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Many Ways to Win

Value Investing Congress

October 18, 2011

T2 Partners Management L.P.

Manages Hedge Funds and Mutual Funds

and is a Registered Investment Advisor

The General Motors Building

767 Fifth Avenue, 18th Floor

New York, NY 10153

(212) 386-7160

[email protected] www.T2PartnersLLC.com

-3-

Disclaimer

THIS PRESENTATION IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND SHALL NOT BE CONSTRUED TO CONSTITUTE INVESTMENT ADVICE. NOTHING CONTAINED HEREIN SHALL CONSTITUTE A SOLICITATION, RECOMMENDATION OR ENDORSEMENT TO BUY OR SELL ANY SECURITY OR OTHER FINANCIAL INSTRUMENT.

INVESTMENT FUNDS MANAGED BY WHITNEY TILSON AND GLENN TONGUE OWN STOCK IN MANY OF THE COMPANIES DISCUSSED HEREIN. THEY HAVE NO OBLIGATION TO UPDATE THE INFORMATION CONTAINED HEREIN AND MAY MAKE INVESTMENT DECISIONS THAT ARE INCONSISTENT WITH THE VIEWS EXPRESSED IN THIS PRESENTATION.

WE MAKE NO REPRESENTATION OR WARRANTIES AS TO THE ACCURACY, COMPLETENESS OR TIMELINESS OF THE INFORMATION, TEXT, GRAPHICS OR OTHER ITEMS CONTAINED IN THIS PRESENTATION. WE EXPRESSLY DISCLAIM ALL LIABILITY FOR ERRORS OR OMISSIONS IN, OR THE MISUSE OR MISINTERPRETATION OF, ANY INFORMATION CONTAINED IN THIS PRESENTATION.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND FUTURE RETURNS ARE NOT GUARANTEED.

Our Analysis of Berkshire Hathaway,

Which Is, By Far, Our Largest Position

-5-

Berkshire Hathaway: A High-Quality,

Growing 66-Cent Dollar

History

• Berkshire Hathaway today does not resemble the company that

Buffett bought into during the 1960s

• Berkshire was a leading New England-based textile company, with

investment appeal as a classic Ben Graham-style “net-net”

• Buffett took control of Berkshire on May 10, 1965

• At that time, Berkshire had a market value of about $18 million and

shareholder's equity of about $22 million

The Berkshire Hathaway Empire Today

Stakes in Public Companies

Worth $1+ Billion

Note: Shares as of 12/31/10; Stock prices as of 10/19/11.

-6-

Company Shares Price Value ($B)

Coca-Cola 200.0 $67.03 $13.4

Wells Fargo 358.9 $25.18 $9.0

American Express 151.6 $46.13 $7.0

Procter & Gamble 72.4 $64.75 $4.7

Kraft 97.2 $34.85 $3.4

Johnson & Johnson 45.0 $62.64 $2.8

Munich RE 19.3 $133.40 $2.6

Wal-Mart 39.0 $56.25 $2.2

ConocoPhillips 29.1 $69.56 $2.0

U.S. Bancorp 78.1 $24.14 $1.9

Sanofi-Aventis 25.8 $71.59 $1.9

POSCO 3.9 $40,047 $1.6

Tesco 242.2 $6.38 $1.5

http://www.genre.com/page/0,1019,,00.html

https://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&

http://www.netjets.com/default.asp

http://www.sees.com/home.cfm



http://www.johnsmanville.com/default.htm

http://www.shawfloors.com/index.asp

http://shop.borsheims.com/Borsheims/Default.aspx

http://www.buffalonews.com/default.asp

http://www.jordans.com/default.asp

http://www.brick.com/

http://www.bnsf.com/

-7-

The Basics

• Stock price (10/19/11): $111,440

– $74.11 for B shares (equivalent to $111,165/A share)

• Shares outstanding: 1.649 million

• Market cap: $184 billion

• Total assets (Q2 „11): $383 billion

• Total equity (Q2 „11): $163 billion

• Book value per share (Q2 „11): $98,716

• P/B: 1.13x

• Float (Q2 „11): $71 billion

-8-

Earnings of Non-Insurance Businesses Have Soared Thanks

to Burlington Northern and the Economic Rebound

* In 2010, Berkshire changed this table from “Earnings before income taxes, noncontrolling interests and equity method earnings” to “Earnings before income taxes”. Thus, 2008-2010

reflect the new numbers, and all prior years reflect the old ones.

** Burlington Northern‟s run rate annual operating profits are approximately $4.1 billion.

Earnings before taxes* 2004 2005 2006 2007 2008 2009 2010

Insurance Group:

GEICO 970 1,221 1,314 1,113 916 649 1,117

General Re 3 -334 523 555 342 477 452

Berkshire Reinsurance Group 417 -1,069 1,658 1,427 1,222 250 176

Berkshire H. Primary Group 161 235 340 279 210 84 268

Investment Income 2,824 3,480 4,316 4,758 4,896 5,459 5,145

Total Insurance Oper. Inc. 4,375 3,533 8,151 8,132 7,586 6,919 7,158

Non-Insurance Businesses:

Burlington Northern Santa Fe** 3,611

Finance and Financial products 584 822 1,157 1,006 771 653 689

Marmon 733 686 813

McLane Company 228 217 229 232 276 344 369

MidAmerican/Utilities/Energy 237 523 1,476 1,774 2,963 1,528 1,539

Other Businesses 2,253 2,406 3,297 3,279 2,809 884 3,092

Total Non-Insur. Oper. Inc. 3,302 3,968 6,159 6,291 7,552 4,095 10,113

Total Operating Income 7,677 7,501 14,310 14,423 15,138 11,014 17,271

-9-

Quarterly Earnings of Key Business Units

* In 2010, Berkshire changed this table from “Earnings before income taxes, noncontrolling interests and equity method earnings” to “Earnings before income taxes”, but a breakdown

of Q1-Q3 numbers in 2008-2010 isn‟t available, so we use the old numbers for Q1-Q3 of each year, but to get the Q4 numbers in 2008-2010, we subtract from the full-year numbers,

which causes slight anomalies in Q4 08, Q4 09 and Q4 10.

