💩Will KKR Pay Toys R Us' Severance?💩

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Optimism Remains in Toys R Us Situation

Surprisingly.

You’d think that every person on the planet would be sufficiently jaded by anything Toys R Us at this point. Apparently not everyone. And, oddly, the optimism seems to come from someone typically critical/skeptical of private equity…

Yesterday Axios’ Dan Primack’s lead piece asked, “Should the former private equity owners of Toys "R" Us pay around $70 million in severance to the company's 33,000 laid-off employees?” The question seems to stem from reports that limited partners (i.e., pension funds) are questioning what took place with the Toys investment. We noted this on Sunday:

🔥Elsewhere in private equity, maybe there’ll be backlash emanating out of Toys R Us?? The Minnesota State Board of Investment voted to halt investments in KKR pending a review of the bigbox toy retailer. 🔥

With this as background, Primack wrote:

This is not an academic question. It's become the subject of some public pension investment committee meetings, prompted by a lobbying campaign by left-leaning nonprofit advocacy groups, and has gotten the private equity industry's attention.

  • The basic argument: Bain Capital, KKR and Vornado killed Toys "R" Us by saddling it with too much debt, while taking out fees along the way. It's only fair that they help folks who are without work because of private equity's mismanagement, particularly when PE firms are so rich and many of the employees were living paycheck-to-paycheck.

  • The legal argument: There is none. The private equity firms no longer own Toys "R" Us, and a bankruptcy court judge threw out the severance package because employees weren't high enough in the creditor stack.

We’re old enough to remember when mass shootings got private equity’s attention too. They promised to divest. They didn’t. And then Vegas happened. And then Florida happened. And then Bank of America ($BAC) swore off lending to gun companies only to, uh, lend to Remington Outdoor Company.

We’re old enough to remember people like Warren Buffett say that they should pay more in taxes. That his secretary has a higher effective tax rate than he does. But, to our knowledge, he didn’t exactly voluntarily write a billion dollar check to the U.S. Treasury.

Likewise, neither will KKR write a severance check to employees. No frikken way in hell. Why? Because there is no compulsion to do so. The legal argument? He’s right, “[t]here is none.” So, yeah, good luck with that.

And so the above is really where the piece should stop. A nice little moral high ground piece about how employees and vendors got effed, it is what is, now on to tariffs, Petsmart’s asset stripping “mystery,” Harley Davidson’s ($HOG) war with President Trump or Moviepass owner Helios & Matheson’s ($HMNY) stock hitting a record low.

But Primack also points out,

Finally, the pro-severance folks are a bit liberal (no pun intended) with their math. They argue the PE firms took out $464 million, by adding up advisory fees ($185m), expenses ($8m), transaction fees ($128m) and interest on debt held by the sponsors ($143m). Yes, we were first to point out how the general partners may have gotten back more than they put in. But some of those fees were shared with LPs — including the now-aghast public pensions — while the interest was held in CLOs that had their own investors. In other words, PE "profit" was much smaller than claimed (although, on the flip side, you could argue the firms collected management fees on Toys-related capital that ended up being set on fire... again, it's complicated). (emphasis added)

Right. We’re sure the Minnesota State Board of Investment is cutting a check as we speak.

Sadly Primack didn’t stop there; he continued,

PE firms do have moral obligations to portfolio company employees. You break it, you own it (even if you technically broke it while owning it, which caused someone else to own it).

Um, ok, sure.

He continues,

Bottom line: The PE firms should pay at least some of the severance, or figure out some other form of compensation. And I have a sense that they might. Not because of preening public pension staffers or legal obligations, but because it's the right thing to do. Sometimes it's just that simple.

LOL. Riiiiiiight. In the absence of Mr. Primack having an inside track at KKR, it’s just that fantastic (def = “imaginative or fanciful; remote from reality.”).

What to Make of the Credit Cycle. Part 8. (Long Yield, Baby. Yield)

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A. M&A is En Fuego

PwC released an analysis of M&A activity. In summary:

The number of deals north of $5 billion is on pace to double last year’s total, and to date has driven overall deal value up by more than 50%, according to a PwC analysis of Thomson Reuters data. Deals are also getting bigger, with more announced deals of at least $30 billion so far in 2018 than in all of 2017.

Since the start of 2018, one-third of megadeals crossed sector lines, driven largely by an appetite for new technologies. That interest in tech hasn’t been limited to huge transactions, with examples of smaller deals coming in retail, media and printing.

