💥Weinstein Buyer Goes Treasure Hunting💥

The Weinstein Company (Finally) Files for Bankruptcy (Long Justice)

Source: Getty Images

Oh man. So, the good news is that the company believes that its total exposure to victims (and creditors) is limited to 999 people/entities and its liability exposure is capped at $1 billion - or at least that's what one could glean from the boxes that the company checked on its chapter 11 petition. In other words, there are limits to the extent of Mr. Weinstein’s repugnance. So, there’s that.

Source: Bankruptcy Petition

Anyway, let's review what's "new" here without regurgitating everything the mainstream media has covered the last several months... 

The Weinstein Company's primary assets fall into three categories: (i) the film library, (ii) the television business, and (iii) the unreleased films portfolio. The library consists of 277 films and thanks to distribution rights sales internationally and to the likes of Netflix ($NFLX) and broadcast/cable networks, generates ongoing cash flow. The television business includes the Project Runway franchise and other content like Peaky Blinders, Scream and Six. The latter unreleased portfolio includes five completed films (including Benedict Cumberbatch's "Current War") and other projects in various stages of development. So, this is what is at offer.

Now, the previous pre-filing sale effort to a consortium of investors including Yucaipa, Lantern Asset Management and Maria Contreras-Sweet is well documented. As is the Attorney General of New York's complaint against the company. Neither are worth noting in detail here after months of incessant press coverage. Notably, however, Lantern Asset Management stuck with the process after its consortium partners dropped out, agreeing to become the stalking horse bidder for the assets pursuant to a proposed expedited sale process. Why expedited? In the company's words,

"It is an understatement to say that the last six months have been trying for the Company. Intense media scrutiny and various other factors have resulted in, among other things, the Company’s loss of goodwill with employees, contract counterparties, key talent and the entertainment industry at large. In order to preserve the going concern value of the Company’s Assets for the benefit of its stakeholders, the Debtors have determined that a sale of substantially all of their Assets is necessary. Further, the Debtors believe that time is of the essence and that effectuating any such sale as quickly as possible is necessary to maintain operations and preserve value for the benefit of the Debtors’ stakeholders."

Well, also, the company has no cash. Oh, and the buyer is pushing for speed as a condition to its bid. Lantern has that luxury as the remaining bidder; it is offering $310 million and the assumption of certain project-level non-recourse indebtedness (read: the debt associated with individual projects). Moreover, the company has indicated that Lantern anticipates retaining "most of the Company's employees." That's good: something positive must come out of this for those who had nothing to do with Mr. Weinstein's behavior. Speed is needed, the company argues, to prevent more employees from leaving (25% have already left). 

Some other miscellaneous facts of note in no particular order whatsoever:

1. Top Creditor. The number one creditor is a judgment creditor to the tune of $17.36 million.

2. It's Hard Out There for a Pimp. Boies Schiller & Flexner LLC is listed twice in the top 25 creditors. Fresh on the heels of the Theranos fraud suit, this has not been a good week for David Boies and partners. 

3. Other Creditors. Other major creditors include Viacom International ($5.6 million), Sony Pictures Entertainment ($3.7 million), Creative Artist Agency ($1.49 million), and Disney ($1.13 million). Remember: CAA took a lot of heat for its relationship with Mr. Weinstein.

4. It's Hard Out There for a Pimp Part II. Several law firms are listed in the top 25 creditors for accounts payable due and owing for professional services. Notably, O'Melveny & Myers LLP is listed at #10 and $3.1 million owed; it had long been rumored to be representing the company leading into the bankruptcy filing. This means, more likely than not, that Cravath was hired as an 11th hour replacement, leaving O'Melveny as a creditor. Also, Debevoise & Plimpton LLP has been left hanging after conducting the internal investigation of the charges against Mr. Weinstein. That’s just cold.

5. The Cumberbatch. "Current War," the feature starring Benedict Cumberbatch is levered up by $7mm under a production-level loan agreement with East West Bank. Nothing unusual here: just a fun fact. We'll see if Cumberbatch's star power can raise this movie above the debt and the Weinstein taint. 

