🎅A Wave of Filings Crash the Holidays🎅

🤖Are There More #BustedTech Bankruptcies Coming?🤖

The recent bankruptcies of Fusion Connect (which just confirmed a plan swapping ~$270mm of debt for equity), Clover Technologies, uBiome (which just sold for a small fraction of its valuation), Loot Crate Inc., Juno Inc., Munchery, and Vector Launch Inc. — combined with the recent negative news surrounding WeWork (of course), Faraday Future (founder already in BK), Proteus Digital Health and Wag — signal that restructuring professionals shouldn’t sleep on “tech.” The sector has been surprisingly active in 2019 and there’s likely more to come in 2020 (e.g., RentPath?).

In the wake of the WeWork debacle, there has been a lot of talk about the end of “growth at all costs” thinking and a newfound emphasis on business fundamentals, i.e., unit economics. Indeed, post-WeWork, funding in startups immediately slowed down … for like a second … and people took measure; likewise, in the public markets, many recently IPO’d companies with questionable fundamentals have performed poorly. Time will tell, then, whether WeWork was just a blip on the radar screen or the canary in the coal mine. There are more signs of the former — this week it seems like 8,292,029 companies announced new raises — but might Vector Launch be validation of the latter? Who knows.

As we’ve argued in the past — obviously VERY prematurely — tech “startups” are more mature at earlier stages now than they used to be which very well may require them to sidestep the assignment for the benefit of creditors and launch headfirst into a bankruptcy court — if and when folks again get scared. With the private markets having become the new public markets over the last decade, there are a ton of private tech companies that are well-developed (read: “unicorns”); that have intellectual property (e.g., actual patents as well as brands); that have valuable contracts/leases; that have investors that seek releases. What they don’t appear to have are viable business models. When the tide goes out (read: the money scares), we’ll see who is wearing clothes.

The question is: what would be the catalyst? With interest rates steady or declining, there’s no reason to suspect the end is near for “yield baby yield” psychology and, therefore, the deployment of endless quantities of capital in alternative asset classes. That should bode well for tech.

And, yet, people are fearful. First Round Capital recently released its “State of Startups 2019” and if some of the fears come true, indeed, there will be more action as noted above:

Founders fear the bubble — concerns are at a 4-year high.

This year, over two-thirds of founders who ventured a guess think we are in a bubble for technology companies. It’s the highest number we’ve seen since 2015 — up 12% from 2018 and 25% from 2017.

Spoiler alert:

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🚛Dump Trucks🚛

Manufacturing, Trucking & the Ports

We’re old enough to remember a narrative that went something like this:

• Amazon Inc. ($AMZN) is dominating retail with 2-day (now 1-day) shipping +

• Traditional brick-and-mortar retailers are converting to e-commerce +

• Digitally-native-vertical-brands are cutting out brick-and-mortar and going direct-to-consumer =

• Increased need for logistics and shipping capabilities.

Because of these developments, among others, this country — it was said — was suffering from a trucking shortage relative to the demand and so wages rose rapidly and seemingly every retailer reported that rising shipping expenses were harming the bottom line. Given this, you’d think truckers would be crushing it.

Maybe…not? At least anymore.

In August we noted the following:

ACT research reflects two straight quarters of negative sector growth and DAT reported a 50% decline in spot market loads, with no category immune to the declining trend. Van load-to-truck is down 50%, flatbed load down 74.5% and reefer load down 55.5%. Some fear this may be a leading indicator of recession. Alternatively, it may just be the short-term effects of tariffs and the acceleration of orders into earlier months to avoid them. 

Still, the trucking industry is worried. 

Van spot rates were down 18.5%, flatbed spot rates down 18.4%% and reefer spot rates down 16.8%. The word “bloodbath” is now being bandied about. Per Business Insider:

“There has been a spate of trucking companies declaring bankruptcy this year, too. The largest was New England Motor Freight, which was No. 19 in its trucking segment. Falcon Transport also shut down this year, abruptly laying off some 550 employees in April.

"We have become increasingly convinced that freight is likely to remain weak through 2019 followed by falling truckload and intermodal contract rates in 2020," the UBS analyst Thomas Wadewitz wrote to investors in a June 18 note.

Trucking's biggest companies have been slashing their outlooks. Knight-Swift and Schneider both cut their annual outlooks earlier this year.”

Will this trend continue as manufacturing numbers continue to slip?

That was a good question. And, indeed, manufacturing does continue to slip — at least according to the ISM Manufacturing PMI report:

With the foregoing context, take some more recent news:

1. Hendrickson Truck Lines Co.

The family-owned trucking company recently filed for bankruptcy in the Eastern District of California (a chapter 22, actually). The company is on the smaller side: liabilities between $10-50mm; roughly 90 trucks and 100 drivers; operations in 10 states. Per FreightWaves:

“The company said its financial problems started in January with a sharp decline in overall freight tonnage. This, combined with excess truck capacity, resulted in a 21% rate drop compared with 2018, resulting in a $400,000 per month revenue drop, according to its petition.  

Two of the carrier’s top customers, which accounted for nearly 50% of its business, switched to lower-cost providers, the company said.” (emphasis added)

The company also blamed a poor truck leasing deal for its filing.

2. Truck Orders Are Down

The Wall Street Journal recently reported:

Order books for heavy-duty truck manufacturers are thinning out as a weaker U.S. industrial economy pushes fleet operators to put the brakes on plans to expand freight-carrying capacity.

Trucking companies in November ordered 17,300 Class 8 trucks, the big rigs used in highway transport, according to a preliminary estimate from industry data provider FTR. That was down 39% from November 2018 and a 21% decrease from October, providing a weak start for what is typically the busiest season for new-equipment orders.

The orders last month were the lowest for a November in four years, and analysts said they expect a backlog at factory production lines that has been dwindling this year to pull back even more.

It continued:

Truck-equipment makers have started scaling back production and laying off workers this year as demand for new trucks has weakened.

Daimler Trucks North America LLC said in October it planned to lay off about 900 workers at two North Carolina Freightliner plants as “the market is now clearly returning to normal market levels.”

Engine-maker Cummins Inc. cut its annual revenue forecast in October and the company last month said it plans to lay off about 2,000 workers early next year. “Demand has deteriorated even faster than expected, and we need to adjust to reduce costs,” the Columbus, Ind.-based manufacturer said in a statement.

What’s going on here? Well, yes, manufacturing is down. But “global trade tensions are weighing on transportation demand.” More from the WSJ:

U.S. factory activity contracted in November for the fourth straight month, according to the Institute for Supply Management.

Freight volumes and trucking prices have been on the decline. U.S. domestic freight shipments fell 5.9% in October compared with the same month last year, while truckload linehaul rates were down 2.5% year-over-year, according to Cass Information Systems Inc., which handles freight payments for companies.

🤔

3. Trade, Declining Truck Orders, and Imports (Short the Ports?)

We’re curious: if tariffs and trade wars are trickling down to trucking, what must this mean for ports in this country? Per Transport Topics:

Three West Coast ports saw significant drop-offs in cargo volume last month, the latest indication that the United States’ long-simmering trade dispute with China is impacting operations at the nation’s ports.

The Port of Los Angeles, the nation’s busiest facility, saw a 19.1% decline in 20-foot-equivalent units (TEUs) container volume, moving 770,188 compared with 952,553 in the same period a year ago. Imports and exports were both down 19%. The drop-off also means the Los Angeles port is 90,697 TEUs behind last year’s record pace, having processed 7,861,964 TEUs through the first 10 months, compared with 7,723,159 at this point last year.

Port Executive Director Gene Seroka and other officials were in Washington on Nov. 12, and he is sounding the alarm over the damage being done to the economy because of the ongoing trade battle and the resulting tariffs on hundreds of billions of dollars worth of products.

And this, apparently, isn’t isolated to the West Coast:

Rough October at Port of NY&NJ as loaded container imports fell slightly and loaded exports dropped 2.7%. The fall's East Coast shipping surge didn't get that far.

— Paul Page (@PaulPage) December 3, 2019

Will we start seeing some port distress in the near future? Fewer trucks and fewer trains mean lower revenue. 🤔

4. Celadon Group Files for Bankruptcy

Indianapolis-based Celadon Group Inc. ($CGIPQ) is a truckload freight services provider with a global footprint. Founded in 1985, the company professes to have pioneered the commerce trail between the United States and Mexico. Thereafter, it IPO’d and used the proceeds for growth capital, expanding its freight-forwarding business with the acquisition a UK-based company and another 36 companies thereafter. Not only did these acquisitions expand its geographic footprint, but they also expanded the company’s freight capabilities, opening up revenue possibilities attached to refrigerated and flatbed transportation. In all, today the company operates a fleet of 3300 tractors and 10000 trailers with 3800 employees. Its primary focus continues to be NAFTA countries; its customers include the likes of Lowes Companies Inc. ($LOW), Philip Morris International Inc. ($PM), Walmart Inc. ($WMT), Fiat Chrysler Automobiles NV ($FCAU), Procter & Gamble Inc. (($PG) and Honda Motor Co Ltd. ($HMC).  

All of the above notwithstanding, it is now a chapter 11 debtor. Worse yet, it will, in short order, wind down and no longer be in existence. In an instant, the aforementioned 3800 employees’ livelihoods have been thrown into disarray.

Not that the signals weren’t there. The company has been in trouble for some time now. In addition to macro woes, it has a large number of self-inflicted wounds. 

Back in July, the company teetered on the brink of bankruptcy but it bought itself a short leash. On July 31, 2019, the company refinanced its term loans held by Bank of America NA ($BAC), Wells Fargo Bank NA ($WFC) and Citizens Bank NA ($CFG) with a new facility agented by Blue Torch Finance LLC* that counted Blue Torch and Luminus Partners Master Fund as lenders.** The new lenders provided $27.9mm of new term loans and, in exchange, received $8mm in original issue discount and fees. The banks, it appears, got out just in the knick of time. Indeed, the company and its lenders have been engaged in an endless stream of negotiations, concessions and waivers ever since: the credit docs have been amended ad nauseam ever since the initial transaction because the company was in constant danger of breaching its covenants.

Why so much drama? Per the company:

“The need to file these chapter 11 cases was a result of a confluence of factors including industry-wide headwinds, former management bad acts, an unsustainable degree of balance sheet leverage and an inability to address significant liquidity constraints through asset sales and other restructuring strategies. In mid-2019, the trucking freight market began to soften. The combination of a decline in overall freight tonnage and excessive truck capacity in the market led to a significant decline in freight rates, and customers began to take bids at lower freight rates. Compared to the year immediately prior, 2019 showed a steady decline in freight rates, including spot freight rates and contractual rates. In addition to declining freight rates, volumes of loads in freight have experienced decreasing numbers for a significant portion of 2019.”