Earnings before taxes* Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11

Insurance Group:

GEICO 295 325 335 158 186 298 246 186 148 111 200 190 299 329 289 200 337 159

General Re 30 230 157 138 42 102 54 144 -16 276 186 31 -39 222 201 68 -326 132

Berkshire Reinsurance Group 553 356 183 335 29 79 -166 1,280 177 -318 141 250 52 117 -237 244 -1,343 -354

Berkshire H. Primary Group 49 63 77 90 25 81 -8 112 4 29 7 44 33 48 52 135 56 54

Investment Income 1,078 1,236 1,217 1,227 1,089 1,204 1,074 1,529 1,354 1,482 1,412 1,211 1,283 1,494 1,218 1,150 1,261 1,404

Total Insurance Oper. Inc. 2,005 2,210 1,969 1,948 1,371 1,764 1,200 3,251 1,667 1,580 1,946 1,726 1,628 2,210 1,523 1,797 -15 1,395

Non-Insurance Businesses:

Burlington Northern Santa Fe 476 974 1,127 1,034 965 1,070

Finance and Financial products 242 277 273 214 241 254 163 113 112 115 119 307 111 155 140 283 156 177

Marmon 28 261 247 197 162 170 194 160 190 219 212 192 222 273

McLane Company 58 72 50 52 73 68 68 67 143 66 64 71 80 109 89 91 82 105

MidAmerican/Utilities/Energy 513 372 481 408 516 329 526 1,592 303 402 441 382 395 338 416 390 451 320

Other Businesses 723 1,015 1,020 957 744 956 798 516 206 201 350 271 583 860 844 805 675 976

Total Non-Insur. Oper. Inc. 1,536 1,736 1,824 1,631 1,602 1,868 1,802 2,485 926 954 1,168 1,191 1,835 2,655 2,828 2,795 2,551 2,921

Total Operating Income 3,541 3,946 3,793 3,579 2,973 3,632 3,002 5,736 2,593 2,534 3,114 2,917 3,463 4,865 4,351 4,592 2,536 4,316

-10-

Berkshire Is Becoming Less of an Investment

Company and More of an Operating Business

Source: 2010 annual letter.

*

(10)

(5)

0

5

10

15

20

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 H1 11

Acquisitions Net Stock Purchases

-11-

After a Two-Year Hiatus, Berkshire

Is Acquiring Stocks Again

• He‟s doing a good job – but the cash is coming in so fast!

– A high-class problem

• Markets have a way of presenting big opportunities on short notice

– Chaos in 2008, junk bonds in 2002

– Buffett has reduced average maturity of bond portfolio so he can act quickly

$B

Cash paid, mostly for

Burlington Northern

(the total value of the company at

acquisition was $34 billion)

Starting to buy stocks again

-12-

Buffett Invested Large Amounts of

Capital During the Downturn in 2008

Investment/Commitment Amount (Bn) Comment

Mars/Wrigley $6.5

Auction rate securities $6.5 Q2 event; sold much in Q3

Goldman Sachs $5.0 Plus $5B to exercise warrants

Constellation Energy stock

and preferred

$5.7 Sold for a $1.1B gain incl.

breakup fee

Marmon $4.5 The remaining 34.6% not

owned by BRK will be

purchased from 2011-14

General stock purchases $3.3 Full year; net of sales

Dow/Rohm & Haas $3.0

General Electric $3.0 Plus $3B to exercise warrants

Fed. Home Loan Disc. Notes $2.4 Q2 event; sold much in Q3

Tungaloy $1.0 Iscar acquisition

Swiss Re unit $0.8 Plus sharing agreement

ING reinsurance unit $0.4

Other businesses purchased $3.9

TOTAL $46.0 Plus $8B to exercise GS &

GE warrants

Note: Does not include capital committed to Berkshire’s new bond insurance business, Berkshire Assurance

-13-

Valuing Berkshire

“Over the years we've…attempt[ed] to increase our marketable investments in wonderful businesses, while simultaneously trying to buy similar businesses in their entirety.” – 1995 Annual Letter

“In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshire's intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per-share ownership of investments (including cash and equivalents) and the second column shows our per-share earnings from Berkshire's operating businesses before taxes and purchase-accounting adjustments, but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column.” – 1997 Annual Letter

“In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs.” – 1997 Annual Letter

-14-

Buffett’s Comments on Berkshire’s Valuation Lead

to an Implied Multiplier of Approximately 12

• 1996 Annual Letter: “Today's price/value relationship is both much different from what it was a year ago and, as Charlie and I see it, more appropriate.”

