Where is the Restructuring Work?

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Strong Voices in Finance Are Raising the Alarm

We have some very exciting things planned for the Fall that we cannot wait to share with you. Until then, we'll be channeling our inner John Oliver and spending the rest of the summer researching and recharging. Oh, and structuring our imminent ICO in a way that (i) circumvents the SEC's recent decision noting that ICOs are securities offerings and (ii) gives all current PETITION subscribers a first look at participation. Don't know what we're talking about? For a crash course, read this, this, and this. The ICO stuff is BANANAS and, yes, we're TOTALLY KIDDING about doing one. We are not kidding, however, about our planned Summer break. We'll be back in September with the a$$-kicking curated weekly commentary you've come to know and love. In the meantime, please regularly check out our website petition11.com, our LinkedIn account, and our Twitter feed (@petition) for new content throughout August. 

But before we ride off to the Lake, a few thoughts (and a longer PETITION than usual)...

There has been a marked drop-off in meaningful bankruptcy filings the last several weeks and people are gettin' antsy. Where is the next wave going to come from? A few weeks ago, Bloomberg noted that there was a dearth of restructuring deal flow and a lot of (restructuring) mouths to feed. Bloomberg also reported that, given where bond prices/yields are, bank traders are so bored that they're filling their days by Tindering and video-gaming like bosses rather than...uh...trading. (You're not going to want to thumb-wrestle millennials.) These trends haven't stopped the likes of Ankura Consulting from announcing - seemingly on a daily basis - a new Managing Director or Senior Managing Director hire (misplaced optimism? Or a leading indicator?). No surprise, then, that financial advisors and bankers are whipping themselves into a frenzy in an attempt to complement Paul Weiss as advisors to a potential ad hoc group in Guitar Center Inc. (yes, people do buy guitars online on Amazon and, yes, $1.1b of debt is a lot given declining trends in guitar playing). Even the media is getting desperate: now the Financial Times is pontificating on the "short retail" trade (firewall; good charts within) that others have been discussing for a year or so. The internet is impacting shopping malls (firewall)? YOU DON"T SAY! Commercial mortgage delinquencies are rising (firewall)? NO WAY! We've gotten to the point that in addition to having nothing to do, no one actually has anything original to say. 

That is, almost no one. After all, there is always Howard Marks of Oaktree Capital Management, who, once again, demonstrates how much fun he must be at parties. Damn this was good. Looooong, but good. And you have to read it. Boiled down to its simplest form he's asking this very poignant question: what the f&*K is going on? Why? Well, because:
(i) we now see some of the highest equity valuations in history;
(ii) the VIX index is at an all-time low;
(iii) the trajectory of can't-lose stocks is staggering, see, e.g., FAANG (though, granted, Amazon ($AMZN) and Alphabet ($GOOGL) both got taken down a notch this week);
(iv) more than $1 trillion has moved into value-agnostic investing;
(v) we're seeing the lowest yields in history on low-rated bonds/loans (and cov lite is rampant again);
(vi) we're seeing even lower yields on emerging market debt;
(vii) there's gangbusters PE fundraising (PETITION NOTE: we'd add purchase price multiple expansion and, albeit on a much smaller scale, gangbusters VC fundraising);
(viii) there is the rise of the biggest fund of all time raised for levered tech investing (Softbank); and
(ix) bringing this full circle to where we started above, there are now "billions in digital currencies whose value has multiplied dramatically" - even taking into account a small pullback.

Maybe we really should consider an ICO after all. 

And then there's also Professor Scott Galloway. He, admittedly, looks at "softer metrics" and highlights various signals that show "we're about to get rocked" in this piece, a sample of which follows (read the whole thing: it's worth it...also the links): 

We don't think he's kidding, by the way. Anyway, we here at PETITION would add a few other considerations:

  1. The Phillips Curve. Current macro trends countervail conventional thinking about the relationship between unemployment and inflation/wages (when former down, the latter should be up...it's not);
  2. The FED. Nobody, and we mean NOBODY, knows what will happen once the FED earnestly begins cleansing its balance sheet and raising rates; 
  3. (Potentially) Fraudulent Nonsense Always Happens Near the Top. SeeHampton Creek. See Theranos. See Exxon ($XOM). See Caterpillar ($CAT). See Martin Shkreli. And note worries about Non-GAAP earnings;
  4. Auto loans. Delinquencies are on the rise; and
  5. Student loans. Delinquencies are on the rise.

We're not even going to mention the dumpster fire that is Washington DC these days (random aside: is anyone actually watching House of Cards or is reality enough?). 

