Is rue21 Becoming rue22? (Short Liberal Return Policies)

On Mary 15, 2017 - nearly exactly a year ago — rue21 Inc. became the latest in what was a string of specialty fashion retailers to file for bankruptcy; it sought to pursue both an operational and a financial restructuring. The company had 1179 brick-and-mortar locations in various strip centers, regional malls and outlet centers. It also had a capital structure that looked like this:

Much of the leverage emanated out of an Apax Partners LLP-sponsored take-private transaction in 2013. We recently discussed Apax Partners in the context of FullBeauty here, in our recent Members’-only briefing.

Without any real contest, it was clear that the term loan holders constituted the “fulcrum” security and would end up swapping said loans for equity in the reorganized company. And that is precisely what happened. The ABL was covered, the term lenders funded a roll-up DIP credit facility along with new money to finance the pendency of the cases and then converted that DIP into an exit facility. The post-emergence capital structure consists of:

• $125 million ABL; and

• $50 million term loan (plus accrued interest on the DIP term loan as of the effective date).

General unsecured claimants were provided an equity “kiss” on the petition date and then, after the Official Committee of Unsecured Creditors’ (“UCC”) formed, it extricated additional value in the form of, among other things, (i) a put option to sell its post-reorg equity to one of the reorganized debtors, and (ii) a waiver by the prepetition term lenders of their $200 million deficiency claim. While the UCC did try and go after third-party releases for Apax, Apax ultimately succeeded in obtaining the release pursuant to the bankruptcy court’s September 9 confirmation order on the basis that it…

“…agreed to (i) support the Plan, including by promptly facilitating and participating in prepetition Plan discussions that culminated in the Restructuring Support Agreement and the Plan, notwithstanding that their equity position would likely be eliminated thereunder; and (ii) participate in the financing of the DIP Term Loan Credit Facility.”

In other words, Apax bought its release for $2 million in DIP allocation.

All told, this was a solid deleveraging of roughly $700 million. Moreover, the company closed roughly 400 stores. The company was seemingly well-positioned to effectuate the rest of its proposed restructuring, including (i) revamping its e-commerce strategy, (ii) improving the in-store experience, and (iii) pursuing a long-term business plan under relatively new management in a highly competitive retail atmosphere.

“Seemingly” being the operative word. In January, The Wall Street Journal reported (paywall) that the retailer experienced lackluster sales and tightening trade terms. Then, in February, Reuters reported that the company “is seeking financing after lackluster holiday sales failed to generate the cash it had hoped for….” It noted, further, that the company had engaged Piper Jaffray Companies ($PJC) to raise the funds. Notably, there has been nothing new on this front since. No news is probably not good news when it comes to this situation. Start the sewing machines: a Scarlet 22 tag may be in order and a liquidation on the horizon.

In the meantime, if the company is looking for ways to preserve liquidity, it might want to consider a far less generous return policy:

With clothes like this and a customer like that, what could go wrong?

Elizabeth Warren vs. the Bankruptcy Bar

A Reminder That Disruption Takes on Many Forms

PETITION is, broadly speaking, a newsletter about disruption. As loyal readers have surely noticed, the predominant emphasis, to date, has been tech-based disruption. But, spoiler alert, there are other forms. Earlier this week, Senators Elizabeth Warren and John Cornyn proposed a bill that swiftly reminded a cohort of (mostly Delaware) legal professionals that legislation, if passed, can be an even more immediate, powerful and jarring form of disruption.

Let’s take a step back. Shortly before Christmas, the Commercial Law League of America (CLLA) indicated that the U.S. Senate should consider a new bankruptcy venue reform bill. The gist of the proposal is that a debtor should have to file for bankruptcy in its principal place of business (or where their principal executive offices reside) - as opposed to, as things currently stand, its state of incorporation (the "Inc Rule"), where an affiliate is located (the "Affiliate Rule"), or where a significant asset is located (the "Abracadabra Rule"). Notably, a large percentage of companies are incorporated in Delaware, a state with well-established and well-developed corporate laws and legal precedent. Consequently, thanks to the "Inc Rule," Delaware is typically the most sought after venue by debtors, perennially topping annual lists with the most bankruptcy filings. In other words, the state of Delaware is the biggest beneficiary of the status quo. 

