NEW YORK — It’s the Eighties all over again.
In a move reminiscent of the corporate raids of 20 years ago, private equity firms Cerberus Capital Management LP and the Carlyle Group, along with one other private equity shop, are partnering to attempt a takeover of J.C. Penney Co. in a $16 billion to $18 billion leveraged buyout, market sources said Wednesday.
Cerberus was said to be the lead sponsor of the LBO and is believed to have caught Penney’s by surprise.
The Penney’s news comes days after New York-based Cerberus confirmed a March 24 WWD report that it hired Penney’s former number-two executive, Vanessa Castagna, as a senior member of its operations team and executive chairwoman of Mervyn’s department store chain, which Cerberus partially owns. Castagna will not start at Cerberus until April 4, but the play for Penney’s could end up exacting sweet revenge for the retail veteran: Castagna left Penney’s late last year, disappointed that the board rejected her for the company’s chief executive spot, following the retirement of Allen Questrom, who left a year earlier than he had planned. Under Questrom, Castagna helped lead the company’s turnaround, as chairman and ceo of J.C. Penney stores, catalogue and Internet, and was widely viewed as the only viable inside candidate for the top slot.
The man who did succeed Questrom, Myron Ullman 3rd, is no novice on the takeover battlefield. Most notably, he was ceo of R.H. Macy when Federated Department Stores — then led by Questrom — bought Macy’s out of bankruptcy in 1994. Ullman fought hard to keep Macy’s independent, but ultimately capitulated to Federated. He’s a hard worker and a determined executive and might decide to fight hard against a takeover of Penney’s, if it threatened his position or the company’s stability.
While Penney’s lately has been rumored to be interested in acquiring other retailers, such as Gottschalks Inc. or Saks Inc.’s department store group, a takeover by Cerberus and Carlyle comes as the retail landscape exhausts viable acquisition targets that tout “for sale” signs.
A Penney’s spokesman declined comment, saying the company does not comment on rumors. Cerberus and Carlyle could not be reached for comment.
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“It was inevitable that J.C. Penney be targeted by a private equity firm,” said Richard Kestenbaum, a partner at Triangle Capital. “There’s a lot of money out there that needs to be put to use. Right now, everything is in play. If Saks is considering a partial sale, Neiman’s is up for sale and Sears was bought by Kmart, why not Penney’s?”
Penney’s would be an easy takeover target because fewer people would have to be swayed in the LBO, as the majority of the shareholders are institutional investors, owning 89 percent of the shares.
An LBO is an acquisition where a large portion of the purchase price is borrowed against assets of the company being acquired. In the case of Penney’s, because it has $1 billion in cash, financial sources said it can sustain a “material level of indebtedness.” And with its turnaround history and enterprise value of $13 billion, a minimum purchase price in the range of $16 billion seemed appropriate, said one investment banker.
A spate of private equity firms have been surveying the retail field since before the recently completed Kmart Holding-Sears, Roebuck & Co. merger was announced last November.
What the market currently lacks, however, are appealing acquisition targets: underperforming companies whose operations have the potential to be effectively turned around. Now that the Federated-May merger is in the works, rather than investors or retailers that are flush with cash picking off smaller players or merging with competitors, financial investors are instead left seeking out these same cash-rich retailers with the hopes that the incoming cash will give an immediate — and eventually considerable — return on investment. And, with interest rates sitting near multiyear lows, financing a transaction of this nature is a no-brainer.
Moving toward an LBO strategy reveals how much the private equity players are willing to invest their money. There is between $110 billion and $130 billion in the hedge fund market right now.
With a market capitalization of about $13 billion and $4.7 billion of cash and short-term securities on its balance sheet, up from $3 billion a year ago, Penney’s is an attractive LBO target. The goal of the Cerberus-Carlyle investment could be to milk Penney’s for cash while also improving operations at the business, especially considering the company has a bit more steam left in its turnaround program.
Penney’s is also an appealing LBO option because the retailer is in the best position to benefit from the ongoing consolidation in the retail sector. From an investor’s point of view, Penney’s is attractive due to the merger between Federated Department Stores and May Department Stores, a report earlier this month from Bear Stearns equity analyst Christine Augustine said.
