Nine West Finally Bites It

Another Shoe Retailer Strolls into Bankruptcy Court

A few weeks back, we wrote this in “👞UGGs & E-Comm Trample Birkenstock👞,”

“Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect ‘not a hell of a whole lot’.”

Now we know: $123 million. (Frankly more than we expected.)

Consistent with the micro-brands discussion above, we also wrote,

“Saving the most relevant to Nine West for last,

Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.

Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages. Query whether this factor will be featured in Nine West’s First Day Declaration with such specificity. Likely not.”

Now we know this too: definitely not.

But Nine West Holdings Inc., the well-known footwear retailer, has, indeed, finally filed for bankruptcy. The company will sell the intellectual property and working capital behind its Nine West and Bandolino brands to Authentic Brands Group for approximately $200 million (inclusive of the above-stated $123 million allocation to IP, subject to adjustment) and reorganize around its One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments. The company has a restructuring support agreement (“RSA”) in hand with 78% of its secured term lenders and 89% of its unsecured term loan lenders to support this dual-process. The upshot of the RSA is that the holders of the $300 million unsecured term loan facility will own the equity in the reorganized entity focused on the above-stated four brands. The case will be funded by a $247.5 DIP ABL which will take out the prepetition facility and a $50mm new money dual-draw term loan funded by the commitment parties under the RSA (which helps justify the equity they’ll get).

Regarding the cause for filing, the company notes the following:

“The unprecedented systemic economic headwinds affecting many brick-and-mortar retailers (including certain of the Debtors’ largest customers) have significantly and adversely impacted the operating performance of the Debtors’ footwear and handbag businesses over the past four years. The Nine West Group (and, prior to its sale, Easy Spirit®), the more global business, faced strong headwinds as the macro retail environment in Asia, the Middle East, and South America became challenged. This was compounded by a difficult department store environment in the United States and the Debtors’ operation of their own unprofitable retail network. The Debtors also faced the specific challenge of addressing issues within their footwear and handbag business, including product quality problems, lack of fashion-forward products, and design missteps. Although the Debtors implemented changes to address these issues, and have shown significant progress over the past several years, the lengthy development cycle and the nature of the business did not allow the time for their operating performance within footwear and handbags to improve.”

Regarding the afore-mentioned “macro trends,” the company further highlights,

“…a general shift away from brick-and-mortar shopping, a shift in consumer demographics away from branded apparel, and changing fashion and style trends. Because a substantial portion of the Debtors’ profits derive from wholesale distribution, the Debtors have been hurt by the decline of many large retailers, such as Sears, Bon-Ton, and Macy’s, which have closed stores across the country and purchased less product for their stores due to decreased consumer traffic. In 2015 and 2016, the Debtors experienced a steep and unanticipated cut back on orders from two of the Debtors’ most significant footwear customers, which led to year over year decreases in revenue of $16 million and $46 million in 2015 and 2016, respectively. These troubles have been somewhat offset by e-commerce platforms such as Amazon and Zappos, but such platforms have not made up for the sales volume lost as a result of brick-and-mortar retail declines.”

No Allbirds mention. Oh well.

But wait! Is that a POSITIVE mention of Amazon ($AMZN) in a chapter 11 filing? We’re perplexed. Seriously, though, that paragraph demonstrates the ripple effect that is cascading throughout the retail industrial complex as we speak. And it’s frightening, actually.

On a positive note, The One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments, however, have been able to “combat the macro retail challenges” — just not enough to offset the negative operating performance of the other two segments. Hence the bifurcated course here: one part sale, one part reorganization.

But this is the other (cough: real) reason for bankruptcy:

Source: First Day Declaration

Soooooo, yes, don’t tell the gentlemen mentioned in the Law360 story but this is VERY MUCH another trite private equity story. 💤💤 With $1.6 billion of debt saddled on the company after Sycamore Partners Management LP took it private in 2014, the company simply couldn’t make due with its $1.6 billion in net revenue in 2017. Annual interest expense is $113.9 million compared to $88.1 million of adjusted EBITDA in fiscal year 2017. Riiiiight.

A few other observations:

1. Leases. The company is rejecting 75 leases, 72 of which were brick-and-mortar locations that have already been abandoned and turned over to landlords. Notably, Simon Property Group ($SPG) is the landlord for approximately 35 of those locations. But don’t sweat it: they’re doing just fine.

2. Liberal Definitions. As Interim CEO, the Alvarez & Marsal LLC Managing Director tasked with this assignment has given whole new meaning to the word “interim.” Per Dictionary.com, the word means “for, during, belonging to, or connected with an intervening period of time; temporary; provisional.” Well, he’s been on this assignment for three years — nearly two as the “interim” CEO. Not particularly “temporary” from our vantage point. P.S. What a hot mess.

3. Chinese Manufacturing. Putting aside China tariffs for a brief moment, if you're an aspiring shoe brand in search of manufacturing in China and don't know where to start you might want to take a look at the Chapter 11 petitions for both Payless Shoesource and Nine West. A total cheat sheet.

4. Chinese Manufacturing Part II. If President Trump really wants to flick off China, perhaps he should reconsider his (de minimus) carried interest restrictions and let US private equity firms continue to run rampant all over the shoe industry. If the recent track record is any indication, that will lead to significantly over-levered balance sheets borne out of leveraged buyouts, inevitable bankruptcy, and a top 50 creditor list chock full of Chinese manufacturing firms. Behind $1.6 billion of debt and with a mere $200 million of sale proceeds, there’s no shot in hell they’d see much recovery on their receivables and BOOM! Trade deficit minimized!!

5. Yield Baby Yield! (Credit Market Commentary). Sycamore’s $120 million equity infusion was $280 million less than the original binding equity commitment Sycamore made in late 2013. Why the reduction? Apparently investors were clamoring so hard for yield, that the company issued more debt to satisfy investor appetite rather than take a larger equity check. Something tells us this is a theme you’ll be reading a lot about in the next three years.

6. Athleisure & Casual Shoes. The fleeting athleisure trend took quite a bite out of Nine West’s revenue from 2014 to 2016 — $36 million, to be exact. Jeans, however, are apparently making a comeback. Meanwhile, the trend towards casual shoes and away from pumps and other Nine West specialties, also took a big bite out of revenue. Enter casual shoe brand, GREATS, which, like Allbirds, is now opening a store in New York City too. Out with the old, in with the new.

7. Sycamore Partners & Transparency in Bankruptcy. Callback to this effusive Wall Street Journal piece about the private equity firm: it was published just a few weeks ago. Reconcile it with this statement from the company, “After several years of declines in the Nine West Group business, part of the investment hypothesis behind the 2014 Transaction was that the Nine West® brand could be grown and strong earnings would result.” But “Nine West Group net sales have declined 36.9 percent since fiscal year 2015—from approximately $647.1 million to approximately $408 million in the most recent fiscal year.” This is where bankruptcy can be truly frustrating. In Payless Shoesource, there was considerable drama relating to dividend recapitalizations that the private equity sponsors — Golden Gate Capital Inc. and Blum Capital Advisors — benefited from prior to the company’s bankruptcy. The lawsuit and accompanying expert report against those shops, however, were filed under seal, keeping the public blind as to the tomfoolery that private equity shops undertake in pursuit of an “investment hypothesis.” Here, it appears that Sycamore gave up after two years of declining performance. In the company’s words, “Thus, by late 2016 the Debtors were at a crossroads: they could either make a substantial investment in the Nine West Group business in an effort to turn around declining sales or they could divest from the footwear and handbag business and focus on their historically strong, stable, and profitable business lines.” But don’t worry: of course Sycamore is covered by a proposed release of liability. Classic.

8. Authentic Brands Group. Authentic Brands Group, the prospective buyer of Nine West's IP in bankruptcy, is familiar with distressed brands; it is the proud owner of the Aeropostale and Fredericks of Hollywood brands, two prior bankrupt retailers. Authentic Brands Group is led by a the former CEO of Hilco Consumer Capital Corp and is owned by Leonard Green & Partners. The proposed transaction means that Nine West's brand would be transferred from one private equity firm to another. Kirkland & Ellis LLP represented and defended Sycamore Partners in the Aeropostale case as Weil Gotshal & Manges LLP & the company tried to go after the private equity firm for equitable subordination, among other causes of action. Kirkland prevailed. Leonard Green & Partners portfolio includes David's Bridal, J.Crew, Tourneau and Signet Jewelers (which has an absolutely brutal 1-year chart). On the flip side, it also owns (or owned) a piece of Shake Shack, Soulcycle, and BJ's. The point being that the influence of the private equity firm is pervasive. Not a bad thing. Just saying. Today, more than ever, it seems people should know whose pockets their money is going in to.

