Unsanitized: JCPenney Follows the Private Equity Model, Sinks Into Bankruptcy

Plus, Facebook makes a move and the Heroes Act passes. This is The COVID-19 Daily Report for May 16, 2020.

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First Response

Century-old retailer JCPenney filed for bankruptcy late on Friday, the latest large retailer to succumb this year. And you could hear private equity fund managers breathing a sigh of relief. Unlike J.Crew and Neiman Marcus, JCPenney is a publicly traded company. At least private equity wouldn’t be called out for this retail bankruptcy, and maybe that could absolve them of the high debt loads and mismanagement that has driven much of the retail apocalypse. If public and private firms are equally at risk, maybe the sector’s just obsolete.

First of all, you can’t cherry-pick one company and absolve the failed PE business model. According to the Wall Street Journal, 27 of the 38 retailers with the “weakest credit profiles” are private equity-owned. The incredible debt burden placed on these firms made them inflexible amid industry changes. And that was JCPenney’s problem too; its downfall mirrored the tell-tale signs of a private equity portfolio company.

Back in 2010, hedge fund titan Bill Ackman and real estate investor Vornado bought a quarter of JCPenney stock, and vowed to turn around the company. They effectively installed a new CEO, Ron Johnson, who subsequently ran JCPenney completely into the ground. He brought in his own inexperienced managers, fired 19,000 workers in cost-cutting measures, and reorganized the stores without market testing. Sales dropped 25 percent in a year and by 2012 Johnson was fired. Ackman and Vornado sold out and took losses. Private equity circled around the company, hinting at a purchase. But there was a problem: it was already weighed down by too much debt.

By 2013, JCPenney had $1.9 billion in net debt. And a loan from Goldman Sachs added another $1.75 billion. In other words, it was already acting like a private equity-held company, using debt to survive. Like its private equity-owned colleagues, JCPenney went into conserve-cash mode, shunning investments in the business. This made it impossible to adapt and build an enduring presence online as e-commerce grew. The company also sold off real estate, stripping assets out to feed the debt machine.

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But that debt mountain grew to $4 billion amid falling sales, and the coronavirus crisis tipped the company over the edge. It started skipping interest payments and the end was nigh. There are still 85,000 employees, most of them on the floor in sales and support. At least 200 stores will likely be shuttered.

After bankruptcy, JCPenney might finally become the attractive, debt-light company that private equity would want to play their turnaround game. It could find itself at the beginning of a new asset-stripping cycle, to the benefit of new private equity owners. The fear is that discounted, hobbled firms would get swallowed up into the PE borg, giving financiers an easy way to extend dominance.

But private equity may not be in the position to capitalize right now. Its portfolio companies keep going under or are considering bankruptcy. Major firms like KKR and Apollo have reported big losses. Valuations are impossible, given the uncertainty of reopening and returning sales. Selling companies, consequently, can’t happen. The federal government has supplied surprisingly little relief, although the Federal Reserve money cannon could still come to the rescue by purchasing junk bonds.

Private equity has lots of money in reserve for deals, and some have been dipping into that. But whether there will be enough appetite to take on companies like JCPenney is an open question. Meanwhile, we can say pretty definitively that the private equity business model adds hidden risk that can be incredibly damaging in a crisis. Where the valie lies is another question.  

Meanwhile the Brobdingnagians

Speaking of deals, Facebook announced its intention to purchase Giphy for $400 million. It’s bizarre to say, but this is an infrastructure deal; Giphy provides the back end for creating and sourcing GIFs across the Internet. By purchasing it, Facebook makes its competitors reliant on its product and at its whim. As the American Economic Liberties Project notes, the backstory reveals Google’s involvement. Through an acquisition of the company Tenor, Google integrated GIF finding into its market-leading search engine, dramatically reducing Giphy’s use. Facebook took advantage by getting the company at a cheaper price.

With Google/Tenor and Facebook/Giphy, the GIF market is firmly in the hands of the duopoly. Finally we’re seeing regulators question the wisdom of that structure. News broke last night that the Justice Department and many states will file antitrust proceedings against Google this summer, mainly over Google’s dominance in online advertising and its leveraging of search. (The Tenor acquisition falls into that somewhat.) Meanwhile Amazon is fending off Congressional hearings. The guys (and they are guys) at the top of the mountain are finally feeling a little pressure. Rejecting the Giphy deal would further that.

Some Heroes Don’t Wear Capes

The House was able to pass the Heroes Act on Friday, with a fairly close vote considering that there was no real organized opposition to the bill. Pramila Jayapal’s comment that she would vote no, but that wasn’t a statement of opposition from the caucus she leads, and she wouldn’t whip the vote, and “can you please put that in your story?” was seriously pathetic.

Some are trying to spin a hopeful narrative out of the whole thing, that a disorganized progressive wing still found a core of nine members willing to buck Speaker Pelosi. This is the kind of thing Pelosi’s staffers laugh at, the pride taken in doing well without trying. I’m sure there’s a participation trophy for that somewhere. Meanwhile every member that voted yes will have to explain their decision to bail out debt collectors and corporate landlords and venal mortgage servicers and lobbyists and insurance companies. The excuses made for this are not compelling, as I’ll get into in a future Unsanitized.

As a postscript, this explanation for why generating automatic stabilizers—provisions for expanding unemployment or cutting checks that kick in once certain economic factors are hit, meaning no negotiations or Congressional wrangling amid recessions—is unreal. The bill (a marker for negotiations, not something that will become law) already has a price tag of $3 trillion, but Pelosi balked at an automatic stabilizer measure the whole caucus wanted because of another $400 billion, which isn’t even $400 billion because it’s just a technicality, an artifact of passing the bill during a recession (so the Congressional Budget Office scores it as more likely) than before one. This continuing Democratic desire to appeal to “adults” because of a deep fear of wielding power themselves is going to hurt all of us.

Here’s my piece from a million years ago (actually January) on the Congressional Budget Office, and how politicians enable it to stand in the way of progressive ambitions.

Today I Learned

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