Putting aside the Inc Rule for a moment, the “Affiliate Rule” and “Abracadabra Rule,” respectively, have provided debtor companies with wide and crafty latitude to file in jurisdictions other than that of their principal place of business. Again, typically Delaware (and then, to a lesser extent, New York). Have a non-operating subsidiary formed in Delaware? Venue, check on the "Affiliate Rule." Got a random (unoccupied) office you set up last week in a WeWork in Manhattan? POOF, venue! Check on the "Abracadabra Rule." Got a bank account set up (a week ago) with JPMorgan Chase Bank in New York? Venue, again check on the "Abracadabra Rule". It is, seemingly, THAT optional. All of this is like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, General Motors ($GM) should file for bankruptcy in New York rather than Michigan. Oh, wait. That actually happened. Take two: that’s like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, Chrysler should file for bankruptcy in New York rather than Michigan. Damn. That also happened. Ok, here’s a good one: that’d be like saying it’s okay for the Los Angeles Dodgers to file for bankruptcy in Delaware rather than California. Wait, SERIOUSLY!?!? WTF. Who is to blame for this outrage? 

We'll keep this simple, lest this become a treatise absolutely nobody will want to read: federalism. Bankruptcy law is federal but every state has their own courts, circuit courts, and legal precedent. Some states have bankruptcy courts that are historically more favorable to debtors (cough, Delaware...need that incorporation business) - which, speaking commercially and realistically - are de facto clients of the state. Currently, debtors typically choose the venue so if you want to drive debtors to your courthouse steps, favorable corporate and debtor-favorable bankruptcy case precedent goes a long way towards filling court calendars. Not to mention hotels. In this regard, the bankruptcy court isn't all too dissimilar from a large tech company. Go fast and furious to market, aggregate a ton of users (here: debtors), acquire talent (read: judges), and build a database full of information (read: precedent) to then use against everyone else who tries to compete with you. That aggregation is the moat, the competitive advantage. Say, "we're the most sophisticated due to our talent, data, and predictability" and win. Boom. Dial up the Hotel Du Pont please!  

As a consequence of federalism, one jurisdiction's "makewhole provision" enriching bondholders is another jurisdiction's "no recovery for you" enraging bondholders. One jurisdiction's "restructuring support agreement" is another jurisdiction's "meaningless bound-to-be-blownup-worthless-piece-of-paper." That's the beauty of venue selection, currently. The system allows debtors to choose based on that precedent. Ask any of your biglaw buddies about "venue analysis" and watch their eyes roll into the back of their heads. That is, if you're even still reading this. They've all had to do it. It's a big part of the filing calculus. And everyone knows it. 

Enter Senators Warren and Cornyn. They're saying, "No way, Jose. This sh*t needs to stop." Okay, they didn't say that, exactly, but Senator Warren did say this, "Workers, creditors, and consumers lose when corporations manipulate the system to file for bankruptcy wherever they please. I’m glad to work with Senator Cornyn to prevent big companies from cherry-picking courts that they think will rule in their favor and to crack down on this corporate abuse of our nation’s bankruptcy laws.” The argument goes that the bill “'will strengthen the integrity of the bankruptcy system and build public confidence' by availing companies, small businesses, retirees, creditors and consumers of their home court." Ruh roh. 

A few years ago, a heavy hitter lineup of restructuring professionals were asked by The Wall Street Journal what they thought about this venue debate. The general upshot was "nothing to see here." With apologies for the paywall attached to the following links, you'll get the general idea. See, e.g., "the myth of forum shopping." See, also, "venue reform is a solution in search of a problem."; 
“allowing fiduciaries to exercise their business judgment about what filing location might maximize enterprise value or reduce execution risk or both.”; “If it ain’t broke, don’t fix it.”; "the current status quo of wide venue choice – should win out.”; “It’s not clear that these rules are problematic, so don’t apply a fix with its own set of unintended consequences.”; “The truth is that venue provisions are very appropriate and do not need to be adjusted”; "Letting debtors choose as they can now is 'good business sense.'"; and "current venue requirements 'strike a fair balance.'” In summary, you've got Senators Warren and Cornyn up against a LARGE subset of the bankruptcy bar. And those aren't all Delaware practitioners. That's a cross-section of the entire bar - with some financial advisors and investment bankers thrown in for good measure. Pop us some popcorn.