9. Official Committee of Unsecured Creditors. It’ll be busy going after Sycamore for the 2014 spin-off of Stuart Weitzman®, Kurt Geiger®, and the Jones Apparel Group (which included both the Jones New York® and Kasper® brands) to an affiliated entity for $600 million in cash. Query whether, aside from this transaction, Sycamore also took out management fees and/or dividends more than the initial $120 million equity contribution it made at the time of the transaction. Query, also, whether Weil Gotshal & Manges LLP will be pitching the committee to try and take a second bite at the apple. See #8 above. 🤔🤔

10. Timing. The company is proposing to have this case out of bankruptcy in five months.

This will be a fun five months.

Enough Already With the “Amazon Effect”

Resale and Micro-Brands Are a Big Piece of the Retail Disruption Story

Let’s start with this SHAMELESS Law360 piece (paywall) which doubles as a promotional puff piece on behalf of the private equity industry. Therein a number of conflicted professionals go on record to say that private equity has taken far too much flack for the demise of retail. The piece is pure comedy…

To read the rest of this a$$-kicking commentary, you need to be a Member. 

Southeastern Grocers = Latest Bankrupt Grocer (Long Amazon/Walmart)

Another day, another bankrupt grocer.

Yesterday, March 27 2018, Southeastern Grocers LLC, the Jacksonville Florida-based parent company of grocery chains like Bi-Lo and Winn-Dixie, filed a prepackaged bankruptcy in the District of Delaware. This filing comes mere weeks after Tops Holding II Corporation, another grocer, filed for bankruptcy in the Southern District of New York. Brutal.

In its filing papers, Southeastern noted that, as part of the chapter 11 filing, it intends to "close 94 underperforming stores," "emerge from this process likely within the next 90 days," and "continue to thrive with 582 successful stores in operation." Just goes to show what you can do when you aren’t burdened by collective bargaining agreements. In contrast to Tops.

Also unlike Tops, this case appears to be fully consensual. It appears that all relevant parties in interest have agreed that the company will (i) de-lever its balance sheet by nearly $600 million in funded liability (subject to increase to a committed $1.125 billion and exclusive of the junior secured debt described below), (ii) cut its annual interest expense by approximately $40 million, and (iii) swap the unsecured noteholders' debt for equity. The private equity sponsor, Lone Star Funds, will see its existing equity interests cancelled but will maintain upside in the form of five-year warrants that, upon exercise, would amount to 5% of the company. 

Financially, the company wasn’t a total hot mess. For the year ended December 2017, the company reflected total revenues of approximately $9,875 million and a net loss of $139 million. Presumably the $40 million cut in interest expense and the shedding of the 94 underperforming stores will help the company return to break-even, if not profitability. If not - and, frankly, in this environment, it very well may be a big "if" - we may be seeing this trifecta of professionals (Weil, Evercore, FTI Consulting) administering another Chapter 22. You know: just like A&P. To help avoid this fate, the company has secured favorable in-bankruptcy terms from its largest creditor, C&S Wholesale Grocers, which obviates the need for a DIP credit facility. C&S has also committed to provide post-chapter 11 credit up to $125 million on a junior secured basis. 

Other large creditors include Coca-Cola ($KO) and Pepsi-Cola ($PEP). Given, however, that this is a prepackaged chapter 11, they are likely to paid in full. Indeed, a letter sent to suppliers indicates exactly that:

In addition to its over-levered capital structure, the company has a curious explanation for why it ended up in bankruptcy: 

"The food retail industry, including within the Company’s market areas in the southeastern United States, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national, and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company’s primary competitors include Publix Supermarkets, Inc., Walmart, Inc., Food Lion, LLC, Ingles Markets Inc., Kroger Co., and Amazon."

"Adding to this pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."

Sound familiar? Here is what Tops said when it filed for bankruptcy:

"The supermarket industry, including within the Company’s market areas in Upstate New York, Northern Pennsylvania, and Vermont, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company also faces intense competition from online retail giants such as Amazon."

"Adding to this competitive pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a competitive disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."

At least Weil is consistent: we wonder whether they pitch clients now on cost efficiencies they derive from just copying and pasting verbiage from one company's papers into another...? We also wonder whether the billable hours spent drafting the First Day Declaration here are less than they were in Tops. What's your guess? 

Anyway, there's more. No "First Day Declaration" is complete without a reference to Amazon ($AMZN). Here, though, the company also notes other competitive threats — including Walmart ($WMT). In "Tops, Toys, Amazon & Owning the Robots," we said the following,

In Bentonville, Arkansas some Walmart Inc. ($WMT) employee is sitting there thinking, “Why does Amazon always get the credit and free publicity? WTF.” 

Looks like Weil and the company noticed. And Walmart got their (destructive) credit. Go $WMT! 

Other causes for the company's chapter 11 include food deflation of approximately 1.3% ("a drastic difference from the twenty-year average of 2.2% inflation"), and reductions in the Supplemental Nutrition Assistance Program (aka food stamps). And Trump wasn’t even in office yet.

Finally, in addition to the store closures, the company proposes to sell 33 stores pursuant to certain lease sale agreements it executed prior to the bankruptcy filing. 

Will this mark the end of grocery bankruptcies for the near term or are there others laying in wait? Email us: petition@petition11.com.

The Fallacy of "There Must be One" Theory

Dick's Sporting Goods, Toys R Us, iHeartMedia, & Amazon

Ah, R.I.P. Toys R Us.

This week has undoubtedly been painful for employees, vendors, suppliers and fans of Toys R Us. The liquidation of the big box toy retailer is a failure of epic proportions; many creditors will be fighting over the carcass for months to come — both inside and outside of the United States; many employees now have two months to find a new gig; many suppliers need to figure out if and how they’ll be able to manage now that they’re exposure to unpaid receivables has increased. Good thing the company’s CEO is a man-of-the-people who can help cushion the blow.

Hardly. Enter CEO David Brandon and his shameless, out-of-touch attempts to cast blame onto outside parties: “The constituencies who have been beating us up for months will all live to regret what’s happening here.” Wait. Huh?!

TO READ THE REST OF THIS PIECE, YOU NEED TO BE A PETITION MEMBER. SIGN UP HERE.

America's Second-Largest Retailer is Closing Stores

Guest Post By Mitch Nolen (@mitchnolen)

Source: Kroger & Co. 

America’s largest supermarket operator is shrinking.

Kroger Co., the owner of over 20 grocery chains and other retailers, is closing supermarkets and jewelry stores, as well as selling hundreds of convenience stores, while simultaneously hitting the brakes on new openings that the company had already publicly announced.

It's a major U-turn for a serially acquisitive company that has become the nation's second-largest retailer, behind only Walmart in total U.S. sales. While cutting its store count, Kroger is prioritizing $9 billion in spending over three years on initiatives like splashy technology upgrades at its remaining stores.

The upheaval is just the latest in a grocery industry grappling with Amazon’s aggressive advances into its territory.

The Cincinnati-based retailer sold 762 convenience stores to British firm EG Group last month, is shutting an undisclosed number of jewelry stores and has shed net total of 13 jewelers in the first three quarters of 2017, and has closed or is closing at least 18 of its grocery stores since the start of the company's fourth quarter, a development one community leader describes as a “crisis.”

The supermarket closures are a departure for Kroger from recent years. Their store count grew in 2015 and 2016, and there was no store reduction in the final quarters of those years. Combined with the suspension of planned openings, and the company’s explanations, it becomes clearer that this isn't normal annual pruning.

Already in the first three quarters of Kroger's fiscal year that ended February 3, there's been a net closure of six grocery stores.

Kroger is suspending multiple — but not all — store openings and other major projects, such as store remodels, replacements and expansions.

A Kroger spokesperson declined to comment for this story, citing a quiet period before the company’s annual earnings report due out Thursday morning. However, in earlier statements made to local media, one representative said, “Company wide, the pace of construction has slowed down.”

Another official described a “shifting of capital expenditures in the short term from brick and mortar to focus on the customer experience in our existing stores, e-commerce and digital technology.”

The supermarkets that are shutting down are just a fraction of the more than 2,700 that Kroger operates, but any grocery store that closes has an impact on the neighborhood it served. Some closures are devastating.

Two supermarkets have closed in Peoria, Ill., a city once considered synonymous with Middle America. Kroger says neither store had been profitable in over 15 years. Two food deserts have been left in their stead.

