Fast Forward: What's Ahead in Distress

  • Chapter 22 (Retail). Payless Inc. earned itself an S&P Global Ratings downgrade this week to CCC after "operating performance...continued to deteriorate meaningfully in the third quarter of fiscal 2017, following its emergence from bankruptcy in August 2017, a trend we expect to persist in fiscal 2018." S&P also assessed the shoe retailer's liquidity down to "weak" from "adequate." Yikes. Shoe retailers just can't seem to catch a break. Formerly-bankrupt rue21 Inc. also doesn't seem to be recovering well despite its recent emergence from bankruptcy with a wildly trimmed down balance sheet. Reuters reported this week that the company is in need of financing after an underwhelming holiday season. As we stated previously, Kirkland & Ellis LLP may want to hold off on celebrating their awards. 
  • Energy. Jones Energy Inc. ($JONE) is facing opposition from bondholders over its proposed $450mm first-lien deal. Davis Polk & Wardwell LLP has been retained to advise the bondholders.
  • Pharma. After adjusting guidance, Teva Pharmaceutical Industries Ltd. ($TEVA) was downgraded this week by S&P Global Ratings to BB due to a "series of lower-than-expected operating results." The company is facing increased competition, drug price regulation and negative effects from tax reform; it also carries $32.5b of acquisition-related debt. Both the company's stock and bonds took a dive this week. Meanwhile, Purdue Pharma LP announced that it will cut its sales force by more than half to 200 and stop promoting opioid drugs to doctors in the US. PETITION Reminder: time to dig in on which companies have real exposure to opioid-related risk. 
  • Retail (CPG). Claire's Stores Inc. has adopted a key employee retention program that pays certain executives $2.55mm in the aggregate presumably so that their expertise doesn't jump ship prior to the company's seemingly inevitable bankruptcy filing. You'll recall that Toys R Us executives received similar bonuses prior to that bankruptcy filing - a point that proved contentious in the context of post-bankruptcy incentive plan. In the context of an upgrade of Tempur Sealy International Inc's stock ($TPX), Wedbush analyst Seth Basham had some choice commentary about Mattress Firm's future (see image below).
  • Retail (Grocery). Southeastern Grocers LLC, owner of Bi-Lo and Winn-Dixie supermarket chains, has an interest payment due on 2/15/18 on two tranches of notes. It will almost certainly NOT make the payment. 
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Private Equity and Sun Capital Partners (Long Selective Marketing)

The private equity shop sent around its "2017 Highlights" touting, among other things, the realization of "over $1 billion of gross proceeds across the portfolio, driven by four successful exits, numerous dividends and divestitures, bringing distributions to our investors to $4.8 billion over the past five years." Conveniently missing from the firm's "Select Current Portfolio" list are Shopko, Vince and Paperworks, all of which have been on distressed radars for some time (and the latter of which will presumably file for bankruptcy any day now). Furthermore, there is, of course, zero mention of some of 2017's Greatest Bankruptcy Hits: Gordmans Stores Inc., Limited Stores Company LLC, and Marsh Supermarkets Holding LLC. If you'd like to see the marketing piece, email us and we'll send it to you.

Meanwhile, this Bloomberg piece celebrates Apax Partners for their transparency and frankness about bad bets like rue21.

And, finally, The Carlyle Groupcrushes it.

Restaurants (Short Kitchens, Long Bikes)

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Options abound for food these days - particularly if you live in an urban area. You can get your food sent to you in kits (Hello Fresh and Blue Apron), as groceries (Amazon Fresh, Fresh Direct) or from restaurants via the gazillion delivery services that are duking it out with one another AND capitalizing upon the rise in co-cooking kitchens (Caviar, Postmates, Grubhub and UberEats). We could fill 6 minutes of a$$-kicking reading just by continuing the list.

