😴Mattress Firm's Nightmare😴

Mattress Firm May File for Bankruptcy (Long Cardboard Box Manufacturers)

Source: PETITION LLC

⚡️Nerd alert: we need to lay a little foundation here.⚡️

For the uninitiated, a First Day Declaration (“FDD”) typically accompanies a chapter 11 petition when a debtor-company files for bankruptcy. The FDD is the first opportunity for a representative of a chapter 11 debtor to sell a particular narrative to the Bankruptcy Judge and other parties in interest; it sets the tone for the company’s “first day hearing,” which is the first formal appearance the company makes in bankruptcy court (typically within 24-48 hours after filing for chapter 11). The FDD is a descriptive document that often spells out the what, why and when of a company’s demise. Nearly all FDDs follow the same format: they (i) provide some color about the declarant, (ii) describe the history and nature of a business, (iii) delineate the capital structure, (iv) outline the events leading to bankruptcy, (iv) articulate the hopes for the bankruptcy case, and (v) summarize the relief sought on the first day. Lawyers often request that the FDD be admitted into the record at the first day hearing (subject to cross examination of the declarant).

Frustratingly, lawyers also often seem compelled to regurgitate the FDD once at the podium at the hearing. This is typically the role of the senior most partner on the matter, i.e., the person who — as it relates to certain firms — probably knows the least about the company, why it’s in bankruptcy and how the hell its going to grind its way out of it. We’re not entirely sure why they feel the need to do this: the judge has presumably read the papers. Perhaps they feel it’s necessary to repeat the narrative to set the tone for the case and establish credibility (more important in controversial cases than in uncontested hearings); perhaps they just like hearing themselves speak; or — the most likely justification — perhaps they bill by the hour and need to justify their (a) existence, (b) exorbitantly high billing rate and/or (c) first billing on the case caption. Maybe it’s all of the above. In any event, this custom is exactly the opposite of what lawyers are taught in law school: be concise and to the point.

We often like to imagine what the FDD would look like in certain situations. Long time PETITION readers may recall our mock FDD for Remington Outdoor Company. Well, we’re at it again. This time for Mattress Firm Holding Corp. Hopefully this will spare the estate some expenses.

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💰Goldman Sachs Has its Cake and Eats it Too💰

Short GNC Holdings Inc. Long Care/of. 

We’ve written extensively here, here, here and here about GNC Holdings Inc. ($GNC) and the challenges that the company faces. We won’t revisit all of that here other than to note that GNC was, upon information and belief, preparing for a bankruptcy filing prior to it amending and extending its term loan, entering into a new ABL, and obtaining $275mm of asset-backed FILO term loans. We quipped that this was the quintessential “kick-the-can-down-the-road” transaction. Goldman Sachs ($GS) advised the company on the entire capital structure fix. Suffice it to say, then, that Goldman Sachs is intimately familiar with the GNC business.

Which, naturally, makes the fact that Goldman Sachs Investment Partners (a division of Goldman Sachs Asset Management) served as the lead investor in vitamin startup Care/of’s Series B financing all the more interesting.

Now, of course, we know Goldman is a big shop. They’re probably talking to WeWorkabout how to design their spaces to balance the sheer volume of “Chinese walls” with the need for an aesthetic that appeals to the millennial mindset. And, surely, Goldman Sachs’ capital advisory arm is entirely different and separate from Goldman’s asset management and venture arm.

But still.

Earlier this week Care/of, a direct-to-consumer wellness brand that specializes in monthly subscriptions of personalized vitamins and supplements, announced the new round of $29mm. In addition to Goldman, investors included Goodwater Capital, Juxtapose, RRE Ventures and Tusk Ventures. Former President of GNC, Beth Kaplan, also invested and will be joining the Board. 🤔

Bloomberg notes:

Care/of, a startup selling vitamins and herbal supplements online, raised funds from investors including Goldman Sachs Group Inc.’s venture arm that value the company at $156 million, within striking distance of publicly traded retail chains that are among the industry’s leaders.

The startup’s $156 million valuation isn’t far from Vitamin Shoppe Inc., with 3,860 employees and a market capitalization of about $203.5 million, or GNC Holdings Inc., which has a market value of $254.2 million with 6,400 employees. Care/of has about 100 workers, Chief Executive Officer Craig Elbert said.

“Consumers are increasingly shifting spend online and so I think large retail footprints have the potential to be a liability,” Elbert said in an interview. “There’s a lot of growth ahead of us and lot of reasons why this should be an e-commerce business.”

This is so Goldman-y. Collect an advisory fee to extend the life of the dominant brick-and-mortar retailer with one hand while investing in a nimble direct-to-consumer upstart that will chip away on that very same retailer on the other hand. Even before the former requires capital markets advice from a Goldman-type in a few years — which, it undoubtedly will — it may be on the lookout for an M&A banker. Perhaps to sell itself. Perhaps to buy a start-up and build a moat against Amazon. How convenient that Goldman will have familiarity with both businesses. We’d say that maybe there’d be a conflict somewhere in there but, well…do those really even exist anymore??

🛋There's Disruption Afoot in the Furniture Space🛋

Add Furniture to the List of Disrupted Categories (Home Heritage Group Inc. Filed for Bankruptcy)

“New Chapter 11 Filing!” Or is it technically a Chapter 22? 🤔

We know what you’re thinking. You’re thinking “this filed a few days ago and I’ve already read all about it.” You may have read something about it, but not like this. Bear with us…

Home Heritage Group Inc. (“HHG”) is a North Carolina-based designer and manufacturer of home furnishings; it sells product via (i) retail stores, (ii) interior design partners, (iii) multi-line/independent retailers, and (iv) mass merchant stores.” In addition, the company has an international wholesale business.

Why do we mention Chapter 22? For the uninitiated, Chapter 22 in bankruptcy doesn’t actually exist. It is a somewhat snarky term to describe companies that have round-tripped back into chapter 11 after a previous stint in bankruptcy court. That, to some degree, is the case here.

WAAAAAAAY back in November 2013, KPS Capital Partners LP formed the newly bankrupt HHG entity to acquire a brand portfolio and related assets out of the bankruptcy estate of Furniture Brands International Inc. (“FBI”). FBI had been, in the early 2000s, a very successful purveyor of various furniture brands — to the tune of $2b in annual sales. But in the 12 months prior to the acquisition, the company’s sales were down to $940mm and, more importantly, its EBITDA was negative $58mm. At the time of filing, it had $142mm in total funded debt outstanding, $200mm in unfunded pension obligations and another $100mm in general trade obligations.

Given this debt, a decline in sales at the time was devastating. The company noted in its court filings on September 9, 2013 (Docket #16):

As a manufacturer and retail of home furnishings, Furniture Brands’ operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Economic conditions deteriorated significantly in the United States and worldwide in recent years as part of a global financial crisis. Although the general economy has begun to recover, sales of residential furniture remain depressed due to wavering consumer confidence and several, ongoing global economic factors that have negatively impacted consumers’ discretionary spending. These ongoing factors include lower home values, prolonged foreclosure activity throughout the country, a weak market for home sales, continued high levels of unemployment, and reduced access to consumer credit. These conditions have resulted in a decline in Furniture Brands’ sales, earnings and liquidity.

