Southeastern Grocers = Latest Bankrupt Grocer (Long Amazon/Walmart)

Another day, another bankrupt grocer.

Yesterday, March 27 2018, Southeastern Grocers LLC, the Jacksonville Florida-based parent company of grocery chains like Bi-Lo and Winn-Dixie, filed a prepackaged bankruptcy in the District of Delaware. This filing comes mere weeks after Tops Holding II Corporation, another grocer, filed for bankruptcy in the Southern District of New York. Brutal.

In its filing papers, Southeastern noted that, as part of the chapter 11 filing, it intends to "close 94 underperforming stores," "emerge from this process likely within the next 90 days," and "continue to thrive with 582 successful stores in operation." Just goes to show what you can do when you aren’t burdened by collective bargaining agreements. In contrast to Tops.

Also unlike Tops, this case appears to be fully consensual. It appears that all relevant parties in interest have agreed that the company will (i) de-lever its balance sheet by nearly $600 million in funded liability (subject to increase to a committed $1.125 billion and exclusive of the junior secured debt described below), (ii) cut its annual interest expense by approximately $40 million, and (iii) swap the unsecured noteholders' debt for equity. The private equity sponsor, Lone Star Funds, will see its existing equity interests cancelled but will maintain upside in the form of five-year warrants that, upon exercise, would amount to 5% of the company. 

Financially, the company wasn’t a total hot mess. For the year ended December 2017, the company reflected total revenues of approximately $9,875 million and a net loss of $139 million. Presumably the $40 million cut in interest expense and the shedding of the 94 underperforming stores will help the company return to break-even, if not profitability. If not - and, frankly, in this environment, it very well may be a big "if" - we may be seeing this trifecta of professionals (Weil, Evercore, FTI Consulting) administering another Chapter 22. You know: just like A&P. To help avoid this fate, the company has secured favorable in-bankruptcy terms from its largest creditor, C&S Wholesale Grocers, which obviates the need for a DIP credit facility. C&S has also committed to provide post-chapter 11 credit up to $125 million on a junior secured basis. 

Other large creditors include Coca-Cola ($KO) and Pepsi-Cola ($PEP). Given, however, that this is a prepackaged chapter 11, they are likely to paid in full. Indeed, a letter sent to suppliers indicates exactly that:

In addition to its over-levered capital structure, the company has a curious explanation for why it ended up in bankruptcy: 

"The food retail industry, including within the Company’s market areas in the southeastern United States, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national, and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company’s primary competitors include Publix Supermarkets, Inc., Walmart, Inc., Food Lion, LLC, Ingles Markets Inc., Kroger Co., and Amazon."

"Adding to this pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."

Sound familiar? Here is what Tops said when it filed for bankruptcy:

"The supermarket industry, including within the Company’s market areas in Upstate New York, Northern Pennsylvania, and Vermont, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company also faces intense competition from online retail giants such as Amazon."

"Adding to this competitive pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a competitive disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."

At least Weil is consistent: we wonder whether they pitch clients now on cost efficiencies they derive from just copying and pasting verbiage from one company's papers into another...? We also wonder whether the billable hours spent drafting the First Day Declaration here are less than they were in Tops. What's your guess? 

Anyway, there's more. No "First Day Declaration" is complete without a reference to Amazon ($AMZN). Here, though, the company also notes other competitive threats — including Walmart ($WMT). In "Tops, Toys, Amazon & Owning the Robots," we said the following,

In Bentonville, Arkansas some Walmart Inc. ($WMT) employee is sitting there thinking, “Why does Amazon always get the credit and free publicity? WTF.” 

Looks like Weil and the company noticed. And Walmart got their (destructive) credit. Go $WMT! 

Other causes for the company's chapter 11 include food deflation of approximately 1.3% ("a drastic difference from the twenty-year average of 2.2% inflation"), and reductions in the Supplemental Nutrition Assistance Program (aka food stamps). And Trump wasn’t even in office yet.

Finally, in addition to the store closures, the company proposes to sell 33 stores pursuant to certain lease sale agreements it executed prior to the bankruptcy filing. 

Will this mark the end of grocery bankruptcies for the near term or are there others laying in wait? Email us: petition@petition11.com.

Busted Narratives: Fast Fashion Falters (Short H&M)

We’re old enough to remember when fast fashion was allegedly decimating retail and every apparel retailer under the sun was rejiggering its supply chain to fight fire with fire. Well, yesterday, fast fashion retailer Hennes & Mauritz HB — better known in the U.S. as H&M —reported earnings and to say that they were dogsh*t would be an understatement. Here is the stock as of yesterday:

Man that chart is ugly: that’s a 50% drop in the last year. This takes the company all the way down to 2005 levels. What is going on?

For starters, operating profit fell 62% in the three months through February from 3.2 billion SEK to 1.3 billion SEK. And more problematic: the company has $4.3 billion of unsold inventory. This is the stock-in-trade picture as of yesterday:

Y’zikes. Analysts are freaking out.

In the words of Karl-John Persson, the company’s CEO:

“While the assortment is appreciated by our customers, we have not improved fast enough. In addition to this, we made some mistakes in the assortment mix in the second half of 2017 that affected the top line. And now, we're working hard to ensure improvements, including fashion improvements and to improve value for money further as well as, of course, and also to have the right balance and assortment mix with the right products in the right -- at the right time, in the right amount to the right channels.”

Clearly. So, after dropping this steaming pile of bad news, Persson does what all good retail CEOs do these days: drop buzzwords and hot catch phrases like they’re hot. In trying to assuage analyst concerns after this buzzsaw of an earnings report, Persson goes all in with '“new store concepts", “optimize the store portfolio,” “image recognition,” “personalized product feeds,” “automated warehouses,” “advanced analytics and artificial intelligence,” “cloud, APIs and microservices,” and “RFID and 3D.” Did you catch all of that? Don’t know about you, but we’re impressed. These guys really threw the whole kitchen sink at us with this pixie cloud of meaninglessness. Take note: if you’re a restructuring advisor or performance improvement specialist seeking a company-side retail mandate, you have our permission to cut and paste this paragraph into your deck. Perhaps you can win over an executive team too-embarrassed to ask you what the hell any of it actually means as a practical matter.

GNC Holdings Inc. Kicks the Can

The Rise of DTC Supplements Constitutes a Threat to GNC

via GIPHY

Speaking of a concessions business, GNC Holdings Inc. ($GNC) is a big proponent (have you been to Rite-Aid lately?) and look how well…oh, wait…nevermind.

When we last wrote about GNC back in February, the company had reported surprising earnings, margins and free cash flow; it also paid down its revolving credit facility and seemed on the verge of amending and extending its term loan. It had also just received a cash infusion commitment from a Chinese investment fund in exchange for 40% of the company. Subsequently, the company was able to amend and extend the term loan to 2021. 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!