“I am not exaggerating when I say we are now in a food crisis in this zip code, 61605,” says Peoria City Councilwoman Denise Moore. “That is one of the most hard-pressed zip codes in the country, let alone the state.”

“There is no supermarket in the entire district,” she adds, referring to her constituency that stretches along the Illinois River and cuts through Downtown Peoria. The district was home to Caterpillar Inc.’s corporate headquarters until earlier this year.

Moore worries about residents not only losing access to healthy food, but also to the store’s pharmacy and Western Union facility, where people without bank accounts can pay their bills.

The company is also shelving store expansions at two of Peoria’s other Krogers.

Another city, Memphis, was also hit by two Krogers closing. The city's mayor, Jim Strickland, took to Facebook to say he was “disappointed by Kroger's decision.”

In a potential reference to the predominantly African-American communities the stores served, he added that “these neighborhoods are no less important than any other neighborhoods in our city, and citizens who live there absolutely deserve access to a quality grocery store.”

The impetus for the closures may be financial, but residents have noticed the affected neighborhoods’ demographics.

In Peoria, one of the closed stores, on Wisconsin Ave., served a majority-minority neighborhood. The closest supermarket now is a Save-A-Lot discount grocer in a majority-white neighborhood two miles away. Walking there from the closed store would take 44 minutes, according to Google Maps.

The other Peoria Kroger sat just outside the edge of city limits, on a highway across from a predominantly black neighborhood where 36 percent of households and 83 percent of families with children under five live below the poverty line. The store is a mile and a half from the next-closest supermarket in a predominantly white neighborhood.

Kroger didn't respond to a Memphis news station that asked last month about an effort to boycott the company, but Kroger had previously stated that each closing store in the city had lost more than $2 million since 2014. The company similarly declined to respond for this story, citing the quiet period.

In other cities, Kroger is closing in different types of neighborhoods. One location, a concept store called Main & Vine, closed in a predominantly white neighborhood in suburban Seattle where the median household income is $82,000. The store went dark less than two years after it opened.

Kroger is said to be eyeing potential e-commerce acquisitions. Online bulk seller Boxed reportedly rejected a bid from Kroger, and the company was said in January to be considering an offer for Overstock.com. Kroger was also reported to be weighing a partnership with Alibaba, China's largest e-commerce site.

At its supermarkets, Kroger is rolling out a scan-as-you-shop system to 400 stores called “Scan, Bag, Go.” Available as a phone app or a dedicated handheld device, it will eventually let customers transact their own payments, too, so shoppers can just walk out with their items.

The sudden ramp-up of “Scan, Bag, Go” came after Amazon teased Amazon Go, Amazon’s newly opened convenience store with “just walk out” technology, which uses cameras and sensors to eliminate checkout lanes.

But just because retailers offer new technology doesn't mean shoppers will use it. Earlier pilots of grocery scanning apps failed to gain traction. And mobile payment systems like Apple Pay and the newly rebranded Google Pay aspire to be the future of commerce, but three years after they first launched, everyday usage remains stubbornly low, according to data from PYMNTS.com, an industry journal.

Kroger is also expanding its online grocery service, called ClickList, which is now available at over 1,000 of the company’s approximately 2,800 grocery stores. Amazon is rolling out free two-hour shipping for Prime members at Whole Foods.

Kroger-owned stores known to have closed or be closing since the start of the company's fourth quarter include:

Tucson, AZ: Fry’s at 3920 E Grant Rd.

Savannah, GA: Kroger at 14010 Abercorn St.

Peoria, IL: Kroger at 2321 N Wisconsin Ave.

Peoria, IL: Kroger at 3103 W Harmon Hwy.

Mitchell, IN: JayC at 1240 W Main St.

Jackson, MI: Kroger at 3021 E Michigan Ave.

Clarksdale, MS: Kroger at 870 S State St.

Charlotte, NC: Harris Teeter at 16405 Johnston Rd.

Columbus, OH: Kroger at 3353 Cleveland Ave.

Portland, OR: Fred Meyer at 5253 SE 82nd Ave.

Memphis, TN: Kroger at 1977 S 3rd St.

Memphis, TN: Kroger at 2269 Lamar Ave.

Brownwood, TX: Kroger at 302 N Main St.

Plano, TX: Kroger at 4836 W Park Blvd.

Gig Harbor, WA: Main & Vine at 5010 Point Fosdick Dr. NW

Cudahy, WI: Pick ’n Save at 5851 S Packard Ave.

1000 store closures have been announced in the past two weeks. Follow @mitchnolen to get updates and @Petition for news about disruption, generally.

Nine West & the Brand-Based DTC Megatrend

Digitally-Native Vertical Brands Strike Again

The Walking Company. Payless Shoesource. Aerosoles. The bankruptcy court dockets have been replete with third-party sellers of footwear with bursting brick-and-mortar footprints, high leverage, scant consumer data, old stodgy reputations and, realistically speaking, limited brand value. Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect “not a hell of a whole lot”.

Back in December, we snarked about Proctor & Gamble’s efforts to innovate around cheaper razors in the face of competition from digitally-native vertical brands like (now Unilever-owned) Dollar Shave Club and Harry’s. The struggle is real. Per the Financial Times,

In 2016, revenues of the large consumer good companies — from beer to soft drinks, food and household products — grew at their slowest rate since 2009, when the recession took hold. The 207 results for many of those companies that have reported remain weak.

A few weeks ago the Interactive Advertising Bureau released a new study entitled, “The Rise of the 21st Century Brand Economy.” It is well-worth perusing. In fact, we’re a bit late to the game here because we wanted to give it an earnest review. The upshot? Consumption habits are rapidly shifting away from third-party wholesalers like Nine West towards direct-to-consumer relationships. With nimble, oft-outsourced supply chains, DTC e-comm brands are stealing market share from consumer products manufacturers and distributors. In the aggregate, it’s creating real shocks. Some significant themes:

Economic benefits are accruing to firms that create value by tapping into low-barrier-to-entry, capital-flexible, leased or rented supply chains. These include thousands of small firms in all major consumer-facing categories that sell their own branded goods entirely or primarily through their owned-and-operated digital channels.

First-party data relationships are important not for their marketing value independent of other functions, but because they fuel all significant functions of the enterprise, including product development, customer value analysis, and pricing.

An arms race for first-party data is influencing strategy, investment, and marketing strategies among major incumbent brands across all categories.

The significance of these themes cannot be overstated. Putting some numbers around them:

In the razor category, Gillette’s share of the U.S. men's-razors business fell to 54% in 2016, from 70% in 2010. Almost all of that share has shifted to Dollar Shave Club, Harry’s, and several other digital primary sellers.

In pet food, subscription service The Farmers Dog is averaging 40-50% revenue growth monthly, in a U.S. pet food market projected up 4.4% in 2018.

Grocery store revenue growth is projected to be about 1 percent annually through 2022. Over that same period, the market for Meal Kits is expected to grow by a factor of 10x.

Amazon ($AMZN) has meal kits. Walmart ($WMT) just launched meal kits. Albertsons purchased Plated. Meanwhile, the bankruptcy courts have a laundry list of grocers on their dockets.

Saving the most relevant to Nine West for last,

Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.

Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages. Query whether this factor will be featured in Nine West’s First Day Declaration with such specificity. Likely not.

Retail Roundup (Some Surprising Results; More Closures)

Retail Remains in a State of Transition

• Macy’s ($M) reported earnings earlier this week and surprised to the upside - particularly with the news that its sales grew in the latest quarter (after 2.75 years of consistent decline). Most of the upside came from cost control measures (and the expansion of its off-price offering, Backstage). Likewise, Dillard’s.

• Toys R Us entered administration in the UK.

• Charlotte Russe earned itself what we would deem a “tentative” upgrade after consummating an out-of-court exchange transaction that delevered its balance sheet. S&P Global cautioned that it expects “liquidity to be tight” over the next 12 months.

• Chico’s FAS Inc. ($CHS) reported same store comp sales down 5.2% and indicated that it closed 41 net stores in 2017, including 14 net stores in Q4. Net income and EPS was higher.

• Foot Locker ($FL) intends to close net 70 stores in 2018 after closing net 53 stores in 2017.

• Kohl’s Corp. ($KSS) is becoming a de facto co-retailing location after first partnering with Amazon ($AMZN) and now Aldi.

• JCPenney ($JCP) announced that it is cutting full-time employees and increasing use of part-time employees instead. Total sales rose 1.8% but missed estimates. Comparable sales rose 2.6% and net income, ex-tax reform benefits, was down 6.6%.

• Office Depot ($ODP) reported comp store sales declines of 4% and total sales down 7%. It closed 63 stores, including 26 in Q4. Note that we’re not reporting net closures: the company didn’t open any stores.