• 1997 Annual Letter: “Berkshire's intrinsic value grew at nearly the same pace as book value” (book +34.1%)

• 1998 Annual Letter: “Though Berkshire's intrinsic value grew very substantially in 1998, the gain fell well short of the 48.3% recorded for book value.” (Assume a 15-20% increase in intrinsic value.)

• 1999 Annual Letter: “A repurchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value...We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated...Recently, when the A shares fell below $45,000, we considered making repurchases.”

Pre-tax EPS

Excluding All Year-End

Investments Income From Stock Intrinsic Implied

Year Per Share Investments Price Value Multiplier

1996 $28,500 $421 $34,100 $34,100 13

1997 $38,043 $718 $46,000 $46,000 11

1998 $47,647 $474 $70,000 $54,000 13

1999 $47,339 -$458 $56,100 $60,000

Pre-tax EPS

Excluding All Subsequent

Investments Income From Intrinsic Value Year Stock

Year End Per Share Investments Per Share Price Range

2001 $47,460 -$1,289 $64,000 $59,600-$78,500

2002 $52,507 $1,479 $70,000 $60,600-$84,700

2003 $62,273 $2,912 $97,000 $81,000-$95,700

2004 $66,967 $3,003 $103,000 $78,800-$92,000

2005 $74,129 $3,600 $117,300 $85,700-$114,200

2006 $80,636 $5,200-$5,400 $143,000-$144,400 $107,200-$151,650

2007 $90,343 $5,500-$5,700 $156,300-$158,700 $84,000-$147,000

2008 $75,912 $5,727 $121,728 (8 multiple) $70,050-$108,100

2009 $91,091 $3,571 $126,801 (10 multiple) $97,205-$128,730

2010 $94,730 $7,200 $166,730 (10 multiple) ?

Q2 2011 $95,500 $7,200 $167,500 (10 multiple) ?

Estimating Berkshire’s Value: 2001 – 2011

1. Unlike Buffett, we include a conservative estimate of normalized earnings from Berkshire‟s insurance businesses.

2. Actual result was $6,492, but we reduce this to assume the 2nd-worst year ever for super-cat losses.

3. Actual result was $6,270 but we reduce the pre-tax, pre-investment-income margins of the insurance businesses by 400 basis points

(from 14% to 10%) to reflect Buffett‟s guidance in the Annual Report.

Given compressed multiples at the end of 2008, we used an 8 rather than a 12 multiple.

We’ve now increased this to a 10 multiple, still below the historical 12 multiple we believe Buffett uses.

-15-

1

2

3

Berkshire Is 34% Below Intrinsic Value,

Close to a Multi-Decade Low

Intrinsic value*

* Investments per share plus 12x pre-tax earnings per share (excluding all income from investments) for the

prior year, except for YE 2008 (8 multiple) and YE 2009 onward (10 multiple).

Intrinsic value estimate of

$169,500 using 10 multiple

34% discount to

intrinsic value

-16-

12-Month Investment Return

• Current intrinsic value: $167,500/share

• Plus 5% growth of intrinsic value of the business

• Plus cash build over next 12 months: $7,000/share

• Equals intrinsic value in one year of $182,875

• 64% above today‟s price

-17-

-18-

Catalysts

• Meaningful share repurchases

• Continued earnings growth of operating businesses

• $1+ billion of pre-tax earnings from Lubrizol

• New equity investments

• Additional cash build

• Eventually, Berkshire could win back a AAA rating (not likely in

the near term)

• Potential for more meaningful acquisitions and investments

– If there‟s a double-dip recession, this becomes more likely

-19-

Berkshire’s New Share Repurchase Program

• On September 26th, Berkshire announced the first formal share

repurchase program in Berkshire‟s history, and only the second time

Buffett has ever offered to buy back stock

• It‟s unusual in three ways:

1. There‟s no time limit

2. There‟s no dollar cap

3. Buffett set a price: “…no higher than a 10% premium over the then-

current book value of the shares. In the opinion of our Board and

management, the underlying businesses of Berkshire are worth

considerably more than this amount…”

• Book value at the end of Q2 was $98,716 ($65.81/B share); we

estimate that book value today has declined slightly to perhaps

$97,000 ($64.67/B share).

• Thus, a 10% premium means that Buffett is willing to buy back stock

up to $106,700 ($71.13/B share), roughly 3% below today‟s price

-20-

The Share Repurchase Program Has Significantly Improved

the Risk-Reward Equation, So We Bought More Stock

• It confirms that Buffett shares our belief that Berkshire stock is deeply undervalued

– He wouldn‟t be buying it back at a 10% premium to book value if he thought its intrinsic value

was, say, 20% or even 30% above book

– Our estimate is nearly $170,000/share, more than 50% above today‟s levels

• Buffett put a floor on the stock: he was clear in numerous interviews after the program

was announced that he is eager to buy back a lot of stock – and he has plenty of dry

powder to do so:

– Berkshire has $43.2 billion of cash (excluding railroads, utilities, energy, finance and financial

products), plus another $34.8 billion in bonds (nearly all of which are short-term, cash

equivalents), which totals $77 billion

– On top of this, the company generated more than $6.5 billion in free cash flow in the first half

of the 2011 – in other words, more than $1 billion/month is pouring into Omaha

– The press release notes that “repurchases will not be made if they would reduce Berkshire‟s

consolidated cash equivalent holdings below $20 billion,” so that leaves $57 billion to deploy

(and growing by $1 billion/month), equal to nearly one-third of the company‟s current market

cap

• It‟s unlikely, however, that Buffett would repurchase anything close to this amount, as some of the

cash and bonds are held at various insurance subsidiaries, plus Buffett likely wants to keep plenty of

dry powder to make acquisitions and investments like the recent $5 billion one into Bank of America

– In summary, Buffett could easily buy back $10-20 billion of stock and still have plenty of dry

powder for other investments

-21-

Berkshire Stock Outperformed the S&P 500 by 83

Percentage Points in the Year After the Only Other

Time Buffett Offered to Buy Back Stock

Berkshire Hathaway

S&P 500

March 11, 2000 – March 11, 2001

Up 72%

Down 11%

-22-

Risk: Who Will Replace Buffett?

