Some of the largest buyers of distressed debt have been shopping at J.C. Penney Co. (JCP:US) in recent months, with bets reflecting a divergence of opinion about the fate of the beleaguered retailer.
Avenue Capital Group LLC, the $12 billion fund manager run by Marc Lasry, bought J.C. Penney’s unsecured bonds on the expectation that Chief Executive Mike Ullman will pull off a turnaround, a person with knowledge of the matter said. Meanwhile, Third Avenue Management LLC, which manages about $13.5 billion, sold most of its bond holdings after the company’s decision to take out a $2.25 billion loan in May made them riskier, a portfolio manager at the firm said.
The views on J.C. Penney’s bonds -- some of which now trade for 71 cents on the dollar -- highlight disagreement among some of Wall Street’s top investors about whether Ullman can stem a slump in sales that’s eroding the retailer’s cash. While J.C. Penney raised almost $4 billion since he returned to the company in April, its free cash flow was a negative $2.1 billion (JCP:US) in the year through August, a record rate according to data compiled by Bloomberg since 1987.
“Nobody really knows what’s going to happen with J.C. Penney,” Will Frohnhoefer, a special situations analyst at New York-based BTIG LLC, said in a telephone interview. “People have concerns about the business and whether the company will be in need of more cash if the business doesn’t turnaround quickly.”
Ares Management LLC and Oaktree Capital Group LLC are playing it safer by investing in J.C. Penney’s $2.25 billion term-loan that’s secured by the company’s real estate and inventories, people with knowledge of the matter said. The loan trades at a slight discount to face value and in the event of a financial restructuring it would give the funds influence over the company’s future, and could be converted into equity.
That loan, taken by J.C. Penney in May, is senior to other debt - meaning it will be repaid first - a factor that prompted Third Avenue to sell its bond positions, said Ryan Dobratz, who manages the Third Avenue Real Estate Value Fund.
“Although the secured financing alleviated liquidity concerns, the bonds were pushed lower in pecking order in terms of the claims on the company’s assets,” Dobratz said.
The fund had bought the bonds, which mature in 2036, after they plunged in price in 2012 when the company first reported steep monthly sales declines, Dobratz said. Third Avenue made a profit on its position when it sold, he said.
The loan, due in 2018, was partly used to redeem J.C. Penney bonds that were due in 2023 and imposed restrictions on the company’s ability to borrow. One distressed debt investor, Centerbridge Capital Partners LLC was a large holder of those bonds and received a substantial premium for them, said a person with knowledge of the matter. The fund would consider buying the secured loan if it falls in price, which may happen if holiday sales are weak, the person said.
Spokesmen at Ares, Oaktree Capital, Avenue, and J.C. Penney declined to comment. A spokesman at Centerbridge didn’t return calls seeking comment.
The loan yesterday was valued at 97.3 cents on the dollar, data compiled by Bloomberg show. By comparison, Plano, Texas-based J.C. Penney’s $2.6 billion in unsecured bonds traded in the range of 71 to 89 cents on the dollar, with prices varying on different maturities, the data show.
Distressed-debt funds typically wait for the debt to trade at deep discounts -- usually when a company is considered to be nearing a restructuring -- with the aim of profiting from either a recovery in the debt’s value should the business improve, or engaging in bankruptcy proceedings should the business fail.
The loan’s price reflects its relative safety, because it is backed by collateral, said James Goldstein, a New York-based credit analyst at CreditSights.
“Investors are taking a more defensive stance, buying into loans versus bonds and equity,” he said in a phone interview. “The term-loan has the security that unsecured bonds and stocks don’t offer, in case the company fails to turn around the business.”
J.C. Penney struggled since 2008, when the financial crisis led to a halving of profits and slump in its shares. The decline prompted activist investor Bill Ackman to take the largest stake in the company and push for changes including the appointment of a new CEO to replace Ullman, who had served as chairman and chief executive for about seven years.
Ackman’s handpicked appointee, Ron Johnson, made changes -- including ending discounts -- that turned customers off, and widened losses. The company reported a $985 million loss for the year through February, compared with a $152 million loss the year before, data compiled by Bloomberg show.
Ullman has revived discounting and brought back merchandise to attract core customers. The moves are starting to yield results, and the department-store chain last week reported the first monthly sales gain in almost two years.
The company also sold shares in September, in addition to the getting the term loan and drawing $850 million in from its revolving credit facility.
Other investors in J.C. Penney include J. Kyle Bass, who owns the secured debt as well as shares of the company. Soros Fund Management LLC and Glenview Capital Management LLC also own shares, filings show. Those have lost (JCP:US) more than half their value this year.
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