And, finally, not to steal anyone's thunder but one avid biglaw reader added that a telltale sign of an imminent downturn is the rise of biglaw associate salaries. Haha. At least there are wage increases SOMEWHERE.

All of the above notwithstanding, even Marks cautions against calling an imminent downturn admitting, upfront and often, how he has been premature in the past. That said, nobody saw oil going from $110 to $30 as quickly as it did either. So he's right to be highlighting these issues now. At a minimum, it ought to give investors a lot of pause. And, perversely, this all ought to give restructuring professionals a little bit of hope for what may lay ahead for '18 and '19. 

Have a fun and safe rest of Summer, everyone. Don't miss us too much.

The Curious Case of Jefferies LLC v. Banro Corp.

In many respects the restructuring industry benefits from an information dislocation. Management teams thrust into stressed or distressed territory are dealing with different subgroups of investment banks and law firms than they're accustomed to. The professionals are different, the terminology is different, and the terms of engagement are different. On the flip side, sometimes the terms SHOULD be different, but aren't.

A fee tail is a great example of that. We've seen a variety of investment banker engagement letters that include a one year tail. Boiled down to its simplest form, this generally means that an investment banker is entitled to its fee (or a pre-negotiated portion thereof) if the company consummates a "transaction," as defined, within 12-months of the bankers engagement - regardless of whether THAT banker got the transaction to the finish line.

In the compressed timeline of a distressed issuer, a year is like a decade. Given that, we would argue, as a general matter, that a 12-month tail is absurd in the restructuring context. There are so many externalities that could come into play during that time that might require a change of strategy. A 6-month tail strikes us as far more reasonable. After all, we've heard of instances where a company considered filing for bankruptcy merely to be in position to reject a retention agreement and avoid the potential duplicative and monstrous fee. That's ridiculous. 

Now you're probably expecting us to shred some banker for a specific (ridiculous) provision. We hate to disappoint. Notwithstanding the above, we're actually of the view that tails serve a critical function. Why should an investment banker roll up sleeves and go to bat for a client if the client can cut ties at any moment and transfer all of that work over to an execution banker for a fraction of the cost? 

Jefferies LLC is asking precisely that question. In Jefferies LLC v. Banro Corp. (1:17-cv-05490), Jefferies is asking the New York Southern District Court to enforce the terms of its engagement letter with the once-bankrupt gold-miner, Banro Corp.(and, in turn, Banro is attempting to transfer the litigation to federal court.). Jefferies alleges that it is contractually owed approximately $3.7mm in fees and expenses on account of a $175mm note exchange that is, according to Jefferies, expressly contemplated in its retention. The company purportedly terminated its relationship with Jefferies mere days before announcing that very transaction. Call us crazy but a tail of a few days strikes us as eminently reasonable. Professionals across the board ought to watch this case with great interest.

Short Murray Energy's Litigation Strategy

We have to admit: we're afraid to even mention Murray Energy. And that is precisely the problem: Bob Murray's penchant for litigation is intended to have a chilling effect on the media. This week, though, Reorg Research achieved - with the assistance of much bigger media organizations - a big appellate victory in the face of Murray's attempts to get Reorg to disclose sources. You can read the decision here. Many are championing this as a big victory for business journalists (and facing vitriolic off-point comments in response - see comments). Others, however, are wondering whether there are insider trading implications...? 

Shorting Retail Just Got Easier

Quick caveat: nothing we write in PETITION ought to be construed as investment advice and we have all kinds of lawyerly things to say on this topic in our disclaimer here. Cool? Cool.

Now that that boring disclaimer stuff is out of the way, if you've ever wondered whether you could ACTUALLY short retail - other than getting into restructuring - there is a new group of ETFs that do just that. Bloomberg and Axios both reported this week on the rise of ETFs targeting the retail industry, including, gulp, one's that use leverage to do so. It's our understanding that even firms with strict trading/conflicts policies allow for index fund investing. So, knock yourselves out. 

(Footnote: another alternative is investing in distressed Puerto Rican real estate.)

Again, note the disclaimer and if you lose money don't blame us. 

Like #Tech, Corporate Restructuring Has a Gender Imbalance

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Unless you've been hiding under a rock, you've probably noticed the controversy that embroiled Silicon Valley over the July 4th weekend. In a nutshell, some super brave and bada$$ women came forward and accused a variety of high-powered men of sexual harassment and improper behavior. First, The Information reported (firewall) a story backed by the accounts of six women recounting the behavior of Justin Caldbeck of Binary Capital. He soon stepped down (as did his two partners, thus thwarting the close of BC's second fund). Then The New York Times published a piece implicating Chris Sacca (of Shark Tank fame) and Dave McClure of the venture capital firm, 500 Startups. The former had already given up on investing (and Shark Tank); the latter first stepped down as CEO of the firm, then, in a matter of days, stepped down as General Partner as well. Silicon Valley's gender imbalance has been in the spotlight for some time now. Now we're learning more and more why that imbalance exists in the first place. 

