🤪Malls, Malls, Malls (Long Eccentric High-AF CEOs)🤪

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Things continue to get worse for certain players in the mall REIT space.

On October 24th, Washington Prime Group Inc. ($WPG) reported earnings and managed to surpass rock bottom expectations. The above-referenced net operating income decrease came from a $4.3mm “negative impact of cotenancy and rental income from 2018 anchor bankruptcies (Bon-Ton Stores, Sears, Toys R Us), and $2.1mm was attributable to 2019 bankruptcies (Charlotte Russe, Gymboree and Payless ShoeSource).” Occupancy decreased 1.1% to 92.9% during Q3 and the company lowered guidance (negative EPS).

S&P Ratings subsequently downgraded WPG from BB to BB- saying:

…despite slight sequential improvement, same-property NOI growth at tier 1 enclosed properties remained extremely negative, declining 8.8% with negative 7.6% releasing spreads over the past year, affected by co-tenancy clauses and additional bankruptcies/liquidations, with some expected redevelopment deliveries delayed. We believe overall metrics are modestly worse when factoring in the company's 14 remaining tier 2 and noncore malls, which we continue to include in our analysis of Washington Prime. Due to third-quarter results, management downwardly revised its publicly stated operating target for same-property NOI growth in 2019.

Washington Prime Group Inc.'s operating performance has continued to deteriorate such that we now view the company's business less favorably, with weaker cash flow, lower EBITDA margins, and diminishing prospects for stabilization in 2020.

Louis Conforti, WPG’s CEO, took to alt rock to explain the company’s negative performance, saying “[t]ake it from the Strokes, one of my all-time favorite bands, it's not hard to explain” before describing the effects of the #retailapocalypse on performance.

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🍴Declining Restaurant Trends Ripple Through (Short Dinnerware)🍴

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There are a number of trends that are taking hold currently that may be disruptive to a company that manufactures and distributes glass tableware (i.e., shot glasses, tumblers, stemware, mugs, bowls, etc.) and ceramic dinnerware products (i.e., servicing utensils and trays) to food service distributors, mass merchants, department stores, retail distributors, houseware stores, breweries and other end users of glass container products. First, people don’t go to department stores or houseware stores anymore (in case you hadn’t heard, check out the stock performance of every department store in the US and, for good measure, Bed Bath & Beyond ($BBBY)). Second, millennials aren’t drinking as much as Generation Z did. Third, people are ordering food more frequently and cooking and hosting dinner parties far less often than they did prior to VC-subsidized companies like UberEats ($UBER), Postmates and Caviar coming along. Indeed, per the company’s most recent report:

In U.S. foodservice, restaurant traffic for Q3 as reported by Black Box was down 3.6% compared to down 1.3% in Q3 of 2018.

All of these things are headwinds to a company like Libbey Glass ($LBY), an Ohio-based company founded in 1888. The longevity of the business is uber-impressive, but the year is currently 2019, and sh*t is unforgiving out there: Libbey is starting to look a bit troubled.

The company reported Q2 numbers back in August and revenue was down across all segments: food service and retail. The company cited “intense global competition” and trade headwinds (in both Mexico and China) as major factors. Net sales were $206.2mm, down 3.5% YOY, and the company reported a net loss of $43.8mm in the quarter (primarily due to a non-cash impairment charge). Notably, business was particularly bad in EMEA: $5.5mm decline. It was the second straight quarter where the business performed poorly on a year-over-year basis.

On the August 1 earnings call, the company noted:

“We do…continue to see declines in U.S. & Canada foodservice traffic, as has been reported by third-party research firms Knapp-Track and Blackbox every quarter since 2012. Our U.S. & Canada foodservice channel is currently performing in-line with market trends. Management expects these trends, and the challenging environment experienced during 2018 and the first half of 2019, to continue for the remainder of the year.”

In particular, one disturbing trend is takeout and delivery:

While this channel continues to adapt to the new norm of takeout and delivery, we've seen our focus on new products and differentiated service begin to pay dividends. In addition to these ongoing efforts, we are adapting our approach and resource deployment to expand into growing and/or underpenetrated segments of the channel, like health care and hospitality. As previously mentioned, we also see a significant opportunity to leverage digital tools to reach end users and further support our distribution partners.

Sure, they did. And they certainly needed to: a quick look at their numbers shows that the second quarter is typically the business’ strongest. This didn’t portend well for Q3 performance.

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How Are the Investment Bankers Doing?

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PJT Partners Inc. ($PJT) reported fiscal Q3 numbers yesterday and total revenue hit $174.2mm (up 24% YOY) — no thanks to the restructuring group. Per Mr. Paul Taubman, compared to last year, restructuring:

…revenues decreased meaningfully in the third quarter, but held almost even for the nine month period. Given the increase in distress within certain industries, such as energy, media, telecommunications, pharma, consumer retail, our outlook for the full-year has become a bit more positive and we now expect full-year restructuring revenues to be up slightly year-over-year. This activity level combined with restructurings increasing ability to leverage the expertise and connectivity of our Strategic Advisory bankers should result in a stronger backlog heading into 2020 versus a year ago. (emphasis added)

Wait. There’s distress in energy and consumer retail? Who knew. Anyway, this isn’t fake news but it isn’t really big news either: banker assignments close choppy which makes quarterly reporting for restructuring a tough game. Still, if you’re counting on a sizable year-end bonus, you probably don’t want the company CEO singling you out for being a drag on numbers — encouraging guidance notwithstanding.

⚡️Newsflash: PG&E Corporation⚡️

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You got cute. You invested in the equity. Now you may be up sh*t’s creek.

With each passing day and each damaged structure, a growing administrative expense claim is squeezing any hope of equity value and potentially threatening the backstop commitments received back in…wait…carry the one…FRIKKEN SEPTEMBER. We’re old enough to remember reading this somewhere:

Interestingly, Abrams & Knighthead have conditioned their support on, among other things, two key components: (1) a “wildfire claims cap” of $17.9mm and (2) no “occurrence of one or more wildfires in the Debtors’ service territory after the Petition Date and prior to January 1, 2020 that is asserted by any person to arise out of the Debtors’ activities and that destroys or damages more than 500 Structures.” Will global warming blow up this deal? Note: the Thomas Fire ripped through Ventura and Santa Barbara counties in December 2017, wrecking 281k acres, 1063 structures, and killing 23 people. 