• Supervalu may be shutting down 50 Farm Fresh Supermarkets in North Carolina and Virginia.

iHeartMedia 👎, Spotify 👍?

Channeling Alanis Morissette: In the Same Week that Spotify Marches Towards Public Listing, iHeartMedia Marches Towards Bankruptcy

In anticipation of its inevitable direct listing, we’d previously written about Spotify’s effect on the music industry. We now have more information about Spotify itself as the company finally filed papers to go public - an event that could happen within the month. Interestingly, the offering won’t provide fresh capital to the company; it will merely allow existing shareholders to liquidate holdings (Tencent, exempted, as it remains subject to a lockup). Here’s a TL;DR summary:

And here’s a more robust summary with some significant numbers:

• Revenue: Up 39% to €4.1 billion ($4.9 billion) in ‘17, ~€3 billion in ‘16 and €1.9 billion in ‘15. Gross margins are up to 21% from 16% in 2014 - and this is, in large part, thanks to renegotiated contracts with the three biggest music labels. Instead of paying 88 cents on every dollar of revenue, the company now only pays 79 cents. Only.

• Free Cash Flow: €109 million ($133 million) in ‘17 compared to €73 million in ‘16.

• Profit: 0. Net loss of €1.2 billion in ‘17, €539 million in ‘16, and €230 in ‘15.

• Funding: $1b in equity funding from Sony Music (5.7% stake), TCV (5.4%), Tiger Global (6.9%) and Tencent (7.5%). Notably, Tencent’s holdings emanate out of a transaction that converted venture debt held by TPG and Dragoneer into equity - debt which was a ticking time bomb. Presumably, those two shops still hold some equity as Spotify reports that it has no debt outstanding.

• Subscribership. 159 million MAUs and 71 million premium (read: paid) subscribers as of year end - purportedly double that of Apple Music. Services 61 countries.

• Available Cash. €1.5 billion

• Valuation. Maybe $6 billion? Maybe $23.4 billion? Who the eff knows.

For the chart junkies among you, ReCode aggregates some Spotify-provided data. And this Pitchfork piece sums up the ramifications for music fans and speculates on various additional revenue streams for the company, including hardware (to level the playing field with Apple ($AAPL) and Amazon ($AMZN)…right, good luck with that), data sales, and an independent Netflix-inspired record label. After all, original content eliminates those 79 cent royalties.

Still, per Bloomberg,

Spotify for a long time was a great product and a terrible business. Now thanks to its friends and antagonists in the music industry, Spotify's business looks not-terrible enough to be a viable public company. 

Zing! While this assessment may be true on the financials, the aggregation of 71 million premium members and 159 million MAUs is impressive on its face - as is the subscription and ad-based revenue stemming therefrom. Imagine the disruptive potential! Those users had to come from somewhere. Those ad-dollars too.

*****

Enter iHeartMedia Inc. ($IHRT), owner of 850 radio stations and the legacy billboard business of Clear Channel Communications. In 2008, two private equity firms, Bain Capital and Thomas H. Lee Partners, closed a $24 billion leveraged buyout of iHeartMedia, saddling the company with $20 billion of debt. Now its capital structure is a morass of different holders with allocations of term loans, asset-backed loans, and notes. The company skipped interest payments on three of those tranches recently. While investors aren’t getting paid, management is: the CEO, COO and GC just secured key employee incentive bonuses. Ah, distress, we love you. All of which will assuredly amount to prolonged drama in bankruptcy court. Wait? bankruptcy court? You betcha. This week, The Wall Street Journal and every other media outlet on the planet reported that the company is (FINALLY) preparing for bankruptcy. And maybe just in time to lend some solid publicity to the DJ Khaled-hosted 2018 iHeartRadio Music Awards on March 11.

For those outside of the restructuring space, we’ll spare you the details of a situation that has been marinating for longer than we can remember and boil this situation down to its simplest form: there’s a f*ck ton of debt. There are term lenders who will end up owning the majority of the company; there are unsecured lenders alleging that they should be on equal footing with said term lenders who, if unsuccessful in that argument, will own a small sliver of equity in the reorganized post-bankruptcy company; and then there is Bain Capital and Thomas H. Lee Partners who are holding out to preserve some of their original equity. Toss in a strategic partner like billionaire John Malone’s Liberty Media ($BATRA) - owner of SiriusXM Holdings ($SIRI), the largest satellite radio provider - and things can get even more interesting. Lots of big institutions fighting over percentage points that equate to millions upon millions of dollars. Not trivial. Would classifying this tale as anything other than a private equity + debt story be disingenuous? Not entirely.

*****

"It is telling when companies like Spotify hit the markets while more traditional players retrench. Like we've seen in retail, disruption is real and if you stand still and don't adapt, you'll be in trouble. It gets harder to compete when new entrants are delivering a great product at low cost." - Perry Mandarino, Head of Restructuring, B. Riley FBR.

Indeed, there is a disruption angle here too, of course. Private equity shops - though it may seem like it of late - don’t intentionally run companies into the ground. They hope that synergies and growth will allow a company to sustain its capital structure and position a company for a refinancing when debt matures. That all assumes, however, revenue to service the interest on the debt. On that point, back to Spotify’s F-1 filing:

When we launched our Service in 2008, music industry revenues had been in decline, with total global recorded music industry revenues falling from $23.8 billion in 1999 to $16.9 billion in 2008. Growth in piracy and digital distribution were disrupting the industry. People were listening to plenty of music, but the market needed a better way for artists to monetize their music and consumers needed a legal and simpler way to listen. We set out to reimagine the music industry and to provide a better way for both artists and consumers to benefit from the digital transformation of the music industry. Spotify was founded on the belief that music is universal and that streaming is a more robust and seamless access model that benefits both artists and music fans.

2008. The same year as the LBO. Guessing the private equity shops didn’t assume the rise of Spotify - and the $517 million of ad revenue it took in last year alone, up 40% from 2016 - into their models. Indeed, the millennial cohort - early adopters of streaming music - seem to be abandoning radio. From Nielsen:

Finally, Pop CHR is one of America’s largest formats. It ranks No. 1 nationwide in terms of total weekly listeners (69.8 million listeners aged 12+) and third in total audience share (7.6% for listeners 12+), behind only Country and News/Talk. In the PPM markets it leads all other formats in audience share among both Millennial listeners (18-to-34) and 25-54 year-olds. However, tune-in during the opening month of 2018 was the lowest on record for Pop CHR in PPM measurement, following the trends set in 2017, the lowest overall year for Pop CHR, particularly among Millennials. While CHR still has a substantial lead with Millennials (Country ranked second in January with 8.4%), it will be interesting to track the fortunes of Pop CHR as the year goes on, and music cycles and audience tastes continue to shift.

This is the hit radio audience share trend in pop contemporary:

And, consequently, radio ad revenues have essentially flattened. And if Spotify has its way, the “flattening” will veer downward:

With our Ad-Supported Service, we believe there is a large opportunity to grow Users and gain market share from traditional terrestrial radio. In the United States alone, traditional terrestrial radio is a $14 billion market, according to BIA/Kelsey. The total global radio advertising market is approximately $28 billion in revenue, according to Magna Global. With a more robust offering, more on-demand capabilities, and access to personalized playlists, we believe Spotify offers Users a significantly better alternative to linear broadcasting.

One company’s disruptive revenue-siphoning is another company’s bankruptcy. Now THAT’s “savage.”

---

PETITION LLC is a digital media company focused on disruption from the vantage point of the disrupted. We publish an a$$-kicking weekly Member briefing on Sunday mornings and a non-Member "Freemium" briefing on Wednesday. You can subscribe HERE and follow us on Twitter HERE.

Long "Peloton and Chill"?

GoPro Inc. ($GPRO), as we previously noted, is the poster child for the “hardware is hard” narrative. Look at this chart:

It’s brutal. Of course, there are obvious exceptions to the narrative. Apple($AAPL), for instance. Take a look at this chart:

Apple’s hardware division feeds a services division of other software products that grew 34% in 2017 and generated $34b. That’s massive. And that’s what makes Apple so special: it crushes margins and revenue on its hardware and tags on services revenue for good measure. It’s obvious, then, why Apple is marching towards a $1 trillion market capitalization.

Elsewhere in hardware, Peloton made big waves recently at the Consumer Electronics Show after it unveiled its $3,995 Peloton Tread, a new connected treadmill. It’s the first new Peloton product to market after its wildly popular and “cultish” $1,995 exercise bike came out a few years ago.And, no, those figures are not typos.