Sales have continued to be depressed as a result of a sluggish recovery in the U.S. economy, continuing high unemployment, depressed housing prices, tight consumer lending practices, the reluctance of some households to use available credit for big ticket purchases including furniture, and continuing volatility in the retail market.

PETITION Note: My, how things have changed. Just reflect on that synopsis of the economy a mere five years ago. The company also noted that:

…some of the Company’s larger brands have lost some of their market share primarily due to competition from suppliers who are able to produce similar products at lower costs. The residential furniture industry is highly competitive and fragmented. Furniture Brands competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own store-branded products.

All of these factors stormed together to constrain the company’s liquidity and force a chapter 11 filing and eventual sale. KPS purchased several of the FBI brands for $280mm (subject to working capital adjustments), including Thomasville, Broyhill, Lane, Drexel Heritage, Henredon, Pearson, Hickory Chair, Lane Venture, and Maitland-Smith. In other words: brands that your grandfather would know and you would shrug at the mere mention of. Well, some of you anyway.

Fast forward five years and the successor entity HHG has $280mm of debt and…you guessed it…severe liquidity constraints. In its first day filing papers, HHG notes that the previous bankruptcy continues to have lasting effects on its business; it highlights:

Following years of sales declines, many furniture retailers had lost faith in the ability of the Company to produce, deliver, and service its products, and the bankruptcy led many of them to shift their purchases to a variety of competitors or even further utilize their own private label offerings.

This is what people still nostalgically refer to as “bankruptcy stigma.” Indeed, it still exists. The company continued:

In addition, the Company’s operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Although economic conditions have been steadily improving in recent years, the Debtors have struggled to adjust to certain shifts in consumer lifestyles, which include: (i) lower home-ownership levels and more people renting; (ii) more apartment living and single-person households; (iii) older consumers that want to age in place; and (iv) cash-strapped millennials that are slow in forming households relative to prior generations.

Haha! The poor millennials. Apparently an entire generation is “cash-strapped” and prefers to sleep in a tent under their WeWork desks. Blame the avocado toast and turmeric lattes. But, wait, there’s more:

Consumer browsing and buying practices are rapidly shifting as well toward greater use of social media, internet- and app-based catalogs and e-commerce platforms, and the Company has been unable to develop a substantial sales base for its brands through this key growth channel.

Furthermore, the residential furniture industry is highly competitive and fragmented. The Company competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own private label products. This competitive landscape has proved challenging for some of the Company’s larger brands as well-capitalized competitors continue to gain market share at the expense of the Debtors. (emphasis added)

PETITION Note: My, how things have remained the same. Sound familiar? Have to hand it to the professionals here: why reinvent the wheel when you can just crib from the prior filing? We guess being a repeat customer in bankruptcy has its benefits!! Chapter 22!!!

<p>Meanwhile a short digression relevant to those last two quoted paragraphs. According to Statista, worldwide online furniture and homewares sales are expected to be close to $190 billion. Take a look at this chart:

RetailDive notes:

E-commerce furniture sales have emerged as a major growth area, rising 18% in 2015, second only to grocery, according to research from Barclays.

Accordingly, GartnerL2 cautions that:

…home brands now have an outsized onus to produce best-in-class product pages for the influx of online shoppers. However, many brands have failed to deliver and aren’t keeping pace with industry disruptors.

Sounds like HHG has, admittedly, fallen into this category.

GartnerL2 highlights the disparate user experiences offered by Williams-Sonoma-owned West Elm and Chicago-based DTC disruptor Interior Define, which was founded in 2013 and has raised $27mm in funding (most recently a Series B in March). The latter offers extensive imagery, a visual guide and an augmented reality mobile app. All of these things appeal to the more-tech-savvy (non-cash-strapped??) millennial buyer.

And that is precisely the demographic that La-Z-Boy Incorporated ($LZB) is going after with its purchase of Joybird, a California-based direct-to-consumer e-commerce retailer and manufacturer of upholstered furniture. Founded in 2014, its $55mm in reported revenue last year took a chunk out of, well, someone. Other players in that space include Burrow ($19.2mm in total funding; most recent Series A in March from New Enterprise Associates) and, of course, Amazon’s in-house furniture brands, Rivet and Stone & Beam. <p><end>

All of these factors resulted in continual YOY declines in sales and a liquidity squeeze. Now, therefore, the company is in bankruptcy to effectuate a sale — or sales — of its brands to prospective bidders. It has one purchaser in line for the “Luxury Group” and, according to the court filing, appears close to an agreement with a stalking horse buyer of the Broyhill and Thomasville & Co. properties. In the meantime, the company has a commitment from prepetition lender PNC Bank NA for a $98mm DIP, of which $25mm Judge Gross granted on an interim basis.

Restaurants, Co-Cooking & Delivery. The Future is Now.

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#BustedIPO: Tintri Inc. Files for Bankruptcy

What is the statute of limitations for declaring an IPO busted?

We previously wrote about Tintri Inc. ($TNTR) here and, frankly, there isn’t much to add other than the fact that company has, indeed, filed for bankruptcy. The filing is predicated upon a proposed 363 sale of the company’s assets as a “going concern” or a liquidation of the company’s intellectual property in what should be a fairly short stint in bankruptcy court. Shareholders likely to be wiped out include New Enterprise Associates (yes, the same firm mentioned above in the Tamara Mellon bit), Insight Venture Partners, Lightspeed Venture Partners and Silver Lake Kraftwerk.

Meanwhile, in the above-cited piece we also wrote:

Nothing like a $7 launch, a slight post-IPO uptick, and then a crash and burn. This should be a warning sign for anyone taking a look at Domo — another company that looks like it is exploring an IPO for liquidity to stay afloat.

This bit about Tintri''s financial position offers up an explanation for the bankruptcy filing -- in turn serving as a cautionary tale for investors in IPOs of companies that have massive burn rates:

"The company's revenue increased from $86 million in fiscal 2016 to $125.1 million in fiscal 2017, and to $125.9 million in fiscal 2018, representing year-over-year growth of 45% and 1 %, respectively. The company's net loss was $101.0 million, $105.8 million, and $157.7 million in fiscal 2016, 2017, and 2018, respectively. Total assets decreased from $158.1 million as of the end of fiscal 2016 to $104.9 million as of the end of fiscal 2017, and to $76.2 million as of the end of fiscal 2018, representing year-over-year change of 34% and 27%, respectively. The company attributed flat revenue growth in fiscal 2018 in part due to delayed and reduced purchases of products as a result of customer concerns about Tintri's financial condition, as well as a shift in its product mix toward lower-priced products, offset somewhat by increased support and maintenance revenue from its growing installed customer base. Ultimately, the company's sales levels have not experienced a level of growth sufficient to address its cash burn rate and sustain its business."