Meanwhile, this is what the stock looks like:

Pretty ugly. And it may get worse when you factor in what’s going on in the world of supplements, generally. What’s going on, you ask? A sh*t ton of venture capital investment, corporate cash infusion and growth.

Earlier in March, a company called Ancient Nutrition, producer of bone broth protein and collagen supplement, raised $103 million of funding from VMG Partners, Hillhouse Capital and ICONIQ Capital. Notably, the product is available throughout Chicago — just not at GNC. Rather, it is available at Whole Foods, Fresh Thyme Farmers Market and Heinan’s. Similarly, in New York City, it is predominantly found at Whole Foods, Fairway and Natural Green Market, among other places.

Supplements are going gangbusters elsewhere too. Earlier this month, Hims, an erectile dysfunction and hair loss company aimed at millennials and dubbed “Viagra, but for hipsters” (yup, you read that right), raised $40 million of funding at a $200 million valuation (kudos to GQ for creative photography). It’s distribution channel? Direct-to-consumer. Sorry GNC. Same goes for Roman and Keeps, two Hims-like competitors.

Meanwhile, The Clorox Company got into the game last week with an $700 million acquisition (3.5x sales) of Nutranext, a Florida-based wellness company that makes supplements and has a strong direct-to-consumer business. You know where you can’t get Nutranext…?

That’s right: GNC.

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

The Fallacy of "There Must be One" Theory

Dick's Sporting Goods, Toys R Us, iHeartMedia, & Amazon

Ah, R.I.P. Toys R Us.

This week has undoubtedly been painful for employees, vendors, suppliers and fans of Toys R Us. The liquidation of the big box toy retailer is a failure of epic proportions; many creditors will be fighting over the carcass for months to come — both inside and outside of the United States; many employees now have two months to find a new gig; many suppliers need to figure out if and how they’ll be able to manage now that they’re exposure to unpaid receivables has increased. Good thing the company’s CEO is a man-of-the-people who can help cushion the blow.

Hardly. Enter CEO David Brandon and his shameless, out-of-touch attempts to cast blame onto outside parties: “The constituencies who have been beating us up for months will all live to regret what’s happening here.” Wait. Huh?!

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Advertising - Short(ened) Ad Time and Short(ed) Ad Companies

Did Netflix Lose a Potential Rev Stream Before Activating it? 

Earlier this week Fox Networks Group’s ad sales chief floated the idea of cutting commercial ad time down from 13 minutes to 2 minutes an hour in a speech he gave in Los Angeles. This is interesting on a number of levels.

First, this would pose a real challenge to advertisers who, undoubtedly, would have to fight for limited but costly supply. Yes, television advertising has flat-lined, but it is still one of the most effective means to get brand messaging out.

Second, such a maneuver could have the effect of squeezing Netflix ($NFLX). Numerous underwriters highlight that Netflix can always open the ad spigot to help it grow into its ever-growing capital structure. And they’re not talking about product placement. If ads are eliminated elsewhere, will consumers focused on the ultimate user experience tolerate ads before watching treasured content like Ozark or 13 Reasons Why? Or will that result in friction and, in turn, leakage? If this decision gains traction, this as-of-yet-untapped revenue stream for Netflix could be collateral damage.

Ultimately, minimal advertising may help draw users back to content. But it will create all sorts of issues for brands trying to sell product AND, by extension, the advertising companies trying to place those brands.

To point, earlier this week the Financial Times reported that “[h]edge funds have amassed bearish bets of more than $3bn against the world’s largest advertising companies in an attempt to profit as the industry undergoes wrenching disruption and slowing growth.” Publicis, WPP, Omnicom Group ($OMC), and Interpublic Group of Companies ($IPG) are all short targets of funds like Lone Pine and Maverick Capital. With corporates like Proctor & Gamble ($PG) cutting ad spend and Facebook ($FB) and Google ($GOOGL) monopolizing same and building custom tools that cut out the middlemen, this is an area worth continued watching.

The Latest and Greatest on Guitar Center

Long Capital Structure Rehabilitation 2.0

Before we dive into the current status of Guitar Center Inc., let’s first establish that there is almost zero chance ⬆️ this kid ⬆️ ends up playing guitar when he’s older given today’s music trends. Just saying.

As everyone knows, the instrument retailer recently popped up on a variety of retail doom and gloom lists due to its over-levered capital structure and (relatively) near-term maturities. A quick flashback: the company was the target of a $2.1 billion 2007 leveraged buyout by Bain Capital. In a 2014 out-of-court restructuring, Ares Capital Management swapped its debt for equity in the company, effectively eliminating Bain from the equation and removing $500 million of debt and nearly $70 million in annual interest expense. The transaction was accompanied by a refinancing and maturity extension of other parts of the capital structure.

As a consequence of that transaction, the current capital structure stands as follows:

• $375 million asset-backed revolving credit facility due April 2019 (“ABL”);
• $615 million senior secured notes at 6.5% and due April 2019; and
• $325 million senior unsecured notes at 9.625% due April 2020.

Yes, that’s a total of $1.2 billion of debt. Despite an uptick in pre-holiday sales, the dominant narrative remains that nobody plays guitar anymore. Consequently, there hasn’t been enough revenue coming into the coffers to service this debt. You can blame Yeezy and The Chainsmokers for that. We’ve harped on about the state of music here and, in a separate guest post about Gibson Brands’ struggles, Ted Gavin of Gavin/Solmonese added some additional perspective. Longer-term trends notwithstanding, Guitar Center seeks to live another day on the back of the short-term uptick. To do so, however, it must address that debt.

On Monday, Guitar Center — with the help of bankers UBS and Houlihan Lokey and the consent of Ares — launched an exchange offer and consent solicitation related to its unsecured notes. The offer is to swap the existing $325 million 9.625% notes for $325 million of 5% cash/8% PIK notes due 2022 (along with with some warrants). Per the company’s press release, $299 million worth of holders have already agreed (92% of the issuance). This swap would save the company $13,812,500 a year in interest expense AND have the effect of pushing out the maturity for three years. Gotta love the capital markets these days.

In tandem, the company is proposing to offer $635 million of new 9.5% senior secured notes due 2021. The use of proceeds of these new notes would be to redeem the $615 million 6.5% senior secured notes due 2019. With this piece of the transaction, the company will be taking on an additional $20.35 million of annual interest expense.

Finally, the company will also refinance the $375 million ABL, extending the maturity out by 5 years.

So, if you made it this far, here’s the upshot: if these transactions are successful, the company will have availed itself of a few years to turn itself around by pushing out its debt maturities. But, it will have eliminated ZERO INTEREST EXPENSE in the aggregate. Said another way: this is a band-aid, not a solution.

All of which means that the company needs to hope and pray some rock God hits the scene and reinvigorates the market for guitars in the next two years. We’ll take the under.