It is ironic that Peloton is expanding its product line right at the same time that GoPro is shrinking. Just a short time ago, GoPro’s growth prospects were predicated upon it moving away from pure hardware and pivoting towards “content” fed by an ever-expanding line of EXTREME new cameras and even EXTREMER drones. Fast forward a little more than a year and the new cameras are official flops, the drones are toast, and its content is nowhere to be found. Hardware is hard, sure, but pivoting into new (hardware) product and (expensive) content is too.

Meanwhile, Peloton ALSO maintains that it is more than just a hardware company; it is a hardware, software, media (read: content), and logistics company rolled into one. And, it seems, its gadgets are only a piece of the pie; its service is equally if not more important. Still, the core product, to date, has been the exercise bike. It is the vehicle for home-based live-streamed fitness workouts that cuts out the chafe of schlepping to the studio, sweating like a beast, showering, changing amidst strangers, and then walking back out into the cold to commute home. For this luxury, people pay handsomely. The numbers bear this out.

The company reported $170mm in sales in 2016 and $400mm in sales in 2017. In additional to the lofty hardware cost, people pay $39/month for the monthly service — just a little over the cost of one SoulCycle class. This monthly recurring revenue helps to offset the company’s breakeven cost on the hardware. Indeed, hardware is hard. But it’s made easier with 600,000 reported subscribers, a 95% retention rate, and a 90+ “Net Promoter Score.”Meanwhile, Peloton has funded its R&D with $450mm of venture capital at a valuation of $1.25 billion — the latest Series E round arranged by JPMorgan ($JPM)(as they make PAINFULLY clear in this video) and participated in by NBCUniversal, Fidelity Investments, and Kleiner Perkins Caufield & Byers, among others. Some suspect an IPO is near. Others — like Tristan Walker — suspect a sale (to Nike?). After all, Peloton is causing people to cancel their gym memberships. And sparking Twitter debates. And none of this really even speaks to the revenue to be generated from a hardware-independent app, branded apparel, and data.

Right, the data. Peloton founders make a point of saying that they WANT you to work out. Think about the difference between that and a gym. A gym doesn’t give a rat’s a$$ whether you use that membership. They just want you to sign up; they know that once they have you, they’ve got you because that membership is sticky AF. In fact, the LESS you go, the better…? That’s less maintenance at the location. Fewer towels to wash. Longer-lasting Kiehl’s product. And so forth. In contrast, Peloton is the best guilt-inducing machine on the planet; it sits right in your living room. With a (relatively) low monthly nut, it just sits there encouraging you to hop on and give it a whirl. Each time that you do, Peloton captures your data. The data makes Peloton a lot like Netflix. It can produce content based on what its users are doing. It has health specs now on 600,000 users. Do most gyms have content geared towards AND health data on you?

Peloton can also make its instructors stars in a way that Netflix can provide Gaten Matarazzo the opportunity to be in literally every commercial on TV. Distribution. Teach a few classes at Equinox a week to 100 riders, in the aggregate, or put yourself on Peloton’s platform and broadcast to 600k. And get paid more to boot. As “celebrity” instructors flock to Peloton, won’t that just juice the network effects further and encourage EVEN MORE people to flock to its platform? And with the treadmill, 51k future NYC marathoners can now get marathon coaching too. So, add a huge running community to the mix.

The disruptive implications of Peloton’s incursion into your home are immense. Look at the way they market: get up and ride before the kids even need breakfast. Who needs to deal with a gym membership when you can do THAT? Note, also, how the Tread is being billed as more than just a treadmill. The video demonstrates people getting off the apparatus, on to the floor for some weights, and back on the Tread. After a while, Peloton will no doubt distribute streaming videos from star trainers without the need for you to even hop on a multi-thousand dollar machine.

---

A few weeks ago, Hollywood released its numbers and they were ugly. Revenues down. Attendance down. Netflix ($NFLX), meanwhile, reported numbers on Monday and, with its addition of millions of subscribers, blew everyone away (and ascended into the $100b market cap stratosphere). In summary, millions more people opted to watch content at home YOY while millions of people opted to view fewer movies in the theater YOY. Now take a look at this third chart:

Now, what happens if Peloton owns home fitness like Netflix owns home entertainment? How does Equinox/SoulCycle do? New York Sports Club? Private-equity owned 24 Hour Fitness? Consider this: Dwayne Johnson has 318k Instagram followers. Half of his posts are photos and videos of him working out. How hasn’t Peloton nailed down a partnership with him? If people will watch other people play videogames on Amazon’s Twitch, and people will stream instructed classes on Peloton, there’s no doubt that they’d watch and mimic the Rock working out. Or Hugh Jackman beefing up to become Wolverine. Or Tom Hardy becoming Bane. Or Gerard Butler jacking up for 300. How hasn’t this happened yet? The sky is the limit.

Others have noticed. Namely, SoulCycle. It filed its S-1 years ago but, for now at least, still remains private. That is indicative of something, isn’t it? But, it, too, is evolving — in this case with different style classes. As is Classpass, which recently introduced ClassPass Live, live-streaming classes for home bodies. And, finally, Fitbit ($FIT), which continues to try anything to remain relevant. It is launching its partnership with Xbox One, making it easier for users to work out at home with its Coach training service. Clearly a number of players have identified the home as the next frontier in fitness. But Peloton may just have a very solid head start.

But here’s the thing: as readers read on Sunday, Guggenheim predicts a recession in late ’19 or early ’20. What happens when that downturn ultimately occurs? When disposable income and consumer confidence both go down? Who gets beat up more — Peloton or, say, SoulCycle? What happens to Peloton and its expensive hardware then? Do people start cancelling their monthly subscriptions? Alternatively, do people quit SoulCycle and migrate towards Peloton on the (arguable) basis that it’s a stronger value for the money? Or is Peloton’s customer demographic — seemingly the 1% — immune to a downturn? What happens, though, if the venture capital dries up? The company has had a tremendous amount of success but is it just a product of a frothy time? These are all important questions.

For now, though, the wind seems to be at Peloton’s back. And more conventional fitness players ought to be concerned. Just like with entertainment and Netflix, the fitness home invasion is happening. And there’ll be winners and losers.

---

PETITION is a digital media company focused on disruption from the vantage point of the disrupted. We have a kick-a$$ weekly newsletter. You can subscribe HERE and follow us on Twitter HERE.

The Quill decision (Short Wayfair)

You'll recall that, in September, we wrote about the disparity that exists in e-commerce taxation. In summary, e-commerce players have been able to avoid state taxation because of a lack of "physical presence." As we pointed out, Amazon ($AMZN) benefitted from this for years - at least until it decided that it wanted to conquer the "last mile." Did this help spark the #retailapocalypse? You betcha. But South Dakotans - all 3 of them - don't like to be effed with and so they're back in South Dakota v. Wayfair for a second bite at the apple in the Supreme Court. You legal bro-dorks may want to dust off your Commerce Clause know-how. This hyperbolic piece describes what's at stake, arguing that the SC's previous Quill decision ought to be fixed to accommodate technology and disruption. The briefers write, "Four negative effects of the physical presence requirement merit emphasis. First, the physical presence rule poses a much more serious threat to the fiscal stability of state and local governments than the Quill Court could have anticipated. Second, the rule results in economically inefficient consumption choices to an extent that the Quill Court could not have foreseen. Third, the physical presence rule distorts firms’ decisions about production, distribution, and corporate structure in ways that perversely discourage businesses from expanding across state lines. Fourth and finally, the physical presence rule likely raises the aggregate cost to consumers and businesses of complying with state sales and use tax laws." No wonder Overstock ($OSTK), which is also implicated, is shifting from e-commerce to bitcoin. 

Entertainment 3.0 (Short Hollywood, Long Subsidized Data Plays & Will Smith?)

More Data = More Crap Like "Bright" 

We've addressed algorithmic-based books and music, we might as well triple-down with movies. It's well known by now that Netflix ($NFLX) and Amazon ($AMZN) are using their respective data sets to develop new original projects. This circumvents the otherwise costly endeavor of licensing deals for outside content which, naturally, is fragmented in such a way that is costly to Netlfix/Amazon and frictionful in certain respects for the end user. Why is some content available internationally while other content is not? Why is certain content downloadable but other isn't? All of that has to do with "rights" for licensable content. 

This is precisely why we get "Bright," the new Will Smith vehicle that "feels like it was produced by an algorithm to fit in as many genres as possible (crime, fantasy, cops, etc.)." Netflix has said that 11mm people watched the movie in the first three days of release. At an average movie price of $8.90/ticket, that's the equivalent of nearly $98mm in revenue in three days. A sequel has been green-lit. This movie was an experiment dripping with data-based motivation and it seems to have worked. What does this portend for Hollywood?

