On Dec. 7, J.C. Penney, a leading department store chain, announced that it is acquiring a 16.6 percent stake in Martha Stewart Living Omnimedia (MSLO) in exchange for $38.5 million in cash, or $3.50 per share. J.C. Penney will receive one board seat as part of the deal, and MSLO will issue a special dividend of 25 cents per share.
In addition to the investment, the department store chain also announced a 10-year strategic alliance with MSLO. Beginning in 2013, J.C. Penney will launch Martha Stewart-branded shops within its stores and launch a co-branded e-commerce website in 2013. According to a statement by MSLO, "these Martha Stewart stores are intended to be destinations where consumers can experience an engaging and inspiring environment and buy a variety of affordable, high-quality home and lifestyle merchandise designed and curated by Martha Stewart and her team.”
The deal has great potential to benefit both companies. MSLO will receive a steady stream of high-margin cash flow—estimated at over $200 million during the 10-year span of the agreement—in the form of royalty payments, design fees and guaranteed advertising placements from J.C. Penney. Penney will also be managing the sourcing and distribution of merchandise sold under the Martha Stewart brand in its shops. This transaction is much-needed for MSLO, as the company has experienced significant revenue declines over the past several years, and the agreement provides a lifeline which buys the company time to find a long-term solution to its declining fortunes.
J.C. Penney, on the other hand, benefits by gaining access to a well-respected brand associated with high quality products. The company operates 1,106 department stores across 49 states and Puerto Rico with over 156,000 employees. According to its most recent quarter financial statement, Penney has over $1.8 billion in cash and short-term investments, more than enough to finance the potential cash required for this deal even under the worst of circumstances.
Despite the clear benefits for MSLO, J.C. Penney's potential return on this deal remains an open question. This transaction is very similar to the deal MSLO arranged with K-mart many years ago. Martha Stewart “Everyday” branded merchandise at K-mart never reached the levels the company projected and the deal turned into a financial loser for K-mart. Knowing this history, it’s clear the Penney believes they can do better. Part of the reason for pursuing this deal is because the company needs radical transformation in order to succeed:
- J.C. Penney sales have been dropping continuously over the last several quarters and so far this quarter has been the same. In its most recent report, same store sales were down 2.6 percent during October with overall sales down 6.6 percent. For November the same store sales were down 2 percent and overall sales decreased 5.9 percent. To put this in context, only one other major, publicly- traded retailer—Kohl’s—showed worse results.
- J.C. Penney targets middle class consumers who happen to be struggling financially given current economic conditions. With an economic turnaround nowhere in sight, the company needs to consider appealing to consumers a little higher up on the economic ladder, like those that will buy MSLO products, which have more disposable income. Even for those customers that are struggling financially, they may be willing to splurge a little if they feel they are getting high quality products in return.
While there is much excitement at the moment for this deal, the history of these types of transactions is a mixed bag of results. Time will tell whether or not this was a wise decision for J.C. Penney. MSLO shareholders, on the other hand, are already popping the champagne.