Sound familiar? Well, these issues alone should have been enough to present problems but they were accentuated by the fact that the company’s prior senior management allegedly engaged in some shady a$$ sh*t. That shady a$$ sh*t ultimately led to a Deferred Prosecution Agreement and a $42.2mm fine. While only $5mm has been paid to date, that $37mm overhang is substantial.

With all of these issues piling up, the company ultimately defaulted on its revolver. Consequently, MidCap Financial Trust, the company’s revolver lender, froze lending and the company’s already-growing liquidity problem became a wee bit more problematic. With barely enough money to fund payroll and payroll taxes, the company had no choice but to file for chapter 11. To put an exclamation point on this, the company had merely $400k of cash on hand when it pulled the trigger on bankruptcy. 

So what now? The company ceased operations and will commence an orderly wind down of its businesses, preserving only Taylor Express Inc. as a going concern. Taylor Express is a NC-corporation that the company acquired in 2015; it is a dry van and dry bulk for-hire services provider, operating principally for the tire and retail industries and primarily in the South and Southeast regions of the US. To fund the cases, the debtors secured a commitment from Blue Torch for $8.25mm in DIP financing. The DIP mandates that any sale order relating to the liquidating business be entered by January 22. 

As for the employees? Well: 

Yeah, they’re understandably pissed. For starters, they were laid off en masse with no notice. One employee, on behalf of all employees, filed an Adversary Complaint alleging a violation of the WARN Act, which requires 60 days’ advance written notice of a mass layoff and/or plant closing. In response, the truckers have formed a “Celadon Closure Assistance and Jobs” group on Facebook. It has 1300 members. Per Fast Company, 

“Truckers in [a] Facebook group are posting about having 20 minutes to clear out their trucks and go. CBS also reported that some drivers “were stranded when their company gas cards were canceled.”

YIKES. All told, this is a hot mess. Per SupplyChainDive:

“’This is noteworthy because of the size of the fleet,’ Donald Broughton, the principal and managing partner at Broughton Capital, told Supply Chain Dive in an interview.  ‘It’s noteworthy because less than 10 years ago Celadon was known as one of the most active, prolific and successful at salvaging small fleets that were struggling and in trouble.’

The failure of Celadon represents the largest trucking failure this year and ‘certainly one of the largest in history,’ Broughton said.”  

“Largest [insert industry here] failure” is not an honor that anyone wants.

*Blue Torch Finance LLC was also active in another DLA Piper LLP bankruptcy, PHI Inc., as DIP lender. 

**Blue Torch hold a priority right of payment on the term loan collateral with Luminus second and revolver lender, MidCap Financial Trust, third. 

💩Retail, the Internet, China & Counterfeiting (Long Unscrupulousness).💩

This is a story about S’well. It illustrates just how vicious competition is today. And made even more vicious by (i) “signaling” and ease of discovery (lots of likes on Instagram), (ii) shady-AF Chinese manufacturers (producing legit product by day, extra off-the-truck product by night), and (iii) Amazon Inc.’s ($AMZN) failure to police third-party sellers. Choice bit:

Counterfeiting is an old game: In ancient Rome, counterfeiters knocked off authentic Roman coins. In recent decades, counterfeits of luxury products like handbags, watches, and sneakers have become commonplace. Now, though, online marketplaces like Amazon and social-media sites like Facebook and Instagram are enabling a new copycat ecosystem that’s become a hall of mirrors for both brands and shoppers. It’s never been easier for makers of knockoffs to reach consumers, project authenticity, and make money — and it’s never been harder for the real companies to regain control.

This is crazy:

…less than a year into starting the business, Kauss realized she had a big problem. Kauss and her then-boyfriend Jeff Peck (now her husband and the company’s president) were heading to S’well’s factory in China when they stopped for a couple days’ vacation in Hong Kong. Kauss saw there was a trade show and insisted on stopping by. When she arrived, it appeared that S’well had a significant presence at the show, with bottles displayed in a case and a ribbon flaunting an award it had apparently won. “A man came over to me and gave me his business card, very properly, and said he was from S’well,” she says. His card had S’well’s logo on it, with the little TM for ”trademark.”

The problem: Kauss at that point was running S’well from her apartment. It had no presence in Asia. Nor did it have a sales rep there. And it had no employees besides Kauss. She had barely gotten the company off the ground, and her bottles were being knocked off.

What. The. Hell. Read the piece. It’s long. And nuts.

But that’s not all. This is a horribly pervasive problem:

Last year, when the Government Accountability Office bought 47 consumer products like cosmetics and travel mugs online from third-party sellers on sites including Amazon.com and Walmart.com, it determined that 20 of them were fakes.

Here’s the problem from another vantage point (also very much worth reading):

I've been talking to a friend who's a cofounder at a womenswear ecommerce startup about their content strategy. I searched around to see what kind of stuff is out there about them (press mentions, reviews, etc.), and stumbled upon something odd. On a Bustle.com top ten sex toys list, it had listed a product from their brand. They do not sell sex toys. I clicked through, and it led to an Amazon site with their company’s branding. They do not sell on Amazon.

It turned out a China-based seller had “hijacked” their brand. This is apparently a regular thing.

A few days later, when visiting my friend's office, I found out that they had one staff member dedicated to monitoring Amazon for exactly these situations. There was a big spreadsheet where they tracked various culprits. There was a specific contact at Amazon they would call when they found shady stuff like this. They had a lawyer they billed, and a process in place to deal with this. It cost time and money and it was a never-ending game of whack-a-mole. It had become such an increasingly frequent problem over the past few years, yet they seemed fairly blasé about it. It was just business as usual.

I understand counterfeiting has always been a problem in retail, but this felt different. Amazon was their competitor. It had launched a private label brand that directly competed, undercutting them on price and shipping speed. Yet, Amazon also sold counterfeit items of theirs (well, Amazon “facilitated” it) and the startup bore the cost of cleaning up the trillion dollar company’s platform. I guess this was how ecommerce worked in 2019.

The article goes on to explain that this is the natural side effect of Amazon’s concerted efforts to court Chinese sellers to its platform. It explains the lack of quality control and…..

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💥Shade of the Week— “We Believe Real Models Will Become Wildly Popular in the Post WeWork Era”💥

Restoration Hardware Inc. ($RH) reported earnings this week and blew it out of the water in every possible way. Not all retail is a hot mess, apparently. When you crush it like they did — 6+% revenue increase and doubled profits — we suppose that gives you some license to sh*t on LITERALLY EVERYONE UNDER THE SUN. This is savage:

DAAAAAAAAAMMMMN. DTC DNVBS and standard brick-and-mortar retailers just got run over by the Restoration Hardware bus. And rightfully so:

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🐝Reality Check: Honey🐝

Paypal Inc. ($PYPL) made a big splash this week when it agreed to a $4b cash and stock acquisition of Honey, an LA-based deal-finding browser extension and mobile app. Yes, $4 BILLION. The company had only raised $49mm in funding soooooo…a lot of people just made one crazy return on investment.

Speaking of crazy, the company reportedly made “more than $100 million in revenue last year and it was profitable on a net income basis in 2018.” Profitably for a startup these days is crazy enough, we suppose, but THAT MULTIPLE. Holy

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⚡️Ride-Sharing is Vicious (Long Matchsticks)⚡️

Starting in 2016, Juno USA LP, a NY-centric ride-hailing company was able, in just 3.5 years, to become the third largest ride-hailing business in New York, counting 50k contracted drivers and 50k rides per day as key business drivers (pun intended). Now it is kaput. The company filed for bankruptcy earlier this week.

At its inception, the company differentiated itself by offering drivers restricted stock units (“RSUs”) “with the expectation that such an approach would result in an overall enhanced driving experience for drivers and, in turn, riders.” This is interesting because, obviously, it incentivizes drivers to be more attentive to Juno rides than Lyft and/or Uber but it obviously doesn’t address the demand side of the marketplace function. 50k rides per day sounds like a lot. Yet, it pales in comparison to its competition: according to the Taxi and Limousine Commission, in 2018, Uber Inc. ($UBER) tallied 400k trips per day in NYC and Lyft Inc. ($LYFT) collected 112k trips per day. Moreover, NYC taxis typically make about 300k trips per day. In total these are staggering numbers — even more so when you consider that taxis are going bankrupt in record-breaking numbers and Uber and Lyft are losing money like crazy (Uber’s loss, ex-stock-based compensation, was $800mm last quarter!). Ultimately, that differential compelled a merger of rivals: Israel-based GT Forge, d/b/a Gett, acquired Juno in Q2 ‘17 and transferred its riders to Juno. At the same time, Juno cashed out the driver RSUs, using other incentives (read: higher commissions of 10%) to maintain its supply-side.

As we all now know from the WeWork debacle, financial metrics for high growth startups are different than what restructuring professionals are used to. EBITDA is a foreign concept here: “success” is measured by revenue growth. Here’s Juno’s revenue trend:

• $218mm in 2017;

• $269mm in 2018 (23% growth) 😀; and

• $133mm in 2019. 😬

Juno does not, however, indicate what its operating costs and expenses were; it merely serves up excuses about early stage capital requirements and the need for monthly cash infusions from Gett. Over time, however, the operating expense burden coupled with “burdensome local regulations and escalating litigation defense costs” led to a 2019 YOY revenue decline of 34%. What the net loss was, however, is left unsaid in the company’s bankruptcy papers.

The litigation runs the gamut. The company has been sued by (a) former drivers for the termination of the RSU program (read: securities fraud); (b) riders for personal injuries allegedly caused in accidents during active Juno rides; (c) competitors for patent infringement; and (d) drivers, alleging that they are employees rather than independent contractors. It’s pretty hard to grow a business when you’re getting sued into oblivion and have poor business fundamentals. 👍

The City of New York really didn’t help those fundamentals. The company’s bankruptcy papers elucidate ride-hailing economics after NYC imposed mandatory minimums of $17.22/hour regardless of the number of rides undertaken during that time (something that Uber and Lyft continue to combat, including by freezing drivers out of the apps during low-demand times, something that irks the hell out of Bill De Blasio, apparently). Here’s how it works:

• Drivers are entitled to a minimum of $0.58/mile + $0.27 per minute. “Each of these figures is separately divided by a so-called “utilization rate,” which is calculated based on the frequency that a TNC sends trips to drivers while they are available for work. The current industrywide average utilization is 58%.” (Petition Note: this also means that 42% of the time, drivers are just moving around clogging up NYC streets).

