiningthetwoCOGSimprovementsyieldsthefollowingCOGSasapercentageofsalesforthenextfiveyears:Table11:Privatelabelimprovement5.4.2.3SG&ASG&Aisexpectedtofallasapercentageofrevenuefollowingstoreclosures,whichwillnotonlyreducethecompany'srentexpensebutalsofutureaccruedsalaries.AlthoughadditionalstaffisrequiredtoincreaseJCP'sonlinepresenceintermsofdevelopingtheonlineplatformandhandlingdistribution,thiswillnotbalanceoutthedecreasefromstoreclosures.Distributionwillbecoordinatedviathecompany'scentraldistributionhubswhicharemoreefficient201620172018201920202021Percentage0private0label0of0total0sales51.0%53.6%56.2%59.0%62.0%62.0%Improved0COGS0(product)64.3%64.1%63.9%63.7%63.5%63.5%Gross0margin35.7%35.9%36.1%36.3%36.5%36.5%201620172018201920202021Private/Label/Improved/COGS64.3%64.1%63.9%63.7%63.5%63.5%Warehousing/improv.00.08%0.17%0.25%0.34%0.34%Overall/Improved/COGS64.3%64.0%63.7%63.4%63.1%63.1%Gross/margin35.7%36.0%36.3%36.6%36.9%36.9%

24andrequirelessstaffcomparedtoitsphysicalstores.Developmentoftheonlineplatformwillrequireanexpansionofbackofficeemployeesandwillincludeoutsourcingofcustomerservicetoe.g.India,wherecostoflaborischeaper.Thus,theneteffectoftherelocationofresourceswillnotcounterweightheimmensedecreaseinSG&Afromstoreclosures.Additionally,thestrategicfocusonimprovedcustomerservicerequiresconsequentinvestmentinemployeetraining,development,andspecialization,thusincreasingSG&A.TakingthesethreeSG&Aincreasedriversintoaccount,JPC'stotalcostsareestimatedtobelessthanthedecreaseinSG&Afromstoreclosures.Hence,anoveralldecreaseinthecompany'sSG&Aoversalesisexpected.AlthoughJCPdidnotranksignificantlyaboveaverageintermsofSG&Aexpense,onemightexpectthecompanytohavelowerexpensescomparedtoahigh-endretailersuchasNordstromandBloomingdales(partofMacy's)whomightofferpersonalshoppersandrelatedservicesandchoosemorehigh-endlocationsfortheirstores.JCPshouldthereforetargetanSG&Aratiobelowtheindustryaverage,andfollowingstoreclosuresSG&Aasapercentageofrevenuewillthereforebereducedto28%,andshouldbedecreasedfurtherovertime.5.4.2.4InterestPaymentsIntherestructuringplan,agoalforreducingthecompany'soutstandingdebtwasdefined,whichwillaffectthecompany'sinterestpaymentsdownwards.Partofthecashgeneratedfromthesaleofphysicalstoresandlowerrentpaymentswillthusbeallocatedtorepayingtheprincipaloftheoutstandingdebt.Lowerinterestpaymentswillincreasethecompany'sbottomlineandfreeupmorecashtofinanceongoingoperationsandhelpexpandthecompany'sonlinepresence.Itwill,however,notaffecttheFCFofthemodelasthevaluationisbasedonNOPATratherthanNetincometoremovetheeffectofcapitalstructureonthevaluation.5.4.2.5CapitalExpendituresTheincreasedcommitmenttoitsonlineplatformislikelytorequireaninvestmentinITsoftwaresuchascloudspace,whichwillleadtoanincreaseinCAPEX.However,theCAPEXsavingsrealizedfromclosingstoresareassumedtocounterbalancetheincrease,resultinginaneteffectonCAPEXofzero.5.4.3M&AAnalysisAfinaloptiontobeevaluatediswhetherJCPmightserveasanattractiveacquisitiontarget(orbidder),andwhether thiswouldgenerateadd itionalvalueto shareholders.As emphasized continuously,traditionalretailerstodayfaceseveralchallenges,includingstagnatinggrowth,thegrowingpressurefromonlineretailers,andfiercecompetitionerodingprofitability,allofwhichpushesfirmstoseeknewwaysofachievinggrowth(Friedman,etal.,2016).In2016,consolidationintheretailindustryreachedanall-timehighsincetherecession,allegedlydrivenbystrongbalancesheets,cashaccumulationaswellasstagnatinggrowth-allofwhichareexpectedtocontinuegoing