Oh, Hollywood. This week we also learned that moviegoing has fallen to its lowest rate in a generation: theater admissions fell nearly 6% in 2017.  Choice quote, “'The industry should be concerned if the metric falls again in 2018,' said Geetha Ranganathan, a Bloomberg Intelligence analyst. 'Especially with a stronger film slate for this year, fewer moviegoers would be a warning sign that the industry may be in secular decline.'” Ruh Roh. 

And so should we really be surprised that there's a company out there now attempting to exploit data relating to Hollywood-produced theatrically-released movies? Enter Moviepass, a subscription-based business that lets movie-goers go to an unlimited amount of movies per month for only $9.95/month (subject to a one movie in 24 hours restriction). The movie theaters are like, "What the hell?" but consumers are like, "Sign me up!" 1 million of them. The movie theaters are like, "That's our data!" and Moviepass is like, "We don't care, go fly a kite home-slice." 

This Tren Griffin piece does a deep dive into the Moviepass business and leaves much to unpack. The piece is long but it provides some real insights into the movie theater business and the numbers are bleak. For theaters. For Moviepass. For basically everyone other than the moviegoers who ought to enjoy the Moviepass-subsidized movie-going while it lasts. And that probably includes malls - many of which are betting their futures on moviegoers seeking the moviegoing "experience." 

All of which would explain the recent waive of consolidation. In the past month alone, Cineworld Group Plc agreed to buy #2 U.S. movie chain Regal Entertainment Group for $3.6 billion. And Walt Disney Co. ($DIS) awaits approval of its proposed $52.4b acquisition of 21st Century Fox Inc., including the company’s movie studio. Content is king right now. It helps drive more data for more content. Yes, this is becoming very circular. 

And so back to Will Smith. Rumor has it that the actor famously performed a data-based analysis to determine how he could best catapult himself to stardom. Then came Independence Day. And Men in Black. Those movies weren't luck: they were strategy. Which is to say that if streamers are all about data, and Hollywood is (now) all about data, and actors are all about data, consumers probably ought to get used to movies like Bright. 

Entertainment (Short Book Stores, Long Myopic Groupthink & Algorithms)

Barnes & Noble May Follow Book World into Obsolescence

Book store sales are down 39% from a decade ago. Why? Well, avid PETITION readers know we love to discount the "Amazon Effect," generally, as most failed retail is more complicated and nuanced than that. Just ask the private equity bros. But books: that's a different story. Amazon ($AMZN) owns that sh*t. And so Book World, the nation's fourth largest physical book seller, is liquidating. And Barnes & Noble Inc. ($BKS) is slowly unraveling before our eyes. The book retailer reported holidays sales for the 9-week period ending 12/30/17 and MAN O' MAN were they crappy. Total sales were down 6.4%. At least they nailed e-commerce, right? Wrong. Online sales declined 4.5%. Comp store sales declined too, "primarily due to lower traffic." The book business declined 4.5%. And the stock collapsed 14+%. Ouch. Luckily there's some in-demand non-controversial political book out there that people are literally lining up to purchase. You know, that little one about @realdonaldtrump. Hopefully they can capitalize on that. 

Ironically, of course, Amazon has launched 15 physical book stores and they're a sight to behold. We checked in on one for the first time over the holidays and several things struck us. One, the footprint of the place was dramatically smaller than the typical, say, BKS, with reduced inventory to match. Two, the signage/placards emphasized the online reviews in lieu of prices. Third, most of the displays emphasized best sellers and wish list selections. You know, that old data play. There isn't much discovery there. Just a small selection of "popular" books force fed to the populace so that everyone can come to the very same conclusions from the very same books. Awesome.

Is Charming Charlie's Bankruptcy a Canary in the Coal Mine?

Chapter 11 Filing May be Warning Sign for "Treasure Hunt" Retailers

In its December 11 issue, Barron's noted the following (firewall): "Even the companies that look immune to the impact of the internet could be at risk. Consider off-price retailers like TJX ($TJX) and Ross Stores ($ROST). Bulls have argued that the experience of digging through the racks looking for buried treasure is something that can't be replicated online -- and that, they argue, puts them at an advantage to other retailers."Acknowledging some contrarians among the analyst ranks, Barron's continues "There may even come a day when the bargain-hunting experience loses its thrill. Already, companies are creating the technology that allows shoppers to have their measurements taken at home, and then create the clothes people want without having to search for it...." 

Enter Charming Charlie Holdings Inc. The company filed for bankruptcy earlier this week, capping a bloodbath of a year for retail. For the unfamiliar, Charming Charlie is a Houston-based specialty retailer focused on colorful fashion jewelry, handbags, apparel, gifts, and beauty products. It has 350 domestic stores and a core demographic of 35-55 year-old women. The company blamed (i) "adverse macro-trends" and (ii) operational shortfalls (e.g., merchandising miscalculations, lack of inventory, an overly broad vendor base) for its underperformance and reduced sales. EBITDA declined 75% "in the last several fiscal years." 75-effing-percent! With a limited amount of money available under its revolving credit facility and even less cash on hand, "Charming Charlie is out of cash to responsibly operate its business." Ouch. Two weeks before Christmas. Rough timing.

As it relates to "merchandising miscalculations," this bit caught our eye: "Historically, Charming Charlie utilized a sophisticated inventory system to position products according to their color and theme. Merchandise is offered in as many as 26 different hues and arranged at each store according to the item’s color and theme, creating what has been referred to as a “treasure hunt” experience. While this approach initially provided Charming Charlie with a strategic benefit, and engendered significant brand loyalty, it eventually caused Charming Charlie to be saddled with excess merchandise in underperforming color offerings." Curious. 

Long time PETITION readers know that we love to discuss what we call "busted narratives." Reminder: our focus is "disruption" and not necessarily "restructuring." And we'll acknowledge upfront that we may be cherrypicking one statement in an otherwise lengthy court document. But one ongoing narrative is that off-price "treasure hunt" retailers are safe from e-commerce. We're not so sure. It stands to reason that as things become more convenient at home - with 3D-printing, Amazon Echo Show, Amazon private label (see below), free returns, etc. - retailers will continue to focus more and more on inventory management. That is, if they have inventory at all. Obviously, direct-to-consumer is the not new retail trend and newer brick-and-mortar locations supporting the likes of Bonobos, Warby Parker, etc., are merely showrooms in furtherance of brand enhancement rather than inventory and supply chain management. Indeed, Charming Charlie announced that is reducing its vendor base down from 175 to 80. As inventories are more streamlined, that strikes us as an obvious headwind to discounted "treasure hunt" retailers. After all, they benefit from inefficient inventory management. And, notably, TJX had a relatively rough quarter recently. Now, TJX isn't filing for bankruptcy anytime soon, but query whether this is a trend to watch going forward. Query whether the "off price" narrative holds. 

Some other notes on Charming Charlie while we have your attention:

• The company has also commenced the closure of ~100 of its 370 stores (350 domestic + 20 international), a meaningful reduction in its brick-and-mortar footprint. Note some carefully crafted language, "The Debtors anticipate 276 go-forward locations following the first round of store closures." Key words, "FIRST ROUND." We wouldn't be shocked if the company shutters more. That depends on the landlords, it seems...
• ...and the landlords are getting squeezed too. The company seeks "to amend lease terms to reduce occupancy costs and obtain rent abatements for the first quarter of 2018...." As Starbucks ($SBUX) and Whole Foods ($AMZN) recently discovered, there's a big difference handling leases in vs. out of bankruptcy court.
• The fashion industry has suffered a 15% downturn in fashion jewelry sales and the company experienced a disproportionate 22% decline itself. Query whether the direct-to-consumer model is helping to disproportionately batter brick-and-mortar fashion jewelers.

Amazon's Disruptive Force...

