J.C. Penney's CEO Drama Is a Distraction to Turnaround (Update 1)

This story has been updated from 11:42 am ET.

NEW YORK ( TheStreet) - The ongoing boardroom battle at J.C. Penney ( JCP) featuring its biggest stakeholder, the activist investor Bill Ackman, has become a nagging distraction from the retailer's pressing mission to revive the struggling department store chain, according to Wall Street analysts who cover the stock.

Events took another turn for the chaotic on Friday when Pershing Square Capital Management's Ackman, who owns just under 18% of the company and doubles as a J.C. Penney director, sent a second letter to the board, which, among other things, calls for the removal of Chairman Thomas Engibous.

"After having read the board's public response to my letter and considering the events of the last few weeks, I am concerned that a small subset of the board is negotiating and speaking on behalf of the full board, that the rest of the board has not been properly informed and has not been given an opportunity to express its views, nor is even included in deliberations about what to do," wrote Ackman in a five-page invective.

"I have lost confidence in our Chairman's ability to oversee this board. I would therefore recommend that Tom be replaced as Chairman," he said.

J.C. Penney board quickly moved to counter Ackman's accusations.

"The board is focused on the important work of stabilizing and rejuvenating the business," Engibous said in a statement issued Friday afternoon. "It is following proper governance procedures, and members of the board have been fully informed and are making decisions as a group. This includes the CEO search process, which is being conducted at an appropriate pace. The board also continues to actively oversee management as it conducts the important work underway to rebuild the company.

"Mr. Ackman`s statements are misleading, inaccurate and counterproductive," the statement read.

Separately, CNBC reported earlier Friday that Perry Capital, which owns a 7.3% stake in J.C. Penney, will disclose in a Securities and Exchange Commission filing later today that it has asked the company to replace Ullman with former J.C. Penney veteran Allen Questrom and Foot Locker's ( FL) CEO Ken Hicks.

Perry Capital apparently recently bought a stake in the company. As of its most recent 13-F filing from the March 31 quarter, it had no positions in J.C. Penney.

All the while J.C. Penney shares were plunging 7.1% to $12.69, more than giving back yesterday's gains.

Analysts voiced concern that the drama will hinder the company from any turnaround.

"JCP is at a crucial stage in trying to affect a turnaround. Any interference with this is counterproductive and can only further add to the line-up of challenges," Credit Suisse analyst Michael Exstein writes in a research note on Thursday. Exstein rates the company at underperform.

Hedge fund investor Bill Ackman's statements "as well as public attention to internal political conflict, will in our opinion, only contribute further to the pressure on the company as it is registering a negative EBITDA every day the doors are open," the Credit Suisse note says. "We continue to remain cautious on these shares. The very public debate around Mr. Ullman's tenure will only make it more difficult to attract senior level executives to J.C. Penney."

Today's events followed Thursday's spike in the shares after Ackman sent his first letter to the board expressing his frustration at not finding a permanent CEO to replace Myron "Mike" Ullman sooner. The shares rallied as investors interpreted the letter to mean that leadership change was imminent.

Also see: The Investing Lesson of J.C. Penney

Also see: Why J.C. Penney Is Worth $191 a Share

In his letter Thursday, Ackman said that even as the board had made the decision to search for a permanent CEO at the time of Ullman's rehire in April when he replaced Ron Johnson, the company had just begun to address the search for a CEO last month.

"As J.C. Penney's largest shareholder, I strongly urge that we immediately put together a short list of candidates, determine their interest level, and schedule a fast-track interview process with the board," the letter said. "We can't afford to wait."

Ackman is demanding that a new CEO be in place within the next 30 to 45 days, a timeframe that was suggested by Questrom, who agreed to return as Chairman under the "right conditions," according to the letter.

The Plano, Texas-based company publicly responded late Thursday to Ackman's letter.

"The board of directors strongly disagrees with Mr. Ackman and is extremely disappointed that his letter was released to the media at the same time that it was sent to the board," J.C. Penney's Chairman Thomas Engibous said in the statement.

"Mr. Ackman has been integrally involved in the board's activities since he joined two years ago," Engibous said. "This includes leading a campaign to appoint the company's previous CEO, under whose leadership performance the company deteriorated precipitously. His latest actions are disruptive and counterproductive at an important stage in the company's recovery."

Engibous emphasized that the company would be "careful and deliberate to ensure we find the right long-term leader," the statement said. "In the meantime, Mike and the leadership team will continue the work under way to improve the company's performance and get back on a path to profitable growth."

Citigroup analyst Deborah Weinswig reiterated on Friday her sell rating on J.C. Penney.

The company "needs a 'dream team' in order to right the ship," Weinswig writes in a research note Friday. "Time is of the essence with the holiday season just around the corner and liquidity in question for 2014 according to our proprietary cash burn analysis."

In Weinswig's opinion, that "dream team" consists of Questrom and Hicks, who was the former head of J.C. Penney merchandising before leaving in 2009 to join the footwear company.

Questrom, who was Chairman and CEO of J.C. Penney from 2000 to 2004, has also held chairman and/or chief executive positions at Federated Department Stores (now Macy's ( M)), Barney's and Neiman Marcus.

"If Mr. Ullman and the board were able to convince Hicks to rejoin JCP in an executive role, we believe that our sell call would be at risk," the note says. "We do not think it is realistic to expect business to improve without a full team and turnaround plan in place. There have been over 10 senior-level management exits since Ron Johnson left in April. JCP is operating with a 'Swiss cheese' executive team, and we think the company has had a difficult time finding talent."

The giant retailer's troubles seem to have intensified of late. The New York Post reported on July 31 that CIT Group ( CIT) "abruptly stopped financing deliveries" from smaller manufacturers that sell to JC Penney. The company responded the following day saying the rumor was untrue.

Despite the brief spike on Thursday, investors and analysts remain skittish over concerns the retailer's financial troubles are more dire than previously thought.

"We believe near-term sales trends have been more challenging than expected. The return to couponing and increased marketing have failed to drive traffic. As a result, we expect gross margin to be pressured, reflecting higher promotional and markdown activity," Weinswig writes in her investment thesis.

"Over the long term, we believe that the lack of a clear and compelling turnaround strategy, holes in the management team, and the inability to connect with the company's core customers will pressure earnings. Liquidity, while not a near-term concern, could become an issue if results continue to be pressured," she writes.

-- Written by Laurie Kulikowski in New York.

To contact Laurie Kulikowski, send an email to: Laurie.Kulikowski@thestreet.com.

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