Before we get ahead of ourselves, we'll be upfront here: what we're about to say is in no way meant to imply that sexual harassment and inappropriate behavior runs rampant in the restructuring community. But, let's be honest: there is a wild gender imbalance in firm partnership ranks, conference room negotiations, and bankruptcy courts. The industry's most lucrative and prolific restructuring law firm has exactly one woman partner. One of the industry's top restructuring advisory IBs has exactly zero women partners and, yet, that didn't stop the leader of that group from being honored by Her Justice, an organization that provides legal services to NYC women in need. And those are just two examples. Suffice it to say, there are many.

Now there are exceptions to the general rule: AlixPartners LLC, for one, and Greenberg Traurig LLP, for another (see below), in that they are led (or co-led as the case may be) by women. Weil Gotshal & Manges LLP, as another example, includes a number of women partners on its roster. But there should be more. Industry-wide. And charity honorees should be the women who have risen through the ranks - despite the odds - AND cultivated other women to follow in their footsteps. Overall, the industry can do much much better.

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

Dov Charney = Bankruptcy Pro

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

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

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

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

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

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

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

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

What Comes Next? (Healthcare? More Oil & Gas? More Retail?)

Oil and gas exploration and production is SO 2016. Everyone is sick of 2017's #retailapocalypse. So, now what? 

The above notwithstanding, there are many who believe that oil restructurings will hit again if (when?) oil dips below $40/barrel again. Early reorganizations that didn't delever enough or didn't tackle bloated SG&A will need a solution - even if just to stay competitive with companies that did, in fact, file and clean themselves up (though, based on the recent trading levels of post-reorg equities, some of those guys aren't doing so hot either; notably, none of them have gotten the support of a large institutional sponsor behind them). And some Chapter 22s may start rolling in too. 

On the retail side, November is not too far away. If retailers can't bridge themselves to Q4/Q1 by this point, they're probably beyond repair. 

In the meantime, restructuring professionals are earnestly turning their attention to "healthcare" - a catch-all category that subsumes various subsegments like biotech, pharma, and medical services. Industry decks have been circulating around like wildfire to the point where we have a pool as to whether we'll read more banker/advisor decks in the next 12 months than we'll see meaningful bankruptcies in that time (who wants in?). Leading indicator of hype-flow: the panels are starting. Last Monday there was a New York City Bar panel on healthcare issues.

So far in 2017, there have been a number of healthcare-related bankruptcies spanning across the various subsegments including, among others, 21st Century Oncology, Adeptus Health Inc., Halt Medical Inc., Bostwick Laboratories Inc., Unilife Corporation, and California Proton Treatment Center. There have been a number of smaller deals too but those don't ramp up advisory fees, e.g., this one from this week. Healthcare services providers have also been hurt, e.g., Angelica Corporation. And there are tons of other sizable healthcare names on distressed watchlists - though it's unclear whether they'll ultimately file for bankruptcy, e.g., Pernix Therapeutics ($PTX), HCR Manorcare (Carlyle Group owned), and Concordia International Corp. ($CXRX).

Getting out ahead of all of this, some Kramer Levin Naftalis & Frankel LLP attorneys released a recent thought-piece issuing a "Code Red" for the healthcare industry. They delineate the various reasons why healthcare is the new hot thing - from uncertainty around the ACA/AHCA (even with this week's release of Trumpcare Senate-version) to reimbursement pressure from Medicare to the change to bundled payments (rather than "fee for service" payments) to unsustainable capital structures emanating out of debt-driven acquisitions. A "Code Red" ladies and gentlemen. Hold on to your butts. 

Now, there are unique considerations that apply to healthcare restructurings - one among them the likelihood of the appointment of a Patient Care Ombudsman - which just means that there'll be another contingent of estate-sponsored advisors soaking up fees. That prospect alone probably gets juices flowing. Professionals love tables with a lot of seats around them. 

But, most of the companies highlighted in decks don't have maturities until 2019 or 2020 and so this has to, in the near-term, be a liquidity/covenant story...? Maybe. And it's unclear how that story will unfold - particularly with so much regulatory overhang. We're wondering if all of the current focus on healthcare is more hype than substance and maybe is a bit premature...? What do you think?

