a J C Penney (JCP) stock issue post-mortem

More strangeness from JCP.

the final offering price (only mildly strange)

Last Friday, JCP filed a final prospectus with the SEC indicating that it had sold 84 million shares of its common stock to underwriter Goldman Sachs after the close the night before.  JCP received $9.36 for each.  Goldman intended to (and presumably did) sell the shares to the public for $9.65 before the market opened on Friday, netting a fee of $.29/ share.

Goldman retained a 30-day option to purchase another 12.6 million JCP shares on the same terms (the “overallotment” (or “green shoe”)–more about this below).

What’s strange?  The offering price is higher than initially thought–suggesting GS found eager buyers.

the stranger stuff

1.  Mike Ullman, the CEO of JCP was reported by CNBC a couple of days earlier to have assured investors that no fund raising was in the offing.  The stock rallied sharply on this.

Didn’t he know?  If the CNBC news is correct, apparently not.

JCP denies CNBC got the story right, however.

2.  Goldman was the underwriter even though the offering comes right on the heels of a GS report warning investors to be wary of JCP because of declining liquidity and lackluster sales.

Note:  in a separate SEC filing, JCP said its online business was up “double digits,” year over year.  It also stated it expected positive comp store sales for 3Q13 and 4Q13.  If the entire JCP business were growing in double digits, I presume JCP would have said so.  So I take the statement as meaning that the in-store business is up, but not by a lot.  In theory, but highly unlikely in my view, the online business could be going through the roof and in-store sales could be down.

3.  Goldman apparently was able to find institutions willing to buy all those JCP shares.

4.  post-issue trading  

There are two (related) aspects to this:

–hedge fund Perry Corp, which had just recently raised its stake in JCP dumped out 9 million shares on Friday.  Seems to me the issue took them by surprise, too–and they didn’t like it.

–the “overallotment.”  (Even though I stuck this in last place, it’s the real reason I wanted to write this post.)

The way the overallotment works is this:

JCP announced an offering of 84 million shares, with an overallotment of 12.6 million.  The underwriter has the right, but no obligation, to buy an extra 12.6 million shares of JCP within the 30 days following the offering.

In reality, GS sells all 96.6 million shares, including the overallotment, to the public.  In this case, that gets GS an extra $121.6 million.  It does so in order have money at hand to “stabilize” the price of the stock in the initial hours after the offering It does so by standing in the market and offering to buy JCP at $9.65.  Normally, trying to influence the stock price like this is illegal, but there’s an exception for a short post-issue stabilization period.

Stabilization is a no-lose situation for the underwriter, provided he doesn’t get carried away and start using his own money to do this (fat chance of that).  If the stock goes up, he buys nothing in the market.  He exercises his overallotment option with the issuing company and delivers those shares to the client.  If the stock is flat to down, he takes the shares he buys in the market at the issue price or lower and delivers them to the client.  The overallotment option lapses without being used.

Two points:

a.  Unless it’s completely clueless, Perry Corp was well aware of the stabilization period.  Its best exit strategy would have been to sell aggressively while GS was stabilizing the price.

b.  The $9.65 line didn’t hold for a nanosecond in regular trading.  Volume in JCP for the day was a whopping 256.3 million shares.  Yahoo Finance shows an open of $9.53 and a high of $9.67–but I don’t see anything on either Yahoo or Google charts to suggest the price got close to the $9.60s.  In any event, stabilization was a lost cause.

the strangest stuff

Many third-party analysts foresaw JCP’s need for extra cash a long time ago.  Like most things in business, the calculations are relatively simple.  It’s odd the JCP couldn’t make them.

I also find it very odd that JCP generously stepped aside and allowed former large holders Pershing Square and Vornado to sell their shares at much higher prices–and using up potential demand for JCP stock–over the past six weeks before testing the market itself.