• When Buffett is no longer running Berkshire, his job will be split into two

parts: one CEO, who has not been named, and a small number of CIOs

(Chief Investment Officers) – Two have been named already, Todd Combs and Ted Weschler, who both appear to be

excellent investors

• Nevertheless, Buffett is irreplaceable and it will be a significant loss when

he no longer runs Berkshire for a number of reasons: – There is no investor with Buffett‟s experience, wisdom and track record, so his successors‟

decisions regarding the purchases of both stocks and entire business might not be as good

– Most of the 75+ managers of Berkshire‟s operating subsidiaries are wealthy and don‟t need

to work, but nevertheless work extremely hard and almost never leave thanks to Buffett‟s

“halo” and superb managerial skills. Will this remain the case under his successors?

– Buffett‟s reputation is unrivaled so he is offered deals (such at the recent $5 billion

investment in BofA) on terms that are not offered to any other investor – and might not be

offered to his successors

– Being offered investment opportunities on terms/prices not available to anyone else also

applies to buying companies outright. There‟s a high degree of prestige in selling one‟s

business to Buffett. For example, the owners of Iscar could surely have gotten a higher

price had they taken the business public or sold it to an LBO firm.

– Buffett‟s Rolodex is unrivaled, so he gets calls (and can make calls that get returned) that

his successors might not

-23-

Aren’t We Concerned About the Uncertainty

of Berkshire After Buffett?

Answer: Not really, for two primary reasons:

1. Buffett isn‟t going anywhere anytime soon. We think it‟s at least

80% likely that Buffett will be running Berkshire for five more

years, and 50% likely he‟ll be doing so for 10 more years

– Buffett turned 81 on Aug. 30th and is in excellent health

– There are no signs that he is slowing down mentally – in fact, he appears to be

getting better with age

• A life expectancy calculator (http://calculator.livingto100.com) shows that

Buffett is likely to live to age 93 (12 more years)

2. The stock is very cheap based on our estimate of intrinsic value

(nearly $170,000/A share), which does not include any Buffett

premium

• We simply take investments/share and add the value of the operating

businesses, based on a conservative multiple of their normalized earnings

• The value of the cash and bonds won‟t change, and Coke, American Express,

Burlington Northern, GEICO, etc. will continue to generate robust earnings

even after Buffett‟s gone

-24-

The Real Buffett Risk

• Buffett is often asked (as are we): “What would happen to the

company (and stock) if you got hit by a bus (i.e., die suddenly)?

– If it happened tomorrow, our best guess is that the stock would fall 10-15%

(which would give Berkshire the opportunity to buy back a lot of stock if it was

trading below 110% of book value)

– But this isn‟t likely. Not to be morbid, but most people don‟t die suddenly from

something like an accident or heart attack, but rather die slowly: their bodies

(and sometimes minds) break down gradually

– A far greater risk to Berkshire shareholders is that Buffett begins to lose it

mentally and starts making bad investment decisions, but doesn‟t recognize it

(or refuses to acknowledge it because he loves his work so much) and the

board won‟t “take away the keys”, perhaps rationalizing that a diminished Buffett

is still better than anyone else

– Buffett is aware of this risk and has instructed Berkshire‟s board members, both

publicly and privately, that their most important job is to “take away the keys” if

they see him losing it

– We trust that both Buffett and the board will act rationally, but also view it as our

job to independently observe and evaluate Buffett to make sure we‟re

comfortable that he‟s still at the top of his game. Today, we think he‟s never

been better.

-25-

An Analogy with Apple & Steve Jobs

• The most comparable example of a business that, like Berkshire,

is closely associated with its legendary founder and CEO is Apple

– As Steve Jobs‟s health began to fail, he assumed fewer day-to-day

responsibilities, passing them to top lieutenants

– Jobs resigned as CEO on Aug. 24, 2011 and died exactly six weeks later

– Apple‟s stock on the first trading days after his retirement and death were

announced declined less than 1%, as this chart shows:

First day of

trading after

Steve Jobs

announces

retirement

First day of

trading after

Steve Jobs dies

-26-

Other Risks

• A double-dip recession impacts Berkshire‟s earnings materially

• No catalyst occurs, so the stock sits there and doesn‟t go up

– Intrinsic value will likely continue to grow nicely

• Berkshire‟s stock portfolio declines

• Losses in the shorter-duration derivatives such as credit-default

swaps are larger than expected and/or mark-to-market losses

mount among the equity index puts

• A major super-cat event occurs that costs Berkshire many billions

• Berkshire is downgraded

-27-

Conclusion

• Cheap stock: 66-cent dollar, giving no value to recent

investments and immense optionality

• Extremely safe: huge cash and other assets provide downside

protection

• Strong earnings should eventually act as a catalyst

Our Analysis of J.C. Penney,

Our Second-Largest Position

-29-

Summary of Investment Thesis

• A decent business that has underperformed

– But this is NOT Sears/K-Mart

• A fairly valued stock based on current performance

– 5.6x EV/EBITDA; 18.1x P/E

• An extraordinary combination of people, covering the key value

drivers, have come together to bring about change – and you get

this for free

– New top management: Ron Johnson and Michael Francis

– Real estate: Steve Roth, Vornado

– Capital allocation: Bill Ackman, Pershing Square

• The business has been undermanaged, so there are many areas

for improvement that can drive enormous value creation

– Increase sales/sq. foot

– Cut costs

– Unlock real estate value

– Optimize capital structure

-30-

The Basics

• Stock price (10/17/11): $29.99

• Shares outstanding: 213.3 million

• Options and warrants: 24.8 million

• Market cap: $6.4 billion

• Enterprise Value: $7.9 billion

• Book value per share (7/31/11): $22

• Sales: $17.7 billion

• P/E (LTM): 18.1x

• EV/EBITDA (LTM): 5.6x

• P/S: 0.36x

-31-

JCP’s Stock Has Done Little Over

the Past Decade

-32-

JCP’s Stock Since Activists’

Investments

JCP reports May SSS -1%

JCP announces Ron

Johnson as next CEO

JCP reports June SSS +2% (vs. KSS

+7.5%, M +6.7%); lowers EPS guidance

JCP reports July SSS +3.3%

JCP reports Aug SSS -1.9%

Pershing Sq. and Vornado

investment announced

JCP Valuation vs. Peers

-33-

JCP Comp group Mkt Cap EV TEV/EBITDA

LTM

P/E (LTM)

Dillard's Inc. (NYSE:DDS) 2,575 3,353 5.1x 13.9x

Kohl's Corp. (NYSE:KSS) 13,593 16,118 5.9x 12.7x

Macy's, Inc. (NYSE:M) 12,497 18,078 5.5x 12.0x

Nordstrom Inc. (NYSE:JWN) 10,681 12,393 7.9x 16.8x

Target Corp. (NYSE:TGT) 35,753 52,448 7.1x 12.6x

The TJX Companies (NYSE:TJX) 21,986 21,715 7.9x 17.3x

Average 6.6x 14.2x

J. C. Penney (NYSE:JCP) 6,408 7,956 5.7x 18.1x

JCP’s History

-34-

James Cash Penney opens The

Golden Rule, a dry goods and clothing

store, in Kemmerer, Wyoming

Store sales exceed $1B

for first time

J.C. Penney issues its

first catalogue

Company launches

jcpenney.com, its

online store

Incorporated in Utah

as the J.C. Penney

Corporation

Moved headquarters

to NYC Moved headquarters

to Plano, Texas

Exits catalogue

business

Announces

Sephora inside

jcpenney concept

Myron Ullman III joins

as company’s 9th

Chairman and CEO

1902 1913 1914 1951 1963 1992 1994 2004 2006 2010 2011

Ron Johnson to begin

as 10th CEO 11/1/11

• JCP operates 1,106 department stores in 49 states and PR

• JCP owns 426 of its 1,106 stores (38.5% of stores, ~42mm sq. ft.)

and 17 of its 26 distribution/warehouse centers (~12m sq. ft.)

• JCP‟s real estate alone could be worth over $3b (total EV of $7.9b)

JCP’s Broad Footprint

-35-

Revenues Over the Past Decade

-36-

Revenue Growth Has Been a Zero

Sum Game

-37-

EBIT Over the Past Decade

-38-

EBITDARP Over the Last Decade

-39-

* Earnings before interest, taxes, depreciation, amortization, rent and pension expense;

assumes $302mm LTM rent expense

A Diverse Business Mix

-40-

Women’s apparel,

24%

Men’s

apparel/accessories,

20%

Home, 18%

Women’s

accessories,

12%

Children’s

apparel, 11%

Footwear, 7%

Fine jewelry, 4%

Services and other,

4%

Private Brands

-41-

49% of revenue comes from private brands developed,

designed, and sourced in-house

Billion

dollar

brand

Billion

dollar

brand

National Brands

-42-

45% of revenue comes from national brands

Exclusive Brands

-43-

6% of revenue comes from exclusive brands/concepts –

a major opportunity

Investment Thesis

• New management team & active Board of Directors

• Opportunity for operational improvement

• Significant real estate value

• Capital structure optimization

-44-

Investment Thesis





-45-

Ron Johnson Left Apple for JCP

• Ron Johnson, 52, beings as new CEO on Nov. 1st

• After graduating from Harvard Business School,

was one of only a few of his classmates to go into

retailing, at Mervyn‟s

• Mervyns was acquired by Target, where Johnson

rose to become senior vice president of

merchandising

– “During his 15 years there, Target got hip, went

national, and crushed sales records…[His track

record is nuts.” – The Atlantic

• In 2000, Steve Jobs hired him to lead Apple‟s retail

stores

– Today: More than 350 stores worldwide, generating

sales of over $4,000/sq. ft.