• So, for a 10-mile trip that takes 30 minutes, you end up with:

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💩Acosta = Not a Good Look, Carlyle💩

Disruption Flummoxes Carlyle. Destroys Billions of Value.

Back in September 2018’s “Trickle-Down Disruption from Retail Malaise (Short Coupons),” we noted a troubled trio of “sales and marketing agencies.” We wrote:

With the “perfect storm” … of (i) food delivery, (ii) the rise of direct-to-consumer CPG brands, (iii) increased competition from private-brand focused German infiltrators Aldi and Lidl, and (iv) the increasingly app-powered WholeFoods, there are a breed of companies that are feeling the aftershocks. Known as “sales and marketing agencies” (“SMAs”), you’d generally have zero clue about them but for the fact that you probably know someone who is addicted to coupon clipping. Or you’re addicted to coupon clipping. No shame in that, broheim. Anyway, that’s what they’re known for: coupons (we’re over-simplifying: they each perform other marketing, retailing, and data-oriented services too). The only other way you’d be familiar is if you have a private equity buddy who is sweating buckets right now, having underwritten an investment in one of three companies that are currently in distress. Enter Crossmark Holdings Inc., Acosta Inc., and Catalina Marketing (a unit of Checkout Holding Corp.). All three are in trouble.

What’s happened since?

• Catalina Marketing filed for chapter 11 bankruptcy. ✅

• Crossmark Holdings Inc. effectuated an out-of-court exchange transaction, narrowing averting a chapter 11 bankruptcy filing. ✅

• And, as of last week, Acosta Inc. launched solicitation of a prepackaged chapter 11 bankruptcy filing. It will be in bankruptcy in the District of Delaware very very soon. We’ve basically got ourselves an SMA hat-trick. ✅💥

Before we dive into what the bloody hell happened here — and it ain’t pretty — let’s first put some more meat on those SMA bones. In doing so, mea culpa: we WAY over-simplified what Acosta Inc. does in that prior piece. So, what do they do?

Acosta has two main business lines: “Sales Services” and “Marketing Services.” In the former, “Acosta assists CPG companies in selling new and existing products to retailers, providing business insights, securing optimal shelf placement, executing promotion programs, and managing back-office order-to-cash and claims deduction management solutions. Acosta also works with clients in negotiations with retailers and managing promotional events.” They also provide store-level merchandising services to make sure sh*t is properly placed on shelves, stocks are right, displays executed, etc. The is segment creates 80% of Acosta’s revenue.

The other 20% comes from the Marketing Services segment. In this segment, “Acosta provides four primary Marketing Services offerings: (i) experiential marketing; (ii) assisted selling and training; (iii) content marketing; and (iv) shopper marketing. Acosta offers clients event-based marketing services such as brand launch events, pop-up retail experiences, mobile tours, large events, and trial/demo campaigns. Acosta also provides Marketing Services such as assisted selling, staffing, associate training, in-store demonstrations, and more. Under its shopping marketing business, Acosta advises clients on consumer promotions, package designs, digital shopping, and other shopper marketing channels.”

In the past, the company made money through commission-based contracts; they are now shifting “towards higher margin revenue generation models that allow the Company to focus on aligning cost-to-serve with revenue generation to better serve clients and maximize growth.” Whatever the f*ck that means.

We’re being flip because, well, let’s face it: this company hasn’t exactly gotten much right over the last four years so we ought to be forgiven for expressing a glint of skepticism that they’ve now suddenly got it all figured out. Indeed, The Carlyle Group LP acquired the company in 2014 for a staggering $4.75b — a transaction that “ranked … among the largest private-equity purchases of that year.” Score for Thomas H. Lee Partners LP(which acquired the company in 2011 from AEA Investors LP for $2b)!! This was after the Washington DC-based private equity firm reportedly lost out on its bid to acquire Advantage Sales & Marketing, a competitor which just goes to show the fervor with which Carlyle pursued entry into this business. Now they must surely regret it. Likewise, the company: nearly all of the company’s $3b of debt stems from that transaction. The company’s bankruptcy papers make no reference to management fees paid or dividends extracted so it’s difficult to tell whether Carlyle got any bang whatsoever for their equity buck.*

Suffice it to say, this isn’t exactly a raging success story for private equity (calling Elizabeth Warren!). Indeed, since 2015 — almost immediately after the acquisition — the company has lost $631mm of revenue and $193mm of EBITDA. It gets worse. Per the company:

“Revenue contributions from the top twenty-five clients in 2015 have declined at approximately 14.6 percent per year since fiscal year 2015. Furthermore, adjusted EBITDA margins have decreased year-over-year since fiscal year 2015 from over 19 percent to approximately 16 percent as of the end of fiscal year 2018.”

When you’re losing this money, it’s awfully hard to service $3b of debt. Not to state the obvious. But why did the company’s business deteriorate so quickly? Disruption, baby. Disruption. Per the company:

Acosta’s performance was disrupted by changes in consumer behavior and other macroeconomic trends in the retail and CPG industries that had a significant impact on the Company’s ability to generate revenue. Specifically, consumers have shifted away from traditional grocery retailers where Acosta has had a leadership position to discounters, convenience stores, online channels, and organic-focused grocers, where Acosta has not historically focused.

Just like we said a year ago. Let’s call this “The Aldi/Lidl/Amazon/Dollar Tree Effect.” Other trends have also taken hold: (a) people are eating healthier, shying away from center-store (where all the Campbell’s, Kellogg’s, KraftHeinz and Nestle stuff is — by the way, those are, or in the case of KraftHeinz, were, all major clients!); and (b) the rise of private label.

Moreover, according to Acosta, consumer purchasing has declined overall due to the increased cost of food (huh? uh, sure okay). The company adds:

These consumer trends have exposed CPG manufacturers to significant margin pressure, resulting in a reduction in outsourced sales and marketing spend. In the years and months leading to the Petition Date, several of Acosta’s major clients consolidated, downsized, or otherwise reduced their marketing budgets.

By way of example, here is Kraft Heinz’ marketing spend over the last several years:

Compounding matters, competition in the space is apparently rather savage:

“Acosta also faced significant pressure as a result of the Company’s heavy debt load. Clients have sought to diversify their SMA providers to decrease perceived risk of Acosta vulnerability. In fact, certain of Acosta’s competitors have pointed to the Company’s significant indebtedness, contrasting their own de-levered balance sheets, to entice clients away from Acosta. Over time, these factors have tightened the Company’s liquidity position and constrained the Company from making necessary operational and capital expenditures, further impacting revenue.”

So, obviously, Acosta needed to do something about that mountain of debt. And do something it did: it’s piling it up like The Joker, pouring kerosene on it, and lighting that sh*t on fire. The company will wipe out the first lien credit facility AND the unsecured notes — nearly $2.8b of debt POOF! GONE! What an epic example of disruption and value destruction!

So now what? Well, the debtors clearly cannot reverse the trends confronting CPG companies and, by extension, their business. But they can sure as hell napalm their balance sheet! The plan would provide for the following:

• Provide $150mm new money DIP provided by Elliott, DK, Oaktree and Nexus to satisfy the A/R facility, fund the cases, and presumably roll into an exit facility;

• First lien lenders will get 85% of the new common stock (subject to dilution from employee incentive plan, the equity rights offering, the direct investment preferred equity raise, etc.) + first lien subscription rights OR cash subject to a cap.

• Senior Notes will get 15% of new common stock + senior notes subscription rights OR cash subject to a cap.

• They’ll be $250mm in new equity infusions.

So, in total, over $2b — TWO BILLION — of debt will be eliminated and swapped for equity in the reorganized company. The listed recoveries (which, we must point out, are based on projections of enterprise value) are 22-24% for the holders of first lien paper and 10-11% for the holders of senior notes.

We previously wrote about how direct lenders — FS KKR Capital Corp. ($FSK), for instance — are all up in Acosta’s loans. Here’s what KKR had to say about their piece of the first lien loan:

We placed Acosta on nonaccrual due to ongoing restructuring negotiations during the quarter and chose to exit this position after the quarter end at a gain to our third quarter mark.

This was the mark back in December 2018 = $2.4mm fair value:

And this is the mark as of Q3 close, September 2019 = $1.3mm fair value:

Soooooo….HAHAHAHA. Now THAT is some top-notch spin! Even if they did mark to a gain versus the Q3 mark, they undoubtedly lost money on this position: the mark was cut in half in less than a year.

You have to take the benefits of quarterly reporting where you can, we suppose. 😬😜

*There have been two independent directors appointed to the board; they have their own counsel; and they’re performing an investigation into whether “any matter arising in or related to a restructuring transaction constituted a conflict matter.” There is no implication, however, that this investigation has anything to do with potential fraudulent conveyance claims. Not everything is Payless, people.

👟The Latest in Fitness Trends (Long Innovation)👟

There are a lot of venture investors operating under the hypothesis that audio is the next frontier in wearables and that the Apple AirPods were just the opening salvo. Amazon Inc. ($AMZN) is apparently working on pods that double-up as fitness trackers. This is a space worth watching.

Elsewhere in fitness, we’re writing this particular section midweek and yet we literally just walked by someone rocking his NYC Marathon medal. Seems a bit aggressive to still be wearing that thing 72 hours post-race but, whatevs. To each his own. 

Here’s a piece from Reess Kennedy about fitness and marketing, discussing the rise of the Nike Vaporfly 4%, a running shoe that Nike Inc. ($NKE) alleges will enhance performance by…wait for it…4%. Regarding the NYC marathon, he writes, “I’d safely wager that 70% of the men and women running under 3:10 were wearing it.” He adds:

“…Sunday all I was thinking was, “Why and how did Nike win so hard here?! They’ve gobbled up significant market share and achieved one of the most successful product adoption feats in the history of footwear—possibly in the history of product adoption!—and, at $250, they’ve also set a new off-the-chart, ‘luxury’ price point for racing shoes in the process!’”

He concludes that much of the adoption is attributable to FOMO: if your competitors are juicing with the Vaporfly, you should be juicing too.  He writes:

“I think the far more powerful demand ignitor was actually the brazen insertion of a precise performance gain right into the name of the actual product: The Vaporfly 4%.”