America's Second-Largest Retailer is Closing Stores

Guest Post By Mitch Nolen (@mitchnolen)

Source: Kroger & Co. 

America’s largest supermarket operator is shrinking.

Kroger Co., the owner of over 20 grocery chains and other retailers, is closing supermarkets and jewelry stores, as well as selling hundreds of convenience stores, while simultaneously hitting the brakes on new openings that the company had already publicly announced.

It's a major U-turn for a serially acquisitive company that has become the nation's second-largest retailer, behind only Walmart in total U.S. sales. While cutting its store count, Kroger is prioritizing $9 billion in spending over three years on initiatives like splashy technology upgrades at its remaining stores.

The upheaval is just the latest in a grocery industry grappling with Amazon’s aggressive advances into its territory.

The Cincinnati-based retailer sold 762 convenience stores to British firm EG Group last month, is shutting an undisclosed number of jewelry stores and has shed net total of 13 jewelers in the first three quarters of 2017, and has closed or is closing at least 18 of its grocery stores since the start of the company's fourth quarter, a development one community leader describes as a “crisis.”

The supermarket closures are a departure for Kroger from recent years. Their store count grew in 2015 and 2016, and there was no store reduction in the final quarters of those years. Combined with the suspension of planned openings, and the company’s explanations, it becomes clearer that this isn't normal annual pruning.

Already in the first three quarters of Kroger's fiscal year that ended February 3, there's been a net closure of six grocery stores.

Kroger is suspending multiple — but not all — store openings and other major projects, such as store remodels, replacements and expansions.

A Kroger spokesperson declined to comment for this story, citing a quiet period before the company’s annual earnings report due out Thursday morning. However, in earlier statements made to local media, one representative said, “Company wide, the pace of construction has slowed down.”

Another official described a “shifting of capital expenditures in the short term from brick and mortar to focus on the customer experience in our existing stores, e-commerce and digital technology.”

The supermarkets that are shutting down are just a fraction of the more than 2,700 that Kroger operates, but any grocery store that closes has an impact on the neighborhood it served. Some closures are devastating.

Two supermarkets have closed in Peoria, Ill., a city once considered synonymous with Middle America. Kroger says neither store had been profitable in over 15 years. Two food deserts have been left in their stead.

“I am not exaggerating when I say we are now in a food crisis in this zip code, 61605,” says Peoria City Councilwoman Denise Moore. “That is one of the most hard-pressed zip codes in the country, let alone the state.”

“There is no supermarket in the entire district,” she adds, referring to her constituency that stretches along the Illinois River and cuts through Downtown Peoria. The district was home to Caterpillar Inc.’s corporate headquarters until earlier this year.

Moore worries about residents not only losing access to healthy food, but also to the store’s pharmacy and Western Union facility, where people without bank accounts can pay their bills.

The company is also shelving store expansions at two of Peoria’s other Krogers.

Another city, Memphis, was also hit by two Krogers closing. The city's mayor, Jim Strickland, took to Facebook to say he was “disappointed by Kroger's decision.”

In a potential reference to the predominantly African-American communities the stores served, he added that “these neighborhoods are no less important than any other neighborhoods in our city, and citizens who live there absolutely deserve access to a quality grocery store.”

The impetus for the closures may be financial, but residents have noticed the affected neighborhoods’ demographics.

In Peoria, one of the closed stores, on Wisconsin Ave., served a majority-minority neighborhood. The closest supermarket now is a Save-A-Lot discount grocer in a majority-white neighborhood two miles away. Walking there from the closed store would take 44 minutes, according to Google Maps.

The other Peoria Kroger sat just outside the edge of city limits, on a highway across from a predominantly black neighborhood where 36 percent of households and 83 percent of families with children under five live below the poverty line. The store is a mile and a half from the next-closest supermarket in a predominantly white neighborhood.

Kroger didn't respond to a Memphis news station that asked last month about an effort to boycott the company, but Kroger had previously stated that each closing store in the city had lost more than $2 million since 2014. The company similarly declined to respond for this story, citing the quiet period.

In other cities, Kroger is closing in different types of neighborhoods. One location, a concept store called Main & Vine, closed in a predominantly white neighborhood in suburban Seattle where the median household income is $82,000. The store went dark less than two years after it opened.

Kroger is said to be eyeing potential e-commerce acquisitions. Online bulk seller Boxed reportedly rejected a bid from Kroger, and the company was said in January to be considering an offer for Overstock.com. Kroger was also reported to be weighing a partnership with Alibaba, China's largest e-commerce site.

At its supermarkets, Kroger is rolling out a scan-as-you-shop system to 400 stores called “Scan, Bag, Go.” Available as a phone app or a dedicated handheld device, it will eventually let customers transact their own payments, too, so shoppers can just walk out with their items.

The sudden ramp-up of “Scan, Bag, Go” came after Amazon teased Amazon Go, Amazon’s newly opened convenience store with “just walk out” technology, which uses cameras and sensors to eliminate checkout lanes.

But just because retailers offer new technology doesn't mean shoppers will use it. Earlier pilots of grocery scanning apps failed to gain traction. And mobile payment systems like Apple Pay and the newly rebranded Google Pay aspire to be the future of commerce, but three years after they first launched, everyday usage remains stubbornly low, according to data from PYMNTS.com, an industry journal.

Kroger is also expanding its online grocery service, called ClickList, which is now available at over 1,000 of the company’s approximately 2,800 grocery stores. Amazon is rolling out free two-hour shipping for Prime members at Whole Foods.

Kroger-owned stores known to have closed or be closing since the start of the company's fourth quarter include:

Tucson, AZ: Fry’s at 3920 E Grant Rd.

Savannah, GA: Kroger at 14010 Abercorn St.

Peoria, IL: Kroger at 2321 N Wisconsin Ave.

Peoria, IL: Kroger at 3103 W Harmon Hwy.

Mitchell, IN: JayC at 1240 W Main St.

Jackson, MI: Kroger at 3021 E Michigan Ave.

Clarksdale, MS: Kroger at 870 S State St.

Charlotte, NC: Harris Teeter at 16405 Johnston Rd.

Columbus, OH: Kroger at 3353 Cleveland Ave.

Portland, OR: Fred Meyer at 5253 SE 82nd Ave.

Memphis, TN: Kroger at 1977 S 3rd St.

Memphis, TN: Kroger at 2269 Lamar Ave.

Brownwood, TX: Kroger at 302 N Main St.

Plano, TX: Kroger at 4836 W Park Blvd.

Gig Harbor, WA: Main & Vine at 5010 Point Fosdick Dr. NW

Cudahy, WI: Pick ’n Save at 5851 S Packard Ave.

1000 store closures have been announced in the past two weeks. Follow @mitchnolen to get updates and @Petition for news about disruption, generally.