Here's the thing: much like the consumer products e-commerce space - where shipping is cutting into retail margins bigly - food delivery is killing your favorite restaurant. Why? Well, Captain Obvious, there are too many hands in the pot. As The New Yorker highlights (must read), "over-all profit margin has shrunk by a third, and that the only obvious contributing factor is the shift toward delivery." Ruh roh.

The piece is shocking in how ignorant every seems to be about the effect of delivery services on restaurant margins. This bit also struck us, "It’s worth noting that, even while charging restaurants steep rates, most delivery platforms are not yet profitable, either. Their hope is that order volumes will one day become high enough—and couriers will deliver enough orders per hour—to push them into the black." The alleged answer? A kitchen within a kitchen. Uber "is nudging restaurants to embed “virtual restaurants” inside their kitchens—picture a burger joint housing, at Uber Eats’s behest, a cookie company that exists only as a menu on the delivery provider’s site. DoorDash, an Uber Eats competitor, has started to experiment with leasing remote kitchen space to restaurants so that they can expand their delivery radii. If such practices catch on, it’s easy to imagine a segment of the restaurant economy that looks a lot like, well, Uber, with an army of individual restaurants designed to serve the needs of middle-man platforms but struggling to make a living themselves." This is "progress" folks. 
 

Notice of Appearance: Ted Gavin, Managing Director & Founding Partner of Gavin/Solmonese.

PETITION: What is the best advice you've gotten in your career?

TG: Indecisiveness is decisiveness. Most probabilities are 50/50: even if you're right, it may be just dumb luck. So make a decision. Examine the results. And adjust accordingly.

PETITION: What is the best book that you've read that's helped guide your career?

TG: Dangerous Company: The Consulting Powerhouses and the Businesses They Save and Ruin by James O’Shea and Charles Madigan. Random House,1997. 

A glimpse into how consulting powerhouses work, this book provides great insight into how firms and consultants sometimes lose sight of the goal - or replace the goal with their own self-interest - and wreak havoc with their clients. I especially appreciated the focus on strategic decision-making and how personal motivations can lead advisory awry. My friend Teresa Kohl told me about the book shortly after it came out -- I read it, and it remains my "what NOT to do" guide.

PETITION: What is the one product that helps make you a more efficient or relaxed pro? 

TG: My Peloton spin bike. And not because it was featured in PETITION a few weeks ago. It keeps me in good and improving heart health, and there are no excuses when you can go from bed to bike every morning. Forty-five minutes on the bike and I’m mentally relaxed, hugely motivated and ready to attack the day.

PETITION: What is one notable trend you expect to see in '18 that not enough people are talking about?
 
TG: I’m deeply concerned about the continuing erosion of institutions that previously formed what were perceived as the underpinnings of society – notably, the idea of a free, independent and journalism-centric press. We’re in a place now where people don’t choose the news that fits their outlook – but rather, they are encouraged to choose the facts that fit their outlook. Informational tribalism leads to social tribalism, and that leads to economic tribalism. This has already impacted businesses negatively, and will continue to escalate as this behavior progresses.

Toys R Us Fallout

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Mattel Inc. Reported Dogsh*t Numbers

It sure may seem like we have it out for the big box toy retailer. We don't. We just call it like we see it. Last week we called the company a "dumpster fire" on account of the string of emerging negative news. Subsequently, CNBC reported that "poor holiday sales cast doubt on its future" adding, "The poor holiday numbers may require Toys R Us to renegotiate the terms of its debt with its lenders, sources say. They will hover over Toys R Us as it works with debtholders over the next couple of weeks to draft its plans for moving forward. The lenders will have to determine if the Toys R Us business plan is supportable, said the sources." Is it getting hot in here?

Meanwhile, Toys' closure of 180 locations has reportedly exposed 20 CMBS loans with a combined balance of $500mm. 