On an aside, we read stuff like this and it makes us less inclined to make jokes and more inclined to beat someone's a$$. This is people's health we're talking about and so it's disconcerting to see physicians speaking openly and publicly about deficiencies that are sparked by the need to service debt.  

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

How Many Companies Will Amazon Bankrupt?

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Grocery (Short EVERYTHING). So much to unpack in grocery world this past week so here is a brief summary for you: WholeFoods ($WFN) CEO John Mackey called Jana Partners greedy bastards; food deflation trends continued albeit at a markedly slower rate which means that someone wickedly smart may just be timing grocery at a time when it starts benefiting from inflation (imagine that); a Nomura Instinet analyst said - on Thursday - that Amazon ($AMZN) will next disrupt the grocery space (weeks after Scott Galloway predicted something big in grocery); Wegman's announced same day delivery via partnership with Instacart; Kroger ($KR) announced its numbers won't meet guidance and the stock, already down 14% on the year, dipped another 20% (only to fall more a day later on this...); Amazon dropped an atomic bomb on everyone and initiated a $13.7b play for Wholefoods making those greedy bastards pretty damn happy bastards (and sending stocks of everyone else - including Kroger - into even more of a tailspin); people then got busy questioning the viability of Instacart (the goodwill from the Wegman's news instantly evaporated) and BlueApron and Hello Fresh and Costco ($COST) and, well, we could go on and on but suffice it to say that if the food-oriented company was private it will likely stay private longer and if its public then its stock got decimated (including big boxes like Target ($TGT) and Walmart ($WMT)). And we were really beginning to warm to the "How to Beat Amazon" think pieces that have been making the rounds. The real question is: how many bankruptcies in 2018 will mention Amazon as one of the reasons why...?

Divided Recaps Under Attack in Payless Holdings Case

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Niiiiiiiiiice. We're impressed that Reuters and Bloomberg both picked up on something that happens - or at least appears to happen - often in bankruptcy cases: a conflict. 

Here's the drill: the official committee of unsecured creditors (UCC) in the Payless Holdings LLC case filed an application seeking to employ The Michel-Shaked Group as expert consultants. The mandate included providing "expert consulting services and expert testimony regarding the Debtors' estates' claims relating to the pre-petition dividend recapitalizations and leveraged buyout, including solvency and capital surplus analysis." As a quick refresher, Payless' private equity overlords Golden Gate Capital and Blum Capital dividended themselves hundreds of millions of dollars of value via debt incurred - albeit under relatively low interest rates - on the company's balance sheet. The company's debt load - in addition to various other factors characteristic of retail players today - was a major factor in the company's eventual bankruptcy filing.

Payless Holdings LLC - through Munger Tolles & Olson LLP ("MTO") as counsel to "the independent director of the Debtors" - subsequently objected to the UCC's application. The independent director (the "ID") claimed that the application is, at a maximum, duplicative of the services to be rendered by another UCC professional and at a minimum, premature. Why premature? Well, because the ID is conducting, through MTO, his own investigation into the dividend recapitalization claims the company might have against the private equity firms. That investigation is ongoing. Having a simultaneous analysis runs the danger of not only being duplicative and premature but also hindering the Debtors' aggressive proposed timeline for emergence from bankruptcy. 

As loyal readers of PETITION know, we're big fans of the (shadiness of the) dividend recap and, as such, we really enjoyed Bloomberg's snark: "That's right, someone close to private equity is investigating private equity firms for doing a very private equity thing." To be clear, separate counsel at the direction of an independent director is investigating the private equity firms. But, close enough. 

Let's pull the thread. Payless' main counsel, Kirkland & Ellis LLP, does a ton of private equity work - including, upon information and belief, work for the private equity sponsors implicated here. According to its own retention application, K&E has been representing Payless since 2012 as general corporate counsel. The private equity transaction dates back to 2012. Curious. K&E began representing the Debtors in connection with restructuring matters in November 2016; its engagement letter is dated January 4, 2017. 

The ID presumably got his mandate because he has "served as an independent or disinterested director for various companies in financial distress and restructurings." Among his qualifications are four other current director engagements including iHeartMedia Inc. and Energy Future Intermediate Holding Company LLC. Recognizing that the recap might be at issue, the ID hired separate counsel shortly after joining the board in January 2017 - right around the same time that K&E got hot-and-heavy on the restructuring side (if the engagement letter date is any indication). 