– Credited with the Genius Bar concept

-46-

Ron Johnson’s Motivation, Incentives

and Alignment With Shareholders

• "I've always dreamed of leading a major retail

company as CEO, and I am thrilled to have the

opportunity to help J. C. Penney re-imagine what I

believe to be the single greatest opportunity in

American retailing today, the Department Store.” –

Ron Johnson, 6/14/11

• Johnson forfeited150k AAPL restricted stock units

(“RSUs) granted in 2008 (that vest in 2012) and

100k RSUs granted in 2010 (that vest in 2014) with

a market value of $73 million

• In return, he only received 1.7m JCP RSUs that

vest 1/27/12, worth roughly $50 million

• In addition, Johnson personally invested $50m to

buy warrants to acquire 7.3m JCP shares at

$29.92. They expire 7.5 years and Johnson cannot

sell or hedge them for six years

-47-

Michael Francis Left Target for

JCP

• Michael Francis, 48, begins as JCP‟s President on

Nov. 1

• Francis will be responsible for merchandising,

marketing, product development and sourcing

• 21 years at Target (1990-2011)

– 2011: Led Target‟s expansion into Canada

– Chief Marketing Officer (Aug „08- Sept „11)

– EVP Marketing (Feb ‟03 – Aug „08)

• Francis began his merchandising and marketing career

as an executive trainee on the sales floor of Marshall

Field‟s in Chicago in 1986

-48-

-49-

Pershing Square’s Involvement

As of 9/22/11 13-D filing:

• Pershing Square owns 39.1m shares (18.3%) and

has economic exposure to 16.6m shares (7.8%)

through total return swaps for total economic

exposure of 55.6m shares or 26.1% of shares

outstanding

• Pershing Square gave up some voting rights to

increase ownership

• The 8/19/11 stockholders agreement limits

Pershing Square from exceeding 26.1% ownership

Bill Ackman

joined JCP

board Feb 2011

Vornado’s Involvement

As of 10/8/11 13-D filing:

• Vornado owns 23.4m shares (9.9%)

• The 9/16/11 stockholders agreement allows

Vornado to buy up to 15.4% of common stock

• Steven Roth has extensive real estate expertise and

an extraordinary history of value-creation

-50-

Steven Roth

joined JCP

board Feb 2011

Current Equity Price: $30 per share

-51-

Market

value of

equity

Investment Thesis





-52-

-53-

Opportunity for Sales Improvement

Sales per sq. ft. are below peers and remain -14%

below 2007 peak levels vs. peer average of -8%

$177/sq. ft.

in FY 2007 $153/sq. ft.

in FY 2010

JCP’s Net Promoter Score Has Been

Rising Steadily, Outpacing Peers

-54-

Note: Net promoter score is percent of people who answer 9 or 10 minus those who answer 0-6 when asked, on a scale

of 0-10, “How likely is it that you would recommend our company to a friend or colleague?”

Source: JCP 2010 investor day, pp 93 of 120

Dramatic

improvement

since 2003

Initiative #1: Sephora Inside JC Penney

Expected to have ~30% store

base penetration by YE 2011

-55-

Sephora Brand Awareness Is Rising and

Should Drive Increased JCP Traffic

-56-

Google Trends indicates “Sephora” search

traffic is up roughly +50% YTD in 2011

-57-

Initiative #2: Liz Claiborne

“Liz Claiborne is one of the most recognized brands in the history of

American apparel retailing with a deeply loyal following, and our

research shows that it is among the most desired by the J.C. Penney

customer.” – CEO Myron Ullman

October 2011: “J.C. Penney acquires worldwide rights for the Liz Claiborne

family of brands as well as the U.S. and Puerto Rico rights for the

Monet brand for $267.5 million.”

Initiative #3: Grow Online Sales

Online sales have been

flat for 4+ years

-58- Source: Credit Suisse, 10/4/11

JCP Sales Opportunity Could Add

$8/share in Value

-59-

Current

stock

price

$8

$38

15% improvement in sales

per sq. ft. = $8 to equity

There Is Significant Opportunity for

Margin Improvement

EBITDAR margins are 380 bps below peak levels vs.

peers on avg. at or above former peak levels

-60-

13.1% in

FY 2007

9.3% in

FY 2010

EBITDARP Margins Have Also

Been Weak

-61-

EBITDARP margins are 280 bps below peak levels

while peers are hitting new highs

13.8% in

FY 2006

11.0% in

FY 2010

J.C. Penney Spends Much More on

Advertising Than Its Peers

-62-

“Penney Dumps Big Book Catalog” – ChiefMarketer Network, 11/18/09

“Retailer J.C. Penney is discontinuing its traditional catalog

business in favor of “look books,” which refer consumers to the

company's e-commerce site.” – Direct Marketing News, 9/28/10

Margin Improvement Could Add

$15 in Value

-63-

Sales per sq. ft.

improvement

300 bps EBITDA

improvement =

$15 to equity

$53

Current

stock

price

$8

$8

Investment Thesis





-64-

-65-

JCP Real Estate Portfolio (1)

JCP real estate is worth $12 - $15 per share


-66-

Property and Equipment, Net

Land N/A $ 315 $ 308

Buildings 50 4,434 4,276

Furniture and equipment 3-20 2,271 2,356

Leasehold improvements 1,065 1,118

Accumulated depreciation (2,854) (2,701)

Property and equipment, net $ 5,231 $ 5,357

2010 2009($ in millions)

Estimated

Useful Lives

(Years)

Source: JCP 2010 10-K

$20/share in gross book value of buildings


• JCP spends ~$300m/yr to rent the 62% of stores it does

not own

• JCP pays itself ~$180mm in “synthetic rent” for the 38%

of company-owned stores

• $2.3b of owned real estate value (owned stores, ground

leased stores, owned distribution centers) implies 8%

cap rate on the “synthetic rent”