“For the first time in history, a shoe company is making a clear ROI claim to buyers. This is the real reason they’ve sold so many.”

“Many runners really struggle over many marathon attempts to break three hours—often, tragically, missing it by only a few minutes on each attempt. A 4% improvement for these folks hovering around three hours would mean about a seven-minute gain! If you’re on the edge of a lifetime goal is it worth it to pay $250 to achieve it? Yeah, probably. “

This begs the obvious question: how long until the release of the “Brooks Boss 6%,” the “Adidas A$$-kicker 7%” or the “Saucony Supersonic 9%”? Will we start seeing distressed players engage in marketing schemes like this to drive traffic? Should we?*

Why aren’t restructuring firms using this tactic? 

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💰What’s New in Marketing Trends (Long Facebook Inc. ($FB))💰

We’ve often highlighted how distressed retailers may be in for a rude awakening if they think deploying influencer-based social marketing on platforms like Facebook Inc. ($FB) and others will be the cure-all to their woes. And be easy. It won’t be and it’s not. The campaigns require significant expertise to execute and the cost of such campaigns has been on the rise. Until recently, it seems. In Facebook’s recent earnings call, CFO Dave Wehner said: 

“In Q3, the number of ad impressions served across our services increased 37% and the average price per ad decreased 6%. Impression growth was primarily driven by ads on Facebook News Feed, Instagram Stories and Instagram feed.”

Surprisingly, Facebook appears to be driving a large part of that impressions growth rather than Instagram Stories and the Instagram Feed. This means ads are reaching more people on the platform and, yet, the average price of ads decreased. While it’s not clear from the company’s SEC filings nor its earnings call why this is the case, this is a potential positive for retailers looking to deploy social ads. 

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🇺🇸Forever 21: Living the (American) Dream🇺🇸

Back in June we kicked off coverage of Forever 21 Inc. with “💥Nothing in Retail is "Forever💥".

Never include in your company name "Forever", "Long Term (Capital)", or "Amaranth (Capital)" (flower that never dies). https://t.co/9P6T8ylE9z

— Nassim Nicholas Taleb (@nntaleb) September 30, 2019

We then issued quick follow-ups in “💥Fast Forward: Forever21 is a Hot Mess💥” and “🍩Forever21 is Forever F*cking Up.🍩”

@Forever21 has filed for bankruptcy in Delaware. $275mm ABL DIP and $75mm TL DIP. Major landlords are big creditors. $SPG for $8mm. Guess that Cheetos partnership couldn’t save the day. pic.twitter.com/mhWVJSGYpx

— 💥PETITION💥 (@petition) September 30, 2019

Forgive us, then, for feeling like the company’s inevitable bankruptcy filing — which happened earlier this week — was a wee bit anticlimactic. After all, we all knew it was coming. As such, we felt the need to crank up some Kanye West to help get us through this additional coverage…

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What you doing in the club on a Thursday?
She say she only here for her girl birthday
They ordered champagne but still look thirsty
Rock Forever 21 but just turned thirty — Kanye West in “Bound 2”

Just kidding, y’all. Kanye is garbage. We don’t listen to Kanye.*

Anyway, we’ve talked time and time again about how the papers that accompany a company’s chapter 11 bankruptcy petition are a perfect opportunity for a company to frame the narrative for the judge, parties in interest, the media and more. A company’s First Day Declaration, in particular, is the bankruptcy equivalent of home field advantage. Coupled with the first day hearing — usually held within a day or two of the bankruptcy filing — a debtor can leverage the First Day Declaration and the opportunity to present first to a courtroom to gain some sympathy from the judge for their current predicament and plant the seeds in the judge’s ears as to the direction of the case.

Except, over time, the judges must begin to get bored. After all, repetitive themes begin to emerge when you track bankruptcy cases. Themes like “the retail apocalypse.” Blah blah blah. The “Amazon Effect.” Oh, f*ck off. Disruption overcame the business! Zzzzzzz. Private equity is evil because they dividended themselves all of the company’s value! Yawn. There’s too much debt on the balance sheet! Typical. The lenders won’t play ball! Mmmm hmmm. The prior management was corrupt AF. Yup, it happens. Weather this year was uncharacteristically bad. Riiiight…that’s retail excuse-making 101.

And, so, it was with great excitement that we read that the Forever 21 bankruptcy stemmed from…wait for it…the American Dream. That’s right, the American Dream.

In other words, this is a story about unbridled ambition and optimism.

*****

Here’s the short version: two immigrants came to this country in the early 80s from South Korea. They had nothing; they worked hard; they sought out opportunity:

During his time as a gas station attendant, Mr. Chang took notice of the customers that drove the most luxurious cars—the customers working in the garment industry. This realization piqued Mr. Chang’s interest. He recognized that together with his wife, they were perfectly suited to enter the fashion industry. This would enable the couple to capitalize on Mr. Chang’s relationship-building prowess and Mrs. Chang’s keen sense of fashion.

Putting aside how shady the notion of your gas station attendant creeping on you is, this is pretty amazing sh*t.

Mrs. Chang, and her nearly-clairvoyant ability to predict trends, were part of the catalyst that boosted Forever 21’s upswing.

Take note, people: this is the kind of pandering you should get when you pay $1,600/hour.

Anyway, over the years, the Changs built a business that employed tens of thousands of people and generated billions in sales. The Changs put their two daughters through ivy league schools and they subsequently joined the family business. This is a beautiful story, folks. Especially so in today’s fraught political environment where immigration remains a hot button issue. Together, as a family, the Changs grew this company to be a behemoth:

And therein lies the rub. The company went from 7 international stores in 2005 to 251 by 2015.

Unfortunately, this rapid international expansion challenged Forever 21’s single supply chain and the styles failed to resonate over time across other continents despite its initial success.

It appears that the same entrepreneurial spirit that allowed the Changs to conquer the US led them astray internationally. Indeed, those European and Asian adventures — and the Chang daughters’ vanity project, Riley Rose — proved to be too costly. As you can see, while the domestic business has been in decline,** it still shows some promise. The international business, on the other hand, has really sucked the air out of the business⬇️.

Sure, aside from the international issue, some of the usual excuses exist. Mall traffic is down. Not enough attention to e-commerce. Product assortment could have been better. The company had borrowing base issues under its asset-backed loan. Yada yada yada. But this doesn’t appear to be the absolute train wreck that other recent retailers have been. At least not yet.

So what now?

At the first day hearing, company counsel spared us any in-court singing,*** but did rely on some not-particularly-complex imagery. He said the company’s predicament is like a puzzle and that, to paraphrase, you sometimes just need to get all of the pieces to fit.

Those pieces are:

The Footprint. Right-sizing the business by shuttering underperforming locations, domestically and internationally. The company currently spends $450mm in annual rent, spread across 12.2mm total square feet. The company will close 178 stores in the US and 350 in total. In other words, the company is mostly erasing its overzealous expansion; it will focus on selling cheaply made crap to Americans and our southern friends down in Latin America rather than poisoning the clothes racks in Canada, Europe and Asia. The new footprint will be around 600 stores. Or, at least, that’s the plan for now. Let’s pour one out for the landlords. Here is CNBC mapping out where all of the closures are and which landlords are hit the most. Also per CNBC:

“At one point, two of Forever 21′s largest landlords, Simon Property Group and Brookfield Property Partners, were trying to come up with a restructuring deal where they would take a stake in the company to keep it afloat. It would’ve been similar to when Simon and GGP, which is now owned by Brookfield, bought teen apparel retailer Aeropostale out of bankruptcy back in 2016. But talks between Forever 21 and its landlords fell through, according to a person familiar with the talks. Simon and Brookfield are listed in court papers as two of Forever 21′s biggest unsecured creditors. Simon is owed $8.1 million, while Brookfield is owed $5.3 million, and Macerich $2.7 million.”

Only one of the locations marked for closure, however, belongs to Simon Property Group ($SPG).

The company notes:

To assist with the initial component of the strategy, Forever 21’s management team and its advisors worked with its largest landlords to right size its geographic footprint. Four landlords hold almost 50 percent of its lease portfolio. To date, Forever 21 and its landlords have engaged in productive negotiations but have not yet reached a resolution. The parties have exchanged proposals and diligence is ongoing. Forever 21 looks forward to continuing to work with its landlords to reach a mutually agreeable resolution and proceeding through these chapter 11 cases with the landlords’ support.

In tandem with these negotiations, Forever 21 and its advisors met with nearly all of its individual landlords to discuss potential postpetition rent concessions and other relief on a landlord-by-landlord basis. Many of these smaller, individual negotiations proved more fruitful than negotiations with the larger landlords. Although Forever 21 has not finalized the terms of a holistic landlord deal as of the Petition Date, Forever 21 anticipates that good-faith negotiations with its landlord constituency will continue postpetition, and that all parties will work together to reach a consensual, value-maximizing transaction.

Company counsel asserts that, for landlords, Forever 21 is “too big to fail.” This kinda feels like this:

But don’t worry: the A Malls are totally fine. 

And don’t worry about the loans (CMBX) at all. Noooooo.

As per Morgan Stanley, “In total, we identify 89 loans with a balance of $9.8bn with exposure to announced Forever 21 store closures.”

— Danielle DiMartino (@DiMartinoBooth) October 1, 2019

Merchandising. Getting “Back-to-Basics” on the merchandising front and focus on the company’s “core customer base.” Here is Bloomberg’s Jordyn Holman casting some shade on this plan. And here is Bloomberg’s Sarah Halzack. While the bankruptcy papers certainly don’t highlight the competition, bankruptcy counsel made a point of highlighting H&M, Zara and Fashion Nova. Retail Dive writes:

‘They did not grow with their target customer and the Millennials have graduated to Zara & H&M,’ Shawn Grain Carter, professor of fashion business management at the Fashion Institute of Technology, told Retail Dive in an email. ‘Gen. Z is more interested in rental fashion and vintage hand-me-downs because they are more environmentally conscious.’

Interestingly, Stitch Fix Inc. ($SFIX) was up 5% on Monday while the RealReal Inc. ($REAL) was up 15%. (PETITION Note: both got clobbered on Tuesday, but so did everything else).

The Washington Post piles on:

“Slimming down the operation and reducing costs is only one part of the battle,” Neil Saunders, managing director of GlobalData Retail, said in a note to clients. “The long-term survival of Forever 21 relies on the chain creating a sustainable and differentiated brand. This is something that will be very difficult to accomplish in a crowded and competitive sector.