6. Timing. To the extent any bidder wants to trump Lantern Asset Management, the deadline for bids is April 30 and an auction will occur on May 2 for court approval on May 4. 

7. #FakeNews. The New York Times and the New Yorker both get credit for taking down Mr. Weinstein and for starting the #metoo movement and Time's Up campaign. 

8. Ramifications. The company notes that the response to Mr. Weinstein's misconduct was fast and furious including (i) Apple ceasing plans for a 10-part Elvis biopic to be produced by TWC; (ii) Lin Manuel Miranda demanding that TWC release its rights to the movie adaptation of In the Heights, (iii) Amazon ditching TWC, cancelling plans for a David O'Russell series and dropped TWC as co-producer of a Matthew Weiner series; (iv) Channing Tatum halting development of a movie with the company, and (v) Quentin Tarantino seeking a different studio for his next and ninth film, the first time he would use a studio other than TWC. 

9. Board of Directors. 5 members went running for the exits as soon as sh*t hit the fan, including Paul Tudor Jones and Marc Lasry. 

10. Lawsuits. TWC has been named in at least 9 civil actions by victims of Mr. Weinstein, including a broad federal class action, two civil actions by Mr. Weinstein himself, and 6 civil actions by contract counterparties. 

Lastly, it has been reported that any and all NDAs will be "lifted" and no longer apply. This means that those who aren't as financially able as, say, Uma Thurman and Saima Hayek, may now speak out with impunity. Hopefully this frees various women from the shackles of their memories and leads to additional revelations about an industry apparently ripe for change.

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.

Orexigen Therapeutics - Long Obesity & Patents, Short Massive Cash Burn

Only Oprah Winfrey Can Sell Weight Loss

Orexigen Therapeutics Inc. is a publicly-traded ($OREX) biopharmaceutical company with one FDA-approved product named "Contrave.” Contrave is an “adjunct” to a reduced-calorie diet and exercise for chronic weight management in certain eligible adults. In English, it’s a drug to help adults (allegedly) lose weight. And before we continue, please take a minute to appreciate the exquisite creativity these folks deployed with the name, "Contrave." We can only imagine the whiteboarding sessions that went down before someone said in MacGuyver-esque fashion, “Wait! Control + cravings = Contrave!” We hope the company didn't shell out too much cash money to the brand consultants for that one. But we digress.

Anyway, the drug could theoretically service the 36.5% of adults the Center for Disease Control & Prevention has identified as obese — a potential market of 91-93 million people in the United States alone. And that’s just today: that number is predicted to rise to 120 million people in the next several years. Yikes: that's 33% of the U.S. population. Apropos, the company claims that the drug is the number one prescribed weight-loss brand in the US with over 1.8 million prescriptions written to date, subsuming 700,000 patients. The drug is also approved in Europe, South Korea, Canada, Lebanon, and the UAE. 

All of that surface-level success notwithstanding, the company has lost approximately $730 million since its inception. This is primarily because it has been spending the last 16 years burning cash on R&D, clinical studies for FDA approval, recruitment, manufacturing, marketing, etc., both in and outside the U.S. PETITION Note: And people wonder why drugs are so expensive. The company believes it could be profitable by 2019 under its existing operating model and revenue forecasts; it enjoys a patent until 2030. Clearly, the patent is the critical piece to this company’s future.

Prior to filing for bankruptcy, the company’s bankers attempted to effectuate a sale of the company to no avail. The goal of the bankruptcy filing, therefore, is to pursue a sale with the benefit of "free and clear" status (⚡️Nerd alert ⚡️: this means the buyer doesn’t need to take on the substantial litigation risk to clear title in the asset). While no stalking horse bidder is lined up, The Baupost Group LLC, is leading a group of secured noteholders (including Ecori Capital, Highbridge Capital and UBS O'Connor) to provide a $35 million DIP credit facility and buy the company some time. Will they end up owning it? 

Two other things of note here:

1. The Baupost Group LLC is really toning its bankruptcy musculature lately. Between this deal and Westinghouse, the firm has been active.

