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More Walmart. Apparently Walmart doesn't care one iota that it's driving grocer margins way down in a race to the bottom. This is going to get ugly. Case and point: Central Grocers looks like it is on the precipice (with Weil, Conway MacKenzie and Peter J. Soloman in the trenches). And as groceries get cheaper, it will get harder and harder for casual restaurants to compete as well.
With Walmart's rumored acquisition of Bonobos, perhaps we can finally do away with the narrative that these fashion startups will alleviate some of the brick-and-mortar vacancy. Walmart isn't buying Bonobos for its 31 "guideshops"; it is buying Bonobos because it needs to increase its e-commerce skillset and acquire a different demographic of shopper than the typical Walmart shopper. Or, we could be wrong: perhaps with Walmart's resources behind it, Bonobos will, in fact, be able to open more guideshops. But will they be independent of Walmart, or within Walmart? So many questions. And here's another one: if brick-and-mortar retailers continue to go the way of the showroom, which suppliers get hammered? Paper (shopping bag) producers? Meanwhile, speaking of bargain shopping at places like Walmart, it appears that Neiman Marcus shoppers are now getting price conscious too: it's amazing what comparative information at your fingertips can do.
In previous newsletters we have discussed co-cooking kitchens and co-retailing spaces. Now there is also a co-warehousing solution expanding into seven major markets - including New York and LA. Darkstore, a new recipient of $1.4mm in seed funding (which, we recognize, ain't much), empowers brands to offer same-day delivery. The company leverages excess capacity in storage facilities, malls and bodegas and uses those spaces as fulfillment centers (which is an interesting concept considering all of the recent debate about vacant retail space, including in NYC, and the battle for the "final mile"). We have no idea how they'll make money given all of the different players in the mix but this is an interesting idea.
For those of you who aren’t interested in restructuring/legal inside baseball, feel free to just scroll down to the News section below. Why? Well, we about to get legal up in this m*ther$%&$*, that's why.
Thanks to that pesky little thing called federalism, every state has their own court system. This makes "venue" a big deal in bankruptcy cases as companies on the verge of a bankruptcy filing generally have several venue options based on various factors (i.e., principal place of business, location of an affiliate, etc.). Historically, Delaware has been an obvious choice of venue because most companies are incorporated there. It also helps that the jurisdiction's law is debtor-friendly and the judges are viewed as smart, sophisticated, and fit to handle the most complex and commercial of issues.
Right now, though, there are a number of Delaware practitioners wondering what's behind a recent shift of significant bankruptcy filings to other venues. There are a number of theories swirling around.
It’ll be interesting to see where the next set of cases file...
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The retail disruption plot thickens.
Facebook doesn't break out numbers for Instagram, but there are increasing signs that it is becoming a beast for driving retail sales. Yep, Instagram.
As we foreshadowed last week, we find the continued evolution of digital platform-based retail interesting. This week, Bloomberg highlighted how Instagram is "kill[ing] the retail store," noting how more and more entrepreneurs rely on the platform to sell their wares. Brick-and-mortar is merely a complementary channel, used mainly to create brand awareness and otherwise create an aura of scarcity and, well, "cool." Choice quote: "We make sure that our products are sold out quickly through retailers...[w]e create rarity, and then - boom! - we have waves of clientele coming to our website directly, no middleman necessary." No. Middleman. Necessary. Explains a lot, doesn't it?
It is a bit ironic, though. Because the middleman is increasingly the digital platform rather than the brick-and-mortar retailer. And Instagram will eventually figure out a way to monetize the fact that it maximizes "discovery."
In the same vein, other retailers are increasingly using WhatsApp (Net-a-Porter) and iMessage (Coach) as sales channels, highlighting that "conversational commerce" drives higher volume. Indeed, other brands like Patagonia, Everlane and Coach are abandoning their own (expensive-to-maintain relative to value added) native apps, opting to explore further the potential of leveraging the aforementioned platforms as well as others, like Facebook Messenger and WeChat. Which is to say that these platforms are becoming more and more meaningful in the overall retail story and it is not just Amazon eating the world - a somewhat lazy and partially inaccurate narrative too often relied upon by restructuring professionals.