-67-

Valuation Based on Separate Retailer

and Real Estate Earnings Stream

-68-

JCP trades at 3.8x LTM EV/EBITDAP, adjusting for real estate value

Sale-Leaseback & Implied EBITDAP Multiple

Low Case Mid Case High Case

Value of Real Estate $2,058 $2,339 $2,620

Assumed Cap Rate 8.0% 8.0% 8.0%

Implied NOI of Real Estate $165 $187 $210

Current LTM EBITDAP $1,584 $1,584 $1,584

Rent Expense Impact to EBITDAP (165) (187) (210)

Pro Forma LTM EBITDAP $1,419 $1,397 $1,374

Current TEV $7,689 $7,689 $7,689

Less: Real Estate Value (2,058) (2,339) (2,620)

Implied Firm Value $5,631 $5,350 $5,069

Implied EBITDAP Multiple 4.0x 3.8x 3.7x

JCP’s Real Estate Could Be

Worth $13/share

-69-

Base value

of retail

business

Margin

improvement

Real

estate

value

Sales per sq. ft.

improvement

Current

stock

price

$8

$8

$8

$65

$13

Investment Thesis





-70-

Share buyback: $900m Spent in 1H11

• Feb. 2011: Board authorized up to $900m repurchase

• Q1 „11: JCP bought back 21m shares for $787m

• Q2 „11: JCP bought back 3m shares for $113m

• Completed program on 5/6/11

• Average price of $36.98

-71-

Debt Ratios

-72-

Source: Capital IQ

Additional REIT Assets

REIT assets valued 7/30/11 at $300m = $1.40/share

-73-

Value of REIT Assets

JCP’s Total Value Could Exceed $70,

More Than Double Today’s Price

-74-

Capital structure

optimization

$70+…?

Margin

improvement

Sales per sq. ft.

improvement

Current

stock

price

$8

$8

$8

$13

Real estate

value

Base value

of retail

business

$8

$13

Real estate

value

Base value

of retail

business

$65

-75-

Conclusion: Many Ways to Win

• Buy a decent, undermanaged business at a fair price

and get an extraordinary combination of people,

representing significant optionality, for free

Appendix

Management’s Goal is EPS of

$5 by 2014

-77- Source: 1Q11 company presentation

Management’s Goal is EPS of

$5 by 2014 (2)


Management Sees Revenue Growth

from Many Sources


5-Year Income Statement

-80-

JC Penney Income Statement FYE 02/03/2007 FYE 02/02/2008 FYE 1/31/2009 FYE 1/30/2010 FYE 1/29/2011

Total Revenue 19,903 19,860 18,486 17,556 17,759

Cost Of Goods Sold 12,078 12,189 11,571 10,646 10,799

Gross Profit 7,825 7,671 6,915 6,910 6,960

Selling General & Admin Exp. 5,470 5,402 5,395 5,382 5,350

Pension Expense 51 (45) (90) 337 255

Pre-Opening Costs 27 46 31 28 8

Depreciation & Amort. 389 426 469 495 511

Other Operating Expense/(Income) (35) (37) (36) (35) (23)

Other Operating Exp., Total 5,902 5,792 5,769 6,207 6,101

Operating Income 1,923 1,879 1,146 703 859

Interest Expense (270) (278) (268) (255) (223)

Interest and Invest. Income 135 118 37 10 11

Net Interest Exp. (135) (160) (231) (245) (212)

Other Non-Operating Inc. (Exp.) 5 7 6 (15) (19)

EBT Excl. Unusual Items 1,793 1,726 921 443 628

Restructuring Charges - - - - (32)

Gain (Loss) On Sale Of Assets 8 10 10 2 8

Asset Writedow n (2) (1) (21) (42) (3)

Other Unusual Items (7) (12) - - (20)

EBT Incl. Unusual Items 1,792 1,723 910 403 581

Income Tax Expense 658 618 343 154 203

Earnings from Cont. Ops. 1,134 1,105 567 249 378

Earnings of Discontinued Ops. 19 6 5 2 11

Net Income to Company 1,153 1,111 572 251 389

NI to Common Excl. Extra Items 1,134 1,105 567 249 378

Per Share Items

Basic EPS Excl. Extra Items $ 4.95 $ 4.96 $ 2.55 $ 1.07 $ 1.60

Weighted Avg. Basic Shares Out. 229.0 223.0 222.0 232.0 236.0

Diluted EPS Excl. Extra Items $ 4.88 $ 4.90 $ 2.54 $ 1.07 $ 1.59

Weighted Avg. Diluted Shares Out. 232.0 225.0 223.0 233.0 238.0

5-Year Balance Sheet

-81-

5-Year Cash Flow Statement

-82-

JC Penney Cash Flow Statement FYE 02/03/2007 FYE 02/02/2008 FYE 1/31/2009 FYE 1/30/2010 FYE 1/29/2011

Net Income 1,153.0 1,111.0 572.0 251.0 389.0

Depreciation & Amort. 389.0 426.0 469.0 495.0 511.0

Depreciation & Amort., Total 389.0 426.0 469.0 495.0 511.0

(Gain) Loss From Sale Of Assets (8.0) (12.0) (10.0) (2.0) (8.0)

Asset Writedow n & Restructuring Costs 4.0 5.0 29.0 48.0 40.0

Stock-Based Compensation 60.0 45.0 53.0 43.0 56.0

Tax Benefit from Stock Options 6.0 9.0 - - -

Net Cash From Discontinued Ops. 11.0 8.0 (5.0) (2.0) (11.0)