So, to summarize, K&E and management have been working with the private equity owners for five years. During that time, the dividend recaps occurred. The ID came on board right around the same time that K&E's restructuring team got enmeshed with the company. The same ID has a board portfolio of 5 directorships, 60% of which are for companies that are using K&E as restructuring counsel as we speak. Meanwhile, we have to assume that the ID gets paid tens of thousand of dollars for each board mandate with, perhaps, some equity consideration thrown in for good measure. Defensively, the objection drops a nice little footnote to assure us all that the ID is truly independent:

From the Debtors' Objection to the Shaked Application.

From the Debtors' Objection to the Shaked Application.

Perhaps the benefit of the doubt ought to be given to the ID and approval of the Shaked application delayed until after the ID completes his investigation. After all, if he comes down against the private equity shops, the application is moot. On the flip side, well, he won't. Notably, the objection already lays the case that the company relied in its business judgment on the opinions of Duff & Phelps, which issued a solvency opinion and presentation at the time of the transaction(s). Naturally, the UCC won't believe it and will push, again, for this engagement. Presumably, the company will jam them with the "train has left the station" defense. The upshot: if we were litigating this on behalf of the UCC we would certainly call into question the actual "independence" of the investigation sooner rather than later and see if the Judge bites. If done tastefully and in a way that doesn't impugn the character of the ID (which we are in no way advocating), it will at least somewhat offset the impression the Debtors are leaving with the Duff & Phelps bit and plant the seed in the Judge's mind for consideration upon the results of the investigation.

The hearing on the matter was scheduled for May 31 but was subsequently pushed indefinitely. 

Kudos to Kiehl's for Solid Direct Marketing

One of the team - let's call him Mr. Purple - walked into Kiehl's last week and purchased some fancy skin stuff. At the counter, the cashier asked whether he wanted any samples and he chose the "Age Defender Power Scrum." Never too young to worry about the skin, we guess. It didn't really register with Mr. Purple at the time but the cashier scanned the sample. Yesterday he found out why: Kiehl's sent him a direct email asking him whether he liked the sample and providing an easy-click way to purchase some. Conveniently, that email came on the same day as another email with a 20% off coupon. Now THAT is some impressive targeted marketing: in this tough retail atmosphere, anything that reduces friction for buyers is critical. This would be EVEN MORE impressive if he actually bought some (he didn't). 

Reasonability of Fees

We want to apologize for an issue related to last week's newsletter; we failed to recognize that the (Amazon Web Services') link embedded in our feature (apparently) expires with time. Sorry about that. 

The right information could be found all week on our website (hint, hint) and we encourage you all to visit it here. The upshot is that an Iowan judge gave Weil a beating because of redonk fees. But don't take our word for it: the opinion is worth a read if for no reason other than its sheer comedy. We enjoyed where the Court indicates that Weil argued that the fees were reasonable because, well, they're Weil, damn it, and they damn well said the fees were reasonable. 

On the subject of fees and billing, the opinion wasn't nearly as amusing (or bemusing, depending on your POV) as this quote from a Caesars-related story from Q4 '16: "The advisory firms have adopted the attitude that every possible land grab that is is worth chasing. These firms have no capital markets businesses and just outsource the work to JP Morgan and the like. These fees are just a tax on the estate. The creditors are doing most of the work here and these restructuring proposals are really ours [creditors]. But the legal departments of these investment banks are crafty. Debtors have to be more responsible on the front end of an engagement. The problem is that the debtors’ lawyers are completely and utterly conflicted. The bankers are often former restructuring lawyers themselves and they are all just referring each other business. This has become a feeding frenzy." 

In many ways, the problem stems from information dislocation. The buyside appears to be getting sick of WSJ headlines about fees - whether they're in Caesars or Lehman Brothers. And so tighter and tighter DIP budgets are becoming the norm and professionals are increasingly expected to agree, upfront, to some fee concessions. But company management teams aren't nearly as savvy; they don't know where to find out what "market" engagement terms are. Certain resources that track this information are firewalled unless you pay tens of thousands of dollars for access. So, who is going to educate management? Debtor's counsel? If the quote above is any indication - and referrals truly are traded like chips - that may be asking for a lot. And so don't be surprised if there are more activist judges opining on the reasonability of fees going forward.

Professional-Services.ai

Short junior attorneys...the machines are coming for them. And, frankly, why shouldn't they come for attorneys at ALL levels? After all, are there situations where there is "overzealous advocacy and hyperactive legal efforts"? When there are "so many attorneys and their respective billings"? "When the hourly rates and amount of time billed are simply unreasonable"? "Staggering," in fact?  Suffice it to say, you won't see Weil filing any cases in Southern District of Iowa anytime soon (see below). Frankly, "overzealous advocacy and hyperactive legal efforts" seems like it could have just as easily applied to the pissing contest that was the equitable subordination claim in Aeropostale but who are we to judge a grudge match between Weil and Kirkland & Ellis (which the the latter convincingly won)? We were too busy popping popcorn and putting our feet up. Switching gears and looking elsewhere in changing labor markets, here's to wondering: is the "gig economy" working? And what becomes of those 89,000 lost retail jobs?