Nine West & the Brand-Based DTC Megatrend

Digitally-Native Vertical Brands Strike Again

The Walking Company. Payless Shoesource. Aerosoles. The bankruptcy court dockets have been replete with third-party sellers of footwear with bursting brick-and-mortar footprints, high leverage, scant consumer data, old stodgy reputations and, realistically speaking, limited brand value. Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect “not a hell of a whole lot”.

Back in December, we snarked about Proctor & Gamble’s efforts to innovate around cheaper razors in the face of competition from digitally-native vertical brands like (now Unilever-owned) Dollar Shave Club and Harry’s. The struggle is real. Per the Financial Times,

In 2016, revenues of the large consumer good companies — from beer to soft drinks, food and household products — grew at their slowest rate since 2009, when the recession took hold. The 207 results for many of those companies that have reported remain weak.

A few weeks ago the Interactive Advertising Bureau released a new study entitled, “The Rise of the 21st Century Brand Economy.” It is well-worth perusing. In fact, we’re a bit late to the game here because we wanted to give it an earnest review. The upshot? Consumption habits are rapidly shifting away from third-party wholesalers like Nine West towards direct-to-consumer relationships. With nimble, oft-outsourced supply chains, DTC e-comm brands are stealing market share from consumer products manufacturers and distributors. In the aggregate, it’s creating real shocks. Some significant themes:

Economic benefits are accruing to firms that create value by tapping into low-barrier-to-entry, capital-flexible, leased or rented supply chains. These include thousands of small firms in all major consumer-facing categories that sell their own branded goods entirely or primarily through their owned-and-operated digital channels.

First-party data relationships are important not for their marketing value independent of other functions, but because they fuel all significant functions of the enterprise, including product development, customer value analysis, and pricing.

An arms race for first-party data is influencing strategy, investment, and marketing strategies among major incumbent brands across all categories.

The significance of these themes cannot be overstated. Putting some numbers around them:

In the razor category, Gillette’s share of the U.S. men's-razors business fell to 54% in 2016, from 70% in 2010. Almost all of that share has shifted to Dollar Shave Club, Harry’s, and several other digital primary sellers.

In pet food, subscription service The Farmers Dog is averaging 40-50% revenue growth monthly, in a U.S. pet food market projected up 4.4% in 2018.

Grocery store revenue growth is projected to be about 1 percent annually through 2022. Over that same period, the market for Meal Kits is expected to grow by a factor of 10x.

Amazon ($AMZN) has meal kits. Walmart ($WMT) just launched meal kits. Albertsons purchased Plated. Meanwhile, the bankruptcy courts have a laundry list of grocers on their dockets.

Saving the most relevant to Nine West for last,

Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.

Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages. Query whether this factor will be featured in Nine West’s First Day Declaration with such specificity. Likely not.

Busted Tech (All Hail Uber & Lyft)

Rest in Peace, Fasten

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

Retail Roundup (Some Surprising Results; More Closures)

Retail Remains in a State of Transition

• Macy’s ($M) reported earnings earlier this week and surprised to the upside - particularly with the news that its sales grew in the latest quarter (after 2.75 years of consistent decline). Most of the upside came from cost control measures (and the expansion of its off-price offering, Backstage). Likewise, Dillard’s.

• Toys R Us entered administration in the UK.

• Charlotte Russe earned itself what we would deem a “tentative” upgrade after consummating an out-of-court exchange transaction that delevered its balance sheet. S&P Global cautioned that it expects “liquidity to be tight” over the next 12 months.

• Chico’s FAS Inc. ($CHS) reported same store comp sales down 5.2% and indicated that it closed 41 net stores in 2017, including 14 net stores in Q4. Net income and EPS was higher.

• Foot Locker ($FL) intends to close net 70 stores in 2018 after closing net 53 stores in 2017.

• Kohl’s Corp. ($KSS) is becoming a de facto co-retailing location after first partnering with Amazon ($AMZN) and now Aldi.

• JCPenney ($JCP) announced that it is cutting full-time employees and increasing use of part-time employees instead. Total sales rose 1.8% but missed estimates. Comparable sales rose 2.6% and net income, ex-tax reform benefits, was down 6.6%.

• Office Depot ($ODP) reported comp store sales declines of 4% and total sales down 7%. It closed 63 stores, including 26 in Q4. Note that we’re not reporting net closures: the company didn’t open any stores.

• Supervalu may be shutting down 50 Farm Fresh Supermarkets in North Carolina and Virginia.

iHeartMedia 👎, Spotify 👍?

Channeling Alanis Morissette: In the Same Week that Spotify Marches Towards Public Listing, iHeartMedia Marches Towards Bankruptcy

In anticipation of its inevitable direct listing, we’d previously written about Spotify’s effect on the music industry. We now have more information about Spotify itself as the company finally filed papers to go public - an event that could happen within the month. Interestingly, the offering won’t provide fresh capital to the company; it will merely allow existing shareholders to liquidate holdings (Tencent, exempted, as it remains subject to a lockup). Here’s a TL;DR summary:

And here’s a more robust summary with some significant numbers:

• Revenue: Up 39% to €4.1 billion ($4.9 billion) in ‘17, ~€3 billion in ‘16 and €1.9 billion in ‘15. Gross margins are up to 21% from 16% in 2014 - and this is, in large part, thanks to renegotiated contracts with the three biggest music labels. Instead of paying 88 cents on every dollar of revenue, the company now only pays 79 cents. Only.

• Free Cash Flow: €109 million ($133 million) in ‘17 compared to €73 million in ‘16.

• Profit: 0. Net loss of €1.2 billion in ‘17, €539 million in ‘16, and €230 in ‘15.

• Funding: $1b in equity funding from Sony Music (5.7% stake), TCV (5.4%), Tiger Global (6.9%) and Tencent (7.5%). Notably, Tencent’s holdings emanate out of a transaction that converted venture debt held by TPG and Dragoneer into equity - debt which was a ticking time bomb. Presumably, those two shops still hold some equity as Spotify reports that it has no debt outstanding.

• Subscribership. 159 million MAUs and 71 million premium (read: paid) subscribers as of year end - purportedly double that of Apple Music. Services 61 countries.

• Available Cash. €1.5 billion

• Valuation. Maybe $6 billion? Maybe $23.4 billion? Who the eff knows.

For the chart junkies among you, ReCode aggregates some Spotify-provided data. And this Pitchfork piece sums up the ramifications for music fans and speculates on various additional revenue streams for the company, including hardware (to level the playing field with Apple ($AAPL) and Amazon ($AMZN)…right, good luck with that), data sales, and an independent Netflix-inspired record label. After all, original content eliminates those 79 cent royalties.

Still, per Bloomberg,

Spotify for a long time was a great product and a terrible business. Now thanks to its friends and antagonists in the music industry, Spotify's business looks not-terrible enough to be a viable public company. 

