JCPenney's 100-Year Bond Gamble Falls Apart

JC PenneyREUTERS/Keith BedfordAn interactive kiosk sit on display at the JC Penney Experience store in Times Square in New York March 2, 2006. The virtual store, which will be open for three weeks, allows shoppers to browse exclusive lines and purchase the company’s full range of merchandise online at interactive kiosks. J.C. Penney Co. Inc. said on Thursday its February sales rose 2.3 per cent at stores open at least a year.

(Reuters) – It was a “century” deal, but in hindsight it was hardly the deal of the century.
More than 17 years and a dozen credit downgrades ago, JCPenney Co Inc. joined an elite club in capital markets circles by issuing a rare 100-year bond.

The deal from Penney, then sporting a mid-range investment-grade rating of “A” from Standard & Poor’s and coming off record holiday-season sales, matched the year’s largest “century bond” deals at $US500 million, but the company stood out as the only retailer in the mix.

By all accounts the sale of the 7-3/8 per cent notes due 2097, managed by Credit Suisse, JP Morgan, Morgan Stanley and Merrill Lynch, went smoothly. The future seemed bright: Penney was riding high on investor optimism about its $US3.3 billion purchase of the Eckerd drug store chain months earlier and within 18 months its stock would be at then record highs.

But 100 years makes for one long bet, particularly on a player in a sector as flighty as mass-market retailing, and it’s been anything but smooth sailing since.

Like the stock, Penney’s bonds, long since fallen deep into junk status with a CCC- rating, have taken it on the chin as the store group’s sales have plunged amid a disastrous pricing and marketing strategy and failed attempt to appeal to the more affluent shopper. Its recent related tussle with activist hedge fund investor Bill Ackman, and uncertainty about the status of its vendor financing deals, have further undermined investor confidence.

It is now facing a very uncertain holiday season with a temporary CEO at the helm following its firing of Ron Johnson, the former Apple executive who was largely seen as the architect of its failed strategy.

The 2097 bonds have fallen 21 per cent in price since mid-May, and are currently trading at 67 cents on the dollar, near their lowest since the financial crisis. They offer a yield of 11.38 per cent. By contrast, the average effective yield on bonds in the Bank of America Merrill Lynch CCC and Lower U.S. High Yield Index, an index of lower-rated junk bonds, is 9.77 per cent.

Some big names in the bond business can be counted among the casualties.

Loomis Sayles & Co. holds about $US19.4 million of the bonds as of June 30, according to Emaxx, a bond investor tracking service owned by Thomson Reuters.

Dan Fuss, vice chairman and portfolio manager at Loomis, said the firm, which has $US190 billion in assets, is reassessing its position.

“When you lose market share, it is difficult to stop the bleeding, especially in retail,” Fuss said.

Back in 1997, the Penney deal came to market in what turned out to be the banner year for “century bond” issuance.

Following on IBM’s <IBM.N> record $US850 million deal in December 1996, ultra-long bond fever struck Wall Street and corporate treasurers alike, and an unprecedented 26 investment grade century bond sales totaling $US7.12 billion hit the market over the next 12 months, according to IFR Markets data.

Car makers Ford <F.N> and Chrysler both sold $US500 million, as did Baby Bell operators Bell South and US West. Railroads Norfolk Southern <NSC.N> and Burlington Northern Santa Fe clocked in at $US350 million and $US200 million respectively, and Boston University raised $US100 million.

In all, IFR data shows 65 U.S. 100-year bonds with a face value of $US16.29 billion have been issued since Walt Disney <DIS.N> and Coca-Cola <KO.N> debuted century deals on successive days in July 1993. Recent ultra-long issuance has been dominated by high-rated universities, which account for six of the 10 deals since the financial crisis, led by Massachusetts Institute of Technology’s $US750 million deal in May 2011, largely on the basis that they are more likely to be around in the next century than many companies.

In fairness to Penney’s bonds, few of the century bonds have fared well of late as the corporate bond market has been whipsawed by investor anxiety over the future of the U.S. Federal Reserve’s massive stimulus program.

High-grade bonds like IBM’s 2096s, rated AA-, have dropped 18 per cent in price since early May. Even MIT’s AAA-rated notes due 2111 have shed 19.3 per cent in price in that time, with their yield climbing nearly a full percentage point to 4.88 per cent.

Still, the questions around Penney’s future suggest more volatility ahead. Its credit default swaps, insurance against a default, price a nearly 65 per cent default probability in five years and 85 per cent over 10 years, according to data from Markit. For some bond mavens, that’s just too much risk to take on.

Portfolio manager Bonnie Baha, who heads Global Developed Credit at DoubleLine, said the $US57 billion bond house has had Penney bonds on its “avoid” list for years and doesn’t buy the argument that Penney’s swooning securities don’t take into account the value of the retailer’s real estate.

“In the era of and other online retailing, I don’t think much of legacy real estate assets of the Big Box stores,” Baha said.

(Additional reporting by Jennifer Ablan and Anthony Rodriguez at IFR; Editing by Martin Howell and Leslie Gevirtz)

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