Oh right. That was us: we wrote that. We really wish that hadn’t aged so well.

💥What to Make of the Credit Cycle. Part 31. (Long the Consumer)💥

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It appears that the fear of recession is receding a bit:*

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Given the recent data on manufacturing and services, a recession can really only be avoided thanks to the consumer (and interest rates, perhaps). It looks likely they’re ready to do their part:

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Apropos, Deloitte released its “2019 holiday retail survey,” forecasting “that holiday retail sales will increase 4.5-5 percent this year. E-commerce holiday sales are projected to grow 14-18 percent over 2018.” They estimate that online purchases will account for 59% of holiday spending. That doesn’t bode well for brick-and-mortar retailers already feeling a world of hurt (or city streets). Here are some of the survey’s key takeaways:

  • Short-term consumer sentiment is positive and that confidence is likely to translate into spending this holiday season. However, “[f]or the first time since 2012, fewer than 40 percent of consumers expect the economy to improve in 2020. This is a 12 percent drop from 2018.” 

  • Shoppers are increasingly attuned to product, price and convenience. They want high-quality differentiated product……

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⚡️Update: CBL & Associates Properties Inc.⚡️

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In our recent newsletter, â€œđŸ‡şđŸ‡¸Forever 21: Living the (American) Dream🇺🇸,” we highlighted the exposure that landlords have to Forever21:

The company currently spends $450mm in annual rent, spread across 12.2mm total square feet. The company will close 178 stores in the US and 350 in total.

We highlighted how the company noted the impact this plan will have on large mall landlords, the company said:

Forever 21’s management team and its advisors worked with its largest landlords to right size its geographic footprint. Four landlords hold almost 50 percent of its lease portfolio. To date, Forever 21 and its landlords have engaged in productive negotiations but have not yet reached a resolution.

Two of those landlords were the largest unsecured creditors, Simon Property Group ($SPG) and Brookfield Property Partners ($BPY). But another, CBL & Associates Properties Inc. ($CBL), also has exposure. In â€œThanos Snaps, Retail Disappears,” we discussed CBL’s issues: bankruptcy-related store closures are something that CBL is very familiar with. Management said last February that things were going to turn around but, instead, things just keep getting worse as more and more retailers go out of business.

Forever 21 is one of CBL’s top tenants, occupying 19 stores (plus 1 store in “redevelopment phase”). Per CBL’s FY 2018 10-K, Forever 21 accounts for roughly 1.2% of CBL’s revenue or $10 million.

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Of those 20 stores, 7 are subsumed by a motion by Forever 21 to enter into a consulting agreement to close stores (see bankruptcy docket (#81 Exhibit A):

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On October 14, 2019, partly due Forever 21’s bankruptcy, Moody’s downgraded CBL’s corporate family rating to B2 from Baa3 and revised its outlook to negative. Moody’s explained:

CBL's cushion on its bond covenant compliance is modest, particularly the debt service test, which requires consolidated income to debt service to annual debt service charge to be greater than 1.50x. The ratio has declined from 2.46x at year-end 2018 to 2.27x at Q1 2019, and 2.25x at Q2 2019 due principally to declining operating income during these periods. CBL's same-center NOI growth was -5.3% for Q2 2019 YTD and CBL projected same-center NOI growth to be between -7.75% and -6.25% for 2019, which means that the debt service test will likely weaken further.

The chart below reflects the company’s capital structure and debt prices. It is not doing well. In fact, the term loan and the unsecured notes have priced down considerably since March:

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Here is the company's stock performance:

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The last thing CBL needed — on the heals of the downgrade — was near-instantaneous bad news. It got it this week.

Yesterday, the bankruptcy court granted interim approval authorizing Destination Maternity Corporation ($DEST) to assume a consulting agreement with Gordon Brothers Retail Partners LLC. Gordon Brothers will be tasked with multiple phases of store closures. Among those implicated? CBL, of course:

CBL is landlord to DEST on 16 properties that are slated for rejection. Considering that DEST cops to being party to above-market leases, this ought to result in a real economic hit to CBL as (a) it will lose a high-paying tenant, (b) it will take time to replace those boxes, and (c) it is highly unlikely to obtain tenants at as favorable rents.

Let’s pour one out for CBL, folks. The hits just keep on coming.

🤪Lending, Lending, Lending🤪

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Sunday’s looooooong special report, “CLO NO!?!?,” about Deluxe Entertainment, collateralized loan obligations (and their limitations), leveraged lending, EBITDA add-backs and other fun lending stuff sparked A LOT of interest. If you’re not a Member, you missed out and now thousands of people you’re competing with for business are officially smarter than you. Go you!

One thing we didn’t have time (or, given the length, space) to note is how private credit lenders take exception to being lumped in with the syndicated leveraged loan market and, by extension, CLOs. Indeed, “leveraged loans” are a rather broad category and there are differences between lenders that ought to be acknowledged: private credit vs. public BDCs vs. private BDCs vs. syndicating banks, etc., etc.

Regardless of distinctions, however, there’s clearly a ton of green out there looking for some action. To point, back in September, Bloomberg noted:

Globally, private credit, which includes distressed debt and venture financing, has ballooned from $42.4 billion in 2000 to $776.9 billion in 2018. By one estimate, the total is likely to top $1 trillion in 2020.

Public pension funds, insurance companies and family offices are some of the biggest investors putting money to work in private credit. Private equity firms themselves have also flooded into the space, forming their own credit arms or raising cash for private credit vehicles, along with private equity funds of funds from these investors. The frenzy has turned some lending start ups into heavyweights almost overnight. Owl Rock Capital Partners — a New York firm founded by Blackstone, KKR and Goldman Sachs veterans — has amassed $13.4 billion of assets since it started in 2016.

Bloomberg continued:

An influx of new lenders and fresh cash in the space has contributed to cutthroat competition and looser covenants -- terms lenders impose on borrowers to help protect their investments -- in addition to thinner returns. Regulators in Europe have taken note of private credit’s boom, saying its growth has been accompanied by signs of increased risk-taking. UBS credit strategists have called private credit “ground zero” for concerns due to the increased leverage on direct loans. Covenants can also be undermined when borrowers goose their earnings by, for instance, claiming savings from ambitious cost-cutting programs that may never come to pass. Jamie Dimon, CEO of JPMorgan, has also said some non-bank lenders may not survive an economic slump because they’re holding lower-quality loans -- and their disappearance could leave some borrowers “stranded.”