...Is Industry & Asset-Class Agnostic

Scott Galloway likes to say that Amazon simply needs to make a simple product announcement and the market capitalization of an entire sector - of dozens of companies - can take a collective multi-billion dollar hit. On a seemingly weekly basis, his point plays out. Upon the announcement of the Whole Foods transaction, all of the major grocers got trounced. Upon news of Amazon building out its delivery infrastructure, United Parcel Service Inc. ($UPS) and FedEx Corporation ($FDX) got hammered. Upon news that Amazon was getting into meal kits, Blue Apron's ($APRN) stock plummeted. This week it was the pharma companies that got battered on the news that Amazon has been approved for wholesale pharmacy licenses in at least 12 states. It was a bloodbath. CVS Health ($CVS) ⬇️ . Walgreens Boots Alliance ($NAS) ⬇️ . Cardinal Health ($CAH) ⬇️ . Amerisource Bergen ($ABC) ⬇️ . Boom. (PETITION NOTE: obviously impervious - for now - are the ad duopolists, Alphabet Inc. ($GOOGL) and Facebook Inc. ($FB), both of which, despite news that Amazon did $1.12b in ad revenue this quarter, had massive bumps on Friday).* Luckily there isn't an ETF tracking doorman and home security services because if there were, that, too, would be down this week. 

What Galloway has never noted - to our knowledge, anyway - is the effect that Amazon's announcements have on the leveraged loan and bond markets. Remember that Sycamore Partners' purchase of Staples from earlier this year? You know...that measly $6.9b leveraged buyout? Yeah, well, that buyout was financed on the back of $1b of 8.5% unsecured notes (issued at par) and a $2.9b term loan.Ah...leverage. Anyway, investors who expected that the value of that paper would remain at par for longer than, say, 2 months, received an unpleasant surprise this week when Amazon announced its "Business Prime Shipping" segment. According to LCD News, the term loan and the notes traded down "sharply" on the news - each dropping several points. Looks like the "Amazon Effect" is biting investors in a variety of asset classes.

One last point: this is awesome. Maybe the future of malls really is inversely correlated to the future of (livable) warehouses. 

*Nevermind that Amazon's operating income declined 40% due to a 35% rise in operating expenses. Why, you ask, are operating expenses up? How else could Amazon be poised to have half of e-commerce sales this year?
 

Gearing Up for Auto Distress

Is Another Wave of Auto-Related Bankruptcy Around the Corner?

We take this break from your regularly scheduled dosage of retail failure-porn to introduce a topic we haven't addressed yet in detail: auto-related distress.

The auto narrative appears to change by the week depending on, uh, well, generally whatever Elon Musk says/tweets, so let's take a look at what's really been happening recently and filter out the hype (note: Tesla recently failed to deliver on production, lost key execs, and fired hundreds of people on Friday...draw your own conclusions...p.s. stock still going bananas): 

• Short Interest in Auto Parts Stocks. It has increased. This piece attributes this to Amazon's new foray into the car parts business. Is that really the reason why? 
• Sales. Car and light truck sales are trending downward. Auto loans that maybe - just maybe - jacked up sales are also on the decline. Mostly because default rates are going up. Here's a chart showing auto debt climbing as a share of household liability.
• Supply Chain Distress. Last year we saw DACCO Transmission Parts Inc. file for bankruptcy. During the Summer, Takata Inc. filed for bankruptcy (on account of a massive liability, but still) and Jack Cooper Enterprises Inc., a finished-vehicle logistics/transportation provider, reached a consensual agreement with its noteholders that kept the company out of bankruptcy court. For now. Then, a little over a week ago, GST Autoleather Inc. filed for bankruptcy, citing declining auto output. Is this the canary in the coal mine? Hard to say. Literally on the same day that GST filed for bankruptcy - again,citing declining auto output - General Motors, Ford and other OEMs reported the first YOY sales increase (10%), surprising to the upside. It seems, however, that the (sales) uptick may be artificial: in part, it's attributable to (a) Hurricane Harvey damage and mass vehicle replacement; and (b) heavy vehicle discounting. On a less positive note, Ford announced that it will beslashing billions in costs to shore up its financial condition; it also announced back in September that it would slash production at five of its plants. And General Motors Co. announced earlier this week that it would be idling a Detroit factory and cutting production. Production levels, generally, are projected to decline through 2021. Obviously, reduced production levels and idled plants portend poorly for a lot of players in the auto supply chain. 
• EV Manufacturing. There is increasing interest in investing in and developing the (electric) car of the future. And that includes major luxury car manufacturers like Mercedes-Benz and Audi. These manufacturers may just be putting the nail in the coffin for upstarts like Faraday Future, which barely seems like it can get off the ground.
• EV Manufacturing - Second Order Effects. Earlier this year we covered Benedict Evans' (now famous) piece on the second-order effects of the rise of electric and autonomous cars. Others, more recently, have been raising questions about what this electric-car future will look like. While others, still, are saying chill the eff out. We, rightfully questioned what would happen once electric cars gained greater traction given the relatively small number of components therein relative to the combustion engine vehicle. To point, Bloomberg writes, "After disassembling General Motors’s Chevrolet Bolt, UBS Group AG concluded it required almost no maintenance, with the electric motor having just three moving parts compared with 133 in a four-cylinder internal combustion engine." Whoa. That's a lot of dis-intermediated parts manufacturing. UBS also projects that electric vehicles will overtake gas and diesel cars by 2038 - with a rapid ramp up succeeding a slow build. 
• Charging Points. They've doubled in Germany and a plan is in place to get more super-chargers in place by 2020. Royal Dutch Shell announced on Thursday that it agreed to buy NewMotion, one of Europe's largest EV charging companies; it plans to deploy them at existing gas stations. All of this points to bullish views about EV adoption - worldwide. And we didn't even mention China, which is voraciously trying to curb emissions/pollution and go electric. 
• Increases. Range and prices. Anything that combats "range anxiety" will help adoption. Prices, however, still have to come down for electric cars to be competitive. 
• Derivative Distress. This was interesting: folks are concerned that autonomous cars may also mean the end of public radio. Will other players that benefit from captive car audiences, e.g., iHeartMedia Inc. and Sirius, also see effects? In all of iHeartMedia's discussions (see below), what are analysts assuming about the future of car ownership? About the rise of podcasts? 

To put the cherry on top, The Washington Post had a piece just this week asking whether 2017 will mark the end of the internal combustion engine. Once you add up all of the above? Well, it becomes clearer that restructuring professionals may have to re-acquaint themselves with auto distress strategies. Maybe that dude who was once the "gaming guy" who is now the "oil and gas guy" will have enough time to become the "auto guy."

How the Supreme Court Helped Amazon

THE LAW IS ALWAYS ONE STEP BEHIND

Since 2008 Walmart ($WMT) has paid 46x more in income tax than Amazon ($AMZN). That is a crazy stat and the link (source: Axios) is worth a read. But there's more to the Amazon tax story than that: it seems that the United States Supreme Court has contributed to the rise of Amazon and the rise of the "Amazon Effect." 

Here's the condensed version:

• In 1992, the Supreme Court ruled in favor of a mail-order vendor over the state of North Dakota in a dispute over the collection of sales taxes. The case was Quill Corp. v. North Dakota. Why? Taxing the vendor would "unduly burden interstate commerce." The Court ruled that taxation would only apply to retailers with a "physical presence" in states. 
• There's a ton of discussion about the "last mile" now - a reflection of just how much retail continues to evolve - but this ruling impacted corporate decisions in a big way for a long time: why locate a warehouse in the same state as the lion-share of customers and suffer a higher tax burden? 
• Amazon avoided having any fulfillment center in California FOR 17 YEARS to avoid sales taxes. Overstock ($OSTK) and Wayfair ($W) STILL limit their distribution centers for this reason. (Now Amazon collects in all 50 states.)
• The decision looks headed for re-evaluation. In what looks like a purposeful strategy to test the precedent, South Dakota lawmakers passed a law requiring businesses to collect state sales taxes on sales of goods over $100k - even if those businesses have no presence in SD. South Dakota's highest court held that the law violates Quill. 
• So what's next? Looks like the lawyers are primed to petition for certiorari to the Supreme Court with the hope of a reversal of Quill. A reversal could help take some cash off of corporate balance sheets (see chart below) and fill state coffers. This could help counter-balance state budget ills, including underfunded pensions (see below). On the flip side, it may stifle e-commerce startup growth which, in a stroke of irony, may actually benefit Amazon further. Don't hate the player, hate the game...or something.