Zing! While this assessment may be true on the financials, the aggregation of 71 million premium members and 159 million MAUs is impressive on its face - as is the subscription and ad-based revenue stemming therefrom. Imagine the disruptive potential! Those users had to come from somewhere. Those ad-dollars too.

*****

Enter iHeartMedia Inc. ($IHRT), owner of 850 radio stations and the legacy billboard business of Clear Channel Communications. In 2008, two private equity firms, Bain Capital and Thomas H. Lee Partners, closed a $24 billion leveraged buyout of iHeartMedia, saddling the company with $20 billion of debt. Now its capital structure is a morass of different holders with allocations of term loans, asset-backed loans, and notes. The company skipped interest payments on three of those tranches recently. While investors aren’t getting paid, management is: the CEO, COO and GC just secured key employee incentive bonuses. Ah, distress, we love you. All of which will assuredly amount to prolonged drama in bankruptcy court. Wait? bankruptcy court? You betcha. This week, The Wall Street Journal and every other media outlet on the planet reported that the company is (FINALLY) preparing for bankruptcy. And maybe just in time to lend some solid publicity to the DJ Khaled-hosted 2018 iHeartRadio Music Awards on March 11.

For those outside of the restructuring space, we’ll spare you the details of a situation that has been marinating for longer than we can remember and boil this situation down to its simplest form: there’s a f*ck ton of debt. There are term lenders who will end up owning the majority of the company; there are unsecured lenders alleging that they should be on equal footing with said term lenders who, if unsuccessful in that argument, will own a small sliver of equity in the reorganized post-bankruptcy company; and then there is Bain Capital and Thomas H. Lee Partners who are holding out to preserve some of their original equity. Toss in a strategic partner like billionaire John Malone’s Liberty Media ($BATRA) - owner of SiriusXM Holdings ($SIRI), the largest satellite radio provider - and things can get even more interesting. Lots of big institutions fighting over percentage points that equate to millions upon millions of dollars. Not trivial. Would classifying this tale as anything other than a private equity + debt story be disingenuous? Not entirely.

*****

"It is telling when companies like Spotify hit the markets while more traditional players retrench. Like we've seen in retail, disruption is real and if you stand still and don't adapt, you'll be in trouble. It gets harder to compete when new entrants are delivering a great product at low cost." - Perry Mandarino, Head of Restructuring, B. Riley FBR.

Indeed, there is a disruption angle here too, of course. Private equity shops - though it may seem like it of late - don’t intentionally run companies into the ground. They hope that synergies and growth will allow a company to sustain its capital structure and position a company for a refinancing when debt matures. That all assumes, however, revenue to service the interest on the debt. On that point, back to Spotify’s F-1 filing:

When we launched our Service in 2008, music industry revenues had been in decline, with total global recorded music industry revenues falling from $23.8 billion in 1999 to $16.9 billion in 2008. Growth in piracy and digital distribution were disrupting the industry. People were listening to plenty of music, but the market needed a better way for artists to monetize their music and consumers needed a legal and simpler way to listen. We set out to reimagine the music industry and to provide a better way for both artists and consumers to benefit from the digital transformation of the music industry. Spotify was founded on the belief that music is universal and that streaming is a more robust and seamless access model that benefits both artists and music fans.

2008. The same year as the LBO. Guessing the private equity shops didn’t assume the rise of Spotify - and the $517 million of ad revenue it took in last year alone, up 40% from 2016 - into their models. Indeed, the millennial cohort - early adopters of streaming music - seem to be abandoning radio. From Nielsen:

Finally, Pop CHR is one of America’s largest formats. It ranks No. 1 nationwide in terms of total weekly listeners (69.8 million listeners aged 12+) and third in total audience share (7.6% for listeners 12+), behind only Country and News/Talk. In the PPM markets it leads all other formats in audience share among both Millennial listeners (18-to-34) and 25-54 year-olds. However, tune-in during the opening month of 2018 was the lowest on record for Pop CHR in PPM measurement, following the trends set in 2017, the lowest overall year for Pop CHR, particularly among Millennials. While CHR still has a substantial lead with Millennials (Country ranked second in January with 8.4%), it will be interesting to track the fortunes of Pop CHR as the year goes on, and music cycles and audience tastes continue to shift.

This is the hit radio audience share trend in pop contemporary:

And, consequently, radio ad revenues have essentially flattened. And if Spotify has its way, the “flattening” will veer downward:

With our Ad-Supported Service, we believe there is a large opportunity to grow Users and gain market share from traditional terrestrial radio. In the United States alone, traditional terrestrial radio is a $14 billion market, according to BIA/Kelsey. The total global radio advertising market is approximately $28 billion in revenue, according to Magna Global. With a more robust offering, more on-demand capabilities, and access to personalized playlists, we believe Spotify offers Users a significantly better alternative to linear broadcasting.

One company’s disruptive revenue-siphoning is another company’s bankruptcy. Now THAT’s “savage.”

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PETITION LLC is a digital media company focused on disruption from the vantage point of the disrupted. We publish an a$$-kicking weekly Member briefing on Sunday mornings and a non-Member "Freemium" briefing on Wednesday. You can subscribe HERE and follow us on Twitter HERE.

Ad Agencies Get Hammered (Short Don Draper)

Changes Afoot as Large Corporates Like P&G Shift Spend

Draper never would’ve made it in the age of #MeToo anyway.

This week, Proctor & Gamble ($PG) announced that it cut its digital ad spending by approximately $200mm, a shot across the bow of certain undisclosed big ad players (cough, Google) and a major blow to the middlemen ad agencies that seem to be caught in a maelstrom of disruption. Back to that in a sec. More on P&G,

P&G, however, has not cut overall media spending. Funds have been reinvested to increase media reach, including in areas such as TV, audio and ecommerce media, a company spokeswoman told Reuters.

Not yet, anyway. P&G intends to cut an additional $400mm in agency and production costs over the next 3 years. In so doing, they’re also going back to the old school after realizing that the 1.7 seconds of eyeball view time doesn’t necessarily translate into sales. Podcast producers take note.

So what about those middlemen? Judging by WPP’s 10% stock price plummet this week ($WPP), investors are bearish. WPP is a British multinational advertising and public relations company besieged by the ease with which advertisers can publish directly on Facebook ($FB) and Google ($GOOGL) and, in an instant, receive performance metrics. Ad agencies, therefore, are no longer needed as much to connect brands with end users. Per the Wall Street Journal:

For their part, big ad agency companies that have traditionally bought advertising space on behalf of marketing clients are under pressure to reinvent themselves to remain relevant as the industry changes. Advertisers are demanding that their agency partners be more transparent about media-buying, so it is clear that agencies are getting the best possible deal for the clients and aren’t receiving rebates from sellers.