2. Note to company management: Oprah Winfrey may have some more room in her weight loss asset portfolio now that she’s dumped a meaningful amount of her Weight Watchers International Inc. ($WW) stock holdings at a considerable gain.

😡Private Equity Faces Increasing Headwinds 😡

Warby Parker, Claire's Stores, Toys R Us & More

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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.

WeWork Invents a New Valuation Methodology

Yes, we’re obsessed. And how can you not be with #longform pieces like this on the company. Choice bit,

“‘Adam’s explanation for the valuation of WeWork speaks for itself,’ said Chris Kelly, co-founder and president of Convene, a company that offers flexible event spaces and is backed by major real estate firms. ‘This is not an Excel spreadsheet calculation. He believes there’s an energy behind the brand, and he’s gotten people to invest at that valuation. He has not tried to explain it in traditional financial terms.’

Indeed, to assess WeWork by conventional metrics is to miss the point, according to Mr. Neumann. WeWork isn’t really a real estate company. It’s a state of consciousness, he argues, a generation of interconnected emotionally intelligent entrepreneurs. And Mr. Neumann, with his combination of inspiration of chutzpah, wants to transform not just the way we work and live, but the very world we live in.”

A state of consciousness. A state of effing consciousness. Being a biglaw associate is also a state of consciousness but that doesn’t necessarily mind-port you to partner after 8 years, let alone 12.

Wait, more pixie dust - this time from The Atlantic:

“Whether that’s a $20 billion business, however, is a matter of contention. Companies specializing in shared office space have come before. As The Wall Street Journal noted this fall, the office-leasing company IWG manages five times the square footage but has about one-eight the market value. Even Adam Neumann, a co-founder of WeWork and its CEO, admits that his company is overvalued, if you’re looking merely at desks leased or rents collected. ‘No one is investing in a co-working company worth $20 billion. That doesn’t exist.’ he told Forbes in 2017. ‘Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.'“

We’re sure bankers all across the world will be happy to add “energy and spirituality analysis” to the lineup of valuation methodologies like precedent transaction, comparable company and discounted cash flow analyses. What the bloody hell.

But, wait, back to the New York Times:

“If more strangers are colliding by the grapefruit water, the thinking goes, they are more likely to meet up and invest in one another’s socially responsible start-ups, and then the world will be a better place.”

Hahaha. What?!?! We were in New York last week and collided with a lot of strangers on the subway and, suffice it to say, no deals were cut and, as some dude danced on a pole, nearly kicked Nancy in the face, and a dodging Jonny spilled over into the lap of a homeless dude, the world seemed like a pretty sh*tty place. But maybe that’s because the subway car we were in didn’t have retail, free IPAs, or J.Crew threads.* Now that we mention it, maybe it should. Like the Amtrak cafe car. Brilliant.

Anyway, finally, this is obviously not investment advice (clearly, of a private company), but this:

* As for J.Crew, the WeWork partnership may actually be a great move towards injecting some life into the sleepy brand.

Digital Media is Hard (Long Algorithmic Disruption)

Women-focused dIgital publisher, Little Things, a producer of Facebook-based feel-good content (think recipes), announced yesterday that it is shutting down after failing to find a buyer. If it had a First Day Declaration in a bankruptcy filing, it could theoretically start with “What Facebook Giveth, Facebook Taketh Away.”

In case you haven’t heard, Facebook ($FB) has been under a bit of scrutiny lately. Something to do with bots, Russians, influenced elections, and heaps of societal division. So, recently, Mark Zuckerberg announced a tweak to the Facebook algorithm meant to prioritize friends and family content in your newsfeed and de-emphasize other content - including media content. This, naturally, is a big problem for media brands native to the Facebook platform. How big? Quantifiably big: Little Things apparently lost 75% of its organic traffic. Revenues and profit took a corresponding plunge. Yes, tech can obviously disrupt tech too. That’s the beauty of being the platform as opposed to be ON a platform.

