JC Penney Acquiring Kohl's: Costs, Financing & LBO Structure
This paper examines the financial feasibility of JC Penney acquiring Kohl's department stores, beginning with a comparison of each company's market capitalization and the acquisition premium that would be required. It evaluates three conventional payment structures — all-cash, all-stock, and a hybrid — and explains why each is effectively unavailable to JC Penney given its debt load, junk bond credit rating, and limited cash reserves. The paper concludes that the only plausible path forward is a leveraged buyout involving a third-party investor, whereby JC Penney's cash flow and operational synergies would serve as collateral, while noting that even this approach faces substantial risk and uncertainty.
- The Cost of Acquiring Kohl's: Market cap gap and acquisition premium explained
- Methods of Payment: Overview of cash, stock, and hybrid deal structures
- All-Stock Deal: Why It Fails for JC Penney: Why JCP stock value makes all-stock impossible
- All-Cash Deal: Debt, Credit Ratings, and Limits: Cash reserves, junk rating, and borrowing constraints
- How to Structure a Viable Deal: Third-party leveraged buyout as only realistic path
- Conclusion: The Leveraged Buyout as the Only Option: Risks, dividends, and slim odds of success
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What makes this paper effective
- Systematically eliminates conventional financing options before arriving at the only viable structure, giving the argument logical momentum.
- Uses concrete figures — market caps, debt ratios, credit ratings, and dividend yields — to anchor abstract financial concepts in real company data.
- Clearly explains financial terminology (acquisition premium, leveraged buyout, capital structure) in plain language accessible to a general business audience.
Key academic technique demonstrated
The paper employs a process-of-elimination analytical framework common in corporate finance writing: each financing method is assessed against JC Penney's actual financial position, ruled out with specific evidence, and then replaced by a more complex alternative. This technique forces the writer to engage deeply with quantitative data and builds a persuasive, evidence-driven case rather than asserting a conclusion without support.
Structure breakdown
The paper opens by establishing the cost problem using market capitalization data, then devotes separate sections to each payment method (all-stock, all-cash), explaining why each is unworkable. It then pivots to the leveraged buyout structure as the only remaining option, describing its mechanics in detail before closing with a realistic assessment of its risks and low probability of success. Each section builds directly on the prior one.
The Cost of Acquiring Kohl's
The first step in determining how JC Penney could manage to acquire Kohl's is to assess how much it would cost and where JC Penney stands in relation to that figure. As the numbers make clear, JC Penney cannot actually afford to buy Kohl's outright. Kohl's has a market capitalization of $6.9 billion (MSN Moneycentral, 2017), while Penney has a market cap of just $2.05 billion — roughly one-third of Kohl's value (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 straightforward. The current value of Kohl's stock is believed to reflect its efficient, fair value based on everything that is known about the company today. If the market is even remotely efficient, a shareholder would simply sell on the open market. But if shareholders know that someone wants to take over the company, they will demand a premium, knowing that the buyer is motivated. Acquiring firms must therefore offer a premium over the current market value of the shares. Different factors influence the size of that premium — such as whether the target company has other suitors — but the general rule is that the premium will run 20% or more (Investopedia, 2017).
Given this, JC Penney would more likely need to pay Kohl's shareholders somewhere in the range of $8.3 billion as a starting point. Kohl's shareholders, aware of Penney's history of questionable management, might demand even more, because they may be skeptical about having their shares converted into Penney shares. Nevertheless, $8.3 billion is the baseline figure from which any serious analysis must begin.
Methods of Payment
There are typically three ways that a takeover is structured: cash, shares, or a combination of both. The benefit of a cash payment is that JC Penney would use cash to complete the acquisition, which would theoretically increase the value of its shares. However, if the company must take on significant debt to raise that cash, the implications are serious and must be weighed carefully. Using shares is an attractive option for companies whose valuation can support it — Kohl's shareholders would simply become JC Penney shareholders under such an arrangement. The upside for JC Penney is that it would not need to increase its debt load, but the downside is that issuing new shares could damage its stock price. A combination of cash and shares is typically used when the acquiring firm wishes to maintain its capital structure after the deal closes.
All-Stock Deal: Why It Fails for JC Penney
An all-stock deal is not a realistic option for JC Penney. The value of its stock is roughly one-quarter of what it would need to be to acquire Kohl's. While Kohl's could likely acquire JC Penney in an all-stock deal, the reverse is simply not possible. There is nothing JC Penney could do to make an all-stock deal work. The question, then, is whether there is any potential for a cash-based transaction.
Conclusion: The Leveraged Buyout as the Only Option
It would help if Kohl's shareholders were willing to accept a lower acquisition premium. They might be, but it is doubtful. Kohl's has relatively steady financials, and while its growth potential is limited, shareholders continue to collect dividends — currently $1.80 per share. JC Penney would need to account for that in its calculations as well. Kohl's shareholders will demand a premium, and JC Penney would need to find a willing lender or partner to execute a leveraged buyout, because no other financing structure is available to it. Even the leveraged buyout option appears risky and unlikely given current conditions — but it remains the only path even worth considering.
References
Investopedia. (2017). Acquisition premium. Retrieved February 7, 2017, from http://www.investopedia.com/terms/a/acquisitionpremium.asp
Kilgore, T. (2016). JC Penney's credit rating gets two-notch upgrade at Moody's. MarketWatch. Retrieved February 7, 2017, from http://www.marketwatch.com/story/jc-penneys-credit-rating-gets-two-notch-upgrade-at-moodys-2016-09-28
MSN Moneycentral. (2017). JC Penney. Retrieved February 7, 2017, from https://www.msn.com/en-us/money/stockdetails/fi-126.1.JCP.NYS
MSN Moneycentral. (2017). Kohl's. Retrieved February 7, 2017, from https://www.msn.com/en-us/money/stockdetails/fi-126.1.KSS.NYS
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