Blog on Investment Finance
J. C. Penney's Share Buyback and Issuance
by Magnus Erik Hvass Pedersen, March 25, 2014
J. C. Penney is an example of a company that first bought back shares at a high price that would require future earnings growth to justify the share-price, and then the company made a subsequent share issuance at a much lower price that caused disproportionate dilution.
Share Buyback in 2011
In fiscal year 2010, J. C. Penney had revenue of USD 17.8b, reported net income of USD 389m, Free Cash Flow of USD 107m (FCF, defined here as Operating Cash Flow minus Investing Cash Flow).
In the following year 2011, JCP made share buybacks of USD 900m, consisting of about 24m shares at an average price of about USD 37 per share.
The market-cap at the time of the share buyback was about USD 8.8b. If the previous year's net income of USD 389m would have continued then the earnings yield would be around 4.4%. This is much less than the long-term rate of return that could be expected for the S&P 500, which is perhaps 8%. This means JCP would have to grow its future earnings if the share buybacks were to merely sustain shareholder value. But instead earnings decreased in the following years.
In 2011, JCP's revenue decreased slightly to USD 17.3b (almost 3% decline) with a reported net loss of USD (152m) and positive FCF of USD 254m (ignoring an acquisition of USD 268m).
In 2012, the net loss was USD (985m) with negative FCF of USD (303m) (including sale of assets for USD 526 and a small acquisition).
In 2013, the net loss was (1.4b) with negative FCF of USD (2.6b) (including sale of assets for USD 162m).
Share Issuance in 2013
In May 2013, JCP first found it necessary to increase its debt by USD 2.25b for operational needs. Then in October 2013, JCP also found it necessary to increase its equity capital by issuing 84m shares for USD 9.65 per share for total proceeds of USD 786m (after deducting fees of USD 24m).
Effect on Shareholder Value
JCP repurchased shares in 2011 at a price that would require future earnings growth if shareholder value was merely to be sustained. But instead the company experienced large losses in the following years.
Three years after the large share buyback, a share issuance was needed so as to increase equity capital. In 2011, 24m shares were repurchased at a price of USD 37 per share. In 2013, 84m shares were issued (3.5 times as many as were bought back in 2011) at a price of USD 9.65 per share (about 26% of the price in the share repurchase).
The desctruction of shareholder value was compounded by these actions. First a share buyback was made at a high price that would require future earnings growth, otherwise it would decrease shareholder value. Then a subsequent share issuance was made at a much lower price that caused disproportionate dilution.