In the company’s words,

“Unfortunately, as we were receiving those offers a full on catastrophic update to Facebook's algorithm took effect. The prioritization of friends/family content over publishers was the last straw. Our organic traffic (the highest margin business), and influencer traffic were cut by over 75%. No previous algorithm update ever came close to this level of decimation. The position it put us in was beyond dire. The businesses looking to acquire LittleThings got spooked and promptly exited the sale process, leaving us in jeopardy of our bank debt covenants and ultimately bringing an expedited end to our incredible story.”

Ouch. Like we said, media is hard.

EB-5 Visas & Bankruptcy/Distress Part II

A week ago we highlighted the bankruptcy filing of Lucky Dragon Hotel & Casino LLC. In that bit, we wrote the following:

“All of which is all to say that there may be an opportunity for some industrious lawyers seeking an untapped niche as the distressed EB-5 experts.”

We were more prescient than we thought.

Yesterday Greentech Automotive Inc., an electric car company that heavily relied upon 283 EB-5 investors (to the tune of $141.5 million of funding), filed for bankruptcy in Alexandria, Virginia. And the company’s downfall is, in part, an interesting case study in the weaponization of political media.

The debtor noted in its bankruptcy papers that a conservative digital media company named Franklin Center for Government and Public Integrity - through its watchdog.orgweb site - posted 76 negative articles about the debtor which, at one point, was affiliated with liberal Virginia gubernatorial candidate, Terrence McAuliffe. And contrary to what 50 Cent may say, all publicity is apparently NOT good publicity.

In this instance, the attention from watchdog.org avalanched into public scrutiny from the SEC and the Office of the Inspector General of the Department of Homeland Security. Regarding the former, the SEC investigation never led to further action. In the latter, the OIG conducted an investigation of GreenTech and the involvement of Mr. McAuliffe in communications with the DHS’s Citizenship and Immigration Services (“USCIS”). A subsequent report added additional bad publicity. All of which affected the company’s ability to raise more capital AND affected the view of the USCIS toward the investor petitions for permanent residency under the EB-5 program. Whoops. The company blew through a lot of funds combating these various issues and other litigation - including litigation the company lost defending lawsuits from a subset of its EB-5 investors. One such lawsuit resulted in a multi-million dollar judgment; others remain outstanding.

So now the company has filed for bankruptcy to pursue a possible sale of its assets and deal with its outstanding litigation. It sure sounds like they’ll have to deal with several hundred angry EB-5 claimants whose immigration status in the U.S. is now in limbo and who will now become intimately acquainted with the automatic stay.* Have fun with that.

*Nerd alert: when a company files for bankruptcy, an “automatic stay” immediately goes into effect serving as an injunction against claimants pursuing claims against the company.

Ponder This: Gibson Brands' Struggles

By: Ted Gavin, Managing Director & Founding Partner of Gavin/Solmonese

It’s not new information that Gibson Brands, famed maker of guitars, is struggling. And some of the coverage in last week’s PETITION sheds light on why. When Justin Bieber is the only current superstar artist of note that one points to that uses Gibson gear, that’s not a good sign for a brand built on traditional rock star names like Jimmy Page and Slash. Not that they don’t build great guitars – they do, I own several of them. But their problem isn’t aging guys holding on to their musical tendencies. Their problem is that the primary feeder of the market for guitar makers – which is new guitarists – is evaporating.

For the last decade or more, the notion of the rock star front man has all but disappeared. Today’s popular music – like it or not – is more vested in the singer and producer than the musicians. The musicians may be session pros called in for backing tracks on the recording and maybe the tour; or the music may be samples added in production and taken on tour in the form of a digital file. None of this creates the inspiration for people to find a way to pick up a guitar and learn to do that thing that the guitarist in the band they love does on every song. Once Eric Clapton and Buddy Guy are gone, there are no more Eric Claptonsand Buddy Guys to influence the next three generations of hopeful guitar buyers. The Allman Brothers band isn’t the same draw it used to be, and neither is Ace Frehley. Dave Grohl plays Gibson – I have one of his guitars (which is what 1,116,000 American Express Rewards points will buy you). It’s a fantastic instrument and it’s become my primary stage instrument. But not a lot of people are going to buy a $7,000 guitar (for example, I didn’t – hence the AMEX points). John Mayer is perhaps the most well-known mass market virtuoso guitarist-performer today. He plays Fender.