With trends like those, it's no surprise that the IPO generated less capital than the company expected. More from the company:

"Tintri's orders for new products declined, it lost a few key customers and, consequently, its declining revenues led to the company's difficulties in meeting day-to-day expenses, as well as long-term debt obligations. A few months after its IPO, in December 2017, Tintri announced that it was in the process of considering strategic options and had retained investment bank advisors to assist it in this process."

As we previously noted a few weeks ago, "[t]here's no way any strategic buyer agrees to buy this thing without a 363 comfort order."  With Triplepoint Capital LLC agreeing to provide a $5.4mm DIP credit facility, this is precisely the path the company seeks to take.

*****

Meanwhile, Domo Inc. ($DOMO) is a Utah-based computer software company that recently IPO’d. Per Spark Capital’s Alex Clayton:

Domo recently drew down $100M from their credit facility and currently only has ~6 months of cash left with their current burn rate. Given they raised $730M in equity capital from investors and another $100M through their credit facility, it implies they have spent roughly $750M over the past 8 years to reach a little over $100M in ARR, an extraordinary and unprecedented amount of cash burn for a SaaS company. They have $72M in cash.

That was before the IPO. This is after the IPO:

Draw your own conclusions.

Direct-to-Consumer Retail Gets Big Funding

Away, Hims & Parachute All Get Growth Capital

This week was a big financing week for startups. In addition to the Pillpack purchase noted above, there was a ton of action in the direct-to-consumer consumer products space that should definitely have incumbents concerned.

Away, the NY-based “thoughtful” startup that makes travel products that “solve real travel problems” raised $50mm in fresh Series C funding from prior investors Forerunner Ventures, Global Founders Capital and Comcast Ventures. The company intends to use the funds to tap into global markets, expand its product line and continue its clicks-to-bricks initiative with six new retail stores in the second half of 2018. The company recently moved its headquarters within New York City in part thanks to a $4mm Empire State Development performance-based tax credit through the Excelsior Jobs Program.

Hims, the one-year old SF-based company that sells men’s prescription hair and sex products, raised $50mm in Series B-2 funding at a $400mm post-money valuation. Investors include IVP, Founders Fund, Cavu Venture Partners, Thrive Capital, Redpoint Ventures, Forerunner Ventures (notice a pattern here?), and SV Angel.

Earlier this year, beauty products maker Glossier raised $52mm in Series C funding (and subsequently added Katrina Lake from Stitch Fix to its board of directors), shaving company Harry’s raised $112mm in Series D funding, and athleisure brand Outdoor Voices raised $32mm.

But, wait. There’s more: here, there are a variety of startups going after your kitchenware and your bed. Parachute announced this week that it raised $30 million in Series C funding led by H.I.G. Growth Partners. Other investors include Upfront Ventures, Susa Ventures, Suffolk Equity, JAWS Ventures, Grace Beauty Capital and Daher Capital. With three stores currently, the company intends to take the funding to, like Away, expand its clicks-to-bricks plan with 20 more locations in the next 2 years.

Meanwhile, mattress e-tailer Purple is (strangely) doubling-down on its relationship with Steinhoff-owned Mattress Firm, the struggling bed B&M retailer. The tie-up now includes Mattress Firm locations in Sacramento, Austin, DC, Chicago and SF. We hope Purple has baked in bankruptcy protections into its deal agreements so that there’s not question as to ownership.

If you don’t think all of this has incumbent CPG executives worried, you’re not paying close enough attention.

Not to mention the private equity bros:

More from Ryan Caldbeck’s interesting thread here.

Slight tangent: note that nowhere is there any mention of disruption from consumer product subscription boxes.

🔥Amazon is a Beast🔥

The "Amazon Effect" Takes More Victims

Scott Galloway likes to say that mere announcements from Amazon Inc. ($AMZN) can result in billions of dollars of wiped-out market capitalization. Upon this week’s announcement that Amazon has purchased Boston-based online pharmacy startup Pillpack for $1 billion — beating out Walmart ($WMT) in the process — his statement proved correct. Check this out:

We like to make fun of the Amazon narrative because we’re of the view that it’s overplayed — particularly in restructuring circles — and reflects a failure to understand broader macro trends (like the direct-to-consumer invasion noted below). Still, the market reaction to this purchase reflects the undeniable power of the “Amazon Effect” and we’d be remiss not to acknowledge as much. This purchase will likely be a turning point for pharmacies for sure; perhaps also, farther down the line, for benefits managers and pharmaceutical manufacturers. It also may provide Amazon with meaningful cross-pollination opportunities with its payments business — a subject that nobody seems to be talking about (more on this below).

Putting aside the losers for now, there are a variety of winners. First, obviously, are Pillpack’s founders, TJ Parker and Elliot Cohen. They stand to make a ton of money. Also its investors — Accel Partners, Atlas Venture, CRV, Founder Collective, Menlo Ventures, Sherpa Ventures and Techstars — at an 8x return, at least. Oh, and Nas apparently. And then there is Amazon itself. Pillpack isn’t a massive revenue generator ($100mm in ‘17) and it isn’t a big company (1k employees) but it packs a big punch: licenses to ship drugs in 50 sates. With this purchase, Amazon just hurdled over a significant regulatory quagmire.

So what is Pillpack? Per Wired (by way of Ben Thompson):

PillPack is trying to solve the problem of drug adherence by simplifying your medicine cabinet. Medication arrives in the mail presorted into clear plastic packets, each marked in a large font with vital information: day, time, pills inside, dosages. These are ordered chronologically in a roll that slots into the dispenser. Let’s say you need to take four different pills in the morning and two others in the afternoon every day: Those pills would be sorted into two tear-off packets: one marked 8am, followed immediately by the 2pm packet.

Put another way, Pillpack specializes in the convenience of getting you your medications directly with a design and user-experience focus to boot. The latter helps ensure that you’re taking the proper levels of medication at the right time.

Still, there are some limitations. Per The Wall Street Journal:

Amazon will be limited in what it can do, especially to start. PillPack’s specialty—packaging a month’s supply of pills for chronic-disease patients—is a small part of the overall market. It has said it has tens of thousands of customers versus Amazon’s hundreds of millions.

Current limitations notwithstanding, Thompson notes how much Pillpack’s service aligns with Amazon:

Amazon, particularly for Prime customers, is seeking to be the retailer of habit. That is, just as a chronic condition patient may need to order drugs every month, Amazon wants to be the source of monthly purchases of household supplies, and anything else one might want to buy along the way.

Like all aggregators, Amazon wins by providing a superior user experience, particularly when it comes to delivering the efficient frontier of price and selection. To that end, moving into pharmaceuticals via a company predicated on delivering a superior user experience makes total sense.