Speaking of retail jobs, it looks like the bankers have all of them. Now there's M&A noise around Neiman Marcus, which is heating up with Hudson's Bay sniffing around hard but trying to avoid assumption of Neiman's substantial debt-load. Meanwhile Nine West Holdings has hired Lazard to figure out its capital structure. Elsewhere in retail, Macy's ($M), Kohl's ($KSS), Nordstrom ($JWN) and J.C. Penney ($JCP) all reported earnings that looked like a dumpster fire and the stocks promptly got decimated. We're sure the bankers are salivating. And speaking of retailers with jacked-up debt (and bankers), GNC Holdings Inc. and its agent bankers JPMorgan reportedly attempted but ultimately failed to extend GNC's $1.13b loan by three years. Now GNC says it will use its "strong" free cash flow to fund ops and deal with its '18 maturity. This is an interesting story on many levels. First, there have been a TON of share buybacks in recent years (the public equivalent of a dividend recap - our favorite) and so it was only a matter of time before one of them bit an uncreative and misled -- uh, we mean, generous shareholder-minded - management team in the bum. Second, the "Amazon-effect" apparently applies to meatheads too with vitamin sales allegedly shifting online. Who knew Biff could function in an m-commerce world? Go Biff. Third, despite a variety of downward trending financials, GNC's loan is still trading at a tick below par and so the proposed transaction might have affected the lenders' yield metrics (hence the rejection). Which gets us to #4: with crappy loans like GNC's ticking up so far upward, most distressed players can't stop complaining about a dearth of opportunities to target: everything is priced to perfection. Sadly, everyone needs the yield wherever they can get it hoping (praying?) that when the going gets rough, they'll be the first to hit eject. No, no (rate-fueled) bubble to see here.  

A Canadian Property Bubble? ($HCG, $OCN, $APO, $BX)

Last week we mentioned Canada's emerging property bubble. After reading this warning from BlackRock and then this alarming report by RMG Investment Management (out of the UK), perhaps we should've been a bit more focused on it. In a nutshell, they query whether the Home Capital Group (HCG) collapse roughly a week ago - taking a massive and expensive credit facility, stock plummeting, short seller Marc Cohodes ranting and raving - is the precursor to "the bubble" bursting. At five pages, the report is a bit lengthy but it's worth it. The chart within juxtaposing Canadian housing vs. US housing is particularly interesting. As is the fact that Steve Eisman's investment idea at the Sohn Conference in 2013 was to short Canadian housing, including HCG. We wonder if he had the patience to maintain that short over this duration. Either way, perhaps this is all a moot point if, as reported by Reuters, buyout firms such as Apollo Global Management LLC, Blackstone Group LP and Centerbridge Partners LP are looking to buy HCG. Meanwhile, stateside, Ocwen Financial's problems seem to be mounting.
 

An Auto Dumpster Fire. Thanks @Uber. ($HTZ)

We've covered the Uber-effect as it relates to taxis - in particular the precipitous decline in the value of tax medallions, requests for bailouts (in New York), and bankruptcies all across the country (most notably in San Francisco). With auto loan delinquencies on the rise and the used car market looking over-supplied, it's time for more blood in the water. Hertz Global Holdings' 52-week high is $53. It now trades at $15 and that is UP from its low of $7. It reports Q1 earning on 5/8 but last quarter was a bloodbath with EBITDA down 85+% y-o-y. Leverage as of last quarter was 7x pre-cash. On a quick glance the Icahn-backed company has plenty of liquidity - including a largely untapped Barclays revolver - but there could be some near-term covenant issues. And with more and more corporate travelers relying on Uber and Lyft, Hertz' management had better pack windbreakers. Meanwhile, auto dealers are looking for creative ways to alleviate their own pain with upstarts like vroom.com disintermediating the (frustratingly painful) process of purchasing a car. To the extent that anyone is actually purchasing a car. Bueller, Bueller?