Now, we've been highlighting venue shenanigans since our inception. Not because it's wrong to leverage a favorable venue with uber-favorable precedent if you have that option; rather, because it has gotten so FRIKKEN OBVIOUS. Clearly an industry with $1750/hour billing rates isn't known for its subtlety. Want a third-party release to shield the private equity bros? St. Louis here we come! Have the opportunity to take advantage of a "rocket docket" and get those billable rates rubber stamped? Godspeed. Want to issue a "Standing Order" to divert bankruptcy traffic (back) into your court? May the Force be with you. 

That last bit is particularly notable. Venue gaming got so blatant that even the courts got in to the game. That "Standing Order" is as patent an acknowledgement of venue manipulation as anything we've seen of late. Why did this happen? Take a look at the case trends. After a few early (small) oil and gas exploration and production companies (E&P) filed in Texas and things, uh, didn't go particularly well for professionals, a deluge of E&P debtors mysteriously started popping up in Delaware. That's basic cause and effect. The subsequent cascading secondary effect was the "Standing Order" which, in response, guaranteed professionals that they'd get one of two judges and that, effectively, the Texas courts were open for business. Once that Order came out, debtor traffic curiously reverted back to Texas. E&P management teams and creditors could be heard in their home jurisdiction. Local firms could become "local counsel." Delaware counsel's loss was Texas counsels' gain. (If only the same could be said for lead counsel). Naturally, then, both the Texas Bankruptcy Bar Association and Texas Hotel & Lodging Association back the proposed bill: it basically fortifies the Standing Order. Also, guess where Senator Cornyn is from? Alexa, please cancel that Hotel Dupont reservation. 

We're not taking a position in this debate. We have no skin in that game. But we can't help but to chuckle at the timing. Ironically, it seems that more and more debtors are filing near their principal place of business rather than Delaware anyway (cough, third party releases!). See, e.g., Toys R Us, rue21, Payless Shoesource. And so this has the potential to reinforce a recent trend and compound the issues that have already surfaced for Delaware professionals. 

This is nerdy sh*t. But it’s still big deal disruption. Just disproportionately for the Delaware bar and the city of Wilmington. It’s so big that even iHeartRadio released a podcast discussing it. Without irony. Dramatic disruption AND comedy. 

Who knew bankruptcy could be so entertaining?

Will TOM SHOES Be Another Victim of Private Equity?

Is Blake Mycoskie's Company in Distress?

NPR’s “How I Built This” podcast featuring TOMS Shoes founder Blake Mycoskie is great. But it footnotes a big piece of the TOMS story and neglects another entirely: that Mycoskie sold 50% of the company to private equity firm, Bain Capital. And that the company has debt currently trading at distressed levels and faces a potential liquidity crisis.

Let’s take a step back. TOMS Shoes Inc. is an unequivocal success story and Blake Mycoskie is deserving of praise. He took an idea that was originally meant to be purely charitable and created a company that scaled from $300k of revenue in year one to $450mm in revenue in year seven. His "buy-one-give-one" model has resulted in millions without shoes now having shoes. And the model itself has been copied by Warby Parker, Bombas, and others, across various businesses. 

That said, for us, this tweet sparked a renewed interest in the company. Many have speculated for years that the TOMS story isn’t all rainbows and unicorns and that there are unintended consequences that emanate out of the one-for-one model. The report referenced in the tweet drives this point home. 

Why is this important now? Because the charity narrative is critical to TOMS. The company cannot afford for the public to sour on the message. Particularly since the company hasn’t been doing so hot lately. Revenue fell nearly 24% YOY in Q2 and EBITDA fell 72% YOY to $5mm. Cash is thinning and the leverage ratio is fattening. S&P downgraded the company back in August. The company's $306.5mm senior secured Term Loan is trading at distressed levels down in the mid 40s, a marked decline from the mid 70s in the beginning of ’17. And that is up from a week or so ago, when it was in the low 40s: this partnership with Apple ($AAPL) and Target ($TGT) helped pump the quote. For those who don't deal in the world of restructuring or distressed investing, a plunge of loan value by nearly 100% is, well, quite obviously a terrible sign. This means, plainly, that the market is pricing in the very real possibility that TOMS will default (and won't be able to pay back its loan in full). 