Thompson notes further:

The benefit Amazon will provide to PillPack, on the other hand, is primarily about dramatically decreasing the customer acquisition costs for a solution that is far better for consumers; to put it another way, Amazon will make a whole lot more people aware of a much more customer-friendly solution. Frankly, I have a hard time seeing why that is problematic.

To be sure, Amazon will benefit beyond its unique ability to supercharge PillPack’s customer acquisition numbers: just as Walgreen and CVS’s pharmacies draw customers to their traditional retail stores, PillPack’s focus on regular ordering fits in well with Amazon’s desire to be at the center of its customers day-to-day lives. This works in two directions: first, that Amazon now has a direct connection to a an ongoing transaction, and second, that would-be Amazon customers are dissuaded from visiting a retail pharmacy and, inevitably, buying something else along the way. This was a point I made in Amazon’s New Customer:

This, though, is why groceries is a strategic hole: not only is it the largest retail category, it is the most persistent opportunity for other retailers to gain access to Prime members and remind them there are alternatives.

A similar argument could be made for prescription drugs: their acquisition is one of the most consistent and predictable ways by which potential customers exist outside of the Amazon ecosystem. It makes a lot of sense for Amazon to reduce the inclination to ever go elsewhere.

It seems that Amazon is doing that lately for virtually everything. Consistently, further expansion beyond just chronic-disease patients seems inevitable. Margin exists elsewhere in the medical chain too and, well, Jeff Bezos once famously said “Your margin is my opportunity.” David Frankel of Founder Collective writes:

The story of the last five years has been that of bricks and mortar retailers frantically trying to play catch-up with Amazon. By acquiring PillPack, Amazon is now firmly attacking another quarter trillion dollars of TAM. Bezos is a tenacious competitor and has just added the most compelling consumer pharmacy to enter the game since CVS was founded in 1963.

TJ Parker understands the pharma business in his bones, has impeccable product sensibilities, and now has the backing of the most successful retail entrepreneur in history.

Expect some real healthcare reform ahead.

No wonder those stocks all sh*t the bed. That all sounds downright horrifying for those on the receiving end.

*****

Recall weeks back when we noted this slide in Mary Meeker’s “Internet Trends” presentation:

Healthcare spending continues to rise which, no doubt, includes the cost of medication — a hot button issue of price that even Donald Trump and Hillary Clinton have agreed on. This purchase dovetails nicely with Amazon’s overall health ambitions. Per the New York Times:

But Mr. Buck and others said Amazon might have a new opportunity. A growing number of Americans are without health insurance or have such high deductibles that they may be better off bargain shopping on their own. He estimated that 25 million Americans fell into that category.

Until now, he said, PillPack has not aggressively competed on price. With Amazon in charge, “how about they start posting prices that are really, really aggressive?” Mr. Buck said.

As Pillpack increases its scale, Amazon will be able to exert more leverage in the space. This could have the affect of compressing (certain) pharmaceutical prices. To get there, Amazon will undoubtedly seize the opportunity to subsume Pillpack/pharma into Amazon Prime, providing Members discounts on medicine much like it provides Whole Foods shoppers discounts on bananas.

There is other opportunity to expand the user base as well. People are looking to save money on healthcare as much as possible. With cash back rewards, Amazon can offer additional discounts if consumers were to carry and use the Amazon Prime Rewards Visa Signature Card — which already offers 5% back on Amazon.com and WholeFoods purchases (plus money back elsewhere too). Pillpack too? We could envision a scenario where people scrap their current plastic to ensure that they’re getting discounts off of one of the most rapidly rising expenditures out there. Said another way, as more and more consumer staples like food and medicine are offered by Amazon, Amazon will be able to entice Pillpack customers with further card-related discounts. And grow a significant amount of revenue by way of its card offering. No doubt this is part of the plan. And don’t forget the data that they would compile to boot.

Per Forbes shortly after Amazon launched its Amazon Prime Rewards Visa Signature Card,

Given that Amazon credit card holders spend the highest on its platform, the company is looking at ways to expand its credit card consumer base. CIRP estimates that approximately 15% of Amazon’s U.S. customers have any one of Amazon’s credit cards, representing approximately 21 million customers. However, growth of its card base has not kept pace with its growing Prime membership. In June 2016, it was estimated that Amazon has around 63 million Prime members. Assuming that only Prime members have an Amazon credit card, it would mean that only a third of its Prime customers have one of its credit cards. According to a survey by Morgan Stanley, Amazon Prime members spend about 4.6 times more money on its platform than non-prime members. Its credit card holders spend even greater amounts than what Prime members spend. By enticing its prime customers to own its credit cards, Amazon will be encouraging them to spend more on its platform. Its latest card is aimed at attracting Prime customers by offering deals not only on Amazon.com but on other shopping destinations as well. This can lead to higher spending by existing Prime customers and help convert the fence sitters into Prime memberships.

And those numbers are dated. Amazon Prime now has 100mm members. Imagine if they could all get discounts on their meds. 💰💥💰💥

All of which begs the question: who gets hurt and who benefits (other than Visa ($V)) from this potential secondary effect? 🤔

#BustedTech (Short Busted IPOs…cough…DOMO)

Tintri Inc., a publicly-traded ($TNTR) Delaware-incorporated and Mountain View California based provider of enterprise cloud and all-flash and hybrid storage systems appears to be on the brink of bankruptcy. There's no way any strategic buyer agrees to buy this thing without a 363 comfort order. 

In an SEC filing filed on Friday, the company noted:

"The company is currently in breach of certain covenants under its credit facilities and likely does not have sufficient liquidity to continue its operations beyond June 30, 2018."

Furthermore, 

"Based on the company’s current cash projections, and regardless of whether its lenders were to choose to accelerate the repayment of the company’s indebtedness under its credit facilities, the company likely does not have sufficient liquidity to continue its operations beyond June 30, 2018. The company continues to evaluate its strategic options, including a sale of the company. Even if the company is able to secure a strategic transaction, there is a significant possibility that the company may file for bankruptcy protection, which could result in a complete loss of shareholders’ investment."

And yesterday the company's CEO resigned from the company. All of this an ignominious end for a company that IPO'd almost exactly a year ago. Check out this chart:

Nothing like a $7 launch, a slight post-IPO uptick, and then a crash and burn. This should be a warning sign for anyone taking a look at Domo — another company that looks like it is exploring an IPO for liquidity to stay afloat. But we digress. 

The company's capital structure consists of a $15.4mm '19 revolving credit facility with Silicon Valley Bank, a $50mm '19 facility with TriplePoint Capital LLC, and $25mm of 8% convertible notes. Revenues increased YOY from $86mm in fiscal 2016 to $125.1mm in fiscal 2017 to $125.9mm in fiscal 2018. The net loss, however, also moved up and right: from $101mm to $105.8mm to $157.7mm. The company clearly has a liquidity ("net cash") covenant issue (remember those?). Accordingly, the company fired 20% of its global workforce (~90 people) in March (a follow-on to a 10% reduction in Q3 '17). The venture capital firms that funded the company — Lightspeed Venture Partners among them — appear to be long gone. Silver Lake Group LLC and NEA Management Company LLC, unfortunately, are not; they still own a good amount of the company.