25forward(A.T.Kearney,2017).Therehasbeensignificantmergeractivityintheretailindustryinthepastfiveyears.Conductingasearchontransactionswithintheconsumerretailindustrythusyieldsthefollowingresult(Mergermarket,2017):Figure7:Mergeractivitywithinconsumerretail,2013-2017.Althoughthisdoesnotrepresentalldealsthathavetakenplace,itdoesgiveanindicationofthesignificantvolumeoftransactions completedrecently.BCGhasadditio nallyfoun dthatapproximately150M&Adealswithavalueabove$150millionwereconductedintheperiod2014-2016whichamountedtoa45%increaseoverthepreviousthreeyears(Friedman,etal.,2016).Thequestionisthenwhatdrivesthisfiercepursuitofconsolidation,andwhetheritservesasavaluableoptionforJCP?Exhibit7andfigure8highlightssomeofthekeytransactionsthathavetakenplaceintheconsumerretailindustryfrom2012to2017.Thetypeofbuyer(PEorstrategic)andtherationalebehindthemer gerhavebeenemp hasized.Basedonananalys isofamu ltitude oftransactions,fouroverallrationale-categorieshavebeendefinedinordertogetagraspofwhatisreallydrivingthe consolidation.The fourrationales aregeographicexpansion,productdiversification,growthandconsolidation&synergies.

26Figure8:M&AanalysisofprecedenttransactionsinconsumerretailThetworationalesappointedtothemosttransactionsareconsolidation&synergiesaswellasgrowthwhichisinlinewiththetheorythatfirmsaremergingtobeinabetterpositiontomanagedeclininggrowthandfiercecompetition.Lackoforganicgrowthintraditionalbrick&mortarstoresisfrequentlyhighlightedasastrongtriggerofacquisitionsthusservingasanalternativemeansofensuringfuturegrowth(Hurley&Hadad,2017).Ashighli ghtedinthefinancialanalysisandvaluation,JCPanditspeershaveexperienceddecliningsalesinthepastyears,andthoseofJCPareexpectedtocontinuedecliningforthefirstfewyearsofthebudgetperiod.JCP,however,alsoexperiencedproblemsonitscostsidestemmingfromexcessiveCOGSandSG&Aputtingpressureonthecompany'sprofitability.Intheprecedingtransactionanalysis,severalfirmshighlightedpotentialsynergiesandcostsavingsarationaleforenteringintoamerger.Byincreasingscaleand