Speaking of Fender, they’re geniuses. They knew they had to make it easier to attract millennials to the instrument, so they created an online lesson system that fits into every learning stereotype of what millennials want. I’ve been a musician my entire life – you generally aspire to play what your teacher plays, and that creates lifelong loyalty. Loyalty entirely unlike what Gibson’s foray into electronic equipment created (hint: if it created loyalty, it was to someone else’s equipment). Gibson makes more than guitars, but nobody’s making bank on the mandolin market. A week ago, I had a beer with a guitarist bankruptcy lawyer friend and we couldn’t remember if Gibson actually made basses. As it turns out, they do (thank you, handy Internet) – but we couldn’t remember anyone who plays one.

And there’s the problem. Gibson is doomed because their market has gone away and they haven’t done the things they need to do to invent a new market pipeline. They say that kids come out of the womb wanting Oreos – that’s great news for Nabisco, but that’s not how it is with musical instruments. If you want a market, you have to constantly create new buyers. Gibson’s efforts in that regard have been ... *sigh* … off-key.

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Ted Gavin is a Certified Turnaround Professional and the managing partner of Gavin/Solmonese. In 2016, The Deal Pipeline ranked Ted the #1 Crisis Manager in the U.S. based upon the number of active engagements. He has over 20 years of experience working with distressed companies and their stakeholders in diverse industries, including retail, transportation, regulated and non-regulated manufacturing, pharmaceutical and healthcare, professional services, construction, and metal-forming. He has served in leadership roles in engineering, manufacturing, information technology, and regulatory affairs functions. Ted has extensive experience in strategic planning and process re-engineering, with hands-on management experience in nonprofit, for-profit, and public sector operations. Ted testifies frequently as an expert witness on matters such as ordinary course of business issues in preference litigation, as well as on fiduciary duties of management in distressed companies.

Tops, Toys, Amazon & Owning the Robots

In a continuation of the recent grocery bloodbath, Tops Holding II Corporation, a northeastern grocer with 169 stores, filed for bankruptcy on February 21 in New York. As is customary, the company filed a “First Day Declaration” as evidentiary support for its bankruptcy petition which tells the company’s story, including how and why it ended up in bankruptcy court. Notably, the Declaration launches that story with union metrics - a not-so-swell sign for employees.

Tops has 14k total employees. 12.3k of them are unionized There are 12 different collective bargaining agreements. And, there is an ongoing dispute with pensioners:

"[T]he Company has been embroiled in a protracted and costly arbitration with the Teamsters Pension Fund concerning a withdrawal liability of in excess of $180 million allegedly arising from the Company’s acquisition of Debtor Erie Logistics LLC…." 

The company continues, 

"Utilizing the tools available to it under the Bankruptcy Code, the Company will endeavor to resolve all issues relating to the Teamsters Arbitration and address its pension obligations, and the Company will take reasonable steps to do so on a consensual basis."

(Shaking heads). Mmmmm. We bet it will “address its pension obligations.” For the record, the pension is underfunded to the tune of $393mm.

But that is not all. The company will also seek to deleverage its ballooning balance sheet and take care of some leases and supply agreements. The company has secured $265mm in DIP financing to fund the cases; it says that it "intend[s] to remain in chapter 11 for approximately six (6) months." We'll believe that when we see it. Anyway, WHY does Tops need to take all of these steps? Well, private equity, of course:

Despite the significant headwinds facing the grocery industry, over the past five years, the Company has experienced solid financial performance and has sustained stable market share. The vast majority of the Company’s supermarkets generate positive EBITDA and the Company generates strong operating cash flows. Transactions undertaken by previous private equity ownership, however, saddled the Company with an unsustainable amount of debt on its balance sheet. Specifically, the Company currently has approximately $715 million of prepetition funded indebtedness...." 