Indeed, we’ve been writing for some time now that fast fashion seems out of sorts. Going “back to basics” may not actually be the right move in the end.

🤔

Vendor Management. A quick digression: back in May, we wrote about Modell’s Sporting Goods avoidance of bankruptcy. Mr. Modell himself worked the phones and reassured most of his vendors, prompting them to continue doing business with the shrinking sporting goods retailer. This is a feature that you don’t get in PE-backed retail bankruptcies where you have hired guns on management. There, Mr. Modell’s legacy was at stake. He hustled. Likewise, here, the Changs personal business is threatened. Accordingly, the company met with 100 vendors representing 80+% of the vendor base and got them comfortable with continued business; they secured 130 vendor support agreements for equal or better terms. Everyone is invested in making a viable go of the ‘19 holiday season. Sometimes it pays to have someone who is truly invested be all over the supply chain.

Financing. The company’s capital structure is rather simple:

The ABL is with JPMorgan Chase Bank NA as agent. The term loans were provided by the family. One from Do Won Chang for $10mm and the second from the Linda Inhee Chang 2012 Trust. Because nothing says “American Dream” like raiding your kid’s trust fund.

In conjunction with the bankruptcy, the company proposed a DIP credit facility in the form of (a) a $275 million senior secured super-priority ABL revolving credit facility, which includes a $75 million sub-limit for letters of credit and a “creeping roll up” of the pre-petition ABL Facility, and (b) a $75 million senior secured super-priority term loan credit facility, reflecting $75 million of new money financing. The company sought access to $60mm of the term loan at the hearing, indicating that with $40mm due in rent and $18mm in payroll, it would run out of cash without it. The judge approved this request.

And so here we are. The company intends to march forward with negotiations with its landlords, close tons of locations, sure up the vendor base, locate exit financing, and get this sucker out of bankruptcy in Q1 next year.

Ending up in bankruptcy certainly isn’t part of the American Dream. But living long enough to fight another day might just be.

*H/t to @JordynJournals, retail reporter for Bloomberg News on this.

**The company notes that domestic sales have increased over the last 4 quarters.

***For those new to PETITION, the same lawyer from Kirkland & Ellis LLP that represents Forever 21 represented Toys R Us. In the now-infamous “first day” hearing in Toys, the attorney sang the Toys R Us jingle — “I don’t want to grow up…” — in the courtroom. Suffice it to say considering the outcome of that case, that tactic didn’t particularly age well. Indeed, this will age better, we reckon (won’t play in email, only in browser):

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📚Resources📚

We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. We recently added “Super Pumped: The Battle for Uber” by Mike Isaac, which we blew through rather quickly. Next up on our list: “What it Takes: Lessons in the Pursuit of Excellence” by Stephen A. Schwarzman, “The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company” by Bob Iger, and “That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea,” by Netflix co-founder Marc Randolph.

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💰New Opportunities💰

PETITION LLC lands in the inbox of thousands of bankers, advisors, lawyers, investors and others every week. Our website(s) are visited by thousands more. Are you looking for quality people. Posting your job opportunities with PETITION is a great way for your listing to stand out from the LKDN muck.

Email us at petition@petition11.com and write “Opportunities” in the subject line if you’re interested in information about posting your opportunities with us.

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Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.

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🗞The NYT, New Media Models & Snowflake Subscribers🗞

Take a look at these revenue numbers:

This, ladies and gentlemen, represents the most recently reported revenue from New York Times Co. ($NYT). It’s also evolution, illustrated.

We all know the story: in an age of heaps of free media and secular decline of print, media companies are (a) in the midst of a great pivot away from the ad-based business model and (b) as part of a hybrid model, leaning more heavily upon recurring-revenue-producing subscription (and other) products.

This pivot — and the reason for it — couldn’t be clearer from the reported Q2 ‘19 earnings. As you can see above, advertising revenue is flat, while subscription and “other” revenue is growing.

Generally speaking, the report was sound. The company added 131k net subscriptions; it also separately grew its separate subscription channels for “Cooking” and “Crossword,”* and launched a news series, “The Weekly,” on FX and Hulu (PETITION Note: we can’t help but question the long-term success of this series: who really wants to go to Hulu to watch a NYT news series? In the end, that didn’t work for Vice News on HBO. That said, this series apparently contributed to a 30% increase in “other” revenue in the quarter, so, who knows? Maybe we’re dead wrong). In total, subscriptions were up by 197k and the company now reports 3.8mm digital-only subscribers.

On the negative side, the company’s operating costs are increasing and, in turn, its operating profit is decreasing (down $4mm YOY) as it looks to grow its digital channels, properly analyze and manage its sales funnel, acquire additional journalist talent, etc. Some choice bits relating to subscriptions from the earnings call:

Total subscription revenues increased 4% in the quarter with digital-only subscription revenue growing 14% to $113 million. On the print subscription side, revenues were down 2.5% due to declines in the number of home delivery subscriptions and continued shift of subscribers moving to less frequent and therefore less expensive delivery packages as well as a decline in single copy sales. This decrease in print subscription revenues was partially offset by a home delivery price increase that was implemented early in the year.

Total daily circulation declined 8.5% in the quarter compared with prior year, while Sunday circulation declined 7.1%.

No surprises here. Digital is ⬆️, print is ⬇️, and even where there is print, the average revenue per user is shifting down in large part due to subscribers opting for ⬇️ delivery frequency. Interestingly, people are also buying fewer newspapers on the fly (“single copy sales”).

On the advertising side:

Total advertising revenue grew 1.3% compared with the prior year with digital advertising growing 14% and print declining by 8%. The increase in digital advertising revenue was largely driven by growth in direct sold advertising on our digital platforms, including advertising sold in our podcast and our creative services business. The print advertising result was mainly due to declines in the financial services, retail and media categories, partially offset by growth in technology.

The stock market did not act favorably — note the demarcation below:

Indeed, as of the time of this writing, the share price is down 20% from where it was on the date of the release.

There are some interesting takeaways here. First, podcasts continue to be a source of growth for many a media company — despite the lack of viable analytics across the podcasting space. Second, the second order effects of the decline in retail and media are notable. Third, the company’s purchase of Wirecutter is feeding its “other” revenue which implies — though it is not line-itemed — that affiliate-related revenue is a growing part of the business (long Amazon!).**

As for guidance, the company forecasted continued YOY subscription growth in the low-to-mid single digits, a decrease in ad revenue, and an increase in “other” revenue. Notably, “other” revenue also includes income from subletting office space, commercial printing, and licensing deals (i.e., when the NYT is referenced in a movie, etc.).

It will be interesting to see whether the NYT can continue to demonstrate subscriber growth in the midst of a hyper-polarized political environment. To point, a shift to subscribers is not without its dangers. Recently the NYT came under pressure both for (i) its 1619 Project about slavery and (ii) a headline describing President Trump’s reaction to the El Paso and Dayton shootings. Per The Wrap:

The New York Times saw an increase in subscription cancellations after a reader backlash over its lead headline on a story about a Donald Trump speech on Monday, a Times spokesperson told TheWrap.

The paper has “seen a higher volume of cancellations today than is typical,” the spokesperson said on Tuesday.

In an age of hyper-competition for the marginal dollar, this is a big problem. In a story about the dismal performance of the Los Angeles Times’ digital initiatives (net 13k subscriptions in the first six months of ‘19), Joshua Benton writes for Neiman Lab:

But once you get all those subscribers signed up, you’ve got to prove yourself worthy of their money, over and over again. Churn has always been an issue for newspapers, but it’s even more of one in a world of constant competition for subscription dollars. (“Hmm, Netflix raised their price — do I really use that L.A. Times subscription?”) Retention is critical to making reader revenue the bedrock of the new business model….

That’s what happens when you switch to a subscriber model. Investors care less about ad revenue and more about subscriber growth. Each individual subscriber matters. And retention really matters.

*****

But retention cannot come at a cost. A publication must establish values and live up to them. Take, for instance, this note we received from a reader recently:

“Your writings are done well, interesting, and humorous. However, take it from me and many of my colleagues, your anti-Trump insults are aggravating and misguided.  Some of us are considering unsubscribing because of it.”

He is referring to this piece, “Tariffs Tear into Tech+,” wherein we wrote about the recent escalation in trade hostility as follows:

We’re frankly not sure why this is controversial. All we did was insinuate that the man is intemperate (is that really even debatable?) and describe him in his own words.

....to President of the United States (on my first try). I think that would qualify as not smart, but genius....and a very stable genius at that!

— Donald J. Trump (@realDonaldTrump) January 6, 2018

President Trump’s policies — for better or for worse — have an impact on the economy. The delivery of those policies infuses volatility into the markets. It affects whether a company will commit to investing millions in coming months; it affects sales; it affects consumer spending which, in case you didn’t notice, is, for now, the only thing keeping GDP afloat. We’re going to write about that. And we’re going to do so in our usual voice. Just like we would if a democrat were in office: we’re equal opportunity snark.***

So, sure, Mr. Orange County, feel free to cancel your Membership if you think we’re misguided. That’s just what we all need: another highly educated person running for the hills because a few words didn’t comport with his sensibilities. Thanks for summing up this country’s current plight of discourse/discord in three sentences.

In conclusion, we won’t be bullied, subscription be damned.

*Impressively, the Cooking product has 250k subscribers and the Crosswords product has 500k subscribers.

**For those who don’t know, an affiliate fee is essentially a referral fee for sending traffic over to an affiliate partner that ultimately results in a transaction. So, for instance, if you go to Wirecutter.com to look up best back-to-school backpack and click on their #1 choice, a L.L. Bean ‘Quad Pack,’ and buy one, Wirecutter earns approximately 4% on that purchase.

***Case and point: we’ve previously asked, “Are Progressives Bankrupting Restaurants?“

🚴‍♂️The Rise of Home Fitness: Peloton Files its S-1 (Long Twitter Fodder)🚴‍♂️

In case you haven’t heard, Peloton Inc. filed its S-1 earlier this week. An S-1 is like a bankruptcy First Day Declaration. It’s an opportunity to sell and control a narrative. In the case of the S-1, the filer wants to appeal to the markets, drum up FOMO, and maximize pricing for a public capital raise (here, $500mm). So, yeah, want to call yourself a technology / media / software / product / experience / fitness / design / retail / apparel / logistics company? Sure, go for it. In an age of WeWork, a la-dee-da-kibbutz-inspired-community-company-that-may-or-may-not-be-valued-like-a-tech-company-despite-being-a-real-estate-company, hell, anything is possible.