Last week we noted the imminent closure of Blackstone's distressed-debt hedge fund. Here's more about it - and about illiquid funds generally. It's been a rough year+ for hedge funds.
And speaking of alpha (cough), we can't think of a better argument for 2-and-20 than getting profoundly middle-of-the-plate market advice like shorting retail! What genius!! C'mon Lasry. With hedge funds under siege, you'd think that someone with the reputation of Lasry could conjure up some originality here and actually "deliver 'alpha'" - whatever that means these days.
In the even-less-alpha category, Eric Mindich is closing his $7b hedge fund, Eton Park Capital Management LP, after a flat '17 and a 9% loss in '16 - a year when millennials putting money into an index fund through Acorns and/or Wealthfront returned 12%. According to the WSJ piece linked above, the one thing Mindich is delivering is "more of the same," considering over 1000 hedge funds closed shop last year - giving new significance to the derogatory descriptor "hedge fund hotel" (Valeant Pharmaceuticals and SunEdison, anyone?). We particularly loved the kicker in the WSJ piece which was that the closure was "party due to concerns declining assets would make it harder to retain employees," a mind-boggling assertion that, if true, merely reflects a lack of awareness that (a) again, 1000+ funds have failed in the last year (see, e.g., Perry Capital, as just one large example), (b) hedge funders everywhere are screaming bloody murder about comp (as always - such whiners), and (c) it should, at least conceptually, be pretty difficult for those employees to find an alternative with such an atrocious track record looming like an albatross. Finally, as one banker subscriber wrote in to us, "Because they'd rather not have jobs?" Riiiiiiight.
But have no fear. Management probably needs a few lifetimes to burn through the billions of dollars earned to date. Maybe Mindich will even join the bevy of Goldman brethren moving to Washington DC. Nothing would surprise us. This failure notwithstanding, he could always change course in a few years after a downturn and give it another go. He'll get money: hedge fund failures are like tech failures. In the absence of gross negligence or actual fraud, they're almost assured of getting a second bite at the apple from sycophantic suck-up former investors who want in on the next big shiny finance vehicle...
Speaking of tech, Quixey, a "pioneer" of deep mobile search, announced in an epically hubristic blog post that it is shutting down and exploring strategic options (read: IP sale in bankruptcy, most likely). It has $31mm of venture debt and $134mm of venture capital from the likes of Alibaba and Softbank scattered on the cap table. On the topic of venture debt, choice quote from Fred Wilson taken from here: "I have lived [the venture debt] story several times in my career and we are seeing this play out again in the market." Sure sounds like it. We've surveyed a number of restructuring professionals and there seems to be very little attention given to busted tech. Well, maybe other than from us. Why? No debt, we're told. Really? No debt? See, e.g., Violin Memory, Answers.com, Aspect Software. And, now also, some Soundcloud news - a company we have previously identified as a potential bankruptcy candidate. The company appears to have secured an additional $70mm of venture debt (additive to the $30mm previously raised from Tennenbaum Capital Partners) from the likes of Ares Capital, among others. Something tells us that Houlihan Lokey isn't in the business of making nonsensical and useless acquisitions. Interested in this subject? Email us.
Sure doesn't seem like it. Two primary categories here: subprime auto loans and student debt.
Regarding the former, recoveries have declined to 34.8% with losses up from 7.9% to 9.1% YOY. 6mm people are reportedly delinquent by 90 days or more on their loans. This Business Insider piece notes the ramifications for the auto industry and the macroeconomy.
And then there are student loans. The Consumer Federation of America noted a 14% increase in loans that are at least nine months delinquent. For-profit education was a hot area of focus in the restructuring community around election time with Hillary Clinton, Elizabeth Warren and others underscoring the predatory nature of for-profit center (cough, Trump University) and drawing bullseyes. That intense focus has abated and, for now, it looks like the regulatory pressure is off. It will be interesting to see what that does to the $137 billion student loan market.
There's a lot of bluster in the restructuring community about Amazon, e-commerce and the death of brick-and-mortar retail. It's hard not to be sanguine about the future of retail when the bankruptcy roll is littered with names like General Wireless Operations, hhgregg Inc., Gander Mountain Co., Gordmans Stores Inc., and Vanity Shop of Grand Forks Inc. - and those are just the filings that have occurred in March.