Geoffrey is on the Ropes: Toys R' Us is in Trouble

Private Equity Backed Retail is in the Dumps

"No Reason to Exist" - Restructuring Banker

Big news this week was CNBC's report that Toys R' Us hired Kirkland & Ellis LLP to complement Lazard ($LAZ) in a potential restructuring transaction.* This was followed by an S&P downgrade (firewall). This is "Death by self-commoditization," someone said. Sure, that's part of it but the more obvious and immediate explanation is the $5+ billion of debt the company is carrying on its balance sheet (and the millions of dollars of annual interest payments). Which, naturally, quickly gets us to private equity: KKR ($KKR), Bain and Vornado Realty Trust ($VNO) own Toys R' Us and so some are quick to blame those PRIVATE EQUITY shops for YET ANOTHER retailer hitting the skids. Post-LBO, this company simply never could grow into its capital structure given (i) the power of the big box retailers (e.g., Walmart ($WMT) & Target ($TGT)) and (ii) headwinds confronting specialty brick-and-mortar retail today (yeah, yeah, blah, blah, Amazon). That said, the gravity of the near-term maturity, the company's current cash position, and the bond trading levels don't necessarily scream imminent bankruptcy. There must be more to this. Speculating here, but this could just be an international value grab. Alternatively, given the tremendous amount of blood in the (retail) waters, we're betting that suppliers are squeezing the company. Badly. Like very badly. And/or maybe the company is trying to scare its landlords into concessions. We mean, seriously, we're in September. And the company is talking about bankruptcy NOW? Mere months from peak (holiday) toy shopping? Strikes us as odd. Someone has an agenda here. 

On a positive note, we want to give the company some credit: it tried its best to control the narrative by releasing its list of must-have toys for the holidays on the same day the Kirkland news "leaked."

*For anyone taking notes, this is a genius stroke of business development by Lazard: pinpoint a potential distressed corporate candidate and then poach that company's Vice President of Corporate Finance. Power. Move. We dig it. 

Minimalistic Consumption by Inheritance

Much has been made about the death of retail and the "Amazon Effect." We mention it quite a bit in our awesome kick-a$$ weekly PETITION newsletters (which you can subscribe to here). 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.

Baby boomers are retiring in droves now and, along with retirement (and creaky knees), comes downsizing. Many are moving into retirement communities and ditching the two-story suburbian house they filled with decades worth of nonsense. As pointed out recently by the New York Times, millennials don't want a lot of their parents' hand-me-downs. So a lot of it is going to Goodwill. 

We expect this trend will continue for the short-term. That said, 90s clothing is back again and so it's only a matter of time before 60s and 70s vintage returns too. When that happens, those dumbass kids will regret turning away their parent's wares. 

Where is the Restructuring Work?

Strong Voices in Finance Are Raising the Alarm

We have some very exciting things planned for the Fall that we cannot wait to share with you. Until then, we'll be channeling our inner John Oliver and spending the rest of the summer researching and recharging. Oh, and structuring our imminent ICO in a way that (i) circumvents the SEC's recent decision noting that ICOs are securities offerings and (ii) gives all current PETITION subscribers a first look at participation. Don't know what we're talking about? For a crash course, read this, this, and this. The ICO stuff is BANANAS and, yes, we're TOTALLY KIDDING about doing one. We are not kidding, however, about our planned Summer break. We'll be back in September with the a$$-kicking curated weekly commentary you've come to know and love. In the meantime, please regularly check out our website petition11.com, our LinkedIn account, and our Twitter feed (@petition) for new content throughout August. 

But before we ride off to the Lake, a few thoughts (and a longer PETITION than usual)...

There has been a marked drop-off in meaningful bankruptcy filings the last several weeks and people are gettin' antsy. Where is the next wave going to come from? A few weeks ago, Bloomberg noted that there was a dearth of restructuring deal flow and a lot of (restructuring) mouths to feed. Bloomberg also reported that, given where bond prices/yields are, bank traders are so bored that they're filling their days by Tindering and video-gaming like bosses rather than...uh...trading. (You're not going to want to thumb-wrestle millennials.) These trends haven't stopped the likes of Ankura Consulting from announcing - seemingly on a daily basis - a new Managing Director or Senior Managing Director hire (misplaced optimism? Or a leading indicator?). No surprise, then, that financial advisors and bankers are whipping themselves into a frenzy in an attempt to complement Paul Weiss as advisors to a potential ad hoc group in Guitar Center Inc. (yes, people do buy guitars online on Amazon and, yes, $1.1b of debt is a lot given declining trends in guitar playing). Even the media is getting desperate: now the Financial Times is pontificating on the "short retail" trade (firewall; good charts within) that others have been discussing for a year or so. The internet is impacting shopping malls (firewall)? YOU DON"T SAY! Commercial mortgage delinquencies are rising (firewall)? NO WAY! We've gotten to the point that in addition to having nothing to do, no one actually has anything original to say. 

That is, almost no one. After all, there is always Howard Marks of Oaktree Capital Management, who, once again, demonstrates how much fun he must be at parties. Damn this was good. Looooong, but good. And you have to read it. Boiled down to its simplest form he's asking this very poignant question: what the f&*K is going on? Why? Well, because:
(i) we now see some of the highest equity valuations in history;
(ii) the VIX index is at an all-time low;
(iii) the trajectory of can't-lose stocks is staggering, see, e.g., FAANG (though, granted, Amazon ($AMZN) and Alphabet ($GOOGL) both got taken down a notch this week);
(iv) more than $1 trillion has moved into value-agnostic investing;
(v) we're seeing the lowest yields in history on low-rated bonds/loans (and cov lite is rampant again);
(vi) we're seeing even lower yields on emerging market debt;
(vii) there's gangbusters PE fundraising (PETITION NOTE: we'd add purchase price multiple expansion and, albeit on a much smaller scale, gangbusters VC fundraising);
(viii) there is the rise of the biggest fund of all time raised for levered tech investing (Softbank); and
(ix) bringing this full circle to where we started above, there are now "billions in digital currencies whose value has multiplied dramatically" - even taking into account a small pullback.

Maybe we really should consider an ICO after all. 

And then there's also Professor Scott Galloway. He, admittedly, looks at "softer metrics" and highlights various signals that show "we're about to get rocked" in this piece, a sample of which follows (read the whole thing: it's worth it...also the links): 

We don't think he's kidding, by the way. Anyway, we here at PETITION would add a few other considerations:

1. The Phillips Curve. Current macro trends countervail conventional thinking about the relationship between unemployment and inflation/wages (when former down, the latter should be up...it's not);
2. The FED. Nobody, and we mean NOBODY, knows what will happen once the FED earnestly begins cleansing its balance sheet and raising rates; 
3. (Potentially) Fraudulent Nonsense Always Happens Near the Top. SeeHampton Creek. See Theranos. See Exxon ($XOM). See Caterpillar ($CAT). See Martin Shkreli. And note worries about Non-GAAP earnings;
4. Auto loans. Delinquencies are on the rise; and
5. Student loans. Delinquencies are on the rise.

We're not even going to mention the dumpster fire that is Washington DC these days (random aside: is anyone actually watching House of Cards or is reality enough?). 

And, finally, not to steal anyone's thunder but one avid biglaw reader added that a telltale sign of an imminent downturn is the rise of biglaw associate salaries. Haha. At least there are wage increases SOMEWHERE.

All of the above notwithstanding, even Marks cautions against calling an imminent downturn admitting, upfront and often, how he has been premature in the past. That said, nobody saw oil going from $110 to $30 as quickly as it did either. So he's right to be highlighting these issues now. At a minimum, it ought to give investors a lot of pause. And, perversely, this all ought to give restructuring professionals a little bit of hope for what may lay ahead for '18 and '19. 

Have a fun and safe rest of Summer, everyone. Don't miss us too much.

How Many Companies Will Amazon Bankrupt?

Grocery (Short EVERYTHING). So much to unpack in grocery world this past week so here is a brief summary for you: WholeFoods ($WFN) CEO John Mackey called Jana Partners greedy bastards; food deflation trends continued albeit at a markedly slower rate which means that someone wickedly smart may just be timing grocery at a time when it starts benefiting from inflation (imagine that); a Nomura Instinet analyst said - on Thursday - that Amazon ($AMZN) will next disrupt the grocery space (weeks after Scott Galloway predicted something big in grocery); Wegman's announced same day delivery via partnership with Instacart; Kroger ($KR) announced its numbers won't meet guidance and the stock, already down 14% on the year, dipped another 20% (only to fall more a day later on this...); Amazon dropped an atomic bomb on everyone and initiated a $13.7b play for Wholefoods making those greedy bastards pretty damn happy bastards (and sending stocks of everyone else - including Kroger - into even more of a tailspin); people then got busy questioning the viability of Instacart (the goodwill from the Wegman's news instantly evaporated) and BlueApron and Hello Fresh and Costco ($COST) and, well, we could go on and on but suffice it to say that if the food-oriented company was private it will likely stay private longer and if its public then its stock got decimated (including big boxes like Target ($TGT) and Walmart ($WMT)). And we were really beginning to warm to the "How to Beat Amazon" think pieces that have been making the rounds. The real question is: how many bankruptcies in 2018 will mention Amazon as one of the reasons why...?