Finally, in our "Dumpster Fire" piece, we also threw shade all over Bloomberg's rosy view for Mattel Inc. ($MAT). Rightfully so, it seems. The company reported dogsh*t holiday numbers: net sales were down 11%, gross sales were down 9%, and North America was the biggest disappointment with net and gross sales were down 17%. The company straight-up blamed the Toys bankruptcy for some of the poor performance as the company reportedly accounts for 20% of Mattel's U.S. sales and 11% of its international sales. Consequently, Mattel is suspending its dividend, shedding non-core underperforming brands, and targeting $650mm in cost reductions. Read: job cuts.

Auto - "We Wanted Flying Cars..."

Peter Thiel published a "manifesto" in 2011 about "the future," famously subtitled "We wanted flying cars, instead we got 140 characters." Burn. Anyway, this week a 9 year-old "startup" called Joby Aviation raised $100mm in new Series B financing from the likes of Intel, JetBlue, and Toyota to continue its pursuit of its "all-electric vertical take-off and landing (eVTOL) passenger aircraft into pre-production and certification." The 5-seat prototype is described as a cross between a drone and a small plane, and is expected to fly at least 150 miles on a charge. The company aims to solve the problem of city congestion and long commute times. How will it do that? Well, where its going, we don't need roads. 

Finally, Harley-Davidson reported earnings this week and they were ugly. The company's sales declined 11.1% in the US and 7.7% internationally. Consequently, the company is closing an assembly plant in Kansas City and 800 jobs will be cut. To appeal to younger riders, the company is pursuing an electric motorcycle and the first model just went into production with an anticipated delivery date of 18 months. 

Given all of the changes occuring in auto, "architects, developers and planners already are designing new projects with autonomous vehicles in mind" - like internal parking structures that can be converted to office space if (once?) demand for private parking declines. This seems to be the latest iteration of a prior theme: landlords offering Uber credits to residents in lieu of developing parking structures.

Non Sequitur. Speaking of Peter Thiel, the Freedom of the Press Foundation is archiving Gawker.com's content to protect it from the "billionaire problem."

Non Sequitur 2.0. Thiel's Founders Fund is taking the lead on a $15mm round of financing for fad-of-the-moment-app HQ Trivia. The company's founders attempted to raise dough late last year but their efforts were stymied by rumors of womanizing. (Pssst...#MeToo). Founders Fund apparently conducted an independent investigation and got comfort around the situation. Either that or Thiel just continues to have interesting ethical positions. In any event, is there anything more Silicon Valley than this: "The deal, which came together in just the last couple of days, has not yet closed. But the new funding is needed. HQ’s cash prizes have increased, and on special occasions can be as high as $10,000 per game. The app also suffers from constant technical issues, and the games are often delayed while the company gets the video stream up and running. New funding should help in both cases." This is a literal transfer of wealth from Thiel to trivia winners. 

BigLaw Entrepreneurship & Innovation

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Quinn Emanuel Pioneered Themselves to Millions

This profile about Quinn Emanuel Urquhart & Sullivan LLP is eye-popping. Putting aside the profits for partner figures - also eye-popping - the story captures the thinking of a few entrepreneurs disguised as biglaw attorneys. Here you have a couple of lawyers who were comfortably earning "one or two million dollars in revenue per year" from the big banks deciding that they could multiply that if they were to sue the banks rather than represent them. In other words, go where no one else is going. Amazing. 

Elsewhere in biglaw innovation, we couldn't help but chuckle at this sequence of events. On January 25, The American Lawyer reported that Reed Smith LLP "is the latest Big Law firm to implement health and wellness programs to combat the stresses often linked with life in the legal profession." And then on January 26, Bloomberg reported, "Workplace wellness programs have two main goals: improve employees’ health and lower their employers’ health-care costs. They’re not very good at either, new research finds."Womp womp. We're not knocking health and wellness and we are well aware that lawyers, in particular, suffer from high rates of depression (and alcoholism). But "not very good" isn't a great description for an expensive initiative. Maybe it helps with recruiting?

