How the J.C. Penney, Martha Stewart Deal Was Born

Macy's Was Kept in the Dark as Deal Came Together

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Ron Johnson
Ron Johnson
The courtroom was packed today as J.C. Penney's CEO Ron Johnson testified in the trial between Macy's, J.C. Penney and Martha Stewart Living Omnimedia.

Over the course of nearly four hours, Macy's lawyer grilled the executive, trying to establish that J.C. Penney intentionally sought to breach Martha Stewart Living Omnimedia's existing contract with Macy's.

From the beginning of his talks with MSLO in August 2011, Mr. Johnson seemed to be aware that any deal would cause trouble with Macy's. "[Martha] wants to do it.I need to propose a deal so she can go to Terry [Lundgren, CEO] at Macy's and break their agreement," he wrote in an email. "That is the only issue in way of success at this point."

He described MSLO's contract with Macy's as "a tight, exclusive agreement," signifying the company was aware that MSLO was involved in an exclusive agreement with Macy's in certain categories. But Mr. Johnson also contends that MSLO execs told him they were very disappointed in the relationship with Macy's. So it's not surprising that the company welcomed the attention from J.C. Penney and its new CEO, who said he hoped to create "the next Williams Sonoma" with the construction of Martha Stewart shops.

But again, the Macy's agreement stood in the way. "Macy's deal is key. We need to find a way to break the renewal right in spring 2013," wrote Mr. Johnson in an email. He clarified on the stand, however, that he only meant that MSLO and Macy's needed to come to a new agreement on their existing contract.

He asked Martha Stewart to address the exclusivity issue with Macy's with the hope that Macy's would agree to waive it in the three big home categories: bed, bath, and kitchen. But Ms. Stewart never contacted Macy's to discuss the impending deal. J.C. Penney did not reach out to its fellow retailer either.

In Mr. Johnson's mind, an MSLO made stronger by a J.C. Penney partnership would ultimately be better for all MSLO partners, including Macy's. "If you have a vendor partner that is struggling, you have to look to see what you can do to help," said Mr. Johnson.

The J.C. Penney deal also benefited Ms. Stewart as the majority shareholder in MSLO. An initial offer gave Martha Stewart, as an individual, 2% of sales, an offer valuing MSLO stock at $7 per share and J.C. Penney stock "worth $150 to $300 million if things went according to [Mr. Johnson's] plan."

"Martha can earn $500 million if things go well, and I don't think anyone else could provide this to her," wrote Mr. Johnson to Blackstone. Details of the final agreement are confidential.

The companies began to play out two scenarios: either Macy's would amend the contract so that the three home categories were non-exclusive or they wouldn't renew the MSLO deal in January 2013. Of course, there was a third scenario: Macy's would renew the contract as is. Wanting to work with both retailers, MSLO lawyers poured over the agreement to find a loophole in case that happened. And they seemed to have found that in September.

"A big breakthrough," Mr. Johnson wrote, "Martha's lawyers have determined that they can do Martha Stewart Stores which include 'stores within a store'.so like Sephora we have a path should Terry not be amenable."

As Mr. Lundgren testified on Monday, Macy's agreed that it would be acceptable for MSLO to open free standing Martha Stewart stores. He did not consider a "store-within-a-store" to be included in that exception.

Of course, the best scenario for J.C. Penney would be if it was the sole marketer of Martha Stewart home goods. And Mr. Johnson seems to have expected Mr. Lundgren to put a stop to the renewal after he was blindsided by the announcement of the deal on December 7th. Mr. Johnson wrote to one of his directors, "We put Terry [Lundgren] in a corner. Normally when that happens and you get someone on the defensive they make bad decisions. This is good."

On the stand he tried to clarify that he was speaking in generalities, but Macy's lawyer was quick to point out that in his deposition he said that the bad choice would be to drop Ms. Stewart.

Mr. Johnson's testimony resumes Monday.

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