J.C. Penney, Saks bonds fall on reports retailers could be sold; funds see $1.131 billion outflow

By Paul Deckelman and Paul A. Harris

New York, March 31 - J.C. Penney Co. Inc.'s bonds were shockingly lower Thursday, traders said, after a fashion industry trade publication reported that the venerable Plano, Tex.-based department store chain operator might be sold in a leveraged buyout transaction - stoking bondholder fears that Penny will be saddled with more debt and that the new debt will push the existing bonds further down in the capital structure.

Penney's plunge sent shockwaves through the whole retailing sector, felt nowhere more strongly than the bonds of Saks Inc. That operator too was the subject of media reports about the possible sale of the Birmingham, Ala.-based operator of Saks Fifth Avenue and other store chains, and its bonds fell in tandem with Penney's, although not quite so dramatically.

The high-yield primary market meantime remained hunkered in its junker bunker, waiting out the end of the calendar first quarter with no new deals seen having priced, and even very little going on in the way of calendar-building activity.

And after the market had closed for the day, market participants familiar with the weekly high-yield mutual fund flow numbers compiled by AMG Data Services of Arcata, Calif., told Prospect News that a whopping $1.131 billion more left the funds than came into them in the week ended Wednesday - the seventh consecutive week in which the funds have bled money, and the second in a row in which the net outflow topped $1 billion, coming as it did on the heels of the massive $1.49 billion seen in the previous week, ended March 23.

The fund flow numbers are considered a measure of junk market liquidity trends.

In those seven weeks, net outflows have totaled about $3.863 billion, according to a Prospect News analysis of the AMG figures. Outflows have now been seen in 10 weeks out of the 13 since the start of the year. The year-to-date 2005 cumulative outflow ballooned to some $4.789 billion from $3.658 billion the week before, according to the Prospect News analysis. The figures exclude distributions and count only those funds that report on a weekly basis.

"It's painful," said a buy-side source who was digesting the news of the outflow. "March has not been a fun month."

A trader noted that just in the past two weeks alone, "we've had $2.5 billion of outflows. The stability in the high-yield market has evaporated."

This was especially evident in the retailing sector, which the trader termed "disastrous."

He added that "hammered wasn't the word" for what happened to the J.C. Penny bonds, some of which are down as much as 30 points in the last month, about half of that carnage coming on Thursday alone.

The company's bonds "opened about 200 [basis points] wider, and then they went to 300 [bps]. They got totally mowed."

He said that while the 2007 and 2008 bonds "kinda hung where they were," anything longer than that was decimated. "The 9% of '12, the 8% of '10, all the way out to the '37s and the '95s were pretty much down about 20 points from yesterday [Wednesday.]"

He quoted Penney's 7.40% notes due 2037 as having fallen to 86.5 bid, 88.5 offered, well down from 102.5 bid, 104.5 offered going home on Wednesday. A week ago, the bonds were trading around 108 bid, 110 offered, and 113 bid, 114 offered a month ago.

"They've lost around 30 points in the month," he marveled.

The company's 6 7/8% notes due 2015, "which were usually the benchmark," tumbled to 92 bid, 94 offered by the close, he said, from 106 late Wednesday.

He saw the 9% notes of 2012, which had finished at 116 on Wednesday, trade as well as 110 bid, 112 offered during the session, before falling to a close at 104.5 bid, 105.5 offered.

"I can imagine the pain that's going on, with the bigger guys that have all of those" he declared.

Furthermore, Penney "was supposed to be going investment grade up until today [Standard & Poor's even warned that a debt-fueled buyout could push the bonds' ratings lower], now you see markets of a million [bonds] and up, but as of yesterday and the day before it wasn't uncommon to see markets of 10 million [bonds] and up, like a high-grade piece of paper."

The catalyst for the bonds' collapse was a story in Women's Wear Daily, a clothing industry trade publication, to the effect that Cerberus Capital Management LLP and the Carlyle Group are teaming up to make a bid for Penney, raising the specter of a mostly debt-funded leveraged-buyout transaction that will leave Penney groaning under a mountain of new debt, structured so as to be senior to the existing obligations.