Disrupting kickbacks too? Rough.

GNC Makes Moves (Long Brand Equity, Meatheads & Chinese Cash)

GNC Buys Itself Some Time

GNC Holdings Inc. ($GNC) reported earnings recently and, to the chagrin of distressed folks who probably hoped it would be a bigger, messier bankruptcy filing than Vitamin World, the company doesn't look slated for bankruptcy court after all. At least not in the short term. The company reported EPS up $0.18 YOY on a $12.2mm drop in consolidated revenue (weighed down primarily by wholesale). Margins increased by nearly 2% - mostly on account of cost cutting initiatives (which include the closure of 90 locations in 2017). The company reported $196.7mm of free cash flow. That's more than Netflix!

The company is using its cash to pay down its revolver and, as of 12/31/17, had no borrowings outstanding. The company also looks close to an amend and extend of its term loan for two years to 2021 - as of Valentine's Day, the company had garnered the support of nearly 50% of its term lenders. Net debt to EBITDA is 4.6x. The company expects to see a short-term hit on account of the tax reform (limitations on net interest and expensing of capital investments) but a long term benefit.

Interestingly, GNC's brand demonstrated that it still retains some value - even if that value isn't what it once was. CITIC Capital, a Chinese investment fund and controlling shareholder of Harbin Pharmaceutical Group, will inject a $300mm cash infusion in the form of a convertible perpetual preferred security with a 6.5% coupon (cash or PIK) at a $5.35 conversion price. As-converted, this represents roughly 40% of GNC’s outstanding equity. It will also take 5 board seats. The deal is contingent upon the amend-and-extend and a refi of the current revolver. 

But wait. There's more. GNC will also form a JV in China whereby it will drop its current China business into the JV for a 35% interest and $22mm cash payment; it will recognize wholesale sales and receive annual royalty fees, including a $10mm advance on annual royalties. Clearly GNC needed some liquidity now. And clearly this is a branding deal: GNC's brand will be slapped onto Harbin Pharmaceutical Group's product.

We suppose its a good idea to generate value out of your IP BEFORE filing for bankruptcy rather than after. S&P Credit Ratings seemed to think so: it issued an upgrade. While this likely means GNC will stay out of bankruptcy (for now), these transactions, in total, do reflect stress in the franchise. We'll have to keep a close eye on it to see where it goes from here. 

More Retail Dominos Fall

Tax Credits Can't Save Failing Bon-Ton Stores

We're going to stay thematically on-point. If you missed us last week, we recommend that you go back and read our take on the Cenveo bankruptcy. In fact, we owe an apology to some of you: there were about 400 of you who did not get our a$$-kickingness at all due to an inexplicable Mailchimp screw-up. Mailchimp ≠ a$$-kicking (more on this soon). Anyway, here is a link to the entire newsletter.

A quick preface:

Protection of dying industry extends beyond federally-imposed #MAGA (see, e.g., coal, solar tariffs), and trickles down to local communities. Indeed, local-level legislators are looking at tax credits to prop up industry in the wake of, among other things, Appvion’s chapter 11 bankruptcy (and job cuts) and Kimberly-Clark’s reorganization (and mass job cuts). This is familiar: tax incentives to prop up industry aren’t extraordinary. Sheesh, just look at all the governors getting bent in the hope of drawing Jeff Bezos’ attention. The question is, though, how sound is the social contract? How many dying industries can we as taxpayers prop up all at once? We don’t have an answer. But keep reading.

******

Inside and outside of the startup context, people often ask stupid questions about companies. "How many employees does it have?” That’s a regular one. Or “How many locations?” Also common. “What’s revenue?” Irrelevant on its own. Uber makes a ton of revenue but is still bleeding cash. Netflix has gobs of revenue but is free cash flow negative. Cenveo, as we noted last week, had $1.59 billion of gross revenue in ’17. Now it’s in bankruptcy court. 

What if we told you about a particular business that had 23,000 employees and that those employees had an average tenure of 12 years? That had 256 locations. That owned 22 properties. That made $2.55 billion - yes, BILLION - in revenue in 2017. That would sound like a pretty damn successful company wouldn’t it? 

It’s not. 

We omitted some key data points: like the company’s capital structure and business vertical. 

Here’s the capital structure:

• a Tranche A revolving credit facility of up to $730mm
• a Tranche A-1 term facility of up to $150mm

The interest rate on the debt is a formula but, if we understand it correctly, it was no less than 9.5%. Funded debt as of Monday was $339mm under Tranche A (ex-interest), $150mm under Tranche A-1 (ex-interest of $3.9mm), and millions more in letters of credit.  

The company also has $350mm of 8% senior secured notes outstanding (Wells Fargo Bank NA) and due in 2021. Combined with the above debt, that’s a hefty interest expense. Oh, and the company is publicly-traded. Because this particular company is NOT successful - and with equity ranking in “absolutely priority” below debt - we reckon that there are a lot of Moms and Pops eating sh*t right now in their personal accounts. They won’t be the only ones.

The problem is that this company operates in an “increasingly challenging retail environment.” And, therefore, its story  - The Bon-Ton Stores story - is wildly unoriginal. In the company’s words, "Like many other department store and retail companies, the Debtors have been subjected to adverse trends in the retail industry, including consumers’ shift from shopping in brick-and-mortar stores to online retail channels. Bon-Ton, with a significant geographic operating footprint and operating presence, is dependent on store traffic, which has decreased as customers shift increasingly toward online retailers. In addition to competing against online retailers, Bon-Ton faces competition from other established department stores, such as J.C. Penney, Kohl’s and Macy’s.” It's like a zombie cage fight.

More specifically, it continues, "The department store segment of the U.S. retail industry is a highly competitive environment that has evolved significantly in response to new and evolving competitive retail formats, such as the increased prominence of mass merchandisers and increased competition among national chain retailers, specialty retailers and online retailers, as well as the expansion of the internet and, most significantly, the ubiquitous role that mobile technology and social media now play in the retail consumer shopping experience. The Debtors’ results and performance (and that of their competitors) has been significantly impacted by the aforementioned factors in the U.S. retail industry. Presently, numerous business and economic factors affect the retail industry, including the department store sector. These include underemployment and the low labor participation rate, fluctuating consumer confidence, consumer buying habits and slow growth in the U.S. economy and around the globe.” But, but…#MAGA?!?

Given these factors, the company has been engaged in a tug-of-war with its senior creditors for the better part of months. We’ll spare you the back-and-forth but suffice it to say, no concrete long-term plan that would’ve avoided bankruptcy came to pass. Only the retention of a liquidation agent to close 42 stores. And acquisition of a new $725mm credit facility to fund the cases while the company scrambles to find a buyer. Or liquidate.

Remember all of those shiny, positive numbers up above? Um, yeah. 