"Isn't cloud storage supposed to be all the rage," you ask? Yeah, sure, but these guys seem to generate product revenue largely from sales of all-flash and hybrid storage systems (and stand-alone software licenses). They're mainly in the "intensely competitive IT infrastructure market," sparring with the likes of Dell EMC, IBM and VMware. So, yeah, good luck with that.

Don’t. Mess. With. Daisy. Chapter 4. (Petsmart: Long Asset-Stripping Shenanigans)

Man this dog series (and John Wick referencing) is fun. With regard to Petsmart Inc., we previously we wrote:

The company financed the purchase with a two-part debt offering of (a) $1.35 billion of ‘25 8.875% senior secured notes and (b) $650 million of ‘25 5.875% unsecured notes. Rounding out the capital structure is a $750 million ABL, a $4.3 billion cov-lite first-lien term loan and $1.9 billion cov-lite ‘23 senior unsecured notes. Let us help you out here: 1+2+3+4 = $8.2 billion in debt. The equity sponsors, BC Partners, GIC, Longview Asset Management, Caisse de dépôt et placement du Québec and StepStone Group, helped by writing a $1.35 billion new equity check.

That capital structure refresher is important…

Taking a page out of J.Crew’s asset-stripping, litigation-inducing, bird-flip-to-senior-lenders-activating playbook, Petsmart this week announced that it moved a 16.5% stake in Chewy.com (a/k/a the savior) to an unrestricted subsidiary — unironically using a sponsor dividend mechanic for the transaction; it also dividended 20% of the equity in Chewy.com to its parent company, Argos Holdings, an entity controlled by private equity firm BC Partners. Consequently, Chewy.com is no longer a wholly-owned subsidiary of Petsmart. Moreover, per The Financial Times,

“Chewy will no longer guarantee PetSmart's debt, according to Xtract Research, though the remaining 63.5 per cent of the shares will still be pledged to secure term loans and senior bonds.”

We love financial shenanigans that weaken lender collateral packages to the apparent benefit of junior creditors and private equity sponsors. Particularly when they’re done so quickly after the original transaction!

How did the market react? Well, per Bloomberg, initially:

PetSmart’s bonds rallied as the move of the online vendor’s assets was seen as less aggressive than what bondholders had originally priced in, according to the people, who said the initial buyers of the notes have unloaded the positions. Investors sold PetSmart’s debt last year on fears it would sell or spin off as much as 100 percent of the Chewy equity to the private equity owner, removing it from the pool of assets they have recourse to as bondholders.

Haha, right. So instead of getting potentially 100% effed, bondholders only got 33% effed. Can you say: Credit positive!? This is what makes the distressed world just so unmistakably poetic and nasty at the same time: everything is largely a function of…well…you guessed it: asset price and asset value. With the par guys out and buyers at distressed levels in, “credit positive” is entirely relative.

Anyway, more from Bloomberg,

The company’s management said that said they will continue to actively monitor the capital structure and potentially pursue additional strategic opportunities to extend debt maturities, reduce overall leverage and invest in the business, according to the people. Management didn’t have a question and answer portion at the end of the call.

Of course not. Why would they? The first question would be “By ‘reduce overall leverage’ does that mean issuing new bonds secured by the newly siphoned off equity of (valuable?) IP in exchange for the cov-lite unsecured notes?” Even Eli Manning couldn’t so obviously telegraph his next move (The Financial Times, citing Covenant Review, cites some other options here).

This bit is great:

Petsmart’s transfer of assets to an unrestricted subsidiary was not surprising given what J. Crew was able to do with its transfer of intellectual property under its loan documents, James Wallick of Xtract Research said in an interview. The move is “symptomatic” of the current market for loans and bonds, where agreements “are so flexible that you can do a transaction such as this.”

Hahaha. Man people love to gripe about the capital markets these days. Said another way,

Mmmm hmmm. Yield, baby, yield.

When Will ICOs Become a Thing in Distress? (Short SEC Regulations)

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🚲Well-Funded Machines Terrorize Sidewalks 🚲

The Rise of the Electric Scooter

Do y’all remember the segway? It was supposed to revolutionize transportation but it never took off as anything more than the butt of a joke. Why? Look at the above photo. Homeboy can pump as many curls as he needs to but all the bulging biceps in the world won’t make him look bada$$ riding one of those things. Plus, watch the eye level broheim.

Anyway, there is a new mode of transportation that is all the rage. Introducing the dockless electric scooter…

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Disruption Disrupted (Short Money Burning Data Plays): Moviepass

Ok. Soooooo…this won’t shock anyone who has been paying attention. Apparently Moviepass — the company that lets subscribers see one movie a day for only $9.99 a month — is burning cash like nobody’s business. S.H.O.C.K.E.R. A first grade student can do THAT math.

Moviepass’ parent company Helios and Matheson Analytics Inc. ($HMNY) reported in an 8K filed this week that it burned $21.7 million per month from September 2017 through April 2018. The company now has $15.5 million in available cash with another $27.9 million in accounts receivable. Hang on: 15.5 + 27.9 (carry the four) = 43.4. Minus 21.7 and another 21.7 and….💥🔥💥🔥. Which prompted CNN to ask, “is the end near?” Here’s a choice quote...

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WeWork’s Unintentional Comedy

Short “State of Consciousness” Companies

Back in “WeWork Invents a New Valuation Methodology,” we snarked about how WeWork pioneered an entirely new valuation technique. We noted,

"Indeed, to assess WeWork by conventional metrics is to miss the point, according to Mr. Neumann. WeWork isn’t really a real estate company. It’s a state of consciousness, he argues, a generation of interconnected emotionally intelligent entrepreneurs. And Mr. Neumann, with his combination of inspiration of chutzpah, wants to transform not just the way we work and live, but the very world we live in.”

A state of consciousness. A state of effing consciousness. Being a biglaw associate is also a state of consciousness but that doesn’t necessarily mind-port you to partner after 8 years, let alone 12.

We continued,

"Even Adam Neumann, a co-founder of WeWork and its CEO, admits that his company is overvalued, if you’re looking merely at desks leased or rents collected. ‘No one is investing in a co-working company worth $20 billion. That doesn’t exist.’ he told Forbes in 2017. ‘Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.'“

We’re sure bankers all across the world will be happy to add “energy and spirituality analysis” to the lineup of valuation methodologies like precedent transaction, comparable company and discounted cash flow analyses. What the bloody hell.

Then last Wednesday, in 💵WeWork Taps Cap Markets; People Lose Minds 💵, we briefly covered the proposed WeWork’s proposed $500 million high yield bond issuance. People went nuts because the offering memorandum finally shed some more light on the business. And it was a feeding frenzy. Little did we know, that was only Part II of this (unintentional) comedy.

