For JCP Stock Holders, Proposed Poison Pill Isn’t Worth It

by James Brumley | January 29, 2014 11:55 am

The good news coming out of JCPenney (JCP) right now? JCP has taken steps to make it so an outsider can’t buy a huge chunk of the company, gain a controlling interest on the Board of Directors and install an all-new management team.

jcp-stock-poison-pillThe bad news — especially for JCP stock holders? Those same defensive steps will make it so an outsider can’t buy a huge chunk of the company, gain a controlling interest on the Board of Directors and install an all-new management team.

Yes, you read that right. The latest proposed update of the JCPenney poison pill could be considered a blessing or a curse, depending on which side of the JCP fence you sit on.

In a lot of ways, though, this sure-to-be debated issue is going to do something beneficial for everyone with a stake in JCPenney  stock (long or short): It’s going to force JCP shareholders to commit for the long haul or bail out … and it’s going to force the current management team and current Board of Directors to prove they can do the job or leave their post.

In other words, one way or another, the end of the JCP saga is now in sight.

The JCP Poison Pill Makes Sense…

If you’re not sure what’s going on, here’s the quick and dirty version: JCP is close to insuring it won’t suffer a takeover like the one that allowed activist investor Bill Ackman to name Ron Johnson as CEO. Remember, that move pushed the department store to the brink of collapse and slaughtered the JCPenney stock price.

How is JCPenney trying to prevent a repeat disaster? By threatening a painful amount of dilution for any single person’s or entity’s stake that exceeds 4.9%[1] of the total number of shares of JCP stock — a strategy referred to as a “poison pill.”

The onus for the new, lower cap on the size of the permissible stake (the prior poison pill allowed for up to a 10% stake in JCP stock) is founded on a tax rule described in Section 382 of the Internal Revenue Code[2]. In simplest terms, any major change in the company’s ownership could mean part or all of $2 billion worth of tax-reducing losses the corporation could use to offset any future profits may be forfeited.

So on the surface, the poison pill does seem like a smart fiscal move for JCP. After all, things have been inordinately tough for the retailer, and anything that can ease its burden for the first $2 billion worth of net profits would be a welcome relief as JCPenney continues to walk its recovery path.

There’s just one little detail included with the proposed limitation, however, that should concern current JCP stock holders.

… Except That You Have To Get Married To It

Reducing taxable income is a good thing. And if doing so means nobody can become a huge stakeholder in the company … well, that’ll just have to be something JCPenney stock holders learn to like. The board’s proposal as it stands right now, however, will keep the ownership restriction in place for three more years.

So for JCP stock investors, that’s three more years of nobody from the outside being allowed in. Ergo, realistically, that’s three more years of the current Board of Directors, which in turn means three more years of the same management team, the same dated strategies and possibly the same lack of success[3] … with nary a chance of some much-needed personnel changes at the top of the JCPenney hierarchy.

In other words, should JCP shareholders approve the proposal at May’s shareholder meeting, it’s tacitly a bet on the current management team and the current turnaround plan … with a generous three-year timeframe to produce said turnaround for the struggling retailer.

All of a sudden, that $2 billion worth of tax write-offs for JCPenney doesn’t seem nearly as important. Why? Because the poison pill also means it would be impossible for a legitimate retail turnaround artist to be placed somewhere on the Board of Directors, or better yet, within the ranks of JCPenney management.

Indeed, an approval of the updated poison pill proposal is a bet on things just as they are right now at JCP … for better or worse.

The Bottom Line for JCP Stock Holders

Perhaps it won’t matter. In fact, if JCPenney is on the right track, it shouldn’t matter, as the turnaround will have taken hold by 2017.

Given the precarious position JCP is already in[4], though, it’s conceivable that the retailer will need to raise money through a secondary offering, and/or need the capital and expertise (or management) that only a private equity firm can offer. If a major buyer or capital provider can’t own a meaningful chunk of JCP stock, however, they’re not apt to pony up any resources.

That could be the end of JCPenney.

As was noted, the poison pill proposal will be up for shareholder vote at the annual meeting in May. Hopefully JCP stock investors will take a step back and see the bigger picture before making a restrictive decision.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

  1. dilution for any single person’s or entity’s stake that exceeds 4.9%:
  2. Section 382 of the Internal Revenue Code:
  3. lack of success:
  4. Given the precarious position JCP is already in:

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