JC Penney & Kohl's The Cost

The first thing when it comes to determining how JC Penney could manage to pay for Kohl's is to think about how much it would cost to do so, and where JC Penney stands in relation to that. As has been noted previously, JCP cannot actually afford to buy Kohl's. Kohl's has a market capitalization of $6.9 billion (MSN Moneycentral, 2017). Penney has a market cap of $2.05 billion, just one-third (MSN Moneycentral, 2017.

Kohl's would not be purchased at its market cap, however. When acquiring another company on the open market, the acquiring company must pay an acquisition premium. The reasoning behind this is fairly simply. The current value of Kohl's stock is believed to be the efficient value -- that this is fair value based on everything that is known today about Kohl's. If the market is even remotely efficient, then a shareholder would just sell in the market. But if shareholders know that someone wants to take over the company, they will demand a premium for that, knowing that the buyer is motivated. Thus, acquiring firms have to offer a premium over the current market value of the shares. There are different factors that go into this -- like whether the target company has other suitors -- but the general rule is that the acquiring company must pay an acquisition premium, and this will run anywhere from 20% or more (Investopedia, 2017). Knowing that, JC Penney is more likely to have to pay Kohl's shareholders somewhere in the range of $8.3 billion, just as a starting point. Kohl's shareholders, knowing that Penney has struggled with questionable management, might demand more, because they may be skeptical about having their shares converted into Penney shares. But the $8.3 billion figure is a starting point.

Methods of Payment

There are typically three ways that a takeover is structured....

Cash, shares, or both. The benefits of a cash payment are that JC Penney would use cash to make the acquisition, and that acquisition would theoretically increase the value of its shares. But the issue is that if the company needs to acquire debt in order to get cash, then it needs to take that very seriously. Using shares is great for companies that have the valuation to support that. The Kohl's shareholders would simply become JC Penney shareholders in such a deal. The upside for JC Penney is that they would not need to increase debt to make the deal but the downside is that they would risk damaging their share price. A combination of cash and shares is usually used when there is a desire on the part of the acquiring firm to maintain its capital structure post-acquisition.
All Shares

An all-stock deal is impossible for JC Penney. The value of its stock is maybe one-quarter of what it needs to be to acquire Kohl's. So while Kohl's could probably buy JC Penney in an all-stock deal, the reverse is impossible. There is nothing JC Penney could do to make an all-stock deal happen. So the key here is whether or not there is any potential for a cash deal.

All Cash

JC Penney has $900 million in cash, and needs most of that for its day-to-day operating expenses. So this is not getting it done. It has just over $4 billion in current assets, again related mainly to its daily operations, so not only is that not enough money but they need that money just to meet payroll and buy inventory (MSN Moneycentral, 2017). So for JC Penney, the only realistic way to get the cash they would need to make this deal is to take out debt. Because of JC Penney's struggles, it is already at 86.3% debt, and its credit rating at Moody's is B1. While B1 is two points ahead of where it used to be, it remains four notches below investment…