A positive? There are no near term maturities: the $80mm revolver is due in 2019 and the term loan is due in October 2020. Still, at Libor+550bps, the interest rate on the term loan is a minimum of 6.5% which is a cool $21mm in annual interest expense. And that’s before interest rates rise. The company looks like it will have trouble sustaining its capital structure and there’s no indication that the addition of new SKUs will help the company grow into it. With that interest expense, liquidity is going to get tighter. Those of you paying attention have heard this leveraged-buyout-gone-awry-lots-of-interest-expense story before: it’s the same one as Toys “R” Us, rue21, Payless Shoesource, & Gymboree. 

According to S&P, the wholesale business is feeling the trickle down effect of pervasively battered retail with inventory orders on the decline. In a thus far successful effort to maintain margin, TOMS is focusing on operational streamlining. We are guessing that some kind of financial advisor is in there (anyone know?). At a certain point, there are only so many costs you can take out of a business. Does anyone think the wholesale business is set to reverse course anytime soon given the state of retail? We don't. 

Which brings us back to NPR’s podcast. Celebrating how something is built is great and, again, we are big fans. The series has featured a variety of awesome episodes (email us for recs). But it bothered us that we weren't given the whole story. It's not sexy, we get that, but the company's debt load, interest expense, and private equity history should have been the last chapter. What comes next is to be determined. 

Dov Charney = Bankruptcy Pro

This is a long holiday weekend in need of a longform beach read. So here is a recent piece about American Apparel's founder and iconoclast, Dov Charney. Why bother? Well, because Charney probably knows more about retail restructurings at this point than half of you. We kid, we kid. 

Anyway, trust us and take a look. The article demonstrates how in ten short years the retail space has dramatically changed. Charney expanded from a B2B wholesaler to a B2C brick-and-mortar destination in an astounding amount of time (sidenote: Charney's architect running the expansion was none other than WeWork co-founder, Miguel McKelvey). Will we ever see that level of retail expansion again? It doesn't seem likely. 

Otherwise, American Apparel's double vault into bankruptcy is well documented by this point. Charney tried to buy the company out of the first bankruptcy for $300mm; he was denied. He didn't try to buy it the second time which came a cold 6 months later and the company sold its intellectual property to Gilden Apparel for $88mm. Gilden then shut down the entirely of the retail footprint (and the company's Los Angeles warehouse). Now Charney is launching "Los Angeles Apparel" and going all Clint Eastwood on Gilden. We love a good showdown. 

If, at this point, you're thinking "This is my long holiday weekend and I don't want to stress out by reading something about that dumba$$, Charney," well, we get it. So, a few highlights to otherwise spare you:

Choice Quote #1: "...the private equity firms can't wait to get out. They want a pay day. They're not looking to hang around or create something unique, or win accolades for their creativity. They're measured by how much money they can extract from the business. They're not interested in the customer; it's not about authenticity." PETITION note: see, e.g., Payless Shoesource, rue21 Inc., Gymboree, Claire's Stores...arggh, you get the point. 

Choice Quote #2: "'The money's not talented...[t]he money doesn't create the value. Basically the hedge funds and the private equity firms - and it's not all of them - they hire these consulting firms. What these guys do, they just come in, they raid the company - basically the suits take over. But it hasn't worked out in fashion, as far as I can tell." PETITION note: see, e.g., Wet Seal, rue21, Gymboree, Claire's Stores...arggh, you get the point. Query also: which consulting firm is he referring to? Hmmm.

Choice Quote #3: "To avoid over-production, some of those smaller players go as far as crowdfunding their inventory, waiting for a minimum order from their customers before they even contemplate production...." PETITION Note: we've been wondering whether inventory-by-crowdfunding would become more of a trend. Significantly, Elon Musk has been doing that with new Tesla models: make an order and pay a deposit. He he can then know precisely how many new models to manufacture and project cash needs accordingly. Andreesen Horowitz folks cover this topic in this interesting podcast. Moreover, other big brands are using crowdsourcing for consumer product goods. Retail is a tough business these days: we wonder whether additional brands will deploy crowdsourcing to create awareness/buzz and manage inventory simultaneously. Stay tuned and watch this trend.

Want to tell us we're morons? Or praise us? Cool, either way: email us.