Penney's management characterized such speculation as "rumors" - and said that it was the company's policy not to comment on such market scuttlebutt. However, the statement also indicated that Penney would unveil a long-range plan that it will discuss at an analysts' meeting on April 19-20. The statement said that the mystery plan is designed to increase its "leadership position in the retail industry" and "deliver value to its shareholders."

Adding fuel to the speculative fires is the fact that a key Penney executive, Vanessa Castagna, who was once thought to be in line to become chief executive, recently joined Cerberus.

A trader saw Penney's long end "quite weaker," with its 8% notes due 2010 at par bid, 101 offered, down "seven to nine points on the day" in his estimate, and the 8 1/8% notes due 2027 falling to 95 bid, 97 offered from 104.5 bid, 105.5 offered Wednesday.

Even the shorter bonds were weaker, he said, with the 7 3/8% notes due 2008 dipping to 101 bid, 102 offered, down from 105 bid, 106 offered, although he allowed that compared to the long-end plunge, the "shorter guys don't look that interesting."

Talk of a possible buyout delighted holders of Penney's New York Stock Exchange shares, which jumped $4.02 (8.39%) to $51.92, on volume of 20.6 million, almost 10 times the norm.

But the first trader said that the sudden nosedive in the longer bonds from levels slightly above par to levels way below it has left some pretty unhappy campers.

"The 7.40s had a put option at par that everyone said 'go scratch,' and ignored," he said, "because they were trading [at that time] at 113.5. No one in his right mind was going to give up 13½ points.

"So they all laughed, and said 'screw that, I'm not doing that,' and there was a ton of activity in the '37 paper. Hopefully, the retail guys were selling it rather than putting it back at par."

However, he said, "the people that hung on for the 7.40% coupon, are now dying because they're 15 points out of the money, 15 points away from where they could have put the bonds and 30 points away from the highs."

From where he sat, "they have some more downside potential here. There's some short covering I guess, guys that were short the longer paper, across the board it was just horrific, horrific numbers."

The second trader acknowledged that there was "fear of a leveraged balance sheet" among bondholders - but said that there were also skeptics around who consider such a deal to be unlikely, given the large size of the company - a deal would have to be at least $18 billion, by some estimates - and its large cash reserves.

The doubters also point to the recent performance of Penney's stock, which has made a deal that much most costly - the shares are trading at the top of their 52-week range; LBOs traditionally involve companies underperforming in the equity markets, who can be had for a song, relatively speaking, using cheap borrowed money.

The buyout firms also traditionally sell off under-valued assets - but Penney already unloaded its underperforming Eckerd drugstore unit last year, and unlike many retailers - Kmart Corp. comes to mind, and Toys "R" Us, which agreed to a buyout led by Kohlberg Kravis Roberts & Co. - it has little in the way of real estate assets to unlock, since it leases most of its store properties.

Saks down too, but not as much

The first trader said that there was "a similar situation with Saks," which was reported, also by Women's Wear Daily, to be lining up buyers for its regional mid-price department store group, which operates such stores as Proffitt's and Parisian - but is also considering selling its much more famous upscale Saks Fifth Avenue division.

The New York Times separately reported Thursday that Saks board has hired Goldman Sachs and Citigroup to explore "strategic alternatives."

With Penney leading the way downward for the whole sector, Saks, the trader said, was also down, although the fall was "not as vicious."

He saw the company's 7½% notes due 2010 drop to 97 bid, 99 offered at the close from 101.75 bid, 102.75 offered on Wednesday. Those levels were down from 104 bid, 106 offered a week ago and from 107.5 bid, 108.5 offered at the beginning of March.

The Saks 7 3/8% notes due 2019 closed at 89 bid, 91 offered, down from about 96 on Wednesday and well down from 102.5 bid, 104.5 offered in early March.

In the course of a month, he said, "they were down 13, 15 points."