Frankly, we’re surprised Peloton didn’t throw in that it’s a “CBD-infused-augmented-reality-company-that-transacts-in-Pelotoncoin-on-the-blockchain company” for good measure. Go big or go home, dudes! PETITION Note: the bankruptcy/First-Day-Declaration equivalent of this absurdity must be every sh*tty retailer on earth claiming to be an “iconic” brand with loyal shoppers who, despite that loyalty, never spend a dollar at said retailers, all while some liquidators are preparing to sell them for parts:

Value = $0.00.

(JK. Some schmuck will pay for this.) https://t.co/7fCFrmzs5I

— 💥PETITION💥 (@petition) August 27, 2019

But we digress.

For those who don’t live in Los Angeles or New York and are therefore less likely to know what the hell Peloton is (despite its 74 retail showrooms in the US, Canada and UK and pervasive ad-spend), it is a home fitness company that sells super-expensive hardware ($2,245 for the flagship cycle and $4,295 for the treadmill)* and subscription-based fitness apps ($39/month). It’s helped create the celebrity cycling trainer and aims to capture the aspirational fitness enthusiast. And, by the way, it’s a real company. Here are some numbers:

• $196mm net loss (boom!) on $915mm of revenue in the fiscal year ended June 30, 2019 ((both figures up from 2018, which were $47.8mm and $435mmmm, respectively, meaning that the loss is over 4x greater (boom!!) while revenue grew by over 2x));

• Hardware revenues increased over 100%, subscription grew over 100% and “other” revenue, i.e., apparel, grew over 100%;

• 511,202 subscribers in 2019, up from 245,667 in 2018;

• 577k products sold, with all but 13k in the US;

• a TAM that, while not a ludicrous as WeWork’s the-entire-planet-is-an-opportunity-pitch, is nonetheless…uh…aggressive with total capture at approximately 50% of ALL US HOUSEHOLDS

and;

• $994mm VC raised, $4+b valuation;

A big part of that net loss is attributable to skyrocketing marketing spend. But, Ben Thompson highlights:

Peloton spends a lot on marketing — $324 million for 265,535 incremental Connected Fitness subscribers (a subscriber that owns a Peloton bike or treadmill), for an implied customer acquisition cost (CAC) of $1,220.18 — but that marketing spend is nearly made up by the incremental profit ($1,161.40) on a bike or treadmill. That means that subscription profits are just that: profits.

The company also claims very low churn** — 0.70%, 0.64%, and 0.65% in 2017, 2018 and 2019, respectively — though this thread ⬇️ points out some obfuscation in the filing and questions the numbers (worth a click through):

1/ $PTON Peloton subscriber churn looks to me to be around 20-30% per year. But they reported churn of 0.7%!!
Math with me here.. the reported churn is a 'monthly' churn, calculated as net cancels in the period, divided by 3 months. So 0.7% = 2.1% per quarter, or around 8.4%/yr.

— Inquisitive Investor (@QuisitiveInvest) August 27, 2019

Ben Thompson hits on churn too, noting that major company promotions haven’t rolled off yet:

Only the 12 month prepaid plans have rolled off; the 24 and 39 month plans are still subscribers whether or not they are using their equipment (and given the 0% financing offer, I wouldn’t be surprised if there were a lot of them). 

Surely roadshow attendees will have questions on this point and then, market froth being market froth, totally disregard whatever the answers are. 😜

The company also highlights some tailwinds: (a) an increasing focus on health and fitness, especially at the employer level given rising healthcare costs and a general desire to offset them;** (b) the rise of all-things-streaming; (c) the desire for community; and (d) significantly, the demand for convenience. We all work more, weather sucks, the kids wake up early, etc., etc.: it’s a lot easier to work out at home. This thread ⬇️ sure captured it (click through, it’s hilarious):

Love putting my Peloton bike in the most striking area of my ultra-modern $3 million house

— Clue Heywood (@ClueHeywood) January 28, 2019

Which is not to say that the company doesn’t have its issues.*** It appears that like most other fitness products, there’s seasonality. People buy Pelotons around the holidays, after making New Year’s resolutions they undoubtedly won’t keep. There are also some lawsuits around music use. As we noted above, the marketing spend is through the roof ($324mm, more than double last year) and SG&A is also rising at a healthy clip. Many also question whether Peloton’s cult-like status will fizzle like many of its fitness predecessors. And, of course, there’s that cost. Lots or people — ourselves included — have questioned whether this business can survive a downturn.

Once again, for people in the back:
"Late-cycle IPOs are a way for the smart private money to cash out bad companies at the top and dump their risk on dumb retail investors right before a drop"
Thanks for coming to my TED talk. https://t.co/ONjf82Rfay

— Danny Seymour (@DannySeymour18) August 28, 2019

Indeed, among a TON of risk factors, the company notes:

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates.

And:

To date, our business has operated almost exclusively in a relatively strong economic environment and, therefore, we cannot be sure the extent to which we may be affected by recessionary conditions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services could have an adverse effect on our business, financial condition, and operating results. (emphasis added)

Now ain’t that the truth. This will be an interesting one to watch play out.

*****

Questions about the company’s stickiness in a downturn notwithstanding, we ought to take a second and admire what they’ve done here. Take a look ⬇️

Congratulations, Peloton fans. You are now a non-GAAP financial metric.

Please make an acronym from "Average Monthly Workouts Per Connected Fitness Subscriber." pic.twitter.com/GEti13nC7K

— Shira Ovide (@ShiraOvide) August 27, 2019

Sure, sure, it’s a ridiculous metric in an SEC filing but…but…look at the total number of workouts. Look at the average monthly. Unless Peloton is truly expanding the category, those workouts are coming out of someone else’s revenue stream. Remember: SoulCycle did pull its own IPO some time ago.

In a recent piece about the rise of home fitness and the threat it poses to conventional gyms and studios, the Wall Street Journal noted:

U.S. gym membership hit an all-time high in 2018, but the rate of growth cooled to 2% after a 6% rise the year before, according to the International Health, Racquet & Sportsclub Association. Much of the decade’s growth has been fueled by boutique studios like CrossFit, Orangetheory and SoulCycle, whose ability to turn fitness into a communal experience has sparked fierce loyalty to their brands. IHRSA says it’s too early to tell whether streaming classes will reduce club visits. CrossFit, SoulCycle and Orangetheory say they don’t see at-home streaming fitness programs as a threat.

We find that incredibly hard to believe. Is there correlation between the slowdown and growth and Peloton’s 128% and 108% growth from ‘17-’18-’19? Peloton may be more disruptive than the naysayers give it credit for.

Back to Ben Thompson:

Like everyone else, Peloton claims to be a tech company; the S-1 opens like this:

We believe physical activity is fundamental to a healthy and happy life. Our ambition is to empower people to improve their lives through fitness. We are a technology company that meshes the physical and digital worlds to create a completely new, immersive, and connected fitness experience.

I actually think that Peloton has a strong claim, particularly in the context of disruption. Clay Christensen’s Innovator’s Dilemma states:

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

It may seem strange to call a Peloton cheap, but compared to Soul Cycle, which costs $34 a class, Peloton is not only cheap but it gets cheaper the more you use it, because its costs are fixed while its availability is only limited by the hours in the day. Sure, a monitor “underperforms” the feeling of being in the same room as an instructor and fellow cyclists, but being able to exercise in your home is massively more convenient, in addition to being cheaper.

Moreover, this advantage scales perfectly: one Peloton class can be accessed by any of its members, not only live but also on-demand. That means that Peloton is not only more convenient and cheaper than a spinning class, it also has a big advantage as far as variety goes.

The key breakthrough in all of these disruptive products is the digitization of something physical.

In the case of Peloton, they digitized both space and time: you don’t need to go to a gym, and you don’t have to follow a set schedule. Sure, the company does not sell software, nor does it have software margins, but then neither does Netflix. Both are, though, fundamentally enabled by technology.

If Thompson is right about that value proposition, is it possible that, in a downturn, Peloton can win? At $40/class, it would take 57 classes to break even on the hardware and then you’re getting a monthly subscription for the cost of one class. Will people come around to the value proposition because of the downturn?****🤔

Before then, we’ll find out whether the market values this company like a tech hardware company or a SaaS product. And the company can use the IPO proceeds to market, market, market and try and lock-in new customers before any downturn happens. Then we’ll really test whether those churn numbers hold up.

*The company doesn’t break out the success of the two other than to say that the majority of hardware revenue stems from the bike. We would reckon a guess that the treadmill is losing gobs of money.

**It stands to reason that the company would have strong retention rates given the high fixed/sunk cost nature of its product.

***One risk factor is curiously missing so we took the initiative to write it for them:

We sell big bulky products that appeal more to coastal elites.

Unfortunately, given the insanity if housing prices and spatial constraints, a lot of our potential customers in Los Angeles, San Francisco and New York simply may not have room for our sh*t.

****Unrelated but WeWork’s Adam Neumann insists that WeWork presents an interesting value proposition in a downturn: viable office space without the long-term locked in capital commitment. It’s not the craziest thing we’ve heard the man say.

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DISCOVER MORE WITH PETITION

⚡️Data, Baby, Data (Long Ambitious Lawyers)⚡️

Man. The hits just keep on coming for retailers. 

First, a callback to 2014. 

Back in 2014, Twilio Inc. ($TWLO) was a lesser known private company that solved a basic problem: it allowed software developers to programmatically make and receive phone calls, send and receive text messages, and perform other communication functions using its web service APIs. In English? It connected businesses to customers. It was the ultimate "be where your customers are" power move: increasingly, customers are writing or reacting to texts. Twilio enables text message blasts to large groups. This was a total game changer for businesses: it gave them an avenue to connect in a more personal way to their customers and rise above the muck of email (PETITION Note: which is not to say that we don't LOVE email). And now Twilio is an a $18b market cap company:

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🕸Spiderman Can’t Save Everyone (Short iPic Entertainment)🕸

Most moviegoers probably think $17 for a movie ticket is expensive enough and so, more likely than not, they go to the nearby AMC or Regal theater to get their latest shot of Disney-fed superhero drivel. For those who REALLY want to make an event out the movies, however, there is another option: iPic Entertainment Inc’s ($IPIC) “upscale” theater experience. This “experience” includes cocktails, plush pleather couches and waitered food service. All of that pampering can cost upwards of $30/ticket — and that’s just for the movie. Add in the food and this chain probably contributes its fair share to the personal bankruptcy market.