Introducing “Community-adjusted EBITDA.” Per Barron’s:

As The Wall Street Journal reported, while revenue doubled last year, to $866 million, WeWork’s losses also doubled, to $933 million. But WeWork “earned $233 million, based on a metric the company dubbed “community adjusted Ebitda.” That consists of earnings before interest, taxes, depreciation, and amortization — a widely used measure of operating cash flow — but also excludes basic operating expenses, such as marketing, general and administrative, development, and design costs. That’s not in any accounting textbooks I’m aware of.

Per The Wall Street Journal,

“I’ve never seen the phrase ‘community adjusted Ebitda’ in my life,” said Adam Cohen, founder of Covenant Review, a bond research company.

There’s a first time for everything, homie. Or as Bloomberg’s Matt Levine put it,

Well, sure, Mr. Covenant Review, but I bet you’ve never reviewed the covenants of a state of consciousness either. 

Some more choice commentary:

Indeed, Moody’s was mildly schizophrenic (registration required) in its evaluation of the company’s new notes; it didn’t deign to even discuss WeWork’s accounting gymnastics as it assigned a B3 Corporate Family rating and a Caa1 rating to the notes.

Dealbreaker’s Thornton McEnery was far less measured. In lofty prose worthy of a Pulitzer, he led his piece entitled “WeWork’s First-Ever Bond Offering Is A Master Class in Financial Masturbation” with “[n]o company has its head farther up its own ass than WeWork.” We literally laughed out loud at that. But wait. There’s more,

That said, making up your own holistic, artisan, New Age Brooklyn accounting principle just to pretend that you’re hemorrhaging less money than you really are? Well, that’s actually super-ballsy and we’d almost respect it if WeWork wasn’t trying to write down Kombucha on tap and losses associated with ping pong ball replacements. It’s the height of Millennial hipster exceptionalism and it would truly make our skin crawl if, again, we didn’t respect the balls-out ego involved here.

Can you even say “balls-out” anymore? We thought #MeToo killed that. And ping pong? C’mon. That’s so 2014. It’s esporting Fortnite matches that are all the rage now, broheim. Anyways…

Then Bloomberg’s Matt Levine and Axios’ Dan Primack crashed the party by issuing a bit of defense. Levine’s is here — noting that the calculus is a bit different for bond investors. Primack spoiled some of the fun by clarifying what the new-fangled metric represents:

The metric includes all tenant fees, rent expense, staffing expense, facilities management expense, etc. for active WeWork buildings.

The exclusions are company-wide expenditures, which do not get pro rated. Much of that relates to growth efforts, although not all of it (executive salaries, for example).

One comp, and its not perfect, could be how Shake Shack reports "shack-level operating profit margins."

Bottom line: It's still kind of silly, but less silly than it at first appears. And obviously the ratings agencies and bond markets didn't seem put off.

Silly? Less silly? Whatevs.

Either way, the Twitterati largely neglected to take into account today’s dominant theme-among-themes: yield, baby, yield. Or said another way — per The Financial Times,

WeWork does have substantial backing, blue-chip customers and a good plan to increase profit-sharing leases. A high yield in its first bond, adding 150 basis points or so to the index average yield, would help, too. That could swell the offer above $500m. Even sober bond investors may not prove immune to the appeal of succulents and exposed brick.

Prescient. And bond investors did not prove immune. Nor sober.

Welcome to Part III. This is the part in the story where the record scratches, the jukebox stops, and everyone has an utterly perplexed look on their faces. Like, wait. WHAT? That’s right. Demand for this paper was so high, that it upsized from $500 million to $702 million. And just like that, poof! Adam Neumann looks into the camera, smirks, and then walks down the street like Kaiser-m*therf*ckin-Soze. He can tap the venture capital markets — stateside and abroad (in the case of Softbank) — and the debt market.

The Real Deal somewhat inexplicably stated,

WeWork sold $700 million in bonds Wednesday to investors wary of another startup with unstable cash flow entering the debt market.

Wary? How do you explain the upsized offering then? The only thing people should be wary of are other people who are shocked to see this happening. Again: YIELD. BABY. YIELD. And, to be clear, it was actually $702 million (at 7.785%). The notes are guaranteed by US subsidiaries that hold approximately 60% of the company’s assets at year end; “adjusted ebitda” was also used as the base for leverage requirements under the notes’ covenants. There’s hair all over this thing. The Financial Times took a deeper dive into lender protections as it…

wanted to get a general idea of the rights its bondholders might have if the bonds were sold under the terms laid out in the preliminary prospectus and then Millennials everywhere suddenly decided they would prefer to work from home.

Right, exactly. Or in a cafe where you can sit for hours for $3/day. Anyway, you can read that FT analysis here. Moreover, BloombergGadfly cautions about the rent duration mismatch here — a subject of particular note for restructuring professionals well-versed in section 365 of the bankruptcy code. Bloomberg notes,

WeWork acknowledges that its expenditures "will make it difficult for us to achieve profitability, and we cannot predict whether we will achieve profitability in the near term or at all." Risk is all part of the game for junk investors, and this one looks like it will be priced to go with a fat yield. But the more prudent will take that caveat seriously. 

Investors must’ve REALLY wanted in on the action. Many didn’t take that caveat seriously. Something tells us Burton Malkiel will be adding an addendum to his “Greater Fool Theory” coverage in “A Random Walk Down Wall Street” and this will be the case study.

What explains the enthusiasm? As The Wall Street Journal notes, this isn’t a $20 billion decacorn-x2 for nothing:

The numbers offer some positive signs for WeWork. Its net construction costs per desk fell 22% in 2017 to $5,631. And its corporate business—as opposed to revenue from freelance and small companies—appears to be growing well, as rating agency Standard & Poor’s said in its analysis. The agency said it expects large corporations will occupy 50% of WeWork’s desks within two years, up from 25% today.

But then they flip right around and note,

There also are concerns for investors in WeWork’s growth trajectory. Its revenue per user fell 6.2% to $6,928 in 2017, while sales-and-marketing costs more than tripled to $139 million, representing 16% of revenue, up from 9.9% in 2016.

Taking on debt adds risk to a company whose business model hasn’t been tested in a downturn. Given that its members typically sign monthly or annual leases, a drop in demand during a recession would mean the rents it charges tenants would fall, while the payments it owes to landlords would stay constant.

Nevertheless, the market spoke. It gobbled up those bonds.

But then, in Part IV, the market spoke again, mere days later. As Bloomberg noted,

WeWork Cos.’s bonds extended their losses on Tuesday, as investors who were at first enthused to get a piece of the action have since been cashing in their chips.

The $702 million of speculative-grade bonds, which sold last week at par, fell for the fourth straight day on Tuesday to 95.75 cents on the dollar, according to Trace bond-price data. That’s a sharp contrast to the outsized orders the company saw when it marketed its debt in primary markets last week.

And then they kept falling.

Source: Bloomberg

Per Trace, the bonds last printed on Friday, May 4 at 94.9 — a pretty impressive decline on the week (h/t @donutshorts).