Companies are looking to broaden their customer base....

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Oil & Gas (Short Underwriting & Defaults)

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Sometimes distressed investing returns get upended by practical realities. The question is: were those realities accounted for in the underwriting?

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A Trade War With China & Is New York City F*cked? Part IV (#MAGA!)

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Each passing day of Washington DC news this week added an additional 10 years of wear and tear to our already downtrodden souls. Sheesh.

To summarize, President Trump directed the U.S. Trade Representative to identify $200 billion worth of Chinese goods for additional 10% tariffs; he also threatened an additional $200 billion. If this is all a big set up for some profound negotiation that America will “win,” well, generally speaking, you need the other side to return your calls. Apparently China isn’t doing that. Womp womp (speaking of “womp womp,” eff you Corey L.).

Still, U.S. chipmakers are cheering punitive measure against China. Why? Because they’re actively fighting a war with China over attempted intellectual property raids. See, e.g., Micron Technology Inc. ($MU).

According to Bill McBride, Merrill Lynch wrote:

The good news is that we are still many steps away from a full blown global trade war. The bad news is that the tail risks are rising and our work and the literature suggest a major global trade confrontation would likely push the US and the rest of the world to the brink of a recession. So far, the trade actions taken by the Trump White House and trading partners have been relatively modest and in turn have had a limited impact on the economy and financial markets. The next round of $100-$200bn of tariff between US and China may prove more substantial. Further escalation like auto tariffs would lead us to reassess the US economic outlook.

Yikes. Well, if auto stocks were any indication on Friday, that reassessment may be in order:..

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Bankruptcy Cases Suffer from Shrinkage

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FTI Consulting Inc. ($FCN) recently released a “data”-driven analysis-cum-marketing-piece* that highlights the apparent rise of “Pre-filings” — otherwise known as prepackaged, prearranged or prenegotiated chapter 11 bankruptcy cases — during the 2015-2017 period. FTI examined 300 emerged cases (via plan of reorganization) from 2011-2017 and concluded that,

“Most restructuring professionals recognize that the average duration of Chapter 11 cases has become shorter in recent years, but the contraction in average case length has been particularly striking since 2015.”

Indeed, FTI points out that…

“…nearly 66% of cases that emerged in 2016-2017 were Pre-filings compared to approximately 40% over the previous five years….”

And:

“Consequently, the average duration of Chapter 11 reorganizations fell by nearly one-half in 2016-2017 compared to 2011-2015, to 235 days from 435 days.”

Sooooo, despite the rise in Pre-filings....

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Education and Tech (Short Cloudless PE-owned Software)

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Blackboard Inc. is in Trouble

There’s been a lot of news circling around Blackboard Inc. these days. Even children aren’t out of bounds for the distressed vultures, it seems.

Blackboard is a provider of enterprise tech software solutions to the education industry (as well as the government and some businesses); it peddles, among other things, a “learning management system,” virtual classrooms, education analytics (i.e., test scores), and marketing and recruiting services. It is meant to be a one-stop shop for educational providers’ needs.

Back in July of 2011, Providence Equity Partners (“PEP”) took the Nasdaq-listed company private in an all-cash transaction valued at...

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Distressed Debt Funds Fundraise (Long Market Timing)

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At the Wharton Distressed Investing Conference in late February, Marathon Capital Management’s Bruce Richards said that his firm was delaying fundraising new capital. He noted that while he fully expects the cycle to turn and, consequently, that there’ll be a plentiful amount of distressed opportunities, he doesn’t want to mis-time the raise in such a way that his lock-up will expire midway through the investment horizon.

It seems others are of the view that now is the time. Per The Financial Times:

A growing number of US hedge funds specialising in distressed debt are raising money in anticipation that the next economic downturn will punish companies that have borrowed record amounts since the financial crisis.

Mudrick Capital, for instance, is reportedly raising a second fund that will have a five-year lockup and only charge fees upon capital investment. The fundraising goal is December 1. Carry the 1, add the 5, and that effectively means that he’ll have through 2024 to invest.

Marathon Capital had better hope there are still LPs out there looking to fund the asset class. More from FT:

Mudrick Capital is not the only fund preparing for an eventual downturn in a US economy where growth is accelerating this quarter. Strategic Value Partners in May raised almost $3bn to pounce on distressed bonds and loans, while Sheru Chowdhry, formerly co-portfolio manager of the Paulson Credit Opportunities fund, launched DSC Meridian Capital at the start of June.