It gets worse. Though they were ultimately shot down - at least for now - in court yesterday (Feb 6), the bondholders argued “that the best and only available path for the Debtors to maximize value for their creditors in these freewill bankruptcy cases is to conduct an immediate orderly liquidation of the Debtors’ inventory and other assets. The Second Lien Noteholders made this determination after conducting their own due diligence, and following repeated missteps by the Debtors and their various boards and management teams, who proved themselves unwilling and/or unable to adapt to the fierce headwinds facing brick and mortar retailers and in particular, department stores”(emphasis in original). Savage.

Unwilling. Or unable. To adapt. Sadly, this seems to sum up a lot of distressed retailers these days. 

Even sadder, remember those long-tenured 23k employees we mentioned above? Per the company, “[Bon-Ton] has been part of its employees’ and customers’ lives in their communities for years.”

Probably not for much longer. At this point, no tax credits can change that. 

Cenveo Inc. = Poster Child for Disruption

Envelope Manufacturer Succumbs to Technology. And Debt.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Toys R Us is a Dumpster Fire

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

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

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

No one thought it would be this good.

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

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

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

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

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

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

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

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

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

**********

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

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

Long "Peloton and Chill"?

GoPro Inc. ($GPRO), as we previously noted, is the poster child for the “hardware is hard” narrative. Look at this chart:

It’s brutal. Of course, there are obvious exceptions to the narrative. Apple($AAPL), for instance. Take a look at this chart:

Apple’s hardware division feeds a services division of other software products that grew 34% in 2017 and generated $34b. That’s massive. And that’s what makes Apple so special: it crushes margins and revenue on its hardware and tags on services revenue for good measure. It’s obvious, then, why Apple is marching towards a $1 trillion market capitalization.

Elsewhere in hardware, Peloton made big waves recently at the Consumer Electronics Show after it unveiled its $3,995 Peloton Tread, a new connected treadmill. It’s the first new Peloton product to market after its wildly popular and “cultish” $1,995 exercise bike came out a few years ago.And, no, those figures are not typos.

It is ironic that Peloton is expanding its product line right at the same time that GoPro is shrinking. Just a short time ago, GoPro’s growth prospects were predicated upon it moving away from pure hardware and pivoting towards “content” fed by an ever-expanding line of EXTREME new cameras and even EXTREMER drones. Fast forward a little more than a year and the new cameras are official flops, the drones are toast, and its content is nowhere to be found. Hardware is hard, sure, but pivoting into new (hardware) product and (expensive) content is too.

Meanwhile, Peloton ALSO maintains that it is more than just a hardware company; it is a hardware, software, media (read: content), and logistics company rolled into one. And, it seems, its gadgets are only a piece of the pie; its service is equally if not more important. Still, the core product, to date, has been the exercise bike. It is the vehicle for home-based live-streamed fitness workouts that cuts out the chafe of schlepping to the studio, sweating like a beast, showering, changing amidst strangers, and then walking back out into the cold to commute home. For this luxury, people pay handsomely. The numbers bear this out.

The company reported $170mm in sales in 2016 and $400mm in sales in 2017. In additional to the lofty hardware cost, people pay $39/month for the monthly service — just a little over the cost of one SoulCycle class. This monthly recurring revenue helps to offset the company’s breakeven cost on the hardware. Indeed, hardware is hard. But it’s made easier with 600,000 reported subscribers, a 95% retention rate, and a 90+ “Net Promoter Score.”Meanwhile, Peloton has funded its R&D with $450mm of venture capital at a valuation of $1.25 billion — the latest Series E round arranged by JPMorgan ($JPM)(as they make PAINFULLY clear in this video) and participated in by NBCUniversal, Fidelity Investments, and Kleiner Perkins Caufield & Byers, among others. Some suspect an IPO is near. Others — like Tristan Walker — suspect a sale (to Nike?). After all, Peloton is causing people to cancel their gym memberships. And sparking Twitter debates. And none of this really even speaks to the revenue to be generated from a hardware-independent app, branded apparel, and data.

Right, the data. Peloton founders make a point of saying that they WANT you to work out. Think about the difference between that and a gym. A gym doesn’t give a rat’s a$$ whether you use that membership. They just want you to sign up; they know that once they have you, they’ve got you because that membership is sticky AF. In fact, the LESS you go, the better…? That’s less maintenance at the location. Fewer towels to wash. Longer-lasting Kiehl’s product. And so forth. In contrast, Peloton is the best guilt-inducing machine on the planet; it sits right in your living room. With a (relatively) low monthly nut, it just sits there encouraging you to hop on and give it a whirl. Each time that you do, Peloton captures your data. The data makes Peloton a lot like Netflix. It can produce content based on what its users are doing. It has health specs now on 600,000 users. Do most gyms have content geared towards AND health data on you?

Peloton can also make its instructors stars in a way that Netflix can provide Gaten Matarazzo the opportunity to be in literally every commercial on TV. Distribution. Teach a few classes at Equinox a week to 100 riders, in the aggregate, or put yourself on Peloton’s platform and broadcast to 600k. And get paid more to boot. As “celebrity” instructors flock to Peloton, won’t that just juice the network effects further and encourage EVEN MORE people to flock to its platform? And with the treadmill, 51k future NYC marathoners can now get marathon coaching too. So, add a huge running community to the mix.

The disruptive implications of Peloton’s incursion into your home are immense. Look at the way they market: get up and ride before the kids even need breakfast. Who needs to deal with a gym membership when you can do THAT? Note, also, how the Tread is being billed as more than just a treadmill. The video demonstrates people getting off the apparatus, on to the floor for some weights, and back on the Tread. After a while, Peloton will no doubt distribute streaming videos from star trainers without the need for you to even hop on a multi-thousand dollar machine.

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A few weeks ago, Hollywood released its numbers and they were ugly. Revenues down. Attendance down. Netflix ($NFLX), meanwhile, reported numbers on Monday and, with its addition of millions of subscribers, blew everyone away (and ascended into the $100b market cap stratosphere). In summary, millions more people opted to watch content at home YOY while millions of people opted to view fewer movies in the theater YOY. Now take a look at this third chart:

Now, what happens if Peloton owns home fitness like Netflix owns home entertainment? How does Equinox/SoulCycle do? New York Sports Club? Private-equity owned 24 Hour Fitness? Consider this: Dwayne Johnson has 318k Instagram followers. Half of his posts are photos and videos of him working out. How hasn’t Peloton nailed down a partnership with him? If people will watch other people play videogames on Amazon’s Twitch, and people will stream instructed classes on Peloton, there’s no doubt that they’d watch and mimic the Rock working out. Or Hugh Jackman beefing up to become Wolverine. Or Tom Hardy becoming Bane. Or Gerard Butler jacking up for 300. How hasn’t this happened yet? The sky is the limit.

