CEO Hire from Apple Gives New Life to JC Penney

I can't recall another time when a stock has risen 17% the day the company announces the hiring of a new CEO. But that is exactly what happened Tuesday after department store chain JC Penney (JCP) landed Apple retail head Ron Johnson to lead the company. Johnson's track record building up Apple's retail store network over the last 11 years, plus a 15-year stint at Target prior to that, has investors clambering for JCP shares, which jumped from $30 to $35 as soon as the news was announced. So should we go out and buy some JC Penney stock too? Maybe, at the right price (not after a $5 jump).

There are a few things that one should point out when evaluating this management change. First, while the stock price increase indicates that JCP has become more valuable overnight, this will be a long term turnaround story, if it materializes at all. Johnson doesn't even start his new job until November 1st. After that it will likely take him six to twelve months to assemble a hand-picked team, review JCP's operations, and formulate a plan for making changes. Adding on another year for those changes to be implemented company-wide is not an unrealistic assumption. As a result, we might be waiting until 2013 before we really see if Johnson's magic will work at this department store chain. And don't forget, we are not selling MacBook Air's and iPads here. Despite who is running the show, JCP is still in the business of selling Van Heusen shirts and St John's Bay shorts to middle income folks shopping in aging shopping malls, not an easy task for anyone in today's highly competitive retail environment.

Also of note is the pay package that Ron Johnson accepted to come over to JCP. He will receive a base salary of $1.5 million and be eligible for an annual bonus of up to $1.875 million if certain milestones are reached. But the big component of his compensation plan is in stock. Johnson gets $50 million in restricted stock because he was set to have that same amount of Apple stock awards vest in 2012, had he not left the company. And by far the most interesting aspect of his pay plan is that he has agreed to buy 7.25 million warrants with a strike price of $30 per share directly from JCP, for $50 million. The warrants cannot be exercised for six years and he paid about $7 each for them.

That means he is investing $50 million of his own money into JCP stock for the next six years at what is essentially a price of $37 per share. As a result, he loses $7 million for each dollar below $37 the stock fetches six years from now, and if the stock is below $30 at that time he loses the entire $50 million. On the flip side, if the stock goes to $50 per share in the next six years, his $50 million investment will be worth a cool $362 million.

This warrant plan tells us a few things about Johnson's reasons for taking the CEO job at JCP. One, when he says he has wanted to lead a retailer as CEO for a while, he's not kidding. There was plenty of money, job security, and minimal reputational risk by staying at Apple. He really isn't doing it for the money either, because although JCP matched his previous Apple stock grants, he is putting up his own cash to try and profit from his future progress at JCP. The cash salary and bonus payment, while not immaterial to the average person, are fairly meager by today's CEO standards. And JCP isn't paying that much for his services given that the $50 million in restricted stock grants will be completely negated by the $50 million Johnson is paying the company for 7 million warrants.

So should investors buy the stock? As a value investor, I would never want to buy it after a $5 one-day pop, although the shares have dropped to $34. Compared with other department store chains JCP stock is neither cheap nor expensive, at their current multiple of 6.2x trailing cash flow. That valuation compares to Kohls and Macy's at 5.5x, Target at 6.2x, and Wal-Mart at 6.9x. If someone believes JCP is not already a dead retailer, and has enough faith in a guy who helped make Target cool and led the hugely successful Apple retail strategy, then maybe buying the stock makes sense, provided you take a multi-year outlook. What price would be attractive in that scenario? Judging from Johnson's warrant package, I would think $30 (or something close to it) would be an excellent entry point. At that price you can be invested alongside him, at around the same price, without having to fork over $50 million of your own money.

Full Disclosure: No position in JCP at the time of writing but positions may change at any time