đ©Forever21 is Forever F*cking Upđ©
On one hand, you have to respect the desire to sure up liquidity by entering into partnerships. On the other hand, well this:
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âĄïžWhat to Make of the Credit Cycle. Part 28. (Long Financial Ingenuity.)âĄïž
Nobody questions that weâre late stage at this point. Lest you have any doubt, consider the following:
1. Enhanced CLOs
A growing number of money managers are embracing a new strategy designed to benefit from volatility in junk-rated corporate loans, a sign of building worries about riskier borrowers and the market that supports them.
Since November of last year, three different money managers have issued $1.6 billion of so-called enhanced collateralized loan obligations that are set up to hold a much larger amount of loans with extremely low credit ratings than typical CLOs. At least two more managers are expected to follow suit in the coming months.
The emergence of the enhanced CLOs underscores investorsâ growing belief the U.S. economy is due for a recession after more than a decade of expansion. It also reflects particular concerns about corporate loans, starting with a decline in their average credit ratings. Since 2011, the amount of loans rated B or B-minusâjust above near-rock bottom triple-C ratingsâhave ballooned to 39% of the market from 17%, according to LCD, a unit of S&P Global Market Intelligence.
CLOs are weird beasts with certain idiosyncratic limitations. As just one example, many CLOs are limited to a portfolio that includes no more than 7.5% of CCC-rated loans. Upon a rash of downgrades during a downturn, this would force these CLOs to sell their holdings, pushing supply into the markets and inevitably driving down loan prices. An opportunistic buyer could stand to benefit from this opportunity. These newly established CLOs wonât have these constraints; they could âstock up to half their portfolios with triple-C debt.â
By way of example:
Investors say there is ample evidence that the limited ability of CLOs to hold triple-C loans creates unusual price moves in the $1.2 trillion leveraged loan market.
In one example, the price of a loan issued by the business-services company iQor Holdings Inc. dropped from around 98 cents on the dollar to 85 cents last summer immediately after Moodyâs Investors Service and S&P Global Ratings downgraded the loan to triple-C. Data showed CLO holdings of the loan falling sharply at the time.
Ellington Management Group, Z Capital Group and HPS Investment Partners are the funds looking to take advantage of these market moves.
2. Retail CDOs
Ahhhhhh, Wall Street. JP Morgan Chase & Co. ($JPM) apparently wants to expand markets for credit derivatives, including synthetic CDOs. Per the International Financing Review:
The US bank launched its Credit Nexus platform earlier this year, according to a person familiar with the matter. The platform is designed to simplify the cumbersome process investors usually face to trade derivatives, including credit-default swaps, CDS options and synthetic collateralised debt obligations, according to a client presentation obtained by IFR.
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đ„Higher Interest Rates Eff Mortgage Originator (Long FED Fear of POTUS). New Chapter 11 Filing - Stearns Holdings LLCđ„
Hallelujah! Something is going on out in the world aside from the #retailapocalypse and distressed oil and gas. Here, Blackstone Capital Partners-owned Stearns Holdings LLCand six affiliated debtors (the âdebtorsâ) have filed for bankruptcy in the Southern District of New York because ofâŠdrumroll pleaseâŠrising interest rates. Thatâs right: the FED has claimed a victim. Stephen Moore and Judy Shelton must be smirking their faces off.
The debtors are a private mortgage company in the business of originating residential mortgages; it is the 20th largest mortgage lender in the US, operating in 50 states. The debtors generate revenue by producing mortgages and then selling them to government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. To originate loans, the debtors require a lot of debt; they also require favorable interest rates. Favorable interest rates = lower cost of residential home purchases = increased market demand and sales activity for homes = higher rate or origination.
Except, thereâs been an itsy bitsy teeny weeny problem. Interest rates have been going up. Per the debtors:
The mortgage origination business is significantly impacted by interest rate trends. In mid-2016, the 10-year Treasury was 1.60%. Following the U.S. presidential election, it rose to a range of 2.30% to 2.45% and maintained that range throughout 2017. The 10-year Treasury rate increased to over 3.0% for most of 2018. The rise in rates during this time period reduced the overall size of the mortgage market, increasing competition and significantly reducing market revenues.
Said another way: mortgage rates are pegged off the 10-year treasury rate and rising rates chilled the housing market. With buyers running for the hills, originators canât pump supply. Hence, diminished revenues. And diminished revenues are particularly problematic when you have high-interest debt with an impending maturity.
This is where the business model really comes into play. Hereâs a diagram illustrating how this all works:
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đ„We Have a Feasibility Problem. Part VII (Repeat Bankruptcy = Not Charming)đ„
Last month, Ann M. Miller and Lorie Beers, Managing Directors in Cowen Incâs ($COWN)Special Situations Group published a constructive piece in the TMA Journal asking, âChapter 22: Should Retailers Get a Second Chance at a Fresh Start?â They provide (i) a solid overview of the requirements of section 1129(a)(11) of the Bankruptcy Code governing confirmation of a plan (read: where the âfeasibilityâ requirement comes from),* (ii) an acknowledgement of the chapter 22 problem â particularly in retail,** and (iii) a summary of the Gymboree and Payless chapter 22s (which we wrote about here and here, respectively). They write:
Strict constructionists would argue that the Bankruptcy Code requires an affirmative finding of feasibility and that retail debtors are, for the most part, incapable of meeting that burden unless they have changed their business model to account for the Amazon Effect or addressed other challenges with the business model. They would also argue that the burden of establishing feasibility requires an independent evidentiary showing and that the support of the preponderance of the constituencies is not enough.
This view assumes that a Chapter 22 filing is indicative of failure and somehow blemishes the bankruptcy system as a whole. Strict constructionists also argue that sophisticated creditor constituencies game the bankruptcy system inappropriately by using their leverage in the RSA process to extract concessions.
But is that an appropriate view? Shouldnât those whose recoveries are at stake have the opportunity to roll the dice to see if their plan can work? And why should an extended battle over feasibility, which would add additional costs to the bankruptcy proceeding, be tolerated if no one wants to prosecute such a challenge? (emphasis added)
Regarding the Gymboree and Payless chapter 22s, specifically, they write:
The two cases raise several questions in the area of feasibility. In the case of Gymboree, unless the company addressed the disruption it faced from the Amazon Effect, was any amount of debt reduction capable of producing a feasible plan? Maybe not, but does that mean that the initial Chapter 11 plan confirmation should not have been attempted and the initial case should have moved directly to a sale or liquidation? After all, for nearly two years, many people retained their jobs, landlords had tenants, vendors continued to have a counterparty with whom to have a commercial relationship, and creditors received the value they negotiated for their claims.
In the case of Payless, the problems went beyond disruption. Missteps in the business plan that predicated the first filing continued after emergence, almost promising a subsequent filing. But again, initially at least, jobs were saved, tenancies were preserved, and creditors received what they bargained for. (emphasis added)
These are all valid questions and fair points â especially when you see things like this:
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đŹDecreased Birth Rates, Diminished Sales & Distressed Signs: Destination Maternity Deteriorates (Short Turnaround BoD Types)đŹ
The U.S. birthrate fell again in 2018, to 3,788,235 births â representing a 2% drop from 2017. It's the lowest number of births in 32 years, according to a new federal report. The