Hmmm. It sure sounds like the aforementioned distinctions may be without a difference given the market dynamics.

In response, the private credit guys — and, yes, they’re overwhelmingly dudes — love to say that they’re not necessarily overrun by the supply/demand imbalance that generally exists elsewhere in credit. “We have proprietary credit analysis techniques,” they’ll say, thumping their vested chests in the process. “We have specialization in category XYZ,” they’ll argue in an attempt to de-commoditize themselves. Boasts notwithstanding, any actual or alleged competitive differentiation hasn’t, in fact, insulated most lenders from macro market trends where sponsors have the power and lenders capitulate on the regular. No doubt, private equity sponsors are playing competing BDCs and private credit providers against one another to get deals done with favorable terms. Otherwise, we wouldn’t be reading about EBITDA add-backs, and cov-lite or cov-loose, etc.

Still, they’re combative. “Credit quality is more important than documentation,” they’ll say, highlighting how they loan with the intent to satisfy the life cycle of the paper rather than dole it out or ditch it. Management. Industry. Financials. No cyclicality. The documentation is less relevant when these things line up, they’ll say. Do that right and they won’t have to worry about what happens when the thing goes sideways. Counterpoint: restructurings wouldn’t exist if underwriting was 100% bullet-proof.🤔 

Alternatively they’ll deploy the Trump defense. “Sure, sure, our docs suck. But the worst private credit doc is better than the best syndicated loan doc.” Or they’ll argue that they’re able to get favorable pricing in exchange for the lax nature of the docs. Maybe. We suppose we’ll also see in due time if that pricing properly compensates lenders for the risks they’re taking.

Look, we get that the type of loans that now constitute “private credit” fared relatively well in the last cycle. We also understand priority and acknowledge that top-of-the-capital-structure loans ought to be, from a recovery perspective, fine places to play. But to cavalierly play it like there isn’t reason for concern is disingenuous.

Apropos, Golub Capital just hired new Workout Counsel. He — and his ilk — may be busier than these private credit lenders care to admit.

💥CLO NO!?!?💥

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On October 3rd, Deluxe Entertainment Services Group Inc., a content creation-to-distribution video services company (whatever the hell that means), filed a prepackaged bankruptcy case in the Southern District of New York. The purpose? To address the company’s over-levered capital structure ⬇️.

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That’s right, even “content creation-to-distribution video services” companies have no trouble loading up over $1b of debt.

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Gotta love these markets. Anyway, it’s not the capital structure itself that’s interesting here. Rather, it’s the parties playing in that capital structure.

In its bankruptcy papers, the company took pains to note that it thought it would get an out-of-court deal done. In July, it secured a loan — the $73mm “Priming Term Loan” above — to enhance liquidity and bridge the company to a transaction that would substantially reduce its debt obligations by equitizing the “Existing Term Loans.” Shortly thereafter, as all parties were working towards consummating the transaction, it became apparent to all that the company would need $25mm in incremental liquidity. While this is curious from a 13-week cash flow management perspective (), this shouldn’t have been a show stopper.

But then the ratings agencies had to go and screw everything up.

On August 5th, S&P Global Ratings downgraded the company’s debt three notches into junk territory to CCC- from B-. Per the Wall Street Journal:

S&P primary credit analyst Dylan Singh said the ratings were lowered because Deluxe has faced challenges in refinancing its debt structure, a problem that could increase the likelihood of a default.

Although the new $73 million loan will give additional liquidity to Deluxe, Mr. Singh said he doesn’t expect the company to be able to repay its ABL facility when it comes due in November and believes the business will try to extend the maturity before then. The current capital structure is unsustainable, he said.

Crossing over to the CCC threshold is a big problem for a lot of lenders — specifically, CLOs. For the uninitiated, here is a decent CLO primer about what CLOs are and how they work. For purposes of this briefing, it’s important to note that most CLOs are forbidden by their foundational fund docs from holding an allocation of more than 7.5% of their portfolio in CCC-or-lower-rated debt. This effectively handcuffed most of the CLOs in Deluxe’s capital structure from providing the necessary new money.

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🎢Weeeeeeeeeeeeeee🎢

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⚡️Update: WeWork⚡️

This was us covering the hourly news diarrhea that came out about WeWork in the last 48 hours alone:

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Which, we suppose, is better than how the company’s equity and existing noteholders must be managing:

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Or the fine bankers over at JPMorgan Chase ($JPM) who are tasked with finding capital markets suckers…uh…investors…who’d be so kind as extend this steaming pile a lifeline:

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So, sifting through the constant headlines, where are we at?

Okay, right. The hot mess of a liquidity profile and limited amount of debt capacity to get a deal done.  Nothing to see here. All good.

Reminder: it is widely believed that WeWork will run out of cash by the end of the year without a new deal in place. Axios reports:

The company reported $2.4 billion of cash at the end of June, with a first-half net loss of $904 million. At that pace, it should have been able to survive at least through the middle of 2020. But I'm told that it significantly increased spend in Q3, partially due to the lumpy nature of real estate cap-ex, believing it would be absorbed by $9 billion in proceeds from the IPO and concurrent debt deal. One source says that there's probably enough money to get through Thanksgiving, but not to Christmas.

Riiiiiight. So here are the options:

  • A Softbank Group new equity and debt bailout pursuant to which they get control of WeWork and napalm Masa’s former boy, Adam Neumann, in the process. This would reportedly be an aggregate $3b package “to get through the next year” — repeat, TO GET THROUGH THE NEXT YEAR — with the equity component coming significantly cheaper than the previous self-imposed $47b valuation (at a $10b valuation); or

  • JPM arranges some hodge-podge debt package and tests the market’s never-ceasing thirst for yield, baby, yield. The early reports were that the financing package would be $3b, comprised of $1 billion of 9-11% secured debt, $2b of unsecured PIK notes yielding 15% (1/3 cash pay, 2/3 PIK), and letter of credit availability. Wait, 15%?! How does a company with no liquidity even pay that? That’s why the PIK component is so critical: it would simply add 2/3 of the interest due to the principal of the debt. Said another way, the debt would compound annually and creep past $2.5b in two years. Per Bloomberg, “The $2 billion of proposed unsecured debt may carry an additional sweetener for investors: equity warrants designed so that investors could boost their return to around 30% if the company gets to a $20 billion valuation, according to the person who described the structure.” Because debt won’t dilute equity like Softbank’s equity-heavy proposal would, WeWork insiders (read: Neumann) apparently prefer the JPM approach. Regardless of what insiders prefer, however, is whether the market will be receptive to what one investor dubbed, per Bloomberg, “substantial career risk.”