We've Reached Peak #Retailapocalypse ($ARCC $MNI)

Who knew that another element of the retail story is international postal law and an app called Wish? This is bananas. Choice quote: "Services like this offer us a preview of a maximalist capitalist future, in which the near-entirety of current-day retail -- stores, humans and even storelike website -- have been identified as gatekeepers or sources of friction and accordingly obliterated." OBLITERATED. What the F? Meanwhile, you know you've reached peak #retailapocalypse when even the New Yorker is writing pieces about J.Crew's J-Crewiness, bad merchandizing, bad debt, and Matrix-esque mind-control efforts. This just goes to show how hard it is to avoid the retail story these days. Compounding matters, publicly-traded BDCs let us see how they view the retail landscape and, in this case, Ares Capital is writing down the value of their loan in Things Remembered Inc. For those with short memories, Things just did an out-of-court restructuring transaction. Clearly things haven't improved much. Finally, the tack-on affect of the brutal retail environment is showing up elsewhere: The McClatchy Company, for instance, reported a 7% drop in total revenue on account of a 22% decline in print advertising (not offset by a rise in digital advertising) with revenue losses from The Sports Authority and hhgregg Inc. cited. The company is 5.4x levered on $874mm of debt but has no near-term maturities and an untapped revolver. Still, the company is in full-on triage mode trying to expedite its digital transformation which, clearly, is a matter of life or death.

Feature of the Week: More Earnings (Simon Property Group & Starbucks)

This past week was an earnings-fest with Amazon and Google pumping out redonkulous numbers, Vince Holding Corp. missing estimates by 10 cents, declining 26% and continuing its slide towards bankruptcy, and FTI Consulting missing estimates BADLY, declining 3% and charting -23% year-to-date (we wonder how Berkeley Research Group is doing?). While all of these reports were intriguing, we took particular interest in reports from Simon Property Group and Starbucks...

Simon Property Group

Upshot: increased net operating income, increased retail sales per square foot, and increased average base rent. The company reported a flat occupancy rate of 95.6% at Q1 end and affirmed it's previous '17 guidance (typically, the company raises guidance). Snoozefest, we know, but keep reading...

CEO David Simon had a number of choice things to say about the current state of affairs (PETITION commentary follows in italics):

  • Retailers need to improve the in-store experience via technology, look and feel, and merchandising. He straight-up called his tenants to task alleging that they are overspending on the internet vs. the store fleet. He says this is reversing back and notes that pure e-commerce will need brick-and-mortar. Ironically, most recent bankrupt retailers claim that they filed for bankruptcy because they hadn't focused on their e-commerce fast enough! We can't recall one bankrupt retailer who cited too much expense associated with e-commerce as a cause for filing. He also makes no mention whatsoever of Amazon and Walmart's increased market share in clothing, the rise of mobile e-commerce, the rise of platforms, and millennials' lack of interest in shopping (and penchant for vintage clothing). 
  • A lot of the current bad performance is driven by private equity leverage rather than the common theme, the internet. He expressly calls out dividend recaps. No quarrel here whatsoever and more victims of this are in the bankruptcy pipeline. 
  • SPG has lowered apparel in its retail mix by 5-6%. Whether that was elective was not clear.
  • Expect more discounters like TJ Maxx and HomeGoods and grocers like 365, Wegmans and Fresh Market in high end malls. Other specific new tenants include restaurants (Fig & Olive, Nobu) and several movie theater brands with the occasional Dave & Buster's thrown in for good measure. This all seems consistent with the narrative that more experiential-oriented tenants will fill these spaces. Query how long until and to what degree the pain in the grocer segment will come to roost, if at all.
  • Because these long-term anchors aren't driving foot traffic and revenue to the malls, there is a lot of upside in reclaiming and redeveloping department stores for mixed use, lifetime or community-oriented activity. They are actively taking back space from unproductive retailers and they are "not putting good money in the rabbit hole," suggesting, at least, in part, that future Aeropostale-like deals are unlikely. Note, also, Aeropostale's performance shaved several basis points off performance and is likely to continue doing so through Q4. This sure sounds like a solid counter-narrative but won't this eventually boil down to a case of volume assuming the vacancy rate next quarter is lower than this quarter?
  • Store closures in a market also kill internet sales for that business in-market too. Really interesting and speaks to the thesis promoted by the likes of Warby Parker that some retail presence helps scale.
  • Expect improvements in technology in the mall environment. If people had an issue with Unroll.me selling their data, wait until the beacons scale! 
  • The mall "traffic is there" and the retail apocalypse "narrative is way ahead of itself." Yet, he wouldn't provide traffic data noting that there aren't traffic counters in their malls. The parking trackers at their outlets, however, are up 2%. See also Starbucks below.
  • The strong US dollar has had a significant impact on spending by international tourists. So has our President but we won't go there. Oh, wait, we just did. Not a political commentary: just a plain fact.
  • He would not opine as to how much per capital retail needs to come out of the system. It was abstract but, as we noted last week, Vornado Trust's CEO noted somewhere between 10-30% in the next five years.

