Bulls on the shares of J.C. Penney (NYSE: JCP) have long argued that the value of the company's owned real estate would serve as a floor for the stock. In fact, many believed that Vornado Realty's Steve Roth (as an expert in commercial real estate) was drawn to JCP as an investment because of the underlying value of the company's owned properties. This is not unlike the argument we heard about Sears Holdings (Nasdaq: SHLD) back in the mid 2000's.
Well, there is some bad news on this front for those long the stock, as J.C. Penney has had their entire real estate portfolio (stores, distribution centers, headquarters, and other land holdings) appraised as it is now in the process of negotiating a $1.75 billion loan, to be secured by "substantially all tangible and intangible assets of the company."
An independent appraisal has come back and it has valued JCP's entire real estate portfolio at $4.1 billion. Before you get excited about this figure (given that JCP's current market value is $4.2 billion at the current share price of $19), remember that bondholders get paid before equity holders. JCP has $2.6 billion of net debt already, so if you value the company's retail operations at zero, the net value of the real estate to stockholders is only $1.5 billion, or $7 per share.
But wait, it gets worse. That $4.1 billion valuation for JCP's real estate is a "lit value" appraisal, meaning it assumes that the stores remain open. If JCP were to close its stores and sell the real estate to another retailer or a commercial real estate developer, then the "dark value" appraisal comes into play. This number is far lower, at $2.2 billion, according to the independent work done by JCP's appraiser. The difference accounts for the fact that a new owner would have to invest a lot of money into the properties to renovate them for a new tenant.
So, the true value of JCP's real estate portfolio to shareholders is actually zero, because that $2.2 billion in dark value would not even make the unsecured debt holders whole. That would come from inventory liquidations and other asset sales (JCP's inventory last quarter was valued at $2.3 billion, at full retail price).
After this new senior term loan closes (expected in another week or two), J.C. Penney will have $5.2 billion of total debt. At the current $19 share price, the company's enterprise value is $9.4 billion. In order to justify that price, equity investors must hope that JCP sees a dramatic turnaround and can get its annual EBITDA up to $1.5 billion or so (which would put the stock's valuation in-line with Macy's (NYSE: M), Kohl's (NYSE: KSS), and other department store competitors). A real estate liquidation simply would not be a boon for shareholders.
At the company's peak EBITDA margin of 9% (reached several years ago), annual revenue has to rise to $16.5 billion to get to $1.5 billion of cash flow. Sales this year are tracking to more like $12 billion, so new CEO Mike Ullman better have big tricks up his sleeve.
Additional disclosure: I am long both JCP bonds and JCP put options.