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We’re old enough to remember when WeWork’s notes rebounded a mere five days ago for reasons that were wildly inexplicable to us then and even more so now.

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So, to summarize, who are the big winners? IWG/Regus ($IWGFF)(long?). We’re pretty sure they’re loving what’s happening here; we have to imagine that the inbound calls have to be on the upswing. Also, the restructuring professionals. Whether you’re Weil Gotshal & Manges LLP (Softbank), Houlihan Lokey ($HLI)(Softbank), or Perella Weinberg Partners (WeWork’s Board of Directors), you’re incurring more billables/fees than you expected to mere days weeks ago. Somehow, some way, the restructuring pros always seem to come out ahead. And, finally, Goldman Sachs ($GS). Because there’s nothing more Goldman-y than them selling their prop stock right out from under a proposed IPO.

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💊How's GNC Doing (Long Online Supplements, Short Fitness Stores)?💊

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A quick recap of PETITION’s coverage of everyone’s (cough, no one’s) favorite supplements slinger.

In August 2017 in “GNC Holdings Inc. Needs Some Protein Powder,” we wrote:

GNC Holdings Inc. ($GNC) remains in focus as it reported its Q2 numbers this past Thursday. In summary, decreased consolidated revenue, decreased domestic (company-owned and franchised) same-store sales, decreased net income and operating income, decreased manufacturing/wholesale business...basically a hot mess. Limited bright spots included China sales and the new GNC storefront on Amazon. You read that right: the storefront on Amazon. Ugh. The company has $52mm of cash, $163.1mm available under its revolver and a robust $1.5b of long-term debt on its balance sheet. The stock traded down 7% after the announcement (but was up on the week).

In February 2018 in “GNC Makes Moves (Long Brand Equity, Meatheads & Chinese Cash),” we introduced the great strides GNC was undertaking to avoid a bankruptcy filing. These actions included (a) paying down its revolving credit facility, (b) moving towards an amend-and-extend transaction vis-a-vis its term loan, (c) obtaining a $300mm capital infusion by way of issuance of a perpetual preferred security to CITIC Capital, a Chinese investment fund and controlling shareholder of Harbin Pharmaceutical Group, and (d) the formation of a JV in China whereby it would slap its brand on Harbin’s product.

The following month in “GNC Holdings Inc. & the Rise of Supplements,” we highlighted that the amend-and-extend got done. And this:

Concurrently, the company entered into a new $100 million asset-backed loan due August 2022 and engaged in certain other capital structure machinations to obtain $275 million of asset-backed “first in, last out” term loans due December 2022. Textbook. Kicking. The. Can. Which, of course, helped the company avoid Vitamin World’s bankrupt fate.  Goldman Sachs!

We also noted a number of DTC supplements companies that were juiced by financings or acquisitions, citing them as headwinds to GNC and GNC’s nascent DTC business. The stock traded at $3.97/share back then. And we wrote:

Perhaps those restructuring professionals disappointed by Goldman Sachs’ success in securing the refinancing should just put that GNC file in a box labeled “2021.”

We revisited GNC in May 2018 in “GNC Holdings Inc. Isn’t Out of the Woods Yet.” At that time, the stock hovered around $3.53/share and the company reported more bad news including (i) 200 store closures, and (ii) declining revenue, same store sales at domestic franchise locations, and net income. We wrote:

Clearly GNC’s future — now that it has some balance sheet breathing room — will depend on its ability to capture new international markets, e-commerce growth primarily through its private label, innovation around product to combat DTC supplements brands, and continued cost controls. It will also need to execute on its goal of translating e-commerce sales to foot traffic. To accomplish this Herculean task, GNC may just need some supplements.

Last July, we noted that revenue continued its downward trend but earnings generally beat (uber-low) expectations. In August, we highlighted how Goldman Sachs was acting very “Goldman-y,” given that Goldman Sachs Investment Partners was a major investor in DTC vitamins and supplements startup Care/of, which had just raised a $29mm Series B round. We’ve slacked on our coverage since.

So, like, what’s up with GNC now?

It reported earnings back in July and continued to show weakness. Quarterly consolidated revenue and adjusted EBITDA declined meaningfully — the latter down 3% YOY. Same store sales were down 4.6%. E-commerce was down 0.2%. Revenue from franchise locations decreased 1.8%.

The company blamed promotional offers it implemented at the beginning of the quarter for the lousy same-store sales results.

Early in the second quarter, we made some adjustments to some of our promotional offers and our marketing vehicles, and we saw a direct negative impact to the top line. We quickly course corrected and saw sales strengthen throughout the remainder of the quarter.

PETITION Note: somebody must have gotten fired. Hard. Nothing like dropping an idea that is so horrifically bad that it immediately resulted in a “direct negative impact to the top line.” YIKES.

Speaking of yikes, mall performance is, like, YIIIIIIIIIIIKES:

In addition, the negative trends in traffic that we've seen in mall stores over the past several years has accelerated during the past few quarters putting additional pressure on comps. As part of our work to optimize our store footprint, we're increasing our focus on mall locations. And as you know, we have a great deal of flexibility to take further action here due to the short lease terms we have across our store portfolio.

It's important to note that our strip center locations are relatively stable from a comparable sales perspective. As a reminder, 61% of our existing store base is located in strip centers while only 28% reside in malls.

As a result of the current mall traffic trends, it's likely that we will end up closer to the top end of our original optimization estimate of 700 to 900 store closures.

Mall landlords everywhere were like:

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💥What to Make of the Credit Cycle. Part 30. (Long Signs of Coming Pain?)💥

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This week the market got qualitative and quantitative signals that were decidedly mixed.