In the interest of completeness, though, there is SOME nuance here and that nuance largely depends on socioeconomic and geographic considerations. This Washington Post story features interesting data about the adoption of e-commerce and while it has grown in nearly every state, there are some states that have been very slow to adopt it, e.g., Idaho, South Dakota, Colorado, Arkansas and Arizona. The macro trend remains the obvious, of course, but we thought this was worth noting. Sometimes it's erroneous to paint with too broad a brush.
Earlier this week Stone Energy Corporation announced that it completed the recordation of second lien mortgages - as required under its indenture with The Bank of New York Mellon Trust Company N.A.
This seems like such a basic thing that it wouldn't require a press release to celebrate it. But anyone who was paying attention to the last 18 months' of energy bankruptcy cases knows that closing checklist items don't always get done: there were a number of purportedly secured positions that were, well, not necessarily as secured as investors thought (we're looking at you Linn Energy). So, congratulations lawyers...this time you didn't commit malpractice!
After reporting disappointing numbers this week, Urban Outfitters’ shares fell nearly 8% and its CEO, Richard Hayne noted that “[t]he U.S. market is oversaturated with retail space and far too much of that space is occupied by stores selling apparel. Retail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesn’t count digital commerce. This created a bubble, and like housing, that bubble has now burst. We are seeing the results: Doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.” Which is precisely why short sellers have their sights set on mall REITs - and not just the REITs with more class B and C malls, as we’ve long predicted. As the WSJ reported, short interest on Simon Property Group and GGP Inc. has jumped to near a record high. Apropos, we took a look at the rejection motions filed in Radio Shack 22.0 and noted that 6.4% of the locations slated for rejection are from the two aforementioned behemoths. Note, also, that both have been appointed to the official committee of unsecured creditors in BCBG. Allegedly, all of this destruction has landlords looking for alternative clientele for anchor slots including, it seems, grocers like Wegman’s and Aldi. Note: the previously-linked Fox Business/WSJ piece states as fact that “[g]rocers present an advantage for landlords because they are more resistant than traditional retailers to internet competition.” Really? We’ll ponder that as we munch on our fourth delicious Hello Fresh meal of the week.
Back in October, Garden Fresh Restaurants* filed for bankruptcy. In January, The Limited Stores* filed and ultimately sold for a pittance to Sycamore Partners. Soon, if the rumors are true, Gordman's will file. What do all of these companies have in common? Sun Capital Partners. Gordman's would be the third Sun Capital portfolio company bankruptcy in five months - which doesn't really enhance the image of private equity firms now, does it? Thousands of jobs are now gone (a typical and increasingly earned PE trope), but Sun Capital has gotten its dividends and fed its LPs. Did Sun generate returns for its LPs? Looks that way. But we're not sure a track record of multiple liquidations is what Sun was hoping for.
UPDATE: Shortly after publishing this, Gordmans Stores Inc. did, in fact, file for bankruptcy. You can find the case summary for it here.
* click on company names for case rosters
Last week we complained about a dearth of bankruptcy filings. This week we got a handful of cases: two retail, one healthcare, one oil-and-gas servicer, and two "tech" companies. Because this week's case summaries (see below) are longer than usual, we'll rest on those laurels in lieu of a substantive feature (you can find the summaries here: Answers Holdings Inc., California Proton Treatment Center, Vanity Shop of Grand Forks Inc., BCBG Max Azaria Global Holdings LLC, EMAS Chiyoda Subsea Limited, Lily Robotics Inc.). Gotta keep things tight, time-wise, you know? Trying to keep the time you're billing clients to read our kicka$$ newsletter down to 0.1 hours.
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Three weeks ago we wrote a feature (with a pathetic title - not our strong suit) that introduced you to the concept of ghost restaurants. To refresh your recollection, these were restaurants with no real physical location - just some branding, space in a commercial kitchen (like the co-working space unicorn WeWork, but co-cooking kitchen space for chefs), and a distribution mechanism like Seamless. The benefits of this concept are obvious: quick experimentation with food concepts, cross-pollination of food stuffs between different concepts, and avoidance of expensive and fixed long-term duration rentals, among other things.