In total, seven distressed debt funds have raised money this year, with a record average size of $2.2bn, according to data from Preqin. The largest is the GSO Capital Solutions Fund III, which closed in April after drumming up $7.4bn in the fourth-biggest distressed debt fundraising ever.

With tariffs, a trade war, rising interest rates, ramifications relating to tax deductibility in Tax Reform, secular pressures, auto loan delinquencies and more, many people seem to think a downturn is on the horizon. The question is when? Someone is bound to get the timing right.

#BustedTech (Short Busted IPOs…cough…DOMO)

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Tintri Inc., a publicly-traded ($TNTR) Delaware-incorporated and Mountain View California based provider of enterprise cloud and all-flash and hybrid storage systems appears to be on the brink of bankruptcy. There's no way any strategic buyer agrees to buy this thing without a 363 comfort order. 

In an SEC filing filed on Friday, the company noted:

"The company is currently in breach of certain covenants under its credit facilities and likely does not have sufficient liquidity to continue its operations beyond June 30, 2018."

Furthermore, 

"Based on the company’s current cash projections, and regardless of whether its lenders were to choose to accelerate the repayment of the company’s indebtedness under its credit facilities, the company likely does not have sufficient liquidity to continue its operations beyond June 30, 2018. The company continues to evaluate its strategic options, including a sale of the company. Even if the company is able to secure a strategic transaction, there is a significant possibility that the company may file for bankruptcy protection, which could result in a complete loss of shareholders’ investment."

And yesterday the company's CEO resigned from the company. All of this an ignominious end for a company that IPO'd almost exactly a year ago. Check out this chart:

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Nothing like a $7 launch, a slight post-IPO uptick, and then a crash and burn. This should be a warning sign for anyone taking a look at Domo — another company that looks like it is exploring an IPO for liquidity to stay afloat. But we digress. 

The company's capital structure consists of a $15.4mm '19 revolving credit facility with Silicon Valley Bank, a $50mm '19 facility with TriplePoint Capital LLC, and $25mm of 8% convertible notes. Revenues increased YOY from $86mm in fiscal 2016 to $125.1mm in fiscal 2017 to $125.9mm in fiscal 2018. The net loss, however, also moved up and right: from $101mm to $105.8mm to $157.7mm. The company clearly has a liquidity ("net cash") covenant issue (remember those?). Accordingly, the company fired 20% of its global workforce (~90 people) in March (a follow-on to a 10% reduction in Q3 '17). The venture capital firms that funded the company — Lightspeed Venture Partners among them — appear to be long gone. Silver Lake Group LLC and NEA Management Company LLC, unfortunately, are not; they still own a good amount of the company.

"Isn't cloud storage supposed to be all the rage," you ask? Yeah, sure, but these guys seem to generate product revenue largely from sales of all-flash and hybrid storage systems (and stand-alone software licenses). They're mainly in the "intensely competitive IT infrastructure market," sparring with the likes of Dell EMC, IBM and VMware. So, yeah, good luck with that.

Asset Values Soar: Human Asset Values. (Long Inflation)

Asset values have been soaring off into the stratosphere to the point that even Warren Buffett is complaining about a dearth of reasonably-priced opportunities (hence his short dalliance with Uber?). The FED, meanwhile, is keeping tabs on inflation; perhaps the Fed ought to look no farther than the legal world. It is experiencing two forms of inflation this week.

First, Milbank Tweed Hadley & McCloy announced that it was raising first year associate salaries to $190k and generally all associate salaries between $10k-15k. Choice bit from The American Lawyer:

“Two years have now gone by, and there is cost-of-living increases and inflation,” Edelman said. “We want to signal to the market that we do want the best, and we’re willing to pay for the best, and we think after two years, an additional increase is appropriate.”

Inflation indeed. As one biglaw partner told us a year ago, a clear cut sign of a market top is when biglaw firms raise first year associate salaries. Well, then…let the recession commence!

Indeed, nothing says "good timing" (or income inequality) like a pay raise to know-nothing lawyers at a time when Toys R Us’ fees are front page news and mad-as-hell employees are picketing KKR's offices. Sometimes biglaw can be its own worst enemy. More:

Edelman said the change would not have “a material effect on firm finances,” adding that he didn’t expect partner capital contributions to change.