The chain has 123 locations across 16 states, including California, Florida and New York City. How on earth does it make sense to go that route when a month of Netflix costs a fraction of that? Throw in some “chill” and, well, it seems pretty obvious which option has more appeal (insert creepy wink here). Spoiler alert: it ain’t iPIC. 

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💥Mary Meeker’s “State-of-the-Internet” Slide Presentation💥

Another year, another banner “State-of-the-Internet” presentation from Mary Meeker. There are some bits that we thought would be of particular interest to the restructuring community.

• For all we hear about Amazon and e-commerce destroying retail, e-commerce growth is slowing. It constitutes 15% of retail versus 14% a year ago.

• There is a stark shift in time spent on various forms of media and, by extension, the use of ad budgets. This chart ought to frighten the sh*t out of print and radio content producers. Time spent on print and radio is down BIG. Even more disconcerting for print? All of the other mediums appear to have reached an equilibrium between time spent and ad spend but print, however, still enjoys a disproportionate amount of ad dollars. Said another way, print media outlets may still have some pain heading their way.

We’ve made recent mention of rising customer acquisition costs and how that might derail many retailers’ business plans. To reduce CAC, many streaming services (e.g., Zoom, Spotify) use free tiers at the top of their funnel to get potential customers in the door and familiar with their products and then focus primarily on making those potential customers happy instead of otherwise deploying effort to market wholesale (PETITION Note: similarly, this is what we do). That said, CACs are indeed increasing. Ms. Meeker has a chart for this:

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👚Resale is Real Real. Eff “The Amazon Effect.”👚

The #RetailApocalypse is More Than Amazon Inc.

In September 2017 in “Minimalistic Consumption by Inheritance,” we wrote:

Much has been made about the death of retail and the "Amazon Effect." We mention it quite a bit … but we are also on record as calling the Amazon narrative lazy. After all, there's a reason why resale apps are among the highest downloaded apps in the Itunes app store. We've noted this before: millennials have no problem buying, reselling, buying, and reselling. I mean, sh*t, we're now seeing commercials for OfferUp on television. We've noted the rise of Poshmark and other apps here and here. Perhaps there's more here than meets the eye.

We doubled down with “Enough Already With the ‘Amazon Effect’” in April 2018. Citing the ThredUp 2018 Resale Report, we noted:

…the resale market is on pace to reach $41 billion by 2022 and 49% of that is in apparel. Moreover, resale is growing 24x more than overall apparel retail. “[O]ne in three women shopped secondhand last year.” 40% of 18-24 year olds shopped resale in 2017. Those stats are bananas. This comment is illustrative of the transformation taking hold today,

“The modern consumer now has a choice between shopping traditional retail or trying new, innovative business models. New apparel experiences and brands are emerging at record rates to replace old ones. Rental, subscription, resale, direct-to-consumer, and more. The closet of the future is going to look very different from the closet of today. When you get that perfectly curated assortment from Stitch Fix, or subscribe to Rent the Runway’s everyday service, or find that killer handbag on thredUP you never could have afforded new, you start realizing how much your preferences and behavior is changing.”

Finally, we wrote in January — in “ Retail May Get Marie Kondo'd ,” — that the Force is now strong(er) with the resale trend.

We concluded:

…The RealReal is signaling that resale is so big that it’s ready to IPO. Talk about opportunistic. No better time to do this than during Kondo-mania. The company has raised $115mm in venture capital … most recently at a $745mm valuation.

None of this is a positive for the likes of J.C. Penney. They need consumers to consume and clutter. Not declutter. Not go resale shopping. We can’t wait to see who is first to mention Marie Kondo as a headwind in a quarterly earnings report. Similarly, we wonder how long until we see a Marie Kondo mention in a chapter 11 “First Day Declaration.” 

So, where are we going with all of this?

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🚴 Peloton = Gympocalypse? 🚴

The Rise of Peloton, Tonal, Mirror and Other DTC Home Fitness Products (Long Seclusion)

Source: Mirror

Back in January we wrote a longform piece about the rise of Peloton. It’s worth revisiting. Subsequently, the at-home fitness space has only gotten more interesting with (i) Peloton’s soon-to-be-released treadmill and (ii) a couple more well-funded startups going after the gym crowd with high-priced at-home apparatuses that give one further incentive to just stay home, never talk to anyone and never do anything outside. Because that's just what we need in today's hyper-polarized environment: more people just scurrying off into their own corners and refusing to deal with and compromise with anyone or anything. And that apparently includes the use of gym equipment.

The New York Times' Erin Griffith recently wrote that Tonal and Mirror, two new on-the-wall connected fitness platforms, are…

"…among the first start-ups to pounce on the success of Peloton, a stationary bike start-up that investors recently valued at $4 billion. Peloton blends the hardware of a bike with the software of a video streaming subscription and the content of spin classes. Its skyrocketing growth has made investors wary of missing the next big thing in fitness." 

The next big thing in fitness appears to be a flashy screen, a solid wifi connection, expensive hardware and streaming fitness instruction brought to you by a recurring revenue subscription model. 

Web Smith frames it another way. 

He writes:

Silicon Valley wants to redefine the fitness membership. Through the adoption of connected devices like the Peloton bike, there’s been an inflection point as consumers seem to be trickling away from the current model. No longer do you have to drive to a place to be in a community. As Americans become more health conscious and driven to maximize performance, the DTC equipment industry is a timely bet on the next generation of  fitness data-driven IoT (internet of things).

He continues:

Whereas the Fitbit-phase of wearables emphasized individual fitness, the next generation of connected devices seem to be incorporating community in ways that could emerge as a challenge to the status quo: community-driven fitness facilities.

And:

By building systems that allow community to be gained outside of physical retail outlets, these tools are aiming to become the new medium for instruction and training.  These internet-enabled equipment manufacturers aren’t just selling plastic and metal, they’re selling virtual community.

He finished by saying:

"...it could spell trouble for your gym. Spin franchises are already beginning to adjust to the threat of Peloton and as the threat of connected cycles continues to grow as also-has brands rise up in the wake of Peloton’s premium pricing."

That sound you may have just heard was the collective moan of mall owners who are increasingly dependent upon gyms to fill space:

Okay, okay, let's dial it down. Peloton has created a luxury brand experience that, it is argued, makes economic sense relative to the long-term economics of attending Flywheel or SoulCycle classes. We're not so sure that translates to other non-niche forms of fitness. Especially at the price-points these companies are touting. 

Apropos, some of the comments to the NYT piece are amusing:

Obviously, these machines are for a niche market where money is irrelevant and style is paramount. Best of luck to them, but I'll stick to the free version...my own body. 

So far the comments are 22-0 against. I wonder if the Tonal can automatically adjust that resistance.

Or, you know, you could just go outside, feel the sun and wind on your back, do some pushups and chinups to feel your own weight against the pull of the Earth, hear nature all around you, talk to a person (gasp!)... 

But then again it's so nice to stare at a screen all day long, so what do I know.

Look for these items in the free piles left curbside after garage sales in about 6 years. 

While we're not necessarily convinced that Tonal and Mirror are the future of fitness, it seems to us that gyms ought to start thinking "omnichannel" like retailers and figure out way to drive more value to customers both in and outside of the gym, during on and off hours. How is it, for instance, that Equinox doesn't have any streaming classes that you can do at home or in your office? 

Whatever happens, expect the area to get more heated as more and more money chases this burgeoning at-home community-based exercise market. Bloomberg already notes that “the treadmill wars are here.” And, Peloton, for instance, is now suing Flywheel for patent infringement. It knows that the at-home fitness opportunity is now. If it can slow down a rival (in advance of an IPO?), all the better.

We asked in January whether Peloton could thrive in a downturn. Now the question is broader: will any of these companies with high-priced hardware be able to survive a downturn?

Millennials Benefit from Venture Capital, Feel Guilty (Long Subsidies)

Oh man. THIS. Is. Precious. Herein a Wall Street Journal writer feels guilty about the secondary effects of his penchant for cheap home food delivery, two-day shipping, unlimited movies for $9.99/month and 100-day mattress trials. He asks:

These “Where’s the catch?” deals are practically everywhere now, each causing me a similar dilemma:

*I take Uber Pools home at night, knowing even if nobody else gets in the car the ride’s still going to be cheaper. Are we stiffing drivers?

*I let MoviePass buy me tickets for next to nothing when I used to gladly pay full price. Will this contribute further to the decline in nonsuperhero Hollywood films?

*I demand two-day shipping for everything I buy on Amazon. Am I destroying the Earth, one cardboard box at a time?

*I use the Blue Apron free trial, cancel it and switch to HelloFresh , then rinse and repeat with Sun Basket and Plated. Can decent, easy food delivery survive?

We almost mistook this for an Onion article.

Here are some answers.

Yes. Probably. Yes. No. These answers are pretty self-evident.

The very same people that the writer is concerned about affecting is riding Uber in his off time, ordering the free Blue Apron trial, and taking advantage of 2-day shipping. So, nothing to worry about there.

As for it being a “deal”? We’re giving away our data every single time we eat a subsidized meal, take a subsidized ride, or recycle an extra cardboard box. Isn’t that information valuable? Isn’t there a whole world of people hacking away trying to obtain it? If you’re not paying for the product, you are the product. Not sure that’s such a great deal, in the end.

So, with that said, we’re now going to do this:

That’s right: $20/month.

Ah, co-working.

💣Diebold. Disrupted.💣

Are Point-of-Sale & Self-Checkout Systems Effed (Short Diebold Nixdorf)?

Forgive us for returning to recently trodden ground. Since we wrote about Diebold Nixdorf Inc. ($DBD) in “💥Millennials & Post-Millennials are Killing ATMs💥,” there has been a flurry of activity around the name. The company…

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#BustedTech's Secret: Assignment for the Benefit of Creditors

Long Private Markets as Public Markets

⚡️🤓Nerd alert: we need to lay a little foundation in this one with some legal mumbo-jumbo. Consider yourself warned. Solid payoff though. Stick with it.🤓⚡️

Allow us to apologize in advance. It’s summer time and yet we’ve been nerding out more often than usual: on Sunday, we dove into net-debt short activism, for goodness sake! We know: you want to just sit on the beach and read about how Petsmart implicates John Wick. We get it. Bear with us, though, because there is a business development aspect to this bit that you may want to heed. So attention all restructuring professionals (and, peripherally, start-up founders and venture capitalists)!