Why doesn't WeWork for physical consumer products exist then? Well, now it does. In two discreet neighborhoods in New York, anyway (SoHo & Wiliamsburg). A new Y-Combinator backed startup, Bulletin, is a new platform matching up smaller brands with consumers with physical retail space. Rather than specialty retailers taking on expensive leases to display a few select racks of wares, they can simply rent a single sub-section of a larger retail shop on a month-to-month basis. Low friction, zero long-term overhead, mucho flexibility.
Outsourcing rent exposure to Bulletin is even better considering that the brands otherwise maintain autonomy; they choose the products to display, deploy their normal price-points and coach the Bulletin-provided salesperson on how best to market and/or demonstrate their products (some risk on that last part, we'd think, but whatever). Bulletin alleges that the whole setup process can be done in 5 days or less. Query whether a hypothetical brand has any control over whether its wholesome plush children's dolls are situated next to some dude named Lion's rad display of custom bongs, but that's for the brands to safeguard, not us. Perhaps there's some hipster version of co-tenant clauses? Regardless, on the consumer side of things that would be a wildly comical combination: just the right kind of humor and smorgasbord-like experience to get customers returning to the space. It's like an upscale branded flea-market. Throw in some craft beer made out of spider piss and there may just may be lines around the block.
In a time when leases are the largest albatross weighing down retailers (well, other than billions in debt and dividend recaps), we welcome innovative and creative physical structures that aspiring brands can take advantage of. Most successful retailers these days are leveraging digital platforms - whether that's Amazon, Alibaba, Ebay or Etsy. Or - if you're half the average age of this newsletter's readership - Poshmark. SOME kind of brick-and-mortar has to work, right? Will Bulletin be the model? We've got no clue. But we welcome the attempt.
A few weeks ago we summarized a Andreessen Horowitz presentation about autonomous cars and what the rapid movement in that technology means for various kinds of entities: OEMs, municipalities, etc. If you weren't a subscriber at that point, you can go back and read the summary on our website here. As a footnote to that piece, a Tesla Model S has 150 moving parts. A typical internal combustion engine car has over 10,000. So, you can do the math: as cars shift towards electric and towards autonomy, manufacturing will surely be impacted.
We like focusing on tech because once you filter through the 98% of startups who claim to be "revolutionary" and "disruptive," you may actually find some that truly are. And that means incumbents are realistically under attack and further that - particularly where there are unsustainable balance sheets - there will be a world of hurt sometime soon for a number of companies. In many cases probably much quicker than many management teams and restructuring professionals currently advising them realize.
Which brings us to 3D printing. Desktop Metal is a two-year old 3D industrial metal printing startup based in Burlington Massachusetts. It recently raised $45mm in new VC (at a $350mm post-money valuation) from an impressive and notable group of strategic investors, including Alphabet, BMW, GE, Saudi Aramco, Stratasys, and Lowes. The use of proceeds is to ramp up mass production of printers.
That print what, you ask? Good question. Answer: metal components that its new investors would be interested in. BMW could use the printers for car parts, Lowes for in-house product, Saudi Aramco for oil-field services uses, etc. This article notes, specifically, that printed carburetor parts could be immediately deployed on the road.
There are a number of 3D printing companies. And there has been a lot of hype around them and quite a bit of failure in the space. At some point, however, the technology will become cheaper and more dependable. Will it be Desktop Metal, specifically, that gets it there? Nobody knows. But when companies like BMW, GE and Lowes put their weight behind something, incumbents ought to take notice. If not, certain manufacturers may soon find themselves in distressed/restructuring circles before too long.
Screenshot from marblesthebrainstore.com.
"It is likely that other retailers may commence chapter 11 cases in the near term." - Girisha Chandraraj, CEO of Marbles Holdings LLC
How do you know when the retail industry is truly effed? We'll spare you the suspense: when even the big nerds from "The Brain Store" can't find a path to retail sustainability.
This past week, Marbles Holdings LLC, the entity behind "Marbles: The Brain Store," a specialty retailer that sells games, puzzles, books and software for kids (and memory-juicing adults) filed for bankruptcy. The company operates 37 retail stores in 13 states (and a store-in-store concept within 6 Macy's locations); it also maintains e-commerce and wholesale channels. It's on the smaller side of retail which is why it likely didn't get as much attention as the headlines surrounding Eastern Outfitters LLC, Payless or Sears. But like those others and "[d]espite years of popularity," the company simply couldn't overcome declining mall traffic and burdensome rents. So now what? Liquidation.
