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Wednesday’s announcement of JCPenney’s (NYSE:JCP) stake in Martha Stewart (NYSE:MSO) has sent shares of Martha Stewart Living up and left JCPenney shares trading almost flat on the announcement. JCPenney acquired 11 million new shares of Martha Stewart Living at a price of $3.50 a share. The $38.5 million purchase by JCPenney makes it the largest shareholder in Martha Stewart Living with a 16.6% ownership stake. Martha Stewart also announced it would be paying a special dividend of $0.25 per share to its shareholders.

When Ron Johnson was hired as chief executive officer of JCPenney, big things were expected. Johnson was the man who led the Apple’s (NASDAQ:AAPL) retail store efforts and is credited with helping Apple create its retail dominance.

JCPenney’s plan is to open Martha Stewart mini-stores in its larger department stores in February 2013. Johnson was quoted as saying, “A store has to be much more than the products that it sells.” Perhaps Johnson was referring to the likelihood of having products to test inside the Martha Stewart mini-stores. Part of the reason why Apple retail stores are so successful is the products are out in the open and an associate can show you how to use them and you can play around on your own as well. Martha Stewart products could be implemented in the same way inside of JCPenney stores.

Martha Stewart products are also available in rival Macy’s (NYSE:M) right now. It is unclear whether the products will stay in Macy’s stores by 2013, but both parties have said they will be reviewing their distribution deals.

Recently, JCPenny purchased the Liz Claiborne brand away from its founding company. The deal was a follow-up to the deal in 2009 that made JCPenny the exclusive department store to carry the iconic designer’s products. The deal took Liz Claiborne products away from Macy’s and put them only in JCPenney stores.

Martha Stewart Living shares have been losing money. The company announced in May that it would be pursuing opportunities including a possible sale of the entire company. It seems that no one came forward to buy the entire company or Martha Stewart decided this would be the best option for her namesake company and brand. Stewart after all owns about half of the common shares of the company and has over 90% of the voting power of the company.

In my eyes the deal seems to be a win-win for both parties. As JCPenney struggles to keep up with strong sales at Macy's and Kohl's (NYSE:KSS) it has decided to treat its stores as a destination for every product by creating mini stores and catering to many walks of life. Exclusive brands and departments inside JCPenney stores in 2013 could include:

-JCPenney Portrait Studio

-Martha Stewart

-Liz Claiborne

-JCPenney Optical

-Sephora

-Watch Repair

-American Living (Ralph Lauren (NYSE:RL) brand)

-Seattle’s Best Coffee (owned by Starbucks (NASDAQ:SBUX))

-MNG by Mango

-St. John’s Bay

JCPenney began using the motto, “It’s All Inside” in 2007 and Johnson seems to have made this his number one priority since taking over the company. The company has switched mottos since but should think about switching back in my opinion.

Martha Stewart products are licensed by numerous companies including:

-Kmart (NASDAQ:SHLD) - Martha Stewart Everyday Brand

-Macy's - Merchandise line

-Michael’s – Martha Stewart Crafts

-Lowe's (NYSE:LOW) – Martha Stewart Paints

-Home Depot (NYSE:HD) – Outdoor furniture and indoor furnishings

-Costco (NASDAQ:COST) – Ready to serve food products

-Time Warner (NYSE:TWX) – Instructional DVDs

-Random House – Martha Stewart books

-New York Times (NYSE:NYT) – Publishes weekly columns in several of the newspapers it owns.

Martha Stewart Living also owns the Emeril Lagasse brand which includes food products, cookbooks, and television shows, named after the world famous chef.

How to Trade:

An investor meeting in January of 2012 will hold more answers to how they plan to set up the Martha Stewart stores inside JCPenney. Until that time I have a BUY recommendation of JCPenney shares. In a recent article (here) about stores in the mall, I recommended buying shares of JCPenney, Kohl's and Sears while also recommending holding Macy’s shares. I had the following to say about JCPenney:

Department Stores are likely to see increased numbers of customers this holiday season. JCPenney has brought in a former Apple retail leader to lead the rebuilding company. The company has beat analysts’ earnings estimates the past four quarters and will look to keep that streak alive when it reports in January.

Shares of JCPenney trade at $33.20 at the time of writing the article. They have a forward multiple of 17x next year’s predicted earnings (By average analyst’s earnings targets on Yahoo). Although shares sound expensive I think they are in a great buying range right now and think shares will hit $40 by December 31st, 2012, representing a gain of 20% over the next thirteen months.

Shares of Martha Stewart Living trade for $4.23 at the time of writing. Surprisingly enough, shares did not hit a fifty two week high on news of the deal and are trading 22% from that price ($5.49). The company’s IPO in 2000 had shares sold at $18 and they quickly shot up to $36 the day shares hit the big board. Will this new deal resurrect the company and bring shares back to double digits? I would not go that far, but I do think shares look attractive if you can buy them and sit on them until the end of 2013 when sales inside JCPenney stores are calculated on a full year basis.

Between now and then I think there will be several buying opportunities, including the announcement of how Macy’s will be treating the deal and if they will still carry the branded merchandise inside their stores. I would wait for shares to come back down below $4 and think that they could hit $8 by February 2014, representing a double in share price over the next 27 months. This would represent an annualized return of 44% in the long run. The shares are not a guarantee but could be worth a long shot at this price.

Source: J.C. Penney Deal Good For Both Parties, But Could Help Double Martha Stewart Shares