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Is JCPenney the Next Woolworth’s?

Ron Johnson is facing a merciless beating from the financial media these days thanks to JCPenney‘s (NYSE:JCP) pile of problems, which include a tanking turnaround, poor earnings and less-than-scrupulous business dealings.

When Johnson took over from Mike Ullman last February, the company had weaknesses, but it wasn’t yet on the brink of extinction. Now, though, the American retail icon is in serious trouble … so much so it’s conceivable that JCPenney could be on the same well-known downward path Woolworth’s traveled 15 years ago.

The Short Story

For those unaware, the F.W. Woolworth Company was the original five-and-dime store founded in 1879 by Frank Woolworth. By the time Sam Walton was opening his version of the discount store — Walmart (NYSE:WMT) — in 1962, Woolworth’s had more than 2,000 stores and was a corporate behemoth.

Unfortunately, expansion in the 1950s and 1960s was its ultimately undoing, adding stores but not profits. In 1997, Roger Farah, the current president of Ralph Lauren (NYSE:RL), was the top man at Woolworth’s and the one to pull the plug on the 400 stores that still existed. A year later, it changed its name to Venator Group, and three years after that to Foot Locker (NYSE:FL), its strongest brand.

Walmart, meanwhile, went from startup to replacing Woolworth in the Dow Jones Industrial Average.

Oh, how the mighty can fall.

The Rise and the Shakeup

To understand the challenge Johnson faced when he accepted JCPenney’s offer to jump ship from Apple (NASDAQ:AAPL) in June 2011, one needs to go back to December 2004, when Ullman took over from Allen Questrom.

Questrom, a retail veteran, was hired four years earlier to turn around the company. He did so in splendid fashion, leaving a healthy JCPenney in the hands of Ullman, another industry pro with previous stops at the top of LVMH’s (PINK:LVMUY) duty-free business and in the CEO role at Macy’s (NYSE:M).

However, Questrom, while effective, closed more than 100 stores and laid off more than 7,000 employees … while business was improving, people weren’t happy. So, the first thing Ullman did upon taking the top job was improve the morale at the company.

Ullman surveyed all 4,500 staff working in the head office, asking them the 10 things they most disliked about the company. All 10 of those things were changed, including putting more money into technology. Over the span of five years, JCPenney employees went from being generally discontented to generally happy. That, according to D magazine’s Joseph Guinto, is Ullman’s legacy.

Business improved through 2007, with its stock hitting an all-time high of $87.18 in February of that year. Then came Ullman’s fall, which ultimately was caused by two things.

First, the recession hit and the middle class was rocked like never before. JCP’s core customer was broke and confused, and revenues shrunk from $19.9 billion in 2007 to $17.3 billion in 2011 — Ullman’s last at the helm.

The second (and more contentious) reason was the purchase of 26% of JCP stock by Bill Ackman and Vornado Realty Trust (NYSE:VNO). Ackman and Vornado CEO Steve Roth secured two board seats, and the rest is history.

Ron Johnson

Johnson’s hiring made a big splash. JCPenney’s stock price had been steadily moving up since August 2010, when Ackman began accumulating (at an average price of $23 per share) his stake in the company. By the time Johnson stepped into the CEOs chair, Ackman’s 39.1 million shares were 73% higher.

In the span of a year, Ackman’s investment has gone from an unrealized gain of $660 million to a paper loss of $320 million.

Johnson’s move to convert JCP to a specialty store-within-a-store concept — where there will be 100 mini-shops at 700 locations in major metropolitan markets — while working, is taking too long to bring to fruition, and it’s eating up cash. The company’s Q4 results showed a swing in free cash flow from $186 million in 2011 to negative $820 million in 2012.

The billion-dollar reversal in fortune has many wondering if JCPenney can continue to finance its transformation solely with cash from operations. Many analysts expect that it will seek additional financing.

CFO Ken Hannah says the company has more than $3 billion in short-term capital, which includes $930 in cash and a $2.25 billion line of credit, to cover its operating needs. However, if business is as bad in 2013 as it was in 2012, it will run out of cash and be forced to tap equity and debt markets to shore up its financial position.

A sign of things to come: JCPenney recently laid off 2,200 employees to go along with 17,000 previously let go since Johnson’s taken over. This is a company in full-tilt survival mode. Any morale that existed under Ullman’s leadership has clearly gone out the window. Meanwhile, Johnson spends just four days a week in Texas, with the rest of the time back home in California. (Obviously, he doesn’t subscribe to Yahoo‘s [NASDAQ:YHOO] belief that employees must work from the office.)

Coming from Apple, no one should be surprised that Johnson’s leadership style is one of secrecy and poor communication. Clearly, he is not following James Cash Penney’s Golden Rule: Treat others the way you’d like to be treated.

Ironically, that’s “Fair and Square.”

Bottom Line

JCPenney’s Altman Z-Score — which measures a company’s financial health and the likelihood it will go bankrupt — is 1.49 based on its 2012 results. Anything less than 1.80 is considered ready for bankruptcy.

Former CEO Allen Questrom has come out in the press recently, suggesting Johnson should be fired because he’s delusional and can’t be trusted to provide the board with honest facts. While Questrom doesn’t want the job back (I’m sure), he knows a ton about retail.

A couple more wrong moves — like losing the Martha Stewart (NYSE:MSO) line (which he never really had to begin with) and another year of losses — and Johnson should be shown the door.

If the board doesn’t act, I’m afraid JCPenney could end up just like Woolworth’s — a once-great retail titan that became a fading memory.

As of this writing, Will Ashworth did not own a position in any of thee aforementioned securities.

Article printed from InvestorPlace Media,

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