Right. Because with 500 associates, the extra $5 million in expense will surely be passed on to the clients. Get ready for a fee increase folks. That’s something worth singing about in court even.

Anyway, we’re not hating. After all, Milbank needs to incentivize people to go to law school AND choose them over several other biglaw firms. Why would anyone do that if they can make $40k/month as a social media influencer? Why would anyone do that if they can be “Running a $500,000 Retail Empire by iPhone?” Good and serious question. That is the competition these days.

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Second, Weil Gotshal & Manges LLP announced that, in an effort to incentivize lawyers to stay, partnership (and, for some, counsel position) will now be offered to lawyers that have been with the firm for a mere 7.5 years. Per the ABA Journal,

Weil, Gotshal & Manges hopes to improve associate retention by cutting the wait for partnership by two years. 

Except, those "partners" will be non-share partners making “fixed income” rather than receiving partner distributions. And, except, further,

Lawyers in the niche counsel category for specialty practices can remain there as long as they stay at the firm. Lawyers in the other category get, at most, three years in the position. During that time, they may be promoted to partner. Those who don’t make it will be transitioned out of the firm.

Hahaha. C’mon. So you’ll basically have 10.5 years to prove that you merit equity partner before they unceremoniously toss you out into the wilderness…uh, sorry…”transitioned.” You know, rather than 9.5 years. But that new title though!! Title inflation!!

Query: where did Weil get that idea from? (Cough, Kirkland & Ellis). What's that saying: imitation is the sincerest form of flattery? We guess they’re waiting 7.5 years before labeling someone a “partner” rather than 6 years so, uh, there’s that. Just what biglaw needs: more lawyers running around with an inflated sense of self.

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On point.

Don’t. Mess. With. Daisy. Chapter 4. (Petsmart: Long Asset-Stripping Shenanigans)

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Man this dog series (and John Wick referencing) is fun. With regard to Petsmart Inc., we previously we wrote:

The company financed the purchase with a two-part debt offering of (a) $1.35 billion of ‘25 8.875% senior secured notes and (b) $650 million of ‘25 5.875% unsecured notes. Rounding out the capital structure is a $750 million ABL, a $4.3 billion cov-lite first-lien term loan and $1.9 billion cov-lite ‘23 senior unsecured notes. Let us help you out here: 1+2+3+4 = $8.2 billion in debt. The equity sponsors, BC Partners, GIC, Longview Asset Management, Caisse de dépôt et placement du Québec and StepStone Group, helped by writing a $1.35 billion new equity check.

That capital structure refresher is important…

Taking a page out of J.Crew’s asset-stripping, litigation-inducing, bird-flip-to-senior-lenders-activating playbook, Petsmart this week announced that it moved a 16.5% stake in Chewy.com (a/k/a the savior) to an unrestricted subsidiary — unironically using a sponsor dividend mechanic for the transaction; it also dividended 20% of the equity in Chewy.com to its parent company, Argos Holdings, an entity controlled by private equity firm BC Partners. Consequently, Chewy.com is no longer a wholly-owned subsidiary of Petsmart. Moreover, per The Financial Times,

“Chewy will no longer guarantee PetSmart's debt, according to Xtract Research, though the remaining 63.5 per cent of the shares will still be pledged to secure term loans and senior bonds.”

We love financial shenanigans that weaken lender collateral packages to the apparent benefit of junior creditors and private equity sponsors. Particularly when they’re done so quickly after the original transaction!

How did the market react? Well, per Bloomberg, initially:

PetSmart’s bonds rallied as the move of the online vendor’s assets was seen as less aggressive than what bondholders had originally priced in, according to the people, who said the initial buyers of the notes have unloaded the positions. Investors sold PetSmart’s debt last year on fears it would sell or spin off as much as 100 percent of the Chewy equity to the private equity owner, removing it from the pool of assets they have recourse to as bondholders.

Haha, right. So instead of getting potentially 100% effed, bondholders only got 33% effed. Can you say: Credit positive!? This is what makes the distressed world just so unmistakably poetic and nasty at the same time: everything is largely a function of…well…you guessed it: asset price and asset value. With the par guys out and buyers at distressed levels in, “credit positive” is entirely relative.

Anyway, more from Bloomberg,

The company’s management said that said they will continue to actively monitor the capital structure and potentially pursue additional strategic opportunities to extend debt maturities, reduce overall leverage and invest in the business, according to the people. Management didn’t have a question and answer portion at the end of the call.