Macro narrative aside, Mr. Simon remained upbeat about SPG's quarter and guidance. But speaking of REITS, we'd be remiss if we didn't point out this doozy of a red flag piece by the WSJ, highlighting 10 retailers that S&P Global Market Intelligence has noted as at high risk of default: Sears Holding Corp. (for obvious reasons), DGSE Companies Inc. (millennials don't buy precious metals, apparently), Appliance Recycling Center of America Inc. (millennials haven't been buying homes, apparently, so no need for recycled appliances...?), The Bon-Ton Stores Inc. (specialty retailer massacre), Bebe Stores Inc. (what? nobody wants glittery hats and shirts shouting BEBE anymore?), Destination XL Group Inc. ("our financial condition is extremely healthy" says the CEO whose company has a projected net loss on $470mm of revenue), Perfumania Holdings Inc. (mall-based perfume including the foul-stench of the Trump family...also fact, just saying), Fenix Parts Inc. (doesn't Amazon have an auto parts reselling business? why, yes, as a matter of fact it does), Tailored Brands Inc. (tons of quality tuxedo options online these days), Sears Hometown and Outlet Stores Inc. (obvious).

Of SPG's top 10 anchors, Sears is #2 with 69 locations and 11.3mm square footage of space and The Bon-Ton Stores Inc. is #10 with 8 stores and 1.1mm square footage of space. Macy's is #1 with 121 stores and 23.1mm square footage. Top in-line stores? L Brands, Signet Jewelers and Ascena Retail Group - all of which are reporting rough numbers of late. Which may explain why, in the end, SPG's stock was down this week, is down for '17, and is close to its 52-week low. 

Starbucks

Starbucks is just fine from the restructuring community's perspective. With one exception: Teavana. The company indicated that it is "evaluating strategic options." Why? Good question and, quite frankly, the answer is very much at odds with what Mr. Simon says. See, Teavana is a mall-based retailer; it has 350 locations. And they're not faring well predominantly because, per Starbucks' CFO, there is dramatically reduced mall traffic. Accordingly, Teavana has been suffering from negative same store comps and operating losses "for some time" with the rate of decline over the last 6 months far worse than forecast. Now even further declines are expected. And so we did a quick check: there are 78 Teavana locations in Simon Properties which would be 22% of all Teavana locations. Is it possible that those locations are the outliers and are performing extremely well on account of steady foot traffic? Starbucks doesn't break out numbers of a per location basis. But we highly doubt it. 

Diving into Retail IV (Entrepreneuring Like a Boss)

Amidst the doom and gloom of retail there is a capitalistic crop of entrepreneurs popping up looking to take advantage of vacant retail space. Appear Here, for instance, launched its New York office this week; it deems itself the Airbnb of retail space, matching vacant properties with brands looking to experientialize (we may have just made that word up) the consumer experience. Storefront is another company that acts in the same space. 

Diving into Retail III (Liquidating Like a boss)

This piece does a great PR job for the four main bankruptcy liquidators coming just short of the "C" word ("collusion," that is). Choice stat: "Revenues for Great American’s auction and liquidation services increased $26.3 million, or 73.7%, to $61.9 million last year. All of that was due to an increase in revenues from retail liquidation engagements." Recognizing that these figures represent revenue rather than profit, we nevertheless draw two potential conclusions from these massive amounts: 1) companies are doing a horrific job of negotiating deals with these liquidators if there is THAT MUCH value to be reaped by the liquidators amid THAT MUCH competition; and 2) those flashy red/yellow GOB signs belie what kind of deal consumers are actually getting at the end of the day. What are those 40-50% off figures off of? We're curious. Meanwhile, add Bebe Stores as a source of revenue for '17.

Real Estate & Retail

Before the holidays, Vornado Realty Trust ($VNO) CEO, Steve Roth, issued his shareholder letter. We recommend you read it (particularly starting with Page 15) but this choice quote about sums it up: "I do not believe we can grow our way out of this mess. I believe the only fix for brick and mortar retailing is rightsizing by the closing and evaporation of, you pick the number, 10%, 20%, 30% of the weakest space. This very painful process will surely take more than five years. It will also create enormous opportunity for those with the capital and management platforms to feed on the carnage."  He also discusses, briefly, WeWork and exposure to Sears and KMart. You can read the letter here: it doesn't read like a sterile SEC document and so we highly recommend it. Meanwhile, this is where all of that retail spending went, apparently.