27operationalefficienciesorobtaini ngbetterinventoryandsup plychainmanageme nt,thesecompaniestherebysawmergingasawayofimprovingtheircompetitiveness.Basedontheabove,itappearsthatmergingcouldsolvemanyoftheproblemsfacingJCP.Thecompanyhasstruggledwithbothtoplineandbottomlinegrowth,anditmustmakeeffortstoincreasebothitsefficiencyandprofitability,andthiswouldperhapsbeachievedthroughsynergiesderivedfromcombiningitsoperationswithanothercompany.Mergingis,however,acomplicatedprocessandseveralquestionsmustbeansweredbeforeoptingforthissolution.Thefirstrelatestopotentialbuyers.Anobviouscandidatewouldbeoneofthecompany'sclosecompetitors,toincreasescaleandefficienciesandconsolidatetheirpositionwithintheretailmarket.ThedeclininggrowthofseveralpeersimpliesthattheseplayersmayalsobeexaminingalternativeoptionsforobtainingfuturegrowththusincreasingthelikelihoodofthembeinginterestedinJCP.A.T.KearneyhasputforwardthreekeytrendsthatwilldominateM&Aintheretailsectorintheforthcomingperiod,onebeingthegrowin gacquisitionactivityofpr ivateequityandotherfinancialbuy erslookingforcomplementaryfirmsthatbringsynergie stotheircurrentportfoliobusinesses.Based thetransactionanalysisbiddersinconsumerretailmergershavebeenamixofstrategicandprivateequitybuyers,andbothcategoriescouldthereforeserveaspotentialbiddersforJCP.Thesecondissueinrelationtoamergeristhedifficultyinrealizinganticipatedsynergies.Post-mergerintegrationforretailfirmscanbeparticularlychallengingbecauseofthedifficultiesofclosingdownstores,duetoleaseo bligatio ns,thecomplex ityofsupplychainsaswellasthechallengeinrelationtointegratingorupdatingoutdatedITinfrastructures(Friedman,etal.,2016).Torealizeexpectedsynergies,companiesmustproperlyplanforsuchintegrationtopreventthemergerfrombeingacostincreaserratherthanacostandefficiencyenhancer.ThethirdaspectwhichmustbeconsideredisthepriceshareholdersofJCPwouldrealizefollowingitsacquisition.ToestimatethevalueobtainedifJCPweretobeacquired,theaverageandmedianEV/revenue,EV/EBITDAandEV/EBITmultiplesforthehighlightedprecedenttransactionanalysishavebeencalculated.Themedianisusedinthevaluationofthecompanyasitislesssensitivetopotentialoutliers.ThevaluationofJCPiscalculatedbothusingthebasecaseandtherestructuringvalueforboth2017and2021andyieldsthefollowingresults:

28Table12:M&Avaluation,basecasevs.restructuredBasedonthebasecasewithoutanyimprovementsingrossmarginorSG&Aexpenses,thevaluationofJCPrangesbetween$697millionand$10.7billionwiththelowerboundattributabletoalowEBITasaresultofexpensesremainingahighpercentageofrevenue.AsignificantlyhighervalueisobtainedfromtherestructuredcaseastheinitiativesbringsignificantimprovementtoJCP'sfutureEBITDAandEBITresultinginavaluationrangeof$5.3to$10.7billion.Anothertakeawayisthedifferencebetweentherestructuredvaluein2017and2021basedonEBITandEBITDA.Thevaluationtherebyincreasesbyaround1billionfrom2017to2021whichisinlinewiththeideathatrestructuringisatime-consumingprocess.ThisfurtherimpliesthatifoneweretooptfortheM&Aoption,itwouldbesensibletoimplementtherestructuringplanbeforeattemptingtosellJCP.Thefinalaspe cttobeconside redspecificallyinrelationtoasaleofJCP isthec ompany'saccumulationofnetoperatinglosses(NOLs)whichqualifiesasanassetbecauseitcanbeusedforfuturetaxdeductions.AccordingtoJCP,thecompany'sabilitytousethetaxcreditwouldbeseverelyimpairedintheeventofatakeoverwhichhasledthecompanytoimplementaso-calledpoisonpill,makingitdifficultforoutsiderstoacquirethebusiness(Investopedia,2017).Ratherthanprotectingmanagement,theaimofthepoisonpillistoensurethecompany'sabilitytousethetaxbenefitgoingforward.Fromtheaboveanalysis,thereappearstobeseverallooseendswhichmustbefurtherexaminedbeforeembarkingonanM&Aadventure.Therefurthermoreappearstobeagreatdifferencebetweenthevaluewithandwithoutrestructuringinitiatives,andtheperformanceofJCPshouldincreaseovertimeiftheinitiativesindeedturnouttowork.6.RecommendationUptothispoint,severaloptionshavebeenevaluatedforJCP,andtheintentionisnowtooutlinetheone(s)thatwillgeneratethemostvaluetoshareholdersandplaceJCPonatrajectoryoffuturegrowthandprofitability.Fouroverallvalu ationshavebeenconducted,namelyaliquidatio nanalysis,abasecas ean drestructuringvaluationaswellasanM&Aanalysis,theresultsofwhicharehighlightedintable13.