Retail (Cue the Scarlet 22, Paint with Distressed Lipstick)

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We've been very good diversifying our content away from that old #retailapocalypse + "Amazon Effect" narrative. If we do say so ourselves. But, sadly, retail issues haven't gone away and, in certain cases, they may actually be coming back. To point, this week The Wall Street Journal reported (paywall, upshot here if you don't have access) that rue21 is ALREADY struggling - mere months after emerging from bankruptcy. If so, Kirkland & Ellis LLP may want to hold off on celebrating this particular Turnaround Award.

Elsewhere in "deeply distressed" retail, Revlon Inc. ($REV) is busting the oft-repeated broad-brush narrative (by Jim Cramer and others) that beauty is killing it. Clearly not all beauty. 

Investment Banking (Short Lip Service)

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This is an interview (audio) Bloomberg did with Ken Moelis, Chairman of investment banking firm, Moelis & Co. ($MO) at Davos. We perked up when Mr. Moelis was asked the following, "Is it possible that a woman will be the next leader of Moelis & Co.?" "Oh, definitely," Mr. Moelis responded.

Possible, sure. Probable? Statistically speaking, no. 

Take a look for yourself: here is the "Senior Leadership Team" of Moelis. We count 9 women out of 156 Managing Directors. For the math-challenged, that's 5.7%. Which makes Moelis a quintessential investment banking dude-fest. "We don't do as good of a job at retaining them through the life cycle of becoming a managing director." Understatement much? If the "entering work force...is somewhere right around 50-50," that is clearly right. The word "good" shouldn't be anywhere in that sentence.

Chinese Distress (Short Transparency, Long Process Risk)

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There's been a lot of news surrounding HNA Holding Group Co. of late. The company is a large shareholder of Hilton Worldwide Holdings Inc. ($HLT) and Deutsche Bank AG. Now (a) the US government is seeking more information (video), (b) the ECB is considering a review, (c) ratings agencies are downgrading certain segments of the conglomerate, (d) a bankrupt company is suing HNA, and (e) bond prices are decreasing. The company - maybe best known for its proposed acquisition of Anthony Scarramucci's fund of funds - has made more than $40b of acquisitions since 2016. While it is unclear to what degree the capital structure is in trouble, the company is divesting assets, such as a Sydney building to Blackstone Group for $161mm. 

The company also serves as a warning signal to distressed investors with an eye towards China. This past week, Bill Bishop of Sinocism highlighted that the Chinese media has been told to tone down coverage of the firm's travails. They're concerned that market forces will further compound the company's issues. While we don't endorse opacity ever, we surely appreciate - given the recent trends with Toys R Us - why this might be. Per Bloomberg, the company faces some heavy bond maturities from Q3 2018 through Q3 2019. With pressure on the bonds, there very well could be a distressed opportunity here. Provided, that is, you can get your arms wrapped around all kinds of categories of risk. Including, of course, a government-imposed lack of information. 

Speaking of risk, it appears - thanks, of course, to a lot more transparency - that Chinese investors are comfortable with investing in stressed US-based companies (like Community Health Systems ($CYH)). 

Fast Forward (Cenveo, Remington, Nine West, Patriot National & More)

  • Countdown to a Claire's Stores bankruptcy filing. Lazard Ltd. ($LAZ) has been hired.
  • Countdown to a Nine West Holdings Inc. bankruptcy filing in March.
  • Countdown to a FirstEnergy Solutions default in April.
  • iHeartMedia Inc. continues its slow crawl towards bankruptcy.
  • Remington Outdoor Company Inc., the private equity owned (Cerberus Capital Management LP) firearm manufacturer clearly isn't benefitting from #MAGA! Indeed, President Obama's constant (yet empty) threats to the gun manufacturing industry helped drive considerable gun sales. President Trump's coziness with the industry, however, is failing to juice demand. And, therefore, the company has hired Lazard Ltd. ($LAZ) to explore balance sheet restructuring options. Is it us or is Lazard absolutely dominating?
  • We're getting tired of writing about Sears Holding Corp.'s ($SHLD) announcements and downgrades...but, there was another. Downgrade. Not much farther down to go.
  • Discount retailer Stein Mart Inc. ($SMRT) has hired advisors (paywall) as it falls further into distressed territory.
  • Tops Holding LLC earned itself a downgrade. Apollo Capital Management-owned Fresh Market, meanwhile, announced that it is pulling all of its planned new store openings in 2018. We're old enough to remember when grocery stores were supposed to be salvation for malls. Curious.