Toys keeps dropping

Also on the retail front, Toys "R" Us -whose bonds have been sliding for over a week, once the Wayne, N.J.-based toy retailer made it clear to the markets that it does not anticipate an imminent tender offer for them - continued to ease, its 7 7/8% notes due 2013 dipping a point to 90 bid, 91 offered, and its 8¾% notes due 2021 also coming in two points to 88 bid, 90 offered.

A market source at another desk declared that overall in the market, with most issues lower, "retail [investors] is pulling out because of the sell-off. The change in the Fed language combined with the GM news, in a rich market, makes for a very volatile environment.

"On top of that there is the J.C. Penny and the Saks news - there are just a lot of falling knives."

Primary market shut down

The primary market stood rock still on Thursday, according to sources.

With regard to the primary market, a buy-side source painted a scenario in which prospective new issuers are facing extreme difficulty selling high-yield bonds.

"I think the primary market is shut down," the buy-sider said.

As evidence the investor pointed to Navarre Corp.'s $125 million offering of seven-year senior notes (B3/B+) via Bear Stearns & Co, and in so doing became the second buy-sider in the past three days to profess a liking for the company, and an opinion that at the price at which the notes are being marketed the bond is cheap.

To recap, the Minneapolis-based distributor of entertainment software, which is in the market to finance its acquisition of FUNimation, talked its deal last week at 10¼%-10½%. Prospect News learned from other market sources that when deal initially hit the road it was pro formaed at 9½% to 9¾%.

"We were looking at the Navarre deal," the buy-sider said.

"The way it was explained to us is that the only way it was going to get done is if the seller took $40 million. That means that the market was going to take $85 million.

"They started that deal at 9¼%. Now it's at 10¾%. That's pretty ugly."

The source went on to reason that the capitulation on the part of the issuer might actually be hurting the deal as opposed to helping it.

"I liked the deal, and I had the feeling that it was being priced properly relative to the current market conditions, and being priced probably cheap relative to the risk," the investor said.

"But if there is a $40 million overhang in that bond, how can it ever rally? The guys taking that $40 million are not there to hold it to maturity."

Open for small deals, maybe

The buy-sider went on to profess the opinion that at present there may not be enough buyers to get a big acquisition financing done, and brought up the recently announced SunGard Capital Corp. LBO financing.

The deal, to help fund the leveraged buyout of SunGard Data Systems Inc. by a consortium of investors that includes Silver Lake Partners, Bain Capital, The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. LP, Providence Equity Partners and Texas Pacific Group, will involve $4.75 billion of senior secured debt and $3.5 billion of bridge financing.

On Thursday a source told Prospect News that Deutsche Bank Securities will lead the bond deal.

"That's going to be a big deal," the buy-sider commented.

"How will an LBO deal like that get done if there is no 'L'...in other words, if there is no high-yield market?

"To me the high-yield seems like it is shut down for new business. And if you have to move the price another 10 points to get the yields necessary to get people in, that is not going to get people back into the market. It's just going to scare people away.

"There are no new deals coming in. So if you are going to get new money in, you have to get yields higher. But that is going to force the price down on everything else, which will scare away the new money.

"In the meantime, even at these prices the market is shut down. So how does an LBO deal get done?

"I think right now you can do a smaller deal. But I don't think that you can do a billion-dollar deal in this environment."

Only a temporary interruption

Meanwhile a sell-side source, hearing this color from the buy-side, insisted that if the primary market is shut down, it is only shut down for the time being.

This investment banker had no quarrel with color from one of his counterparts who told Prospect News on Wednesday that the high yield appears to be repricing itself by 75 to 100 basis points.

The sell-sider also said that some of the deals parked on the forward calendar as business expected to be priced this week might be moved to next week or the week after.

"With some of these deals there's no hurry," the official said.

"There's no one holding a gun to the company's head forcing it to accept an interest rate that is extraordinarily high because of present market conditions.

"People understand that these periods of repricing come to an end, and then there is stability and the market improves.

"Some of these companies will be content to wait until that happens."

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