Recently the Turnaround Management Association published this piece by Andrew De Camara of Sherwood Partners Inc, describing a process called an “assignment for the benefit of creditors” (aka “ABC”). It outlines in systematic fashion the pros and cons of an ABC, generally, and relative to a formal chapter 11 filing. When the bubble bursts in tech and venture capital, we fear a number of you will, sadly, become intimately familiar with the concept. But there’ll be formal bankruptcies as well. ABCs won’t cut it for a lot of these companies at this stage in the cycle.

Let’s take a step back. What is the concept? Per Mr. De Camara:

An ABC is a business liquidation device governed by state law that is available to an insolvent debtor. The ABC procedure has long existed in law and is sometimes addressed in state statutes. In an ABC, a company, referred to as the assignor, transfers all of its rights, title, and interest in its assets to an independent fiduciary known as the assignee, who liquidates the assets and distributes the net proceeds to the company’s creditors. The assignee in an ABC serves in a capacity analogous to a bankruptcy trustee in a Chapter 7 or a liquidating trustee in a Chapter 11.

He goes on to state some characteristics of an ABC:

• Board and shareholder consent is typically required. “If a company is venture-backed, it may be required to seek specific consent from both preferred and common shareholders. It is possible to enter publicly traded companies into an ABC; however, the shareholder proxy process increases the difficulty of effectuating the ABC and results in a much longer pre-ABC planning process.”

• There is no discharge in an ABC.

• Key factors necessitating an ABC include (a) negative cash burn + no access to debt or equity financing, (b) lender wariness, (c) Board-level risk as a lack of liquidity threatens the ability to pay accrued payroll and taxes, and (d) diminished product viability.

And some benefits of an ABC:

• ABC assignees have a wealth of experience conducting liquidation processes;

• The assignee manages the sale/liquidation process — not the Board or company officers — which, as a practical matter, tends to insulate the assignee from any potential attack relating to the process or sale terms;

• Lower admin costs;

• Lower visibility to an ABC than a bankruptcy filing;

• Secured creditors general support the process due to its time and cost efficiency, not to mention distribution of proceeds; and

• Given all of the above, the process should result in higher distributions to general unsecured creditors than, say, a bankruptcy liquidation.

Asleep yet? 😴

Great. Sleep is important. Yes or no, stick with us.

ABCs also have limitations:

• Secured creditor consent is needed for use of cash collateral.

• Buyers cannot assume secured debt without the consent of the secured creditor nor is there any possibility for cramdown like there is in chapter 11.

• There is, generally, no automatic stay. This bit is critical: “While the ABC transfers the assets out of the assignor and therefore post-ABC judgments may have no practical value or impact, litigation can continue against the assignor, and the assignee typically has neither the funding nor the economic motivation to defend the assignor against any litigation. In addition, hostile creditors may decide to shift their focus to other stakeholders (i.e., board members or officers in their capacity as guarantors or fiduciaries) if they believe there will likely be no return for them from the ABC estate.”

• Assignees have no right to assign executory contracts, diminishing the potential value of market-favorable agreements.

• No free-and-clear sale orders. Instead you get a “bill of sale.” Choice quote: “A bill of sale, particularly from an assignee who is a well-known and well-regarded fiduciary, is a very powerful document from the perspective of creditor protection, successor liability, etc., but it does not have the same force and effect as a free-and-clear sale order from a bankruptcy court.”

The question right now is, given the robust nature of the capital markets these days, should you care about any of the above? Per Pitchbook:

This is a golden age for venture capital and the startup ecosystem, as illustrated by PitchBook's latest PitchBook NVCA-Venture Monitor. So far this year, $57.5 billion has been invested in US VC-backed companies. That's higher than in six of the past 10 full years and is on pace to surpass $100 billion in deal value for the first time since the dot-com bubble.

Fundraising continues at breakneck speed. Unicorns are no longer rare, and deal value in companies with a $1 billion valuation or more is headed for a new record. The size of VC rounds keeps swelling. Deep-pocketed private equity players are wading in.

Signs of success (or is it excess?) are everywhere you look. On the surface, delivering a resounding verdict that the Silicon Valley startup model not only works, it works well and should be emulated and celebrated.

But what if that's all wrong? What if this is another mere bubble and the VC industry is in fact storing up pain…?

That's the question posited by Martin Kenney and John Zysman—of the University of California, Davis, and the University of California, Berkeley, respectively—in a recent working paper titled "Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance?"

Instead of spending millions, or billions, in the pursuit of unicorns that could emulate the "winner-takes-all" technology platform near-monopolies of Apple and Facebook and the massive capital gains that resulted, VC investors and their LP backers could instead be buying a bunch of fat Cheshire cats. Bloated by overvaluation, and likely to disappear, leaving just a smile and big losses, since many software-focused tech startups have no tangible assets.

They then ask whether there’s more here than meets the eye. More from Pitchbook:

The problem is that this cycle has been marked by easy capital and a fetishization of the early-to-middle parts of the tech startup lifecycle. Lots of incubators and accelerators. "Shark Tank" on television. "Silicon Valley" on HBO. Never before has it been this easy and cheap to start or expand a venture.

Yet on the other end of the lifecycle, exit times have lengthened, as late-series deal sizes swell, reducing the impetus to IPO (in search of public market capital) or sell before growth capital runs out.

So, what’s the problem?

…in the view of Kenney and Zysman, the VC industry lacks discipline, seeking disruption and market share dominance without a clear path to profitability. You see, VC-fueled startups aren't held to the same standard as existing publicly traded competitors who must answer to investors worried about cash flows and operating earnings every three months. Or of past VC cycles where money was tighter, and thus, time to exit shorter.

We’ll come back to the public company standard in a second.

The interesting thing about the private markets becoming the new public markets (with funding galore) is that when the crazy frenzy around funding (PETITION NOTE: read the link) eventually stops, the markets will just be the markets. And all hell will break lose. The question then becomes whether a company has enough liquidity to stem the tide. What happens if it doesn’t?

An ABC may very well be a viable alternative for dealing with the carnage. But with private markets staying in growth stages privately for longer, doesn’t that likely mean that there’s more viable intellectual property (e.g., software, data, customer lists)? That a company has a bigger and better San Francisco office (read: lease)? That directors have a longer time horizon advising the company (and, gulp, greater liability risk)? Maybe, even, that there’s venture debt on the balance sheet as an accompaniment to the last funding round (after all, Spotify famously had over $1b of venture debt on its balance sheet shortly before going public)?

All of which is to say that “the bigger they come, the harder they fall.” When the music stops — and, no, we will NOT be making any predictions there, but it WILL stop — sure, there will be a boatload of ABCs keeping (mostly West Coast) professionals busy. But there will also be a lot of tech-based bankruptcies of companies that have raised tens of millions of dollars. That have valuable intellectual property. That have a non-residential real property lease that it’ll want to assign in San Francisco’s heated real estate market. That have a potential buyer who wants the comfort of a “free and clear” judicial order. That have shareholders, directors and venture capital funds who will want once-controversial-and-now-very-commonplace third-party releases from potential litigation and a discharge.

Venture capitalists tend to like ABCs for private companies because, as noted above, they’re “lower visibility.” They like to move fast and break things. Until things actually break. Then they move fast to scrub the logos off their websites. What’s worse? Visibility or potential liability?

And then there are the public markets.

A month ago, we discussed Tintri Inc., a California-based flash and hybrid storage system provider, that recently filed for bankruptcy. Therein we cautioned against IPOs of companies with “massive burn rates.” We then went on to highlight the recent IPO of Domo Inc. ($DOMO) and noted it’s significant cash burn and dubious reasons for tapping the public markets, transferring risk to Moms and Pops in the process. The stock was trading at $19.89/share then. Here is where it stands now:

In the same vein, on Monday, in response to Sunday’s Members’-only piece entitled “😴Mattress Firm's Nightmare😴,” one reader asked what impact a potential Mattress Firmbankruptcy filing could have on Purple Innovation, Inc. ($PRPL), the publicly-traded manufacturer and distributor of Purple bed-in-a-box product. Our response:

And we forgot to mention rising shipping costs (which the company purports to have mitigated by figuring out…wait for it…how to fold its mattresses).*

And then yesterday, Bloomberg’s Shira Ovide (who is excellent by the way) reported that “Cash Wildfire Spreads Among Young Tech Companies.” She wrote:

It’s time to get real about the financial fragility of young technology companies. Far too many are living beyond their means, flirting with disaster and putting their investors at risk. 

Bloomberg Opinion examined 150 U.S. technology companies that had gone public since the beginning of 2010 and were still operating independently as of Aug. 10. About 37 percent had negative cash from operations in the prior 12 months, meaning their cash costs exceeded the cash their businesses had generated. 

A handful of the companies, including online auto dealer Carvana Co., the mattress e-commerce company Purple Innovation Inc. and health-care software firm NantHealth Inc., were on pace to burn through their cash in less than a year, based on their current pace of cash from operations and reserves in their most recent financial statements.

In addition to Purple Innovation, Ms. Ovide points out that the following companies might have less than 12 months of cash cushion: ShiftPixy Inc. ($PIXY), RumbleON Inc. ($RMBL), RMG Networks Holding Corp. ($RMGN), NantHealth Inc. ($NH), Carvana Co. ($CVNA), and LiveXLive Media Inc. ($LIVX).

She continued:

The big takeaway for me: Young technology companies in aggregate are becoming more brittle during one of the longest bull markets ever for U.S. stocks. This trend is not healthy. Companies that persistently take in less cash than they need to run their businesses risk losing control of their own destinies. They need continual supplies of fresh cash, which could hurt their investors, and the companies may be in a precarious position if they can’t access more capital in the event of deteriorating market or business conditions.

It’s not unusual for young companies, especially fast-growing tech firms, to burn cash as they grow. But the scope of the companies with negative cash from operations, and the persistence of some of those cash-burning companies for years, was a notable finding from the Bloomberg Opinion analysis.

Notable, indeed. There will be tech-based ABCs AND bankruptcies galore in the next cycle. Are you ready? Are you laying the foundation? Are you spending too much time skating to where the puck is rather than where it will be?

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*We’ll take this opportunity to state what should be obvious: you should follow us on Twitter.

But, seriously, and more importantly, we know we tout the disruptive effects of the direct-to-consumer model. But make no mistake: we are WELL aware that a number of these upstarts are going to fail. Make no mistake about that.