Cerberus Won't Gobble Up Penney


By Robert Berner with Emily Thornton Reported rumors that an investment group led by Cerberus Capital Management is attempting to acquire retailer J.C. Penney (JCP) are false, according to people familiar with the hedge fund's thinking.

Shares of the Dallas-based retailer soared 8.4% on Mar. 31 in response to a story in trade publication Women's Wear Daily, which didn't identify sources. The gain underscores the frothiness in retailer shares generally as investors try to figure out what company might be on the block next, following recent acquisitions of Toys 'R' Us (TOY) and Sears, Roebuck & Co (S). However, doubt of a pending Penney sale had already begun to surface on Apr. 1 as Penney's shares retreated $1.88, or 3.62%, to $50.04 in late trading.

FUELING SPECULATION. Still, lending credence to the WWD story is the fact that former Penney executive Vanessa Castagna recently joined New York-based Cerberus. Castagna left her post as Penney's No. 2 last year after she was passed over for the top spot after the retirement of Allen Questrom. The latter, formerly the head of Federated Department Stores (FD), retired after he led a turnaround at Penney, a mid-price department-store chain with 1,000 stores and sales last fiscal year of $18.4 billion.

Also adding to the intrigue is that Cerberus teamed up with Sun Capital Partners and Lubert-Adler/Klaff & Partners to acquire the 257-store Meryvn's chain from discounter Target (TGT) last July for $1.65 billion. Meryvn's sells similar apparel as Penney at comparable price points, but its stores are mostly in free-standing locations, unlike Penney's, which are mostly mall-based. This led to speculation that a combination by Cerberus would give Penney access to off-mall locations -- an aim of the retailer's executives.

Even so, investment bankers close to Cerberus say the hedge fund, which has $14 billion in assets, wasn't interested in acquiring Penney. The fund's officials didn't return calls seeking comment, and Penney declined to comment. Another executive familiar with Cerberus' thinking says Castagna was brought on to help in the management of Mervyn's and to help guide Cerberus' retail strategy.

ACQUISITION TREND. The executive, who declined to be named, says Penney didn't fit Cerberus' investment style. The fund generally makes investments in more distressed companies. Mervyn's was losing money when Cerberus and its partners acquired it from Target.

By contrast, Penney's results have rebounded under Questrom's turnaround plan. Its net income last fiscal year was $524 million, up from a prior-year loss of $928 million. In a report, Lehman Brothers analyst Robert Drbul called the rationale behind a Cerberus-led acquisition of Penney questionable, "given our belief that the company is not undermanaged and the stock is not undervalued."

The pop in Penney's stock on a market rumor underscores that retailers are increasingly acquisition targets of private-equity groups and hedge funds. Investment wizard Eddie Lampert set the trend in motion in 2003 when his Greenwich (Conn.)-based fund, ESL Investment, took control of discounter Kmart, then in bankruptcy protection. The Kmart chairman used the soaring value of the retailer's newly issued stock to acquire Sears for $11 billion in March.

NOT SO ATTRACTIVE? A host of copy-cat deals has followed, such as the acquisition last month of troubled Toys 'R' Us by Kohlberg Kravis Roberts, Bain Capital, and Vornado Realty Trust for $6.6 billion. Shares of Saks (SKS), owner of luxury retailer Saks Fifth Avenue and a mid-price group of regional department stores, soared the same day as Penney on published reports that the Saks regional chain was up for sale.

Still, the retail-acquisition game is getting harder to play. As investor interest in the sector mounts, so does retailers' stock valuations. This undermines one of the fundamental attractions when Lampert took control of Kmart -- the value of its underlying real estate was worth more than what the markets were placing on the entire company. This protected the downside to Lampert's investment, meaning any improvement he made in retail operations was pure gravy on the return side.

Few retailers are trading below their real estate values. At $50.04, for example, Penney's stock is trading well above the $32 a share Deutsche Bank places on its real estate. Any acquirer would have to operate Penney better to extract value. That's not to say a potential acquirer won't try. Deutsche Bank retail analyst Bill Dreher believes it could be done.

Just don't expect Cerberus to be one of the bidders. Berner is a correspondent in BusinessWeek's Chicago bureau, and Thornton is an associate editor for BusinessWeek in New York


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