Others have noticed. Namely, SoulCycle. It filed its S-1 years ago but, for now at least, still remains private. That is indicative of something, isn’t it? But, it, too, is evolving — in this case with different style classes. As is Classpass, which recently introduced ClassPass Live, live-streaming classes for home bodies. And, finally, Fitbit ($FIT), which continues to try anything to remain relevant. It is launching its partnership with Xbox One, making it easier for users to work out at home with its Coach training service. Clearly a number of players have identified the home as the next frontier in fitness. But Peloton may just have a very solid head start.

But here’s the thing: as readers read on Sunday, Guggenheim predicts a recession in late ’19 or early ’20. What happens when that downturn ultimately occurs? When disposable income and consumer confidence both go down? Who gets beat up more — Peloton or, say, SoulCycle? What happens to Peloton and its expensive hardware then? Do people start cancelling their monthly subscriptions? Alternatively, do people quit SoulCycle and migrate towards Peloton on the (arguable) basis that it’s a stronger value for the money? Or is Peloton’s customer demographic — seemingly the 1% — immune to a downturn? What happens, though, if the venture capital dries up? The company has had a tremendous amount of success but is it just a product of a frothy time? These are all important questions.

For now, though, the wind seems to be at Peloton’s back. And more conventional fitness players ought to be concerned. Just like with entertainment and Netflix, the fitness home invasion is happening. And there’ll be winners and losers.

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PETITION is a digital media company focused on disruption from the vantage point of the disrupted. We have a kick-a$$ weekly newsletter. You can subscribe HERE and follow us on Twitter HERE.

Is New York City F*cked? Part II.

We previously expressed our concern about the New York City Mayor Bill de Blasio's plan for tackling disruption. The gist was that the Mayor's budget fails to take into account the effect of Uber and Lyft on taxi medallion values. To add insult to injury, this American Council for Capital Formation report makes it sound like the City's pension funds are being managed in a way that would make even Bill Ackman look good. Choice quote: "The performance of the New York City Pension Funds over the past decade has not kept pace with what is needed to stay solvent over the long term. Unfortunately, even conservative estimates project unfunded liabilities to be in excess of $56 billion. It is therefore extremely concerning that managers are spending dwindling resources on investments that are socially or politically motivated, rather than based on performance." The report paints a pretty gnarly picture of how New York City Comptroller Scott Stringer has handled pensions, notwithstanding the funds' recent market-based improvement. Distressed investing fans will particularly love this bit: "For example, the New York City pension funds paid $2.1 million in fees to Perry Capital in fiscal 2016, and had $129 million invested in the firm when it shut down its flagship fund in September 2016 after losing money for three consecutive years. The cumulative return of the city’s pension funds’ investments in Perry Capital inception to date was -14 percent, as of September 2016." Riiiiiiiight. 

As we said before, color us concerned.

Is New York City F*cked?

Uber, Lyft, and Political Incompetence: Mayor de Blasio Needs to Get it Together

Maybe New York City Mayor Bill de Blasio ought to subscribe to PETITION. He clearly doesn’t grasp disruption. And other elected officials are calling him out on it.

Just recently, Thomas DiNapoli, State Comptroller, released his “Review of the Financial Plan of the City of New York”. Buried within the document is a subtle rebuke of the de Blasio administration’s failure to acknowledge any semblance of reality. Here are some key highlights:

• The November (Financial) Plan covers a four-year financial plan from 2018–2021. That plan projects a budget gap of $7.1b, a number dismissed as “relatively small as a share of City fund revenues (averaging 3.5 percent).” The gap has tightened in large part due to pension fund over-performance. PETITION Note: Hmmm. Query how long that will last.
• NYC’s economy has expanded more than at any time since WWII. But job growth is slowing and may slow more given federal tax policies.
• The FY 2019 budget gap estimate was increased by $360mm to $4.4b because “tax receipts have fallen short of expectations.” “Despite the strength of the City’s economy, non-property tax collections have underperformed. For example, the City had assumed that business tax collections would increase by 9.1 percent in FY 2018, but collections declined instead by 8.9 percent during the first four months of the fiscal year (after declining for two consecutive years). Although the City lowered its forecast by $240 million in FY 2018, the out-year forecasts were left unchanged.” PETITION Note: read that last line again!
• The Plan anticipates $8.3b of federal funding in FY 2018, accounting for 10% of the City budget. PETITION Note: Right. We’ll see. There is obviously a real question whether the federal government may be counted on to fund the City at the same levels. And federal taxes and home ownership costs are obviously expected to increase for many City residents. “Changes in federal fiscal policies, however, constitute the greatest risk to the City since the Great Recession.”

And then our favorite bit:

• The City has 1650 taxi medallions to sell but has postponed sales since 2014 with the express acknowledgement that ride-sharing companies like Lyft and Uber are affecting medallion values. “The average sale price for a taxi medallion peaked at $1 million in calendar year 2014, but it was nearly cut in half by 2016. Weakness in market conditions has continued, with the average sale price declining in 2017 to $350,000 as of November 2017.” And, YET, the November Plan assumes the 1650 medallions will be sold at an average price of $728k.

Wait, what? Just last week, First Jersey Credit Union reportedly auctioned off six NYC taxi medallions for a high bid of $186k. And then on Tuesday January 16, five medallions were sold for a total of $875,000. Two additional medallions sold for $189k and $199k, respectively. To quote the previously linked Crain’s New York piece, “When a taxi medallion sold for $241,000 last March, the seemingly rock-bottom price made major news. It turns out, those were the good old days.” And then there is this, “One industry veteran said the auction prices are low, relatively speaking, because these are cash deals at a time when banks are not lending for medallion purchases.” Right, because the banks know that medallions make for crappy collateral and have zero desire to try and catch those falling knives. These are just the latest in a recent trend of distressed medallion sales — many of which have taken place in the bankruptcy courts. This stuff is public information. We’d think that Mayor de Blasio and his administration would be aware of it. Apparently not.

Here’s the problem: either through ignorance (it’s not like others haven’t noticed) or wishful thinking (that, what, Uber AND Lyft will FAIL?), the administration is budgeting on the basis of medallion sales that may never happen. And, even if they do, they are unlikely to fetch the value projected. Per DiNapoli, this error leaves an estimated $731mm shortfall in the budget. This is an astounding level of cluelessness. Even for a politician.

More importantly, if the de Blasio administration can’t see what is occurring right in front of them, how is it to be counted on to address bigger issues coming soon? Like autonomous cars, for instance? “‘Autonomous vehicles will have a significant and fundamental effect on cities and how they’re laid out’”. Color us concerned. If you live in New York, you should be too.

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PETITION is a digital media company focused on disruption from the vantage point of the disrupted. We have a kick-a$$ weekly newsletter. You can subscribe HERE and follow us on Twitter HERE.