Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

J.C. Penney Company, Inc. (JCP), Goldman Sachs Group, Inc. (GS): When $1.75 Billion Isn’t Enough

Earlier this week, I debated whether J.C. Penney Company, Inc. (NYSE:JCP) stock was a falling knife or a screaming value.

On one hand, the company just wrapped up a dismal first quarter during which it lost a whopping $348 million. First-quarter sales dropped 16.4% to $2.635 billion, hurt by comparable-store sales, which fell a terrible 16.6%. The company’s gross margin continued to fall, and operating cash flow also worsened further from the year-ago period.

J.C. Penney Company, Inc. (NYSE:JCP)

On the other hand, believe it or not, those results actually marked a sequential improvement over J.C. Penney Company, Inc. (NYSE:JCP)’s even more horrendous performance in the fourth quarter of 2012, which directly led to the firing of then-CEO Ron Johnson. As a result, shares of J.C. Penney Company, Inc. (NYSE:JCP) are actually up nearly 23% over the past month, and investors are holding on to hope that the company might actually be able to eventually return to sustained profitability.

That’s where the company’s previously announced $1.75 billion five-year loan facility with Goldman Sachs Group, Inc. (NYSE:GS) came in. After all, nobody expects the company’s losses to end overnight, and with only $821 million in cash remaining with more than $3.8 billion in debt, J.C. Penney Company, Inc. (NYSE:JCP) certainly wouldn’t have been able to stay solvent much longer.

More, please
Then, just the other day, J.C. Penney Company, Inc. (NYSE:JCP) announced that it had actually secured the loan for $2.25 billion, or $500 million more than the struggling retailer initially sought.

CFO Ken Hannah elaborated by saying, “This new funding gives us the financial flexibility to pursue our plans to put the company back on a path to profitable growth.”

So what does this mean for investors?

As fellow Fool Adam Levine-Weinberg pointed out last week, the initial loan would have already come at a high cost, especially considering J.C. Penney Company, Inc. (NYSE:JCP) would need to spend around $370 million of the new funds to buy out existing debt holders as a prerequisite for issuing new secured debt.

On a slightly more encouraging note, when we remember that the old $1.75 billion loan would have provided just enough cash to replace the company’s current $850 million line of credit while offsetting its operating losses for the rest of 2013, the extra $500 million should give J.C. Penney a bit more wiggle room if it continues losing money after that point.

Putting aside the fact that those continued losses would be bad for shareholders (to put it kindly), Adam also noted that the minimum 6.75% rate on the $1.75 billion loan would have cost J.C. Penney at least $500 million in interest over the next five years.

Now, based on the new $2.25 billion principal amount, J.C. Penney’s annual net interest expense will increase by almost $133 million, or a total of nearly $670 million over the five-year term of the loan.

Of course, this is great for the bottom line of Goldman Sachs Group, Inc. (NYSE:GS), assuming J.C. Penney will be able to repay the loan in full, but there’s undoubtedly risk involved for both companies. On that note, if J.C. Penney can’t deliver on its turnaround, you can bet the folks at Goldman Sachs Group, Inc. (NYSE:GS) will be the first in line to collect.

Foolish final thoughts
In the end, desperate times call for desperate measures, and I think it’s safe to say J.C. Penney is definitely desperate. However, while this huge loan is necessary for J.C. Penney to have a chance at survival, it’ll only make it that much harder for the company to start making money again. As a result, I’m standing by my assertion that investors should steer clear of J.C. Penney stock.

The article When $1.75 Billion Isn’t Enough originally appeared on Fool.com is written by Steve Symington.

Fool contributor Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.