Of course not. Why would they? The first question would be “By ‘reduce overall leverage’ does that mean issuing new bonds secured by the newly siphoned off equity of (valuable?) IP in exchange for the cov-lite unsecured notes?” Even Eli Manning couldn’t so obviously telegraph his next move (The Financial Times, citing Covenant Review, cites some other options here).

This bit is great:

Petsmart’s transfer of assets to an unrestricted subsidiary was not surprising given what J. Crew was able to do with its transfer of intellectual property under its loan documents, James Wallick of Xtract Research said in an interview. The move is “symptomatic” of the current market for loans and bonds, where agreements “are so flexible that you can do a transaction such as this.”

Hahaha. Man people love to gripe about the capital markets these days. Said another way,

Mmmm hmmm. Yield, baby, yield.

L Brands (Long "Misplaced Optimism in Retail")

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On Valentine’s Day, in “Misplaced Optimism in Retail: L Brands - What the Holy F*#*?,” we clowned on Leslie Wexner’s aggressive approach to retail and said “tell us that you don’t want to short the sh*t out of the stock.” It was trading at $49.87/share. Now...

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Direct-to-Consumer Food (Short the Butcher Section)

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We have spoken a lot about direct-to-consumer digitally native brands having a tremendous — and understated (in restructuring circles) — affect on brick-and-mortar retail. Apparel in particular. PETITION readers are already familiar with Wish, a unicorn shopping platform with a valuation north of $8 billion. It’s secret sauce is allowing consumers to purchase clothes directly from Chinese factories. Imagine all of the middlemen cut out of that equation. No “brand tax” either.

Earlier this week Sequoia Capital China led an investment in Jollychic, a China-based e-commerce startup that lets Middle Eastern shoppers order unbranded products from Chinese factories.

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What to Make of the Credit Cycle. Part 7.

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TCW Group recently released its Loan Review through April ‘18 and it is telling. Per the commentary:

CLOs represent nearly 50% of the buyer base for loans and April was a huge month for CLOs to be priced, reset and refinanced. There were 28 new issues and 32 resets and repricings, which set a monthly record for the market. Many CLOs require being reset on the coupon date, which led to April being an extraordinarily high month of issuance.

As of April, the CLO markets have printed $43 billion year-to-date, a 58% increase YOY. And per LCDNews, the markets have printed an additional $10+ billion in May.

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Where’s the Auto Distress? (Short PETITION’s Prognistications)

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Back in October, we asked “Is Another Wave of Auto-Related Bankruptcy Around the Corner?” The (free) piece is worth revisiting — particularly in light of Tesla’s recent travails. Among many other things, we wrote:

Supply Chain Distress. Last year we saw DACCO Transmission Parts Inc. file for bankruptcy. During the Summer, Takata Inc. filed for bankruptcy (on account of a massive liability, but still) and Jack Cooper Enterprises Inc., a finished-vehicle logistics/transportation provider, reached a consensual agreement with its noteholders that kept the company out of bankruptcy court. For now. Then, a little over a week ago, GST Autoleather Inc. filed for bankruptcy, citing declining auto output. Is this the canary in the coal mine? Hard to say. Literally on the same day that GST filed for bankruptcy - again, citing declining auto output - General Motors, Ford and other OEMs reported the first YOY sales increase (10%), surprising to the upside. It seems, however, that the (sales) uptick may be artificial: in part, it's attributable to (a) Hurricane Harvey damage and mass vehicle replacement; and (b) heavy vehicle discounting. On a less positive note, Ford announced that it will be slashing billions in costs to shore up its financial condition; it also announced back in September that it would slash production at five of its plants. And General Motors Co. announced earlier this week that it would be idling a Detroit factory and cutting production. Production levels, generally, are projected to decline through 2021. Obviously, reduced production levels and idled plants portend poorly for a lot of players in the auto supply chain. 

But, with limited exception (like Nissan’s announcement this week that it would cut U.S. production by 20%), the auto world has been largely quiet since then. Another exception: International Automotive Components Group S.A., a Detroit-based interior parts manufacturer with 77 manufacturing plants worldwide, announced, in April, a new financing transaction through the issuance of $215 million of ‘23 second lien notes funded by Gamut Capital Management LP. Perhaps we just need to be more patient?