Ah, private equity = a better villain than even Amazon ($AMZN). But hold on, you didn’t actually think Amazon would skate by unscathed did you? The company continues,

“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.”

In Bentonville, Arkansas some Walmart Inc. ($WMT) employee is sitting there thinking, “Why does Amazon always get the credit and free publicity? WTF.” Anyway, the company adds that food deflation, price wars and its higher cost structure (read: unions) compressed margins relative to the competition, furthering the need for a restructuring.

Now, the company notes that all but 21 stores are “currently generating positive EBITDA.” And in court, attorneys from Weil Gotshal & Manges LLP represented that there wouldn’t be a significant footprint reduction (note: a motion is on file to reject the leases of 3 “dark stores”). All of this seems right if the stores are EBITDA positive but we’d bet that (i) there’ll be some closures and (ii) the company will try to “consensually” squeeze its unions for some meaningful union/pension concessions. In other words, the little guy definitely isn’t getting out of this situation at par.

*****

Speaking of the affected little guy, it looks increasingly like Toys R Us is, in fact, an explosive dumpster fire. Consider this week’s news:

• Toys R Us UK is on the ropes with more than 3k jobs at stake.

• CNBC reported that Toys R Us is in danger of breaching a covenant in its $3.1b DIP credit facility. Like, already. Why? Because holiday sales were obviously abysmal.

• The Wall Street Journal reported that Toys R Us may close another 200 stores AND renege on its previous promise to pay severance to those employees burdened with digging their own graves, so to speak. Note, though: a Toys R Us spokesperson claimed that talk of additional closures is premature. Premature but not necessarily inaccurate.

All of this noise will do nothing but create a negative cascading effect with those very parties who were supposed to take comfort from Toys’ massive $3.1b DIP financing package. Apropos, suppliers are contingency planning. Per USAToday:

“Industry analysts who attended Toy Fair said they saw manufacturer support for Toys R Us shift during the four days of the fair, with vendors signaling that they are preparing for life after Toys R Us.”

And, rightfully so. JAKKS Pacific Inc. ($JAKK) reported earnings earlier this week and the company led with Toys R Us in its earning release:

“A number of factors contributed to a soft fourth quarter, including the bankruptcy of Toys R Us….”

Net sales were down $31mm YOY and gross margin decreased by 8.1%. The company reported a net loss per share of $1.33. Ouch. Better contingency plan faster, dudes.

*****

So back to Amazon. Tops blames Amazon. Toys R Us blames Amazon. Everyone blames Amazon. For bankruptcy. For job loss. And yet Amazon Prime subscriptions grow exponentially (to 64% of households). Amazon’s stock price hit $1500/share on Friday; Amazon may soon race past Apple in market cap. As Scott Galloway points out:

“Consider that Amazon, with a market cap of $591 billion, is worth more to the stock market than Walmart, Costco, T. J. Maxx, Target, Ross, Best Buy, Ulta, Kohl’s, Nordstrom, Macy’s, Bed Bath & Beyond, Saks/Lord & Taylor, Dillard’s, JCPenney, and Sears combined.”

Where does this take us? Columbia professor Tim Wu recently wrote in The New York Times,

“Americans say they prize competition, a proliferation of choices, the little guy. Yet our taste for convenience begets more convenience, through a combination of the economics of scale and the power of habit. The easier it is to use Amazon, the more powerful Amazon becomes — and thus the easier it becomes to use Amazon. Convenience and monopoly seem to be natural bedfellows.

Given the growth of convenience — as an ideal, as a value, as a way of life — it is worth asking what our fixation with it is doing to us and to our country.” 

Yes. Yes, it is. Eric Newcomer writes in Bloomberg,

“And we haven't event talked about Amazon yet. Cities are prostrating themselves at the company's feet, trying to secure its second headquarters. Amazon can do no wrong in consumers' eyes. But if you talk to bankers or business people, Amazon is the one that strikes the most fear in their hearts. It controls more than two-thirds of the U.S. e-book market now. Amazon alone has the stock market's support to enter new industries, drive margins to zero and destroy rivals in search of more scale. It's great for shoppers and terrifying if you're in the grocery or pharmaceutical business.”