On Tuesday, the ISM U.S. manufacturing purchasing managers’ index registered 47.8% for September, the lowest reading since June ‘09, and the second straight month of deceleration. A number below 50% suggests economic contraction. Economists all over Wall Street bemoaned tariffs for diminished activity, with one Deutsche Bank economist noting “the recession risk is real.” President Trump, of course, parried, saying that higher relative interest rates and the strong dollar are to blame.

Similarly, pundits dismissed this data’s importance, noting that the US economy is more services-based (70% of growth) than manufacturing-oriented. In addition, a competing survey from IHS Markit showed some positivity, reflecting that “though the sector remains in contraction, the index rose for the second straight month.” It concluded that the US, China and emerging markets are all simultaneously improving. Ah, qualitative reports. Insert grain of salt here. 😬

On Thursday, the ISM non-manufacturing index — a widely watched measurement of the services sector — came out and the numbers were 💩. Like weakest in 3 years 💩💩💩 .

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💥Another Gangbusters Quarter from Pier 1 (Long Slow Deaths)💥

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Callback to previous Pier 1 Imports ($PIR) coverage here (Q1 ‘19 earnings summary), here (Q4, fiscal ‘18), and here ($71mm in cash remaining). Unfortunately, this will be our last coverage of the retailer because it appears to have pulled off a miracle turnaround of epic proportions: it CRUSHED Q2 earnings and appears to be well on its way to reclaiming “iconic” status!

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THIS THING IS A STEAMING TURD.

It’s even worse than we initially tweeted. Gross profit was 16.7% vs. 26.3% last year. The company’s operating loss expanded to $93.1mm compared to $62.5mm a year ago; it reported a net loss of $100.6mm or $24.29/share ($51.1mm and $12.68/share loss last year). The company noted “lower average customer spend” and “decreased store traffic.” And it sank $7mm into professional fees to help it right the ship. Management surely would’ve gotten torn up on the earnings call except, well, only one analyst was actually on the call. Nobody cares anymore. Anywho…

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BEAT YOUR COMPETITION, WITH PETITION.

⚡️Update: What's Up With Francesca's ($FRAN)?⚡️

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We first wrote about Houston-based Francesca’s Holdings Corp. ($FRAN) back in February when (i) the stock was trading at $0.92/share, (ii) the company had announced that it had retained Rothschild & Co. and Alvarez & Marsal LLC, and (iii) the company was coming off of a quarter where it (a) reported -14% same store sales, -10% net sales, and a net loss of $16mm, (b) acknowledged that 17% of its retail footprint was “underperforming,” and (c) blew out its fifth CEO in seven years. That’s all.

A lot has transpired since then. Going into its second quarter ‘19 earnings, the stock — after declining 80% over the last year — was suddenly and mysteriously on a small August upswing, reaching as high as $5.16/share on September 9 (PETITION Note: the company did a mid-summer 12-for-1 reverse stock split so that mostly explains the recovery from the $0.92/share level we’d previously written about but the upswing continued thereafter).

Then some weird sh*t happened. The company issued earnings and comp store sales were down 5% and net sales decreased 6%. Gross margins were also down.

Here is a snapshot of the company’s sales growth / (decline) over the years:

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The company noted a decrease in margin’s due to aggressive markdowns, here are EBITDA margins over the last few years:

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Here is the overall performance over the years:

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And yet the stock popped on the report:

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That’s right. It got as high as $18.14/share on this report. We know what you’re thinking: “that report sucks, the numbers were terrible.” Yes, yes indeed, they were. But, on a relative basis, this marked a dramatic improvement.

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PG&E Picks Up the Pace (Long Seth Klarman)

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Well, that sure didn’t last long. In “Is it a Plan or a Placeholder?,” we discussed the recently proposed plan of reorganization filed by PG&E Corporation and Pacific Gas and Electric Company ($PCG). We wrote:

Moreover, the plan also depends on the “Subrogation Wildfire Claims” — claims “held by insurers or similar entities in connection with payments made to others on account of damages or losses arising from such wildfires” — coming in at a max $8.5b.[] Will these numbers hold? We suspect the answer is an emphatic ‘no.’

As much as we like being right, we certainly weren’t expecting it to happen so soon.

A mere few days after filing its plan of reorganization, PG&E announced an $11b settlement with parties representing 85% of the Subrogation Wildfire Claims. This settlement, still subject to the approval of the Bankruptcy Court, â€œwould satisfy and discharge all insurance subrogation claims against the Debtors arising from the 2017 Northern California wildfires and the 2018 Camp fire.” Per Reuters:

The company also amended its equity financing commitment agreements to accommodate the claims, and reaffirmed its $14 billion equity financing commitment target for its reorganization plan.

One amendment was an increase in the “Wildfire Claims Cap” to $18.9b from $17.9b. The debtors understand the signaling here: with the subrogation claimants almost immediately getting $2.5b more than what was in the plan, they prudently indexed higher to account for wildfire claimant expectations.

Despite the assumption of $3.5b more in liabilities (exclusive of earlier settlements), this is a net positive for PG&E. They removed one constituency from the board (assuming they don’t trade out of their claims and blow up the settlement), got a legitimate impaired accepting class to help usher the plan through, and moved themselves closer to a global settlement.

Anyway, the stock — somewhat mysteriously considering the marked INCREASE in liabilities — reacted favorably to the news, up over 11% on the week and erasing Monday’s post-plan blistering:

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Previously in PETITION. Part II (Short Tony the Tiger)

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In June 23rd’s “Plastic is Ripe for a Reckoning (Long Ridiculous Branded Water)and in a short follow-up on June 30, we talked about how plastic has a bullseye on it. In the latter, we wrote:

Meanwhile, we were curious whether all of this talk about aluminum and glass taking over for plastic was having an effect elsewhere. Compare the bids for Anchor Glass Container Corp’s $150mm second lien term loan maturing 2024:

On May 6, the bid was 55.6 with a yield-to-worst of 25.2%.

On June 24, the bid was 71.4 with a yield-to-worst of 18.5%.

Long bullishness on glass containers?

S&P clearly doesn’t think so:

Here is where the second lien term loan traded this week: 70.7.

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☁️WeWork (Long Corporate Governance Wonks)☁️

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Surely you're sick of WeWork â€” uh, excuse us, “The We Company” — by now. There's been more drama surrounding its upcoming IPO than an episode of The Hills. You’ve likely heard about the $60b-to-$47b-to-$20b-to-$10b valuation drop, the wave pool, the dual-class voting structure, the insider deals between Adam Neumann, landlord, and Adam Neumann, tenant, and so on and so forth. We won’t rehash it all for you. We do have some word limitations. 