Rumblings abound around two more names that may be in more near-term trouble. First, American Tire Distributors’ suffered downgrades on the heels of the announcement that Goodyear Tire & Rubber Co. ($GT) opted to discontinue use of ATD as a distributor. Notably, GT’s stock, itself, is down 20% in the last year:

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Anyway, back to ATD. Per Crain’s Cleveland Business,

The news cratered the market value of ATD's $975 million of bonds and its $700 million term loan. S&P Global Ratings quickly cut the company's credit grade deeper into junk and Moody's followed suit, saying its capital structure was no longer sustainable.

Then, on May 9, the 800-pound gorilla entered the industry, as Amazon.com Inc. teamed up with Sears Holdings Corp. to allow customers to buy replacement tires online and have them installed at the troubled department store.

The moves signal radical changes in the replacement-tire market. Manufacturers are taking control of their own distribution, cutting out wholesalers like ATD, and along with retailers are developing their own internet capabilities to reach consumers directly, according to New York-based research firm CreditSights.

Ah, there it is: Amazon ($AMZN). Is a PETITION entry complete without the mandatory Amazon reference? Indeed, Moody’s noted,

“All else being equal, the magnitude of the associated earnings and cash flow decline will compound an already levered financial risk profile, rendering a pre-emptive debt restructuring increasingly likely, in our estimation.”

The Huntersville North Carolina company is a wholesale distributor of tires, custom wheels and other related auto equipment; it is a behemoth with $5.3 billion in revenues in 2017 and 140 distribution centers located across the U.S. and Canada. It also happens to have $1.8 billion of debt. The company is equally owned by private equity firms Ares Management LP and TPG Capital.

The debt — coupled with the loss of a major customer — is a big concern. More from Crain’s,

But ATD's capital structure is stretched tight, said Lawrence Orlowski, a director in corporate ratings at S&P. While the company has access to $465.4 million in asset-based lending facilities and $22.7 million in cash as of the end of 2017, even that liquidity may not be enough to stay solvent if ATD permanently loses Goodyear's business or if any other major tire makers pressure the company for concessions, according to Orlowski.

Something tells us (restructuring) advisors may be circling around trying to determine whether it can get together a group of the company’s term lenders.

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Second, Tweddle Group Inc., a The Gores Group-owned manufacturer of automotive owners’ manuals (that nobody ever reads) likewise suffered a disastrous blow when Fiat Chrysler Automobiles N.V. announced back in April that it was no longer using Tweddle’s services. Fiat reportedly accounted for 40% of Tweddle’s 2017 revenue and will be hard to replace. Consequently, Moody’s issued downgrades noting,

“The downgrades reflect a credit profile that is expected to be significantly weakened following Tweddle's loss of certain work from a key customer, and the resultant mismatch between the company's earnings and cash flow prospects and its now much more levered balance sheet.”

This reportedly put pressure on the company’s $225mm ‘22 first lien term loan and now the company reportedly has hired Weil Gotshal & Manges LLP for assistance. While it will likely take some time for the loss or revenue to trip any leverage ratios in the company’s credit agreement, this is a name to watch.

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Finally, Bloomberg New Energy Finance recently released its “Electric Vehicle Outlook 2018” report. Therein in noted that there are a variety of factors driving EV sales forward:

  • Lithium-ion battery prices have tumbled, dropping 79% in seven years. Meanwhile, the batteries’ energy density has improved roughly 5-7% per year.

  • Chinese and European policies are pushing fleet electrification.

  • Automakers are aggressively pushing the electrification of their fleets. Choice bit: “The number of EV models available is set to jump from 155 at the end of 2017 to 289 by 2022.”

Bloomberg notes:

Our latest forecast shows sales of electric vehicles (EVs) increasing from a record 1.1 million worldwide in 2017, to 11 million in 2025 and then surging to 30 million in 2030 as they become cheaper to make than internal combustion engine (ICE) cars.

Marinate on that for a second. That is a massive 10x increase in the next 7 years followed by an additional 3x increase in the following 5 years.

Bloomberg continues,

By 2040, 55% of all new car sales and 33% of the global fleet will be electric.

But what about President Trump (#MAGA!) and efforts to limit future alternatives subsidies?

The upfront cost of EVs will become competitive on an unsubsidized basis starting in 2024. By 2029, most segments reach parity as battery prices continue to fall.

