the filing

Yesterday, Soros Investment Management LLC, the manager of the Cayman Islands-based Quantum Partners, filed a Schedule 13-g with the SEC.  It declares Quantum now owns 17.4 million shares, or 7.9% of the outstanding shares, of J. C. Penney (JCP) common stock.

What does this mean?

the basics

An institutional investor is required to file a Schedule 13-g within 10 days after having acquired 5% of a company’s common stock.  Soros IM crossed that threshold on April 15th.  It must make follow-up filings whenever it brings its stake up or down by .5% of the outstanding.  The disclosure requirement ends when the holding falls below 5.0%.  Mutual funds do this all the time.

The 13-g differs from Schedule 13-d, which is filed by basically anyone other than a portfolio investor.  That schedule requires the filer to state his intentions–for example, to obtain control of the company, or to take an active part in its management.  The 13-g requires no such declaration, because the presumption is that the portfolio manager has no such intentions.

Assuming his contracts with his clients permit, the filer can always change his mind, however.  He signals this by filing a 13-d.

what we can conclude

I think the conclusion the financial press has drawn that Soros IM is a purely passive investor is unjustified.  The firm is that for now, but it can always alter its stance simply by filing a 13-d.

The stake represents and investment of about $250 million.

It’s unclear whether Soros is finished buying.  Usually, investors amassing a large stake in a publicly-traded company accumulate as much as they can without attracting attention during the ten days of anonymity they have after they hit the 5% mark.  Presumably the 17.4 million shares represents the Soros IM holding as of yesterday.  If so, we won’t know for about two weeks whether he’s continuing to purchase shares in significant amounts.

Importantly, if–as the filing states–the Soros stake represents 7.9% of JCP’s shares, this means the total outstanding must be 219.8 million shares, more or less.  This is the same number listed in the 10-k as outstanding on February 2nd, the end of the latest fiscal year.  In other words, Soros has bought its stake on the open market, not from JCP.  Therefore, JCP is not getting a cash infusion from Soros IM.  The money went to existing shareholders who are cashing out.  JCP still needs to raise money from outside sources.

does the move help JCP?

Arguably, JCP would have been best off if Soros IM had bought new shares from JCP, instead of already existing shares on Wall Street.  That way the quarter-billion dollars would have gone into Penney’s bank account.

Maybe Soros IM tried to buy shares from the company and was rebuffed.  More likely, in my view, Soros IM concluded it should seize the moment and buy while the stock price was weak.  Soros IM may well also be willing to be a buyer in any future securities offering JCP may make.  On the other hand, Soros IM has a very useful block of stock that could be sold to a new activist eager to enter the picture.

The Soros IM move consolidates the ownership of JCP further.  On the one hand, the probably makes it easier to obtain a majority vote.  On the other, it could end up adding another big ego to the boardroom.

the Soros record?

Are the Soros IM portfolio managers good stock pickers?  Is their purchase of JCP a sign that the company is a significant bargain.

I don’t know.

Most of what I know about George Soros comes from his 1987 book, The Alchemy of Finance. It’s a combination of a statement of his general investing principle (which he calls reflexivity) and a long account of his day-by-day musings about the financial markets.   I could only make it about halfway through.

Two things struck me, though:

–Mr. Soros included on the inside covers a multi-year performance record.  It consists of short periods of daring and brilliantly successful currency speculation–and long periods of continuing equity underperformance.

–the second is a petty point, but apparently not one that’s beneath me.  In the book Soros outlines his principle of reflexivity.  He calls it his original contribution to Western philosophical thought, which he put to use in financial markets after developing it as an abstract philosophical concept.  I was stunned when I read this.  Reflexivity is actually the dialectical method Hegel put forth in the early nineteenth century (take the famous description of the  evolving and reversing relationship between master and slave in the Phenomenology of Mind, for example).  These ideas were later applied to economics by Hegel’s follower Karl Marx.  Is it possible that, although he calls himself a philosopher and was educated in Europe, Soros just wasn’t aware of the most influential European thinker of the nineteenth century?  Or is he the master salesman, who figures no one will know?

Either way, not much to inspire confidence.

To the JCP point, my guess is that at the age of 82 Mr. Soros no longer plays the leading role in Soros IM investment decisions.  While I personally would hesitate to ride on Mr. Soros’s coattails, despite his fame, it’s unclear to me who exactly had the inspiration behind the JCP purchase.

My bottom line:  JCP now has what amounts to a celebrity endorsement.  It’s from a party whose stock-picking prowess is unclear and who, at least for the moment, is a passive investor.  Were Soros IM clearly supportive of Mr. Ackman et al–according to the New York Times, the two parties have offices in the same building–it would have bought its shares directly from JCP, in my opinion.

Therefore, the stake is potentially destabilizing, even though the filing of a 13-g implied no present activist intentions on Soros’s part.  One positive scenario for third-party shareholders would be if the Soros presence somehow triggered a struggle for control of JCP that drove the stock price higher.  The worst case would be if JCP depleted its cash in buying Soros out.

Personally, I’m going to watch from the sidelines.