This sequence of events likely has bondholders screaming, “Yield, baby. YIELD!!!”

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PETITION is twice-weekly newsletter covering disruption from the vantage point of the disrupted. We meander sometimes to other areas. This piece was in today's Members'-only newsletter. You can check us out here and follow us on Twitter here.

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.

Busted Tech (All Hail Uber & Lyft)

Rest in Peace, Fasten

Late on Friday, the co-founders of Fasten, a ride-hailing company that proudly boasts of over 5 million rides completed, sent around a note to users that it has been acquired by Vezet Group. If you’ve never lived or worked in Austin or Boston, you probably don’t give a damn about this so you can move on. But, if you did, you’re aware of Fasten - particularly since it was the only real viable ride-hailing option in Austin during a period of time (2016) when Uber and Lyft fought with regulators. That fight was resolved, however, and Uber and Lyft returned to the city less than a year ago. Now Fasten is done for: this acquisition is an IP-sale. Operations in the US will be shut and 35 employees let go. In the dog eat dog world of ride-hailing, it is telling that the winners like Uber are those who survive - regardless of a cash burn in the billions of dollars annually. Move fast(est), burn cash, and break things.

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.”

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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.

Cenveo Inc. = Poster Child for Disruption

Envelope Manufacturer Succumbs to Technology. And Debt.

As loyal PETITION readers know, our tagline is “Disruption, from the vantage point of the disrupted.” After its Chapter 11 bankruptcy last week, Cenveo Inc. may very well be the poster child for disruption.

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

And, yet, it sells a lot of product. In fiscal year ended December 31 2017, Cenveo generated gross revenue of $1.59 billion with EBITDA of $102.8mm. Those are real numbers. But so are those on the other half of the company’s balance sheet.

After years of acquisitions (16 between 2006 and 2013, representing a strategic shift from print-focus to envelope manufacturing), Cenveo has more than $1 billion of funded debt on its balance sheet and a corresponding $99.4mm in annual debt payment obligations (inclusive of cash and “principle” payments). That’s the problem with a lot of debt: eventually you’re going to have to pay it back. And the only way to do that is to have sustained and meaningful cashflows that are, hopefully, trending upwards rather than down. Therein lies the problem with Cenveo. As liquidity gets tight, a business may start getting a bit looser with payments, a bit less reliable. Savvy trade creditors sniff this from a mile away. With the company (very) publicly struggling under the weight of its balance sheet, vendors started hedging by contracting trade terms and de-risking; they start throwing off business to Cenveo’s competitors, further challenging Cenveo’s liquidity — to the tune of a net liquidity reduction of approximately $20mm. Initiate death spiral.

But, wait! There’s more. And it’s textbook disruption. Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo. More from the company,

“As society has become increasingly dependent on digital technology products such as laptops, smartphones, and tablet computers, spending on advertising and magazine circulation has eroded, resulting in an overall decline in the demand for paper products, and in-turn lowering reliance on certain of Cenveo’s print marketing business. In addition, there is generally a decline in supply of paper products in the industry, such that only a handful of paper mills control the majority of the paper supply. As a result, paper mills and other vendors that sell paper products have a large amount of leverage over their customers, including Cenveo. The overall decline in the paper industry combined with the diminished supply in paper products has led to overall decline in the industry, dramatically impacting Cenveo’s revenues.”

Consequently, the company has spent years trying to implement an operational restructuring (read: streamline operations and cut costs). The company adds,

“Faced with an industry in transformation, Cenveo, beginning in 2014, commenced a strategic review of a significant portion of its businesses and concluded that it needed to focus its portfolio on profitable segments that would be better-positioned to grow in the future and to divest non-core, unprofitable segments. To implement this strategy, between 2014 and 2017, Cenveo applied a number of broad-based cost savings and profitability initiatives, which included downsizing its workforce, reducing its geographic footprint, and divesting certain non-core business segments, which was designed to reduce costs, minimize the possible effect of decreased sales volume for underperforming product lines, and remain competitive.”

While the company notes that it currently employs nearly 5200 people in the US, it is clear that many people have lost their jobs. 100 people in Orchard Park, New York. 108 people in Exton, Pennsylvania. 112 people in the Twin Cities. 91 people in Portland, Oregon. You get the point. You should read theGlassdoor reviews for this company. The employees sound miserable. The comment board is riddled with critiques of management, allegations of squandering, tales of job cuts and no raises. Even sexual harassment. We can’t wait for the uproar over the inevitable Key Employee Incentive Plan.

So what now? The company claims it’s ready for the e-commerce age and that it can make a ton of money on package labels. Provided that it can shed its debt. Accordingly, the company engaged the holders of its first and second lien debt and was able to secure a (shaky?) restructuring support agreement (RSA) and a commitment of $290mm in financing. The RSA exhibits the company’s intent to equitize the first lien holders’ debt. Notably, Brigade Capital Management — representing over 60% of the second lien debt and a meaningful percentage of first lien debt — isn’t on board with the RSA and noted in a filing that the bankruptcy may be “more contentious and protracted than indicated” by the company. Indeed, they are already agitating against the company and certain insiders alleging, among other things, that the Burton family has received approximately $80mm of disclosed compensation between 2005 and 2016 that ought to be investigated. And that the RSA seeks to enrich the insiders with a generous post-reorg equity grant of 12%. In other words, this could get ugly. Fast.

We should also note that the company will also need to address its underfunded pensions (approximately $97.3mm) and 18 active collective bargaining agreements. Funding contributions for 2018 are over $10mm. The pension plan(s) cover 5700 retirees and 734 active employees. And so while sophisticated funds duke it out over valuation and the corresponding value of their claims/recoveries, thousands of employees and retirees will be left in the lurch. Yikes.

As you can see, disruption is hard. Silicon Valley types love to talk about their big revolutionary products and how they’re going to change the world. That sexy stuff gets CEOs on magazine covers. Cameos in Iron Man movies. And more. The attorney from Kirkland & Ellis LLP representing Cenveo used an IPad in court. Symbolic.

But there is a dark underbelly to disruption too. As new technologies come online and habits change, long-standing businesses like Cenveo falter. People lose jobs — or struggle one day at a time to keep them. People lose pensions they’d planned to live on. Hopefully the professionals who make money managing these elements in-court don’t lose sight of these factors and work hard to optimize efficiency in the process. And hopefully the engineers and disrupters take note of what their “big revolution” may mean for others. Cenveo is a great reminder.

Busted Tech (Short Influencers, Data Scientists & Fraudulent Founders)

Congratulations to Beme for being an Inception-like failure within a failure. Little more than a year ago, the ubiquitous Casey Neistat (of "Bike Lanes" fame (video)) sold his company Beme to CNN for $25mm in what, to those who track these things, was very clearly an acqui-hire rather than a legit acquisition. Neistat and his team were meant to be a boost of steroids for CNN's burgeoning digital content plans. Instead, he's gone and Beme is officially toast. Perhaps the shortest acqui-hire of all time. 