Other Operating Activities (376.0) (124.0) (32.0) 352.0 (69.0)

Change In Inventories (190.0) (241.0) 382.0 235.0 (189.0)

Change in Acc. Payable 195.0 106.0 (278.0) 32.0 (93.0)

Change in Inc. Taxes (1.0) (66.0) (36.0) (57.0) 28.0

Change in Other Net Operating Assets 26.0 (10.0) 12.0 178.0 (62.0)

Cash from Ops. 1,269.0 1,257.0 1,156.0 1,573.0 592.0

Capital Expenditure (772.0) (1,243.0) (969.0) (600.0) (499.0)

Sale of Property, Plant, and Equipment 20.0 26.0 13.0 13.0 14.0

Other Investing Activities (32.0) (25.0) - - -

Cash from Investing (784.0) (1,242.0) (956.0) (587.0) (485.0)

Short Term Debt Issued - - - - -

Long-Term Debt Issued - 980.0 - - 392.0

Total Debt Issued - 980.0 - - 392.0

Short Term Debt Repaid - - - - -

Long-Term Debt Repaid (21.0) (737.0) (203.0) (113.0) (693.0)

Total Debt Repaid (21.0) (737.0) (203.0) (113.0) (693.0)

Issuance of Common Stock 135.0 45.0 4.0 4.0 8.0

Repurchase of Common Stock (750.0) (400.0) - - -

Common Dividends Paid (153.0) (174.0) (178.0) (183.0) (189.0)

Total Dividends Paid (153.0) (174.0) (178.0) (183.0) (189.0)

Special Dividend Paid - - - - -

Other Financing Activities 38.0 0 (3.0) (35.0) (14.0)

Cash from Financing (751.0) (286.0) (380.0) (327.0) (496.0)

Net Change in Cash (266.0) (271.0) (180.0) 659.0 (389.0)

JCP vs. Comps

-83-

JCP Comp group Px Shares

Out

Mkt Cap LTM Net

Debt

EV LTM Rev LTM

EBITDA

LTM Adj

EPS

NTM Rev NTM

EBITDA

NTM EPS

Dillard's Inc. (NYSE:DDS) 50.03 51.5 2,575 779 3,353 6,324 657 3.59 - - -

Kohl's Corp. (NYSE:KSS) 50.45 269.4 13,593 2,525 16,118 18,666 2,754 3.97 19,554 3,007 4.76

Macy's, Inc. (NYSE:M) 29.26 427.1 12,497 5,581 18,078 25,720 3,293 2.43 26,505 3,304 2.76

Nordstrom Inc. (NYSE:JWN) 50.7 210.7 10,681 1,712 12,393 10,231 1,563 3.01 10,754 1,655 3.35

Target Corp. (NYSE:TGT) 52.95 675.2 35,753 16,695 52,448 68,441 7,402 4.21 71,327 7,488 4.21

The TJX Companies (NYSE:TJX) 57.71 381.0 21,986 (271) 21,715 22,546 2,744 3.34 23,708 3,129 4.19

J. C. Penney (NYSE:JCP) 30.04 213.3 6,408 1,548 7,956 17,741 1,399 1.66 17,647 1,290 1.74

JCP Comp set TEV/Total

Rev LTM

TEV/EBITDA

LTM

TEV/EBIT

LTM

P/E (LTM) TEV/Fwd

Rev

TEV/Fwd

EBITDA

Dillard's Inc. (NYSE:DDS) 0.53x 5.1x 8.5x 13.9x 0.5x 5.1x

Macy's, Inc. (NYSE:M) 0.70x 5.5x 8.3x 12.0x 0.7x 5.5x

Kohl's Corp. (NYSE:KSS) 0.86x 5.9x 8.2x 12.7x 0.8x 5.4x

Target Corp. (NYSE:TGT) 0.77x 7.1x 9.9x 12.6x 0.7x 7.0x

The TJX Companies (NYSE:TJX) 0.96x 7.9x 9.5x 17.3x 0.9x 6.9x

Nordstrom Inc. (NYSE:JWN) 1.21x 7.9x 10.2x 16.8x 1.2x 7.5x

J. C. Penney (NYSE:JCP) 0.45x 5.7x 9.0x 18.1x 0.5x 6.2x

JCP Comp set NTM Fwd

P/E

Gross

Mrgn (LTM)

EBITDA Mrgn

(LTM)

EBIT Mrgn

(LTM)

Rev growth

(LTM)

EBITDA growth

(LTM)

Dillard's Inc. (NYSE:DDS) 12.2x 36.9% 10.4% 6.2% 2.5% 24.1%

Kohl's Corp. (NYSE:KSS) 10.6x 38.4% 14.8% 10.6% 4.5% 2.2%

Macy's, Inc. (NYSE:M) 10.6x 40.6% 12.8% 8.5% 6.1% 13.5%

Nordstrom Inc. (NYSE:JWN) 12.6x 37.2% 15.3% 11.9% 11.1% 20.9%

Target Corp. (NYSE:TGT) 13.8x 29.9% 10.8% 7.8% 2.8% 4.4%

The TJX Companies (NYSE:TJX) 15.2x 26.9% 12.2% 10.1% 6.0% 1.0%

J. C. Penney (NYSE:JCP) 17.3x 38.7% 7.9% 5.0% 0.8% 9.4%Source: Capital IQ

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