And, finally, this week we should see the bankruptcy filings of Patriot National Inc. and Cenveo Inc.

Hollywood (Long Data)

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We previously wrote about Moviepass and how its controversial subscription service - now apparently at 1.5mm members (PETITION Note: it was at 1mm merely two weeks ago when we wrote about it) - seeks to make the most out of an industry in apparent decline by leveraging data. Now the company says that it has weaponized that data to influence movegoers to go to certain films - an equally tantalizing and scary proposition. And, so, by extension, the company now wants to get into the moviemaking business to capture some of the upside of those efforts. Moreover, it is getting into the targeted ad business. The company is funded by Helios and Matheson Analytics Inc. ($HMNY), which just happens to be the second most shortest stock on the NASDAQ Composite. Clearly investors don't think that Moviepass' business model is real. 

Ski Season (Long the Short-Term; Short the Long-Term)

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It's ski season and so we imagine a number of our readers will be heading out West for some client boondoggles. We thought you'd be interested in knowing that, this past week, Sonnenblick-Eichner arranged a $60mm set of construction and financing loans for the joint venture that owns the St. Regis hotel in Park City, Utah. It's a 10-year financing consisting of separate loans secured by hotel revenue and condo inventory. Use of proceeds? Takeout existing debt on the property (Deer Valley) and construct more condos. The funds came from a domestic life-insurance firm.

Wait, what? A life-insurance firm funded $60mm worth of loans secured by hotel revenues and condo inventory? NOW...when there is, like, virtually no snow on the ground? Apropos, the Commercial Observer notes "some experts argue that climate change threatens to erode the ski industry's profits - although perhaps not over this loan's 10-year term. Last year, a group of researchers from the Arctic and Mountain Regions Development Institute and the University of Colorado, among other institutions, used a climate model to predict that the length of the Rocky Mountains ski season could decline by more than 50 percent over the next three decades, resulting in tens of millions of fewer recreational visits to the area." We hope the owners of those new condos enjoy Spring hikes and Sundance movies.

Advertising & Media (Desperate Times Call for Desperate Measures)

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It's one thing to see a flying car whisk by a Coca-Cola ($KO) sign in Blade Runner 2049. Or Vin Diesel crush a Corona ($BUD) before crushing a skull in Fast and the Furious 2049 (how many of these are there?). Or Mark Wahlberg mention a motorcycle he likes in Big Daddy. It's pretty obvious that those are placement ads. But its an entirely different story when a large corporate partner like Proctor & Gamble ($PG) purchases a plot line and dialogue. That isn't so obvious. But so it is. This week, Variety reported that P&G has done precisely that in a "unique advertising pact" with American Broadcasting Company ($DIS). The network will create an episode of "black-ish" that will - as a central plot device - discuss a P&G-produced short film and its implications on race merely because that's "an issue that the advertiser is trying to burnish." Well, ok, then.

Cord-cutting is getting aggressive and we get that Disney needs to act in-kind to ensure revenues. ESPN is under siege, Netflix ($NFLX) has a head start on stand-alone streaming, and even Star Wars toys have underperformed. But how this is handled will be a bellweather of things to come.

For instance, Instagram influencers are under strict guidance from the FTC on how to handle sponsored posts. Failure to comply has gotten various influencers - the Kardashian's being one notable example - in hot water. Remember the Fyre Festival? Riiiiiiight. To what degree are P&G and DIS required to alert viewers that the dialogue they are listening to is paid for? To the extent there is an alert, should it be noted at the bottom of the screen at the time of the dialogue (makes sense) or noted in the end credits (doesn't make sense). This may very well be another instance where regulation has to play catch-up to innovation.