But at least Beme wasn't a $100mm bust. So, there's that. In contrast, Primary Data, a California-based data virtualization startup crashed and burned this week after 4 years of hype, $80mm in venture capital, $20mm in venture debt, and (practically) zero minutes of actual product delivery. Apple's Steve Wozniak was the company's data scientist. Notable VCs include Litespeed Venture Partners and Accel Partners.

And then there is Loot Crate, a monthly subscription service that sends video games and other nerdy gear to customers. Per Reuters, the company is a cesspool of controversy: it is the defendant in a sexual harassment lawsuit; and it had three non-exec Board members resign in recent weeks (including the high profile Mark Suster of Upfront Ventures). Consequently, it has hired Dendera Advisory LLC, a merchant bank of sorts, to raise new funds. We guess that means that, after $18.5mm of venture capital funding and Suster running for the exits, VC is no longer an option. Meanwhile, Dendera is apparently no stranger to distressed situations; it advised Sports Direct International in its purchase of Eastern Mountain Sports and invested in Performance Sports Group. 

Getting us progressively closer - but not quite in - to bankruptcy court, is Outcome Health, a medical advertising company that deploys technology (read: uh, tv screens) to doctor's offices. The company has (apparently) avoided a chapter 11 filing after settling fraud allegations Goldman Sachs and Google Capital lobbed at the company's founders. Jones Day, Rothschild and FTI Consulting were all reportedly laying in wait for a potential bankruptcy filing. The company has several million dollars of debt. As part of the settlement, the defendants and others will infuse the company with additional liquidity.

And, finally, further busting the everybody-gets-rich-off-of-tech narrative, Practice Fusion, a medical records startup, has sold for $100mm to AllScripts Healthcare Solutions Inc. ($MDRX) at a mere fraction of the once-heralded $1.5b valuation the company reportedly enjoyed. While management - including a General Counsel making $2.2mm - are getting enriched, employees taxed on earlier exercised stock options are getting shafted hard. It's a rough story. Peter Thiel (of Gawker fame) and Kleiner Perkins Caufield & Byers were large investors. 

PETITION NOTE: Startups fail all of the time. We note it only because, eventually, interest rates will rise, the bubble will burst, venture capital money will dry up, and EVEN MORE startups and tech companies will go "bust." A number of these companies - unbeknownst to many who don't follow tech - actually have venture debt (like Primary Data above) and valuable IP. Stay tuned. And imagine how long this section will be when that all that happens.

Toys R Us is a Dumpster Fire

All Signs Point to the Big Box Retailer Being in Serious Trouble

This week AlixPartners LLC released its latest "Retail Viewpoint" and its "Monthly Retail and Economic Update." Both documents cover retail results from the ever-important holiday season. Alix says this in its preface:

"The year 2017 may have been one of apocalyptic headlines, but a lot of forecasts—including ours—still predicted that retailers would have a good holiday performance.

No one thought it would be this good.

According to advance and preliminary numbers from the US Census Bureau, retailers brought the noise this past holiday-shopping season. Core retail sales increased 6.3% over 2016's, blowing past the National Retail Federation's forecast—and ours too. Sales in November and December were absolutely explosive, accounting for 17.2% of annual sales, the largest percentage since 1999.

Every core retail sector performed significantly better than it did the rest of the year (figure 1). Not even public enemy number one—e-commerce pure plays—could stop other sectors from increasing 2.3% during the holiday season compared with the rest of 2017. There must have been a lot of happy little kids (and bigger kids) gathered 'round the tree, because the poster children of recession-era bankruptcies, electronics and sporting goods/hobby/book/music stores, had the largest increases of all: 7.4% and 4.7%, respectively."

While there may have been "a lot of happy little kids," we're guessing they were NOT "Toys R Us kids." 

Consider this week's Toys R US-related operational news: 

• The Washington Post reports that 182 stores will close, with CEO Dave Brandon acknowledging "operational missteps" during the holiday season. The article cites various issues including (i) confusion around the bankruptcy filing, (ii) fear of buying gifts that can't be returned, (iii) weak marketing, and (iv) ineffective email promotions. An analyst at BMO Capital Markets notes that holiday sales in North America were down more than 10%. On the bright side, Reuters reports that all 83 stores in Canada will remain open.
• Quartz notes that the company seeks permission to pay store closing bonuses to those employees who help the company wind down the aforementioned 182 stores (which, for the record, is roughly 20% of the US footprint). Notably, neither the company nor Quartz is estimating the sheer number of jobs these closings affect. But it will be a meaningful number. #MAGA!!
• Bloomberg reported that the company obtained court approval to pay landlords' fees and expenses related to the Chapter 11 case in exchange for additional time for the company to decide whether to assume or reject leases. Nerd alert: the bankruptcy code imposes a 210-day deadline for a company to decide a course of action vis-a-vis its non-residential real property leases. These promised payments were in exchange for an extension of that timeframe. 

And consider, further, this week's Toys R Us-related financial news:

• Per RetailDive, Toys R Us won't release holiday sales results. 
• Per Debtwire, Toys R Us circulated a limited holiday performance snapshot for its international enterprise. The report didn't include number after December 23. Yes, Christmas is on December 25. 

We wonder: why the reluctance to release numbers? Our suspected answer: they must be ugly AF. In the period of October 29 - November 25, the company reported a net deficit (disbursements > receipts) of approximately $53mm. Later this week, we should see the company's monthly filing for the period covering Christmas. We don't like to speculate, but we can only imagine that the deficit will be even greater; we suspect that the company is burning cash like nobody's business. And we're wondering whether a liquidation of the US side of the business is out of the question given all of the "missed opportunities." 

For now, what we KNOW is that - through no fault of its own - Alix' assessment is incomplete. The fine folks over there may want to amend their report after we hear more from Toys R Us in coming days. 

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By extension of the above - and now is as good a time as any to remind you that nothing we write should be construed as investment advice - we'd think it's also safe to assume that this Bloomberg piece about efforts by Hasbro Inc. ($HAS) and Mattel Inc. ($MAT) to innovate is, maybe, a wee bit too rosy. While, yes, they may be pivoting towards mobile and less dependence on brick-and-mortar, how many times have we heard that a transition is slower and harder than anticipated? That excuse is cited in virtually every retail "First Day Declaration" of the past two years. We don't have high hopes for Q4 reports (Mattel supposedly reports Q4 earnings on 2/1 followed by Hasbro on 2/7). Along those lines, Meisheng Cultural Co. may want to wait and see what happens to Jakks Pacific's ($JAKK) numbers before it overpays. 

One last related note: Sphero, the Disney-backed ($DIS) maker of STEM toys like a robotic BB-8 that you can buy at...wait for it...TOYS R US, announced earlier this week that it was laying off 45 staff members globally "following a holiday season that failed to live up to expectations." Curious. Maybe it was too dependent upon a certain big box toy retailer? 

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.

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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.

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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.