We'd, frankly, never even heard of this company. But there are some interesting bits in their papers that merited highlighting:
One final note: this business was seemingly as omni-channel as the come. Physical presences, e-commerce, catalogues, etc. And yet it still fell under the weight of secular and cyclical trends befalling all of retail. The bulletpoints above are important: they show the trickle-down effect of this wave of failing retail. How much exposure do A Malls have to a further decline in retail? How about the City of New York? Or other municipalities dependent upon commercial retail rents? It doesn't take a mind-bending puzzle-junkie to understand that Mr. Chandraraj is on point: there will DEFINITELY be other near-term retail bankruptcies. Are the effects of that anywhere near fully known?
Walk through the streets of Manhattan these days and you are bound to see a lot of “for rent” signs taped to the windows of empty commercial spaces. In Captain Obvious fashion, Crain’s New York last week noted that Amazon is affecting a lot of mom-and-pop brick-and-mortar: revenue is down due to the online competition and rents in New York, despite tons of vacancy, remain unsustainable for many business owners.
It’s rather simple: online retailing is eating up brick and mortar and there aren’t enough Bonobos, Birchbox and Warby Parker showrooms to fill the gap. After expanding to seemingly every corner of the City, banks are in contraction mode: there are now a number of shuttered Capital One and Chase locations in the City. And restaurants? We’ve covered that in detail: forget about it. Art galleries? Mwahahahahaha.
Under the radar are the ghost restaurants that are quietly undermining the commercial real estate market and contributing to the over-supply of space. Wait, what? Ghost restaurants? Picture this: you're on billable hour 26 for the day and you're hungry. You go on Seamless and find a restaurant with glossy food-porn photos and reasonable prices. You order and 35 minutes later you're indulging in your tasty delights while questioning the meaning of life.
A week later, you've got 20 minutes free from the office and your significant other suggests going out to eat. You say, "I know a great restaurant with awesome food. Let's go." You look for an address but you can't find one. Because there isn't one. The place you ordered from has no physical presence whatsoever or, alternatively, is just a kitchen with no seating space. Now you're rubbing your belly and really having an existential crisis. WTF.
With sky-high rents and quick turnover the norm, companies like the Green Summit Group are coming up with varying and unique restaurant concepts, locating themselves online only (or, at best, securing a small commercial space with no seating), skipping the long-term onerous lease with commercial landlords, partnering with commercial kitchens, and using Seamless and Grubhub for distribution.
This model promotes improvisation. One benefit of avoiding an actual storefront is the ability to test different food concepts and pivot menus if there are lower-than-anticipated sales. Rebranding is remarkably easy: just a new name, some different food porn photos, and an update to Seamless. To the extent that one company is running different concepts - say, Middle Eastern and Greek - it can also cross-pollinate by offering the exact same menu items per "restaurant" and sharing ingredients in the kitchen. This limits the need to source new ingredients or engage in extensive food prep training for each and every concept.
It is questionable how sustainable these experiments are long-term. You can read more about some of the cons - loss of alcohol-related sales, no walk-ins, logistics complications - here. The fact is, though, that this represents yet another headwind confronting established restaurant companies. And that potentially means EVEN MORE restaurant bankruptcies in the near future.
Apologies for the cringe-inducing Star Wars prequel reference. Hopefully your PTSD meds are within reach because that movie SUUUUUUUCKED...
That said, we can't help but to think that the concept of a "phantom menace" applies to Puerto Rico. See, on January 11th, the Puerto Rico government - now led by governor Ricky Rossello - announced the winner of the legal sweepstakes that played out down in the Commonwealth. Some big guns were, at one point or another, in the mix for the juicy and lucrative mandate representing the government in the restructuring of its debt-laden morass (and replacing Cleary Gottlieb Steen & Hamilton LLP). This includes the likes of Kirkland & Ellis LLP and Morrison & Foerster LLP, among others.
