🔥David's Bridal = Chapter 11.5🔥

One year, three different capital structures and two restructurings — one in-court and one out-of-court. This has been a hell of a twelve-month stretch for David’s Bridal Inc. Clearly performance continues to sh*t the bed.

A year ago at this time the company was pre-bankruptcy. It had 311 stores, 9,260 employees and a $775mm capital structure split among (i) approximately $25.7 million in drawn commitments under its Prepetition ABL Agreement; (ii) an estimated $481.2 million in outstanding principal obligations under its Prepetition Term Loan Agreement; and (iii) an estimated $270.0 million in outstanding principal obligations under its unsecured notes. It filed a prepackaged bankruptcy on November 19, 2018. It confirmed its plan of reorganization in early January and the plan went effective almost 60 days after the filing.*

Under the plan of reorganization, the company shed hundreds of millions of debt, wiping out its private equity overlord, Clayton, Dubilier & Rice, LLC (except to the extent they owned unsecured notes). The company emerged from bankruptcy with (i) a $125mm asset-backed loan from Bank of America NA (the “ABL”), (ii) a $60mm “Priority” term loan agented by Cantor Fitzgerald and (iii) $240mm L+800bps “Takeback” term loan paper (also Cantor Fitzgerald). The term lenders — including, Oaktree CLO Ltd., a collateralized loan obligation structure managed by Oaktree Capital Group** — walked away as owners with, among other things, the takeback paper and the common stock in the reorganized entity. The unsecured noteholders received a pinch of common equity and warrants. The initial post-reorg board was reconstituted to include a representative from Oaktree, a former executive from Ralph Lauren, a former banker, a senior partner from Boston Consulting Group, and a venture capitalist with experience in the early stage consumer products space.

It didn’t take long for cracks to form. In May, S&P Global Ratings downgraded David’s Bridal’s credit rating into junk territory; it noted that the company’s performance "remained significantly weaker than anticipated after emergence from bankruptcy" and it “expect[s] poor customer traffic will pressure operating performance and lead to added volatility.” The ratings agency gave both term loans the “Scarlet D” for downgrade, noting that the capital structure was “potentially unsustainable based on its rapidly weakening operating performance, which makes it vulnerable to unfavorable business and financial conditions to meet its commitments in the long term.” The term loan quoted downward. The rating proved to be prescient.

Six months later and eleven months post-confirmation, it is clear that the balance sheet was NOT right-sized to the performance of the business. On Monday, the company announced that it obtained a new $55mm equity infusion from its existing lenders. Lenders unanimously exchanged “$276mm of its existing term loans into new preferred and common equity securities” leaving the company with $75mm of funded debt exclusive of the untapped $125mm ABL. The equity that CD&R and the other unsecured noteholders received are clearly worth bupkis today. Those warrants? HAHAHA. Wildly out-of-the-money. Peace out CD&R!

The question is why did this situation flame out so quickly? On a macro level, there are secular changes taking precedence in the marriage space: things just aren’t as formal as they used to be. On a micro level, clearly the company continues to suffer from operational challenges that were not addressed during the filing. Nor post-emergence. Per Bloomberg:

David’s lost its way with customers under prior management, Marcum said in the interview. When the company launched its online marketplace, it was a separate e-commerce profit that had different pricing and marketing promotions than the stores. “Consumers today are very smart and they see that,” [CEO James] Marcum said. “It caused a lot of friction” and an “extremely poor experience” for customers.

Ummm, okay, but wasn’t that supposed to have been fixed by now??

The company underestimated the negative impact that Chapter 11 would have going into its strongest selling period, and the competition “took advantage of it,” Marcum said.

Clearly the lenders underestimated the impact, too. How else do you explain the thinking around 10+% paper?

Given that the paper steadily quoted down for months leading up to this transaction, it’s obvious that (i) brides-to-be were steering clear from David’s Bridal after seeing media clips about other brides getting burned by bankrupted dress sellers, (ii) consequently, the lenders saw a constant stream of declining numbers, and (iii) as they learned more about the state of the business, lenders scrambled to try and dump this turd before a wipeout transpired. Spoiler alert: it has transpired.

As for the capital structure, clearly this thing came out of bankruptcy over-levered: it looks like the take-back paper was driven, in part, by CLOs in the capital structure. Callback to just a few weeks ago when, in “💥CLO NO!?!?💥,” we wrote (paywall):

…most CLO fund documents also don’t permit CLOs to take on new equity in restructurings. This limitation, by default, pushes CLOs towards “take-back paper” (read: new debt) in lieu of equity. If you’re a regular-way lender on an ad hoc group full of CLOs, then, this makes for an interesting dynamic: you may prefer — and have the latitude — to (i) swap debt for equity, thereby taking turns of leverage off to right-size the reorganized debtor’s balance sheet and (ii) give the reorganized entity a fighting chance to survive and drive equity returns. Your CLO counterparts, however, have different motives: they’ll push for more leverage. This misaligned incentive can sometimes get so bad that ad hoc groups will have to negotiate amongst themselves the go-forward capital structure without even getting management input. In this scenario, management projections are besides the point. If you’re looking for some explanation as to why there appears to be a rise in Chapter 22 filings, well, this might be one.

Not everything will have to file for bankruptcy a second time. But, as a practical matter, the result is the same here in terms of a capital structure refresh. Call this a Chapter 11.5.***

*Shockingly, the company didn’t boast of a “successful restructuring” like every other retailer-destined-for-a-chapter-22 tends to do. Perhaps retailers are now taking PETITION’s “Two-Year Rule” into account? 🤔😜

**The term lenders that made up the Ad Hoc Term Lender Group included a hodgepodge of private equity funds, hedge funds and CLOs.

***We really struggled with a witty thing to label a fact pattern where, within a year of bankruptcy, a company has to do a an out-of-court balance sheet refresh without going into a formal Chapter 22. Any ideas? Email us.

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.