“Should Federated move May’s merchandise upmarket, this would leave more room for J.C. Penney to grab share in the moderate arena,” Augustine said in her report.
Of the intense consolidation over the past decade or so, Augustine noted that the department store channel likely has transformed the most. “In 1989, there were more than 50 distinct department store companies, compared to less than 20 today,” she said.
Cerberus’ last major retail purchase was Mervyn’s, the more than 250-store low-price department store chain it bought from Target Corp. for $1.2 billion last July. Sun Capital Partners Inc. and Lubert-Adler/Klaff Partners participated in the deal, as well.
About 50 percent of the Mervyn’s locations are off-the-mall, according to one retail source, which is exactly where Penney’s wants to expand. Penney’s previously purchased some Mervyn’s locations in the Minneapolis area.
Cerberus — a three-headed dog in Greek mythology — and its affiliates manage businesses with capital in excess of $14 billion, according to company information. The firm has been active in the apparel and retail sectors for several years, most recently with the March 2004 acquisition of textile supplier Guilford Mills Inc. for $109 million. Soon after, Cerberus was rumored to be a potential investor in Versace. In March 2003, Cerberus bought Fila for $351 million.
Meanwhile, Washington-based private equity firm Carlyle Group recently raised about $10 billion to make acquisitions in the U.S. and Europe, according to a Tuesday press release from the firm. Carlyle could borrow $45 billion against that amount, a Tuesday Wall Street Journal article reported.
“There are attractive buyout opportunities throughout the United States in Carlyle’s areas of sector expertise. We have the experience and focus necessary to find, close, oversee and successfully exit these opportunities,” Allan M. Holt, managing director at Carlyle, said in the release.
Carlyle now manages more than $25 billion in equity capital. According to the firm’s Web site, its only consumer products-retail investment is in United Components Inc., a designer and manufacturer of filtration products, fueling and cooling and lighting systems for the industrial and trucking industries. Carlyle also has investments in the real estate, aerospace and defense, health care and automotive sectors, among others.
Financial sources said that, especially in light of Neiman Marcus putting itself up for sale two weeks ago, anything is possible in the new realm of retail mergers and acquisitions. Penney’s is apparently not immune, either, despite executing a successful turnaround program in the last two years, which included shedding its ailing Eckerd drugstore chain, implementing aggressive cost reductions and overhauling its private brand offerings for greater quality and value.
Ullman said during Penney’s Feb. 24 fourth-quarter conference call with Wall Street analysts that 2005 will be the last leg of the company’s turnaround. The company plans to open 20 stores in 2005, 12 of which will be in Penney’s new off-mall format.
The department store chain also recently launched nicole by Nicole Miller, a women’s apparel line. The company also sells Bisou Bisou contemporary sportswear and Chris Madden home products exclusively in its stores.
In fiscal 2004, Penney’s reported net earnings of $524 million from a prior-year loss of $928 million. Income from continuing operations rose 83.2 percent to $667 million. Total revenues were $18.4 billion in the year, up 3.6 percent year-over-year.
As of Jan. 29, Penney’s operated 1,017 stores in the U.S. and Puerto Rico, and 62 Renner department stores in Brazil. Although it owns more than 70 stores in California, its strength is east of the Mississippi, especially in Florida, New York, Pennsylvania, Ohio and Michigan. The retailer is in all 50 states except Hawaii.
James Cash Penney opened the Golden Rule Store in 1902 in Wyoming with two partners. He bought them out several years later, and the Golden Rule stores became J.C. Penney’s. By the Thirties, Penney had launched more than 1,250 new stores in Main Street locations in small towns across the U.S. In 1949, it opened its first mall location in St. Louis.
Shares of the Plano, Texas-based company rose 2.6 percent in Wednesday trading on the New York Stock Exchange, closing the session at $47.90.
— With contributions from Vicki M. Young, David Moin, Amy S. Choi and Ross Tucker
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