Galloway, in calling for the breakup of the “Big Four,” mind you, adds the following,

“Consider: Amazon has become such a dominant force that it’s now able to perform Jedi mind tricks and inflict pain on potential competitors before it enters the market. Consumer stocks used to trade on two key signals: the underlying performance of the firm (Pottery Barn’s sales per square foot are up 10 percent) and the economic macro-climate (more housing starts). Now, however, private and public investors have added a third key signal: what Amazon may or may not do in the respective sector.”

To his point, in the absence of some externality (and, to be clear, we’re not taking a position on regulation here), Amazon’s reach is astounding. Said another way: many more bankrupted companies are going to blame Amazon in First Day Declarations.

*****

Which brings us back to the viral Josh Brown “Just Own the Damn Robots” piece we’ve referred to before. As businesses are disintermediated and people lose their jobs, pensions, and employee stock plans (here, Appvion), its no wonder that the FANG stocks continue to shoot through the roof. Just. Own. The. Damn. Robots. But it’s not the people who are losing their jobs, pensions and employee stock plans that are buying Amazon stock at $1500/share. Significantly, Jeff Bezos is reticent to do a stock split. And so, more likely than not, those very same people are shut out from that equity growth story too. No job and no wherewithal makes ownership - of robots, of anything - pretty damn hard.

Gibson Brands (Long #Dadjoke-infused Media Reports)

As we’ve previously discussed, the music industry is in a bit of flux. This week, news reports resurfaced that Gibson Brands, the manufacturer of guitars used by rock legends like Jimmy Page (“swan song”), Keith Richards and Justin Bieber (indeed, he plays the Gibson Hummingbird, but we just wanted to check to see if you were still paying attention), is struggling. The media had a bit of fun with it:

Here, Proactive Investors:

And here, AV Club:

And then there is Reuters which “jams” all kinds of stuff in:

Guitar puns. Ugggh.

We previously noted that Gibson Brands had received an extension of time to report its financials to its private equity overlord, GSO. Clearly those financials are out and literally every media outlet on the planet got a peek.

From what we could gather, both top and bottom lines suffered - the former down 22% and the latter down 45%. The company’s senior secured notes traded down a few points on the news; they mature this summer and there is a springing lien to the company’s GSO-dominated term loan if the notes aren’t taken or refinanced out. The biggest pain point appears to be the various “electronics” related businesses the company tacked on in recent years as musical instruments actually showed some EBITDA growth in the face of revenue decline. With revenue down across the board, however, the notes are of increasing concern. And the noteholders (led by KKR) are advisored up to negotiate a workout with the company. That is, if the company is of the view that there’s such a need.

Late Tuesday, GIbson Brands CEO Henry Juszkiewicz denied all of the reports and indicated via press release that a plan was underway to salvage the brand. Perhaps Mr. Wexler’s optimism is pervasive.

Walmart and Trucking Issues (Short Grocers)

Walmart Inc. ($WMT) reported earnings on Tuesday and promptly got battered in the market.

While the behemoth retailer’s comp sales numbers rose 2.6%, e-commerce demonstrated some considerable cooling and EPS missed by $0.04.

Take a close look at the company’s earnings and you see that gross margin shrank, “due primarily to price investments, higher transportation expense as a result of the higher volumes and fuel costs, and mix effects from our growing eCommerce business.” There’s a lot to unpack here. For now we’ll just focus on transportation costs.

The trucking industry is in a state of transition. With aging drivers, high licensing fees and increased regulation, the United States currently suffers from a shortage of drivers. Its a grueling life on the road and in an effort to make matters better for drivers, regulators instituted limits on the number of consecutive hours a driver is allowed to be on the road. Indeed, trucks are now equipped with ELDs or “electronic logging devices” to ensure that drivers adhere to rules. The ELDs have compounded the shortage problem. Considering that 70% of all freight is moved by truck - including produce and packaged goods - this shortage creates product shortages, delivery delays and higher prices. Given the ongoing grocery price wars, those costs are getting absorbed by companies rather than consumers (so far, anyway).