Given those heavy hitters, many seemed surprised by the Dentons US sleeper victory. This is not to take away from what is a fine firm and, by all accounts, a fine lawyer leading the project, Sam Alberts. The team also includes Claude Montgomery, Jonathan Ballan and Michael Zolandz. The team brings some serious bona fides to the table with experience representing the retirees in Detroit, work with, among other clients, the PBGC and the FDIC. The team seems well-rounded to handle the various legal disciplines that will be called into play - public private partnerships, litigation, securities, securitization, contracting, healthcare, tax, and Puerto Rican law. The government also noted that the Dentons team is "notable" for its "vast experience in the areas of government finance and public policy."
What absolutely NONE of the public announcements note is what sources tell PETITION is a major consideration that factored in Dentons favor. And that is the presence of none other than "Senior Advisor" Newt Gingrich, who is alleged to be a critical piece to this puzzle. See, back in 2015, Newt joined Dentons "Public Policy" practice. If only the PR government highlighted the importance of public poli...oh wait. Hmm.
With the Trump administration taking root and a complex restructuring required, it stands to reason that an ambassador with deep ties to the administration could be helpful towards driving a resolution. But this seems very swamp-y. Just like Puerto Rico.
"The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds." - John Maynard Keynes, The General Theory of Employment, Interest and Money (13 December 1935).
This past week, Michael Batnick, from Ritholtz Asset Management deployed a version of this quote to make a point about investing; he provided a nice callback to Blockbuster and an equity analyst's repeated bad calls vis-a-vis Netflix (which popped this week after impressive subscription growth - despite negative free cash flow (-$600mm+) and an increasingly levered balance sheet). TL;DR: don't be too wed to your ideas.
This applies to the actual businesses that investors pour money into too. In today's rapidly transforming environment, businesses must now, more than ever, pivot, and innovate. They can't be too wed to legacy ideas. Recognizing that is the first step. It then becomes a question of execution in the face of constraints.
Enter Avaya Inc., a privately-held provider of contact center, "legacy" unified communications and networking products and services with 176 global entities, $940mm of adjusted EBITDA, 200,000 customers and 9700 employees. To Avaya's credit, the company pivoted in 2009 away from its historical hardware-based operating model - recognizing the shift towards software-based and cloud-oriented services solutions. It undertook a massive reinvention, adapting its revenue model and streamlining operating performance in a manner that cut $700mm in costs since 2014. To some degree, the company's private equity overlords - TPG Capital and Silver Lake Partners - deserve some credit, too, for working with management and reconciling the need to pivot. After all, they had a $8.2 billion LBO to rationalize.
But sometimes the constraints are insurmountable. Avaya has $6 billion of debt on its balance sheet; it has $440mm of annual interest expense along with an additional $180mm nut for annual pension and OPEB obligations. And it faces stiff competition from the likes of Microsoft, Cisco, and others, necessitating another ~$400mm in expenditures to fund R&D and other investments. It's been bleeding cash, losing over $505mm in the fourth quarter and over $750mm in fiscal '16.
And so the company is now a bankruptcy filer. Notably, the papers accompanying the filing have zero specificity about the company's go-forward business plan. Its one small victory is a robust DIP financing commitment and milestones intended to achieve a rapid turn in bankruptcy court. But then what?
We rarely see big freefall bankruptcy cases anymore. Clearly there seems to be disagreement among the various constituencies about how best to proceed with this business in the face of competition and technological headwinds. That said, the company was able to secure $425mm of its proposed DIP facility at the "First Day" hearing on Friday. So there's that.
"Software is eating the world," we noted last week (per Marc Andreesen). We'll see very soon whether Avaya gets swallowed along with TPG and Silver Lake's investment. Yes, they pivoted. But was it too little too late?
Thoughts? Opinions? Let us know at petition@petition11.com.
Odd ad to place in the WSJ on the day after bankruptcy.
Right before the holidays, Benedict Evans of the venture capital firm Andreesen Horowitz released a fascinating presentation called "Mobile is Eating the World." It's a long presentation - roughly 31 minutes - but well worth reviewing if you have the time. We here at PETITION think there are a lot of nuggets within it relevant to the restructuring industry. After all, technological advancement and disruption help create the industry's client pipeline. Here is a brief summary with some editorial mixed in:
Overview
New Ways to Compete - Artificial Intelligence & Machine Learning
Example 1: E-commerce
Example 2: Cars