29Table13:ValuationscenariosBasedontheabove,itisclearthatmaintainingJCPasagoingconcernwhileimplementingthepreviouslyhighlightedrestructuringinitiativesappearstobethesolutionwhichwouldgeneratethehighestvalue.From theM&Aanalysis italsobecameevidentthatwai tingafewyearswhilerestructuringsolutionsareimplementedsignificantlyimprovesJCP'sEBITandEBITAresultinginahighervaluationbasedonthesemultiples.Inthefuture,astheperformanceofJCPimproves,amergercouldthereforebeaviablesolutiontoincreasescaleandimprovethecompany'sabilitytooperateinanincreasinglycompetitiveindustrygoingforward.7.ConclusionThispaperhassoughttoexamineandoffersolutionsintendedtoimprovetheperformanceofJCP,acompanywhichhasbeenstuckinastageofdistressoveranumberofyears.JCPis,however,notaloneinexperiencingdecliningsalesandprofitability:Itisageneraltrenddominatingtheretailindustry,stemmingfromagrowingimportanceofonlineretailandincreasedcompetitionforcingfirmstolowerpricesandraiseadvertisingexpenses.WhileexternalforceshaveaffectedJCP,amajorpartofitsdeclineisattributabletointernalfactorsandafailuretoproperlyadapttothechangingdynamicsoftheindustrywithinwhichitoperates.ThroughananalysisofJCPanditspeersusingbothquantitativeandqualitativemeasures,itbecameclearthatthecompan ysig nificantly underperformsinterm sofbrandvalueandcustomersatisfaction,andranksfarbelowaverageintermsofkeyefficiencyandprofitabilityratios.Whenlookingatliquidityratios, tho seofJCPappearedsurprisin glyrobust,butthistrendwas onlyobservedwhenexaminingbalancesheetitemswhichhaveaccumulatedoveralongerperiodoftime.Ratiosbasedonrecentfirmperformancesuchasinterestcoverageandcashflowtocurrentliabilitiesyieldedcompletelydifferentandmoreconcerningresults.AfterhighlightingthefinancialdifficultiesfacingJCP,focusshiftedtowardstheuncoveringofkeyreasonsbehindthecompany'sdecliningperformance.Theimplementationofuntested,unsuitable,andattimespoorlyexecutedstrategiesbytopmanagementwerehighlightedasonecontributortothedemiseofJCP.Thecompanyalsofacedseveralproblemsintermsofmorale.Itwasasifaninvisiblewallatsomepointemergedbetweentopmanagementanddifferentsalesdepartments,thwartingcollaborationandrepressingteamspirit.Liquidationvaluation4.1billion

Basecasevaluation7.0billion

Restructuredvaluation15.7billion

30LiquidationandChapter11filingsweredeemedlessviablesolutionsforJCP,andrestructuringinitiativeswereinsteadhighlightedasawayofimprovingperformance.Bothinitiativestargetingtoplinegrowthandcostreductionswerepresentedwithkeyaspectsbeingstoreclosuresandagrowingonlinepresence.Giventheincreasingneedforcostreductionandachievinghigherscale,amergerwasdiscussedasapotentialoptiontoconsolidateJCP'spositioninthemarket.However,basedonpreviousindustrytransactionsandthecurrentoperatingprofitofJCP,thisappearstobealessvaluableoptiontoday,butcouldserveasanopportunityinthefuturewhenthefirm'sperformancehasstabilized.Failingtoinnovateandcontinuouslyadapttotheexternalenvironmentisoneofthebiggestmistakesacompanycanmake.JCPfellintothedangeroustrapofassumingthat'we'vealwaysdoneittha tway 'wasareason able argument,andf aultyaction sfurtherdeterioratedperformance,lettingthefirmspiralanotherstepdowntheorganizationaldistresscurve.Toreturntoprofitability,JCPmustlookinwardsandimplementthehighlightedstrategicandorganizationalchangesandintroduceasustainable,lessriskycapitalstructure.Thefollowingquoteshouldserveasaguidingpillarforthecompanyinthefuture:"itisyourjobtomakeeveryproductyoumakeobsolete.Ifyoudon'tsomeoneelsewill".JCPshouldbealeadershapingtheindustrydynamicsratherthanmakingex-postadaptationsandbecomingthevictimofcreativedestruction.

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