- J.C. Penney is adding $400 million in 8.625% second-lien notes due 2025.
- It is using the proceeds mainly for its tender offer for its 2019 and 2020 unsecured notes.
- The 2019 and 2020 notes are now essentially dealt with, but I believe the ultimate goal of these moves is to improve J.C. Penney's 2023 secured debt situation.
- J.C. Penney will incur around $50 million to $60 million in costs in order to ultimate reduce its 2023 first-lien debt principal by around $340 to $350 million.
- I view these moves as being slightly negative for J.C. Penney's stock and slightly positive for its longer-term unsecured debt.
J.C. Penney's (JCP) move to take on $400 million in second-lien debt to help repurchase its near-term debt maturities can be seen as a largely defensive move. The second-lien debt offering is likely aimed at reducing the risk around its 2023 first-lien debt maturities, as the cash flow that would have gone towards its 2019 and 2020 unsecured debt maturities can now go towards reducing its term loan balance.
The cost of the tender offer premiums, debt offering fees and the increased interest rates are expected to add up to around $50 million to $60 million by the end of 2022. Basically, J.C. Penney is paying that amount of money in order to reduce the amount of 2023 secured debt that it needs to refinance by around $340 million to $350 million.
Near-Term Debt Maturities
The 2019 and 2020 maturities are now essentially taken care of, with the tender offer potentially reducing the outstanding 2019 notes to $80 million and the outstanding 2020 notes to $135 million. J.C. Penney should be easily able to use its free cash flow to deal with the remaining 2019 and 2020 notes. J.C. Penney could have dealt with the 2019 and 2020 maturities via free cash flow and its secured credit facility (if needed), but it appears to have made this move to help plan for its 2023 secured debt maturities. Using its secured credit facility (which currently matures in 2022) to cover any gap between free cash flow and the 2019 and 2020 debt principal would not have helped J.C. Penney's 2023 first-lien debt maturities.
The 2023 Secured Debt
The playbook for J.C. Penney now may be to put its positive cash flow towards prepaying its 2023 term loan, which doesn't appear to have any penalties for voluntary prepayment. This term loan had around $1.625 billion outstanding at the end of 2017 and has a variable interest rate of LIBOR plus 425 basis points. That makes the current interest rate approximately 6%, but with the federal funds rate expected to see a number of hikes in the next couple years, LIBOR is expected to be over 3% by 2020. Thus the interest rate on the term loan could average around 7.75% during 2020.
If J.C. Penney can keep its operational performance fairly stable and generate close to $200 million in positive cash flow per year (without real estate sales), it may be able to reduce the outstanding balance on its term loan to around $900 billion by the end of 2022. This would leave J.C. Penney with around $1.4 billion in first-lien debt coming due in 2023. Without this second-lien debt offering, J.C. Penney would have around $1.75 billion in first-lien debt coming due in 2023. The tender offers and the second-lien debt offering will result in around $50 million to $60 million in extra costs to J.C. Penney by the end of 2022 versus if it had dealt with its near-term debt maturities by using its free cash flow.
Effect On Stock
I'd consider the moves to be slightly negative for J.C. Penney's stock. The cost adds up to around $0.15 to $0.20 per share, while I don't think there is much long-term benefit for the stock. J.C. Penney's chances of refinancing its 2023 first-lien debt somewhat improve, but in any scenario where J.C. Penney is facing questions in 2022/2023 about its ability to refinance its first-lien debt, its stock is likely to be of limited value. As well, the moves underscore that J.C. Penney's focus is likely going to be on reducing its debt for the foreseeable future.
Effect On Bonds
On the other hand, J.C. Penney's moves appear to be slightly positive for J.C. Penney's other unsecured bonds and its bond trusts. The addition of the second-lien debt does noticeably reduce the recovery potential for J.C. Penney's unsecured debt in the short-term. However, if J.C. Penney pays down its term loan with the cash flow that would have been needed for its 2019 and 2020 maturities before, J.C. Penney's secured debt (first-lien and second-lien) will only be around $50 million to $60 million higher by 2020 than before these moves. Therefore in the event of a bankruptcy filing a couple years down the road or later, the recovery potential for J.C. Penney's unsecured debt has probably only gone down by a few percent.
In exchange, J.C. Penney has around $350 million less in first-lien debt that it needs to deal with by 2023. This probably somewhat improves its refinancing chances, giving it more of a safety margin in case its operational performance declines modestly or if the credit markets are less favorable then. It probably wouldn't make much of a difference if J.C. Penney's operational performance goes into a steep decline by that time though.
In any case, an improved chance of refinancing translates into an improved chance of additional bond coupon payments beyond 2023, which is what the long-dated bondholders are mainly interested in.
I view J.C. Penney's recent debt moves as being ultimately aimed at its 2023 first-lien debt maturities rather than the 2019 and 2020 unsecured debt maturities. J.C. Penney had other viable options (using cash flow, its credit facility) to deal with its 2019 and 2020 maturities, but issuing second-lien debt maturing in 2025 appears to be more beneficial for its ability to handle its 2023 first-lien debt maturities.
This comes at a cost of around $50 million to $60 million though, which it seems to be more of a defensive strategy that favors the long-dated bonds over the equity. J.C. Penney's longer-term survival chances are increased at the cost of a bit of additional net debt with a later maturity. I remain primarily involved in J.C. Penney via its KTP bond trust.
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