So, sure. Distressed activity thus far in 2018 has been light in the automotive space. But dark clouds are forming. Act accordingly.

Is Delivery Killing Fast Casual Too? (Long Busted Narratives)

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Zoe's Kitchen is Latest Restaurant Showing Signs of Trouble

Fast casual is supposed to be a bright spot for restaurants. But as the segment has grown in recent years, there are bound to be winners and losers. Zoe’s Kitchen Inc., a fast casual Mediterranean food chain with 250 locations in 20 states ($ZOES), is increasingly looking like the latter.

Last week the company reported sh*tty earnings. Comp restaurant sales declined by 2.3% despite rising prices pushed on to the consumer. The decline is attributable to the usual array of externalities (e.g., weather) but also location cannibalization. Apparently, the company’s growth strategy is pulling consumers from previously established locations. Moreover, the company noted “inflationary pressures in produce and freight costs, that are expected to impact cost of goods sold for the balance of the year.” Wages also increased 3.3%, an acceleration from the 2.9% realized in Q4 ‘17. Accordingly, adjusted EBITDA decreased 30.9%. The net loss for the quarter was $3.6mm or -$0.19/share. The company lowered guidance. The stock tumbled.

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Before you get too excited, note that this is a debt-light company: it currently has a ‘22 $50mm revolving credit facility with JPMorganChase Bank NA, of which $16.5mm is outstanding (with $3.7mm of cash on hand, net debt is only $12.8mm). It also, believe it or not, has covenants — leverage and interest coverage, among others — and the company is in compliance as of April 16, 2018. It also plans to continue its expansion: in the sixteen weeks ended 4/16/18, the company opened 11 company-owned restaurants with a plan to open approximately 25 (inclusive) over the course of fiscal year ‘18. That said, it does intend to rationalize existing locations (and expects some impairment charges as a result), cut G&A and take other operational performance improvement measures to combat its negative trends. There’s a potential opportunity here for low-to-middle-market FAs and real estate advisors.

For our part, we found this bit intriguing (unedited):

We are definitely seen more competitive intrusion, more square footage growth in some of those smaller kind of mid to kind of large markets where we've been there for some time now that's a little bit of what we're seeing in those markets.

We've also seen more competitive catering competition as every ones ramped up catering. And also the value and discounting as we spoke to in the call, in the prepared remarks we've seen that $10 check with that single user kind of moving around and we think that's so from the new competition square footage growth, the value and discounting and then the delivery interruption, we've seen or felt that in many of our markets.

There’s a lot to unpack there. Clearly competition, as we noted upfront, is increasing in the $10-check size cohort of fast casual. Catering is always a competitive business for restaurants like this too. But, the point that really got out attention was that about delivery. The company says pointedly, “We also believe that disruption from delivery and discounting has created headwinds.” The company further states,

Digital comps were 26% positive in Q1 as we leverage improvements from last year's investments in web and mobile platforms to build greater convenience for our guests. Early in Q2, we relaunched and upgraded our loyalty program, which is expected to help drive traffic by making it easier and clearer for our guest to earn and redeem rewards. Delivery sales grew in both our non-catering and catering businesses by 155%. And we have a clear plan to build out the channel for more profitable growth in 2018.

The impact of mobile food ordering and the need for delivery cannot be overstated. Companies need to act fast to activate delivery capabilities that makes sense to a mobile consumer who, more and more, goes to Postmates, Caviar, UberEats and other food delivery services for discovery. This is precisely why Shake Shack ($SHAK) is now on Postmates and Chipotle Mexican Grill Inc. ($CMG) is now available on Doordash. Others, like privately-owned Panera Bread are taking a step farther by building out its own delivery infrastructure in an attempt to own all its data and deliver without owing a cut to a middleman. Query whether this is far too much dependence on the likelihood of people to go directly to Panera’s app when they’re hungry…?

It sounds like the Zoe folks are increasing their focus on delivery. The question is whether they can execute fast enough to offset in-store dining declines. And whether they can do it on their own.

Dentistry (Long Unnecessarily Techie Toothbrushes)

in ,

Subscription-based razors? Check. Subscription-based contact lenses? Check. Now the direct-to-consumer digitally-native-vertical-brand world is coming for your teeth. Direct to consumer teeth alignment? Check. Subscription-based dental floss? Check. Subscription-based bluetooth compatible toothbrushes. Check. No. This is not a joke.

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