Meanwhile, there's been a notable rise in corporate venture capital (CVC) arms over the last several years. What we haven't noticed, however, is the blatant weaponization of the CVC's distribution channels to help scale product. Yet. We wouldn't be surprised to see a rise in (shameless) native plugs of new apps or hardware in future mainstream broadcast content. And that - on the basis of scale opportunity alone - could be a real competitive advantage for corporate-backed startups relative to venture-backed startups. Query, however, what that would do to the viewing experience. Netflix ($NFLX) and HBO ($TWX) don't serve ads for a reason. Yet. We'd be shocked, though, if it doesn't come eventually (our money is on NFLX first). 

P.S. Elsewhere in advertising, Amazon is coming ($AMZN) and coming fast with ad revenue growing faster than Google ($GOOGL) and Facebook ($FB). 

Co-working Spaces (Holy WeWork Batman)

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Brookfield Asset Management Inc. and Onex Corp. are reportedly prepping a $3.7b offer to purchase IWG Plc, a commercial real estate company and office space owner. Those who have been around the restructuring industry long enough will recall that IWG is the successor entity to Regus, which filed for bankruptcy nearly 15 years ago after it expanded too quickly in the midst of the dot-com boom. Now, putting aside "location location location," which, admittedly, is, uh, we guess kind of a big deal in real estate, it's important to note that IWG actually owns its office space. It also has nearly 3k locations. Its main competitor, WeWork, in contrast, does not own most of its 283 lease rejections...uh, oops, we mean, locations. Which, naturally, means that it is valued at 7x BAM and Onex's offer for IWG. Because, you know, pixy dust. 

Since we're on the topic of WeWork, we might as well note that news out of its WeLive division has been scant ever since Bloomberg reported a few months ago that the concept wasn't gaining traction. Notably, however, Node, a co-living company based in London and New York just launched its third Bushwick-based location. Things are only going to get harder for WeWork as it tries to justify its lofty valuation.

Labor (Long Ramen, BigLaw & Banking, Short Family/Fun?)

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Michael Moritz, a Partner at Sequoia Capital, stirred quite a tizzy this week with his hot take in the Financial Times that Silicon Valley - relative to China - is full of a bunch of whiny snowflakes. And, then, ironically, the whiny snowflakes whined about Mr. Moritz seeming distaste for "work/life balance." His overall message - while delivered in about as insensitive and out-of-touch a manner imaginable - rings true, however, in that China is undeniably a force to be reckoned with; his piece is yet another warning signal that U.S. dominance is being threatened by China's ambitions. 

While fawning over China's work ethic, Mr. Moritz says, "...the pace of work is furious. Here, top managers show up for work at about 8am and frequently don’t leave until 10pm. Most of them will do this six days a week — and there are plenty of examples of people who do this for seven. Engineers have slightly different habits: they will appear about 10am and leave at midnight. Beyond the week-long breaks for Chinese new year and the October national holiday, most will just steal an additional handful of vacation days." To which we reacted, "That's it?" Chinese managers ONLY work from 8am to 10pm? They get a day off every week!? They take a handful of vacation days?! Sh*t. These lionized Chinese engineers would NEVER make it on Wall Street or in BigLaw. 

Or maybe they would. "JPMorgan has changed its pitch to the MBA students it targets for recruitment, focusing more on the quality of the roles available than the generosity of the remuneration package." Indeed, there is now "a stronger emphasis on the quality of life, with guarantees to protect weekend leave and holiday time and the opportunity to swap with counterparts based in offices overseas...." Clearly, Moritz and Jamie Dimon ($JPM) haven't been hanging out. 

Anyway, our favorite reaction to Moritz? This thread by David Heinemeier Hansson: "What a f*cking toad."