As you know, Walmart is a pretty damn big grocer. If, considering its scale, there are transportation troubles that it doesn’t have the leverage to work through (though it is trying with fines), imagine how some of the smaller grocers - say, Tops Market and Bi-Lo - are faring. Hmmm.

Why can’t trucking companies appeal to additional drivers? In addition to the brutal lifestyle, it probably doesn’t help that trucking is almost always atop the list of professions soon to be automated away. Query what happens in the gap period between now and full-on automation? More shortage-induced pain for retailers? Or will equilibrium strike?

EB-5 Visas & Bankruptcy/Distress (Short Specialty Casinos)

Back in 1990, Congress created the EB-5 program to “stimulate the U.S. economy through job creation and capital investment by foreign investors.” We’ll spare you all of the glorious details but generally speaking, EB-5 investors must (i) invest in new commercial enterprises, (ii) create 10 full-time (35+ hours per week) positions for qualifying employees (e.g., US citizens, lawful permanent residents or other authorized immigrants), and (iii) contribute a sufficient amount of capital, e.g., $1mm or, in an high-unemployment area or rural area, $500k. In exchange for the investment, EB-5 investors are eligible to become lawful permanent residents (read: “green card holders”). Because of the lower threshold, most EB-5 investors invest in the high unemployment or rural area. And about 80% of the total number of EB-5 investors come from South Korea, Taiwan, the UK, and China. The latter - the Chinese - are getting a nice taste of distressed debt these days.

On February 16, the Lucky Dragon Hotel & Casino LLC filed for bankruptcy in the District of Nevada - sparking all kinds of creative headlines:

If you think that’s bad, we guess we’re all lucky that the casino wasn’t named the “Flaming Dragon Hotel & Casino LLC.” We’d end up with all kinds of “Tropic Thunder” references.

But we digress.

Opened in November 2016, the Lucky Dragon was supposed to be “an authentic Asian cultural and gaming experience.” The core target demographic consisted of the local Las Vegas Asian market - including the regional Asian populations of Los Angeles and San Francisco - as well as international Asian visitors from Mainland China, Taiwan and Canada.

While the project had theoretical appeal to a large swath of the Asian population, the Lucky Dragon also had $45mm in debt; it has to repay its construction loan ($30mm) and revolving loan ($15mm) to its secured creditor, Snow Covered Capital LLC (no, we didn’t make that name up). The hotel/casino also received $89,500,000 from Lucky Dragon LP, an investment vehicle housing the 179 individual EB-5 investments in the property. Snow Covered recorded a Notice of Default on the property to commence foreclosure back in September. Unable to find a buyer at a purchase price sufficient to pay off Snow Covered’s claims outside of court, the hotel/casino filed for bankruptcy to pursue “a quick auction, which will pay Snow Covered in full, provide fresh capital, and reenergize the project, such that it can become profitable and expand into full operation as quickly as possible.” The hotel/casino hopes that such an auction will give EB-5 investors “an opportunity to preserve their investments.” Yeeeeaaah.

The debtor is already facing opposition. Snow Covered is objecting to the use of its cash collateral - taking shots at the debtor’s valuation in the process - and claiming the filing was made in bad faith. A hearing on all of this action is today, February 21.

We’d be remiss if we didn’t point out the active role that EB-5 investors play in the distressed sale of the SLS Las Vegas as well. In that case, EB-5 investors ponied up $400mm and have filed suit against the prospective buyer of the (distressed) property, Alex Meruelo. “The SLS continues to lose money, according to the November lawsuit filed on behalf of the Chinese debt holders.” The sale faces some hurdles; maybe SLS will (finally) end up in bankruptcy court after all…?

All of which is all to say that there may be an opportunity for some industrious lawyers seeking an untapped niche as the distressed EB-5 experts.