We do wonder if the events of the past two weeks are a sign of less frothy times ahead. After all, investors -- equity and bonds -- have gotten so accustomed to getting bent over the last several years that we're going long rheumatologists. Knees must be hurting.

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🗞The NYT, New Media Models & Snowflake Subscribers🗞

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Take a look at these revenue numbers:

This, ladies and gentlemen, represents the most recently reported revenue from New York Times Co. ($NYT). It’s also evolution, illustrated.

We all know the story: in an age of heaps of free media and secular decline of print, media companies are (a) in the midst of a great pivot away from the ad-based business model and (b) as part of a hybrid model, leaning more heavily upon recurring-revenue-producing subscription (and other) products.

This pivot — and the reason for it — couldn’t be clearer from the reported Q2 ‘19 earnings. As you can see above, advertising revenue is flat, while subscription and “other” revenue is growing.

Generally speaking, the report was sound. The company added 131k net subscriptions; it also separately grew its separate subscription channels for “Cooking” and “Crossword,”* and launched a news series, “The Weekly,” on FX and Hulu (PETITION Note: we can’t help but question the long-term success of this series: who really wants to go to Hulu to watch a NYT news series? In the end, that didn’t work for Vice News on HBO. That said, this series apparently contributed to a 30% increase in “other” revenue in the quarter, so, who knows? Maybe we’re dead wrong). In total, subscriptions were up by 197k and the company now reports 3.8mm digital-only subscribers.

On the negative side, the company’s operating costs are increasing and, in turn, its operating profit is decreasing (down $4mm YOY) as it looks to grow its digital channels, properly analyze and manage its sales funnel, acquire additional journalist talent, etc. Some choice bits relating to subscriptions from the earnings call:

Total subscription revenues increased 4% in the quarter with digital-only subscription revenue growing 14% to $113 million. On the print subscription side, revenues were down 2.5% due to declines in the number of home delivery subscriptions and continued shift of subscribers moving to less frequent and therefore less expensive delivery packages as well as a decline in single copy sales. This decrease in print subscription revenues was partially offset by a home delivery price increase that was implemented early in the year.

Total daily circulation declined 8.5% in the quarter compared with prior year, while Sunday circulation declined 7.1%.

No surprises here. Digital is ⬆️, print is ⬇️, and even where there is print, the average revenue per user is shifting down in large part due to subscribers opting for ⬇️ delivery frequency. Interestingly, people are also buying fewer newspapers on the fly (“single copy sales”).

On the advertising side:

Total advertising revenue grew 1.3% compared with the prior year with digital advertising growing 14% and print declining by 8%. The increase in digital advertising revenue was largely driven by growth in direct sold advertising on our digital platforms, including advertising sold in our podcast and our creative services business. The print advertising result was mainly due to declines in the financial services, retail and media categories, partially offset by growth in technology.

The stock market did not act favorably — note the demarcation below:

Indeed, as of the time of this writing, the share price is down 20% from where it was on the date of the release.

There are some interesting takeaways here. First, podcasts continue to be a source of growth for many a media company — despite the lack of viable analytics across the podcasting space. Second, the second order effects of the decline in retail and media are notable. Third, the company’s purchase of Wirecutter is feeding its “other” revenue which implies — though it is not line-itemed — that affiliate-related revenue is a growing part of the business (long Amazon!).**

As for guidance, the company forecasted continued YOY subscription growth in the low-to-mid single digits, a decrease in ad revenue, and an increase in “other” revenue. Notably, “other” revenue also includes income from subletting office space, commercial printing, and licensing deals (i.e., when the NYT is referenced in a movie, etc.).

It will be interesting to see whether the NYT can continue to demonstrate subscriber growth in the midst of a hyper-polarized political environment. To point, a shift to subscribers is not without its dangers. Recently the NYT came under pressure both for (i) its 1619 Project about slavery and (ii) a headline describing President Trump’s reaction to the El Paso and Dayton shootings. Per The Wrap:

The New York Times saw an increase in subscription cancellations after a reader backlash over its lead headline on a story about a Donald Trump speech on Monday, a Times spokesperson told TheWrap.

The paper has “seen a higher volume of cancellations today than is typical,” the spokesperson said on Tuesday.

In an age of hyper-competition for the marginal dollar, this is a big problem. In a story about the dismal performance of the Los Angeles Times’ digital initiatives (net 13k subscriptions in the first six months of ‘19), Joshua Benton writes for Neiman Lab:

But once you get all those subscribers signed up, you’ve got to prove yourself worthy of their money, over and over again. Churn has always been an issue for newspapers, but it’s even more of one in a world of constant competition for subscription dollars. (“Hmm, Netflix raised their price — do I really use that L.A. Times subscription?”) Retention is critical to making reader revenue the bedrock of the new business model….

That’s what happens when you switch to a subscriber model. Investors care less about ad revenue and more about subscriber growth. Each individual subscriber matters. And retention really matters.

*****

But retention cannot come at a cost. A publication must establish values and live up to them. Take, for instance, this note we received from a reader recently:

“Your writings are done well, interesting, and humorous. However, take it from me and many of my colleagues, your anti-Trump insults are aggravating and misguided.  Some of us are considering unsubscribing because of it.”

He is referring to this piece, “Tariffs Tear into Tech+,” wherein we wrote about the recent escalation in trade hostility as follows:

We’re frankly not sure why this is controversial. All we did was insinuate that the man is intemperate (is that really even debatable?) and describe him in his own words.

President Trump’s policies — for better or for worse — have an impact on the economy. The delivery of those policies infuses volatility into the markets. It affects whether a company will commit to investing millions in coming months; it affects sales; it affects consumer spending which, in case you didn’t notice, is, for now, the only thing keeping GDP afloat. We’re going to write about that. And we’re going to do so in our usual voice. Just like we would if a democrat were in office: we’re equal opportunity snark.***

So, sure, Mr. Orange County, feel free to cancel your Membership if you think we’re misguided. That’s just what we all need: another highly educated person running for the hills because a few words didn’t comport with his sensibilities. Thanks for summing up this country’s current plight of discourse/discord in three sentences.

In conclusion, we won’t be bullied, subscription be damned.

*Impressively, the Cooking product has 250k subscribers and the Crosswords product has 500k subscribers.

**For those who don’t know, an affiliate fee is essentially a referral fee for sending traffic over to an affiliate partner that ultimately results in a transaction. So, for instance, if you go to Wirecutter.com to look up best back-to-school backpack and click on their #1 choice, a L.L. Bean ‘Quad Pack,’ and buy one, Wirecutter earns approximately 4% on that purchase.

***Case and point: we’ve previously asked, “Are Progressives Bankrupting Restaurants?“

🚴‍♂️The Rise of Home Fitness: Peloton Files its S-1 (Long Twitter Fodder)🚴‍♂️

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In case you haven’t heard, Peloton Inc. filed its S-1 earlier this week. An S-1 is like a bankruptcy First Day Declaration. It’s an opportunity to sell and control a narrative. In the case of the S-1, the filer wants to appeal to the markets, drum up FOMO, and maximize pricing for a public capital raise (here, $500mm). So, yeah, want to call yourself a technology / media / software / product / experience / fitness / design / retail / apparel / logistics company? Sure, go for it. In an age of WeWork, a la-dee-da-kibbutz-inspired-community-company-that-may-or-may-not-be-valued-like-a-tech-company-despite-being-a-real-estate-company, hell, anything is possible.

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Frankly, we’re surprised Peloton didn’t throw in that it’s a “CBD-infused-augmented-reality-company-that-transacts-in-Pelotoncoin-on-the-blockchain company” for good measure. Go big or go home, dudes! PETITION Note: the bankruptcy/First-Day-Declaration equivalent of this absurdity must be every sh*tty retailer on earth claiming to be an “iconic” brand with loyal shoppers who, despite that loyalty, never spend a dollar at said retailers, all while some liquidators are preparing to sell them for parts:

But we digress.

For those who don’t live in Los Angeles or New York and are therefore less likely to know what the hell Peloton is (despite its 74 retail showrooms in the US, Canada and UK and pervasive ad-spend), it is a home fitness company that sells super-expensive hardware ($2,245 for the flagship cycle and $4,295 for the treadmill)* and subscription-based fitness apps ($39/month). It’s helped create the celebrity cycling trainer and aims to capture the aspirational fitness enthusiast. And, by the way, it’s a real company. Here are some numbers:

  • $196mm net loss (boom!) on $915mm of revenue in the fiscal year ended June 30, 2019 ((both figures up from 2018, which were $47.8mm and $435mmmm, respectively, meaning that the loss is over 4x greater (boom!!) while revenue grew by over 2x));

  • Hardware revenues increased over 100%, subscription grew over 100% and “other” revenue, i.e., apparel, grew over 100%;

  • 511,202 subscribers in 2019, up from 245,667 in 2018;

  • 577k products sold, with all but 13k in the US;

  • a TAM that, while not a ludicrous as WeWork’s the-entire-planet-is-an-opportunity-pitch, is nonetheless…uh…aggressive with total capture at approximately 50% of ALL US HOUSEHOLDS

and;

  • $994mm VC raised, $4+b valuation;

A big part of that net loss is attributable to skyrocketing marketing spend. But, Ben Thompson highlights:

Peloton spends a lot on marketing — $324 million for 265,535 incremental Connected Fitness subscribers (a subscriber that owns a Peloton bike or treadmill), for an implied customer acquisition cost (CAC) of $1,220.18 — but that marketing spend is nearly made up by the incremental profit ($1,161.40) on a bike or treadmill. That means that subscription profits are just that: profits.

The company also claims very low churn** — 0.70%, 0.64%, and 0.65% in 2017, 2018 and 2019, respectively — though this thread ⬇️ points out some obfuscation in the filing and questions the numbers (worth a click through):

Ben Thompson hits on churn too, noting that major company promotions haven’t rolled off yet:

Only the 12 month prepaid plans have rolled off; the 24 and 39 month plans are still subscribers whether or not they are using their equipment (and given the 0% financing offer, I wouldn’t be surprised if there were a lot of them). 

Surely roadshow attendees will have questions on this point and then, market froth being market froth, totally disregard whatever the answers are. 😜

The company also highlights some tailwinds: (a) an increasing focus on health and fitness, especially at the employer level given rising healthcare costs and a general desire to offset them;** (b) the rise of all-things-streaming; (c) the desire for community; and (d) significantly, the demand for convenience. We all work more, weather sucks, the kids wake up early, etc., etc.: it’s a lot easier to work out at home. This thread ⬇️ sure captured it (click through, it’s hilarious):

Which is not to say that the company doesn’t have its issues.*** It appears that like most other fitness products, there’s seasonality. People buy Pelotons around the holidays, after making New Year’s resolutions they undoubtedly won’t keep. There are also some lawsuits around music use. As we noted above, the marketing spend is through the roof ($324mm, more than double last year) and SG&A is also rising at a healthy clip. Many also question whether Peloton’s cult-like status will fizzle like many of its fitness predecessors. And, of course, there’s that cost. Lots or people — ourselves included — have questioned whether this business can survive a downturn.

Indeed, among a TON of risk factors, the company notes:

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates.

And:

To date, our business has operated almost exclusively in a relatively strong economic environment and, therefore, we cannot be sure the extent to which we may be affected by recessionary conditions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services could have an adverse effect on our business, financial condition, and operating results. (emphasis added)

Now ain’t that the truth. This will be an interesting one to watch play out.

*****

Questions about the company’s stickiness in a downturn notwithstanding, we ought to take a second and admire what they’ve done here. Take a look ⬇️

Sure, sure, it’s a ridiculous metric in an SEC filing but…but…look at the total number of workouts. Look at the average monthly. Unless Peloton is truly expanding the category, those workouts are coming out of someone else’s revenue stream. Remember: SoulCycle did pull its own IPO some time ago.

In a recent piece about the rise of home fitness and the threat it poses to conventional gyms and studios, the Wall Street Journal noted:

U.S. gym membership hit an all-time high in 2018, but the rate of growth cooled to 2% after a 6% rise the year before, according to the International Health, Racquet & Sportsclub Association. Much of the decade’s growth has been fueled by boutique studios like CrossFit, Orangetheory and SoulCycle, whose ability to turn fitness into a communal experience has sparked fierce loyalty to their brands. IHRSA says it’s too early to tell whether streaming classes will reduce club visits. CrossFit, SoulCycle and Orangetheory say they don’t see at-home streaming fitness programs as a threat.

We find that incredibly hard to believe. Is there correlation between the slowdown and growth and Peloton’s 128% and 108% growth from ‘17-’18-’19? Peloton may be more disruptive than the naysayers give it credit for.

Back to Ben Thompson:

Like everyone else, Peloton claims to be a tech company; the S-1 opens like this:

We believe physical activity is fundamental to a healthy and happy life. Our ambition is to empower people to improve their lives through fitness. We are a technology company that meshes the physical and digital worlds to create a completely new, immersive, and connected fitness experience.

I actually think that Peloton has a strong claim, particularly in the context of disruption. Clay Christensen’s Innovator’s Dilemma states:

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

It may seem strange to call a Peloton cheap, but compared to Soul Cycle, which costs $34 a class, Peloton is not only cheap but it gets cheaper the more you use it, because its costs are fixed while its availability is only limited by the hours in the day. Sure, a monitor “underperforms” the feeling of being in the same room as an instructor and fellow cyclists, but being able to exercise in your home is massively more convenient, in addition to being cheaper.

Moreover, this advantage scales perfectly: one Peloton class can be accessed by any of its members, not only live but also on-demand. That means that Peloton is not only more convenient and cheaper than a spinning class, it also has a big advantage as far as variety goes.

The key breakthrough in all of these disruptive products is the digitization of something physical.

In the case of Peloton, they digitized both space and time: you don’t need to go to a gym, and you don’t have to follow a set schedule. Sure, the company does not sell software, nor does it have software margins, but then neither does Netflix. Both are, though, fundamentally enabled by technology.

If Thompson is right about that value proposition, is it possible that, in a downturn, Peloton can win? At $40/class, it would take 57 classes to break even on the hardware and then you’re getting a monthly subscription for the cost of one class. Will people come around to the value proposition because of the downturn?****🤔

Before then, we’ll find out whether the market values this company like a tech hardware company or a SaaS product. And the company can use the IPO proceeds to market, market, market and try and lock-in new customers before any downturn happens. Then we’ll really test whether those churn numbers hold up.

*The company doesn’t break out the success of the two other than to say that the majority of hardware revenue stems from the bike. We would reckon a guess that the treadmill is losing gobs of money.

**It stands to reason that the company would have strong retention rates given the high fixed/sunk cost nature of its product.

***One risk factor is curiously missing so we took the initiative to write it for them:

We sell big bulky products that appeal more to coastal elites.

Unfortunately, given the insanity if housing prices and spatial constraints, a lot of our potential customers in Los Angeles, San Francisco and New York simply may not have room for our sh*t.

****Unrelated but WeWork’s Adam Neumann insists that WeWork presents an interesting value proposition in a downturn: viable office space without the long-term locked in capital commitment. It’s not the craziest thing we’ve heard the man say.

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🤖How is Tech Doing? (Long Self-Imposed Pain)🤖

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Silicon Valley Bank ($SIVB) recently issued its “State of the Markets” report, reflecting tech-related activity over the first six months of 2019. Suffice it to say, despite a number of potential headwinds, e.g., trade wars and fears of stagnating global growth (particularly in Europe and China), tech continues to thrive. The question is: can that continue? Here are some key charts from the report:

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As we were writing this China announced that it would retaliate with tariffs on $75b more of US goods (with US auto taking a large hit of 25% on cars and 5% on parts).* As you no doubt know, President Trump responded in his usually temperate manner:

…blah blah blah…something fentanyl…blah blah blah. The stable genius and “Chosen One” then moved the US closer to the easily winning the trade war (cough) by imposing 30% tariffs on $250b of Chinese goods and 15% tariffs on an additional $300b of goods. Anyway, it’s safe to say that these headwinds will only get stronger and will have a big effect on tech.** To point, tech names got battered post-tweets:

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Why? Well…

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But, sure, tweets and stuff. Nothing to see here. Anyway, give the presentation a gander: it has some good slides on the state of venture capital, enterprise vs. consumer IPOs, and international developments.

*****

Meanwhile, The Information came out with this doozy earlier this week:

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☎️Who Knew? People Don’t Use Landlines Anymore? (Short the Peso, Short US-denominated EM Debt).☎️

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We’re all for a reprieve from retail and energy distress. Hallelujah.

Maxcom USA Telecom Inc. is a telecommunications provider deploying “smart-build” approaches to “last mile” connectivity (read: modems, handsets and set-up boxes) for enterprises, residential customers and governmental entities in Mexico — which is really just a fancy way of saying that it provides local and long-distance voice, data, high speed, dedicated internet access and VoIP tech, among other things, to customers.* It purports to be cutting edge and entrepreneurial, claiming “a history of being the first providers in Mexico to introduce new services,” including (a) the first broadband in 2005, (b) the first “triple-play” (cable, voice and broadband) in 2005, and (c) the first paid tv services over copper network using IP…in 2007. That’s where the “history” stops, however, which likely goes a long way — reminder, it’s currently the year 2019 — towards explaining why this f*cker couldn’t generate enough revenue to service its ~$103.4mm in debt.** Innovators!!

And speaking of that debt, it’s primarily the $103.4mm in “Old Notes” due in 2020 that precipitated this prepackaged bankruptcy filing (in the Southern District of New York).***

The Old Notes derive from a prior prepackaged bankruptcy — in 2013 (PETITION Note: not a “Two-Year Rule” violation) — and were exchanged for what were then outstanding 11% senior notes due in 2014. These Old Notes have a “step-up interest rate,” which means that, over time, the interest rate…uh…steps up…as in, increases upward/up-like. The rate currently stands at 8%. Unfortunately, the company doesn’t have revenue step-ups/upwardness/upseedayzee to offset the interest expense increase; rather, the company “…incurred losses of $4.9 million for the three months ended June 30, 2019, as compared to losses of $2.9 million for the three months ended June 30, 2018, and losses of $16 million for the year ended December 31, 2018, compared to losses of $.8 million for the year ended December 31, 2017….” Compounding matters are, among other things, the negative effects of decreased interest income and foreign currency exchange rates (the dollar is too damn strong!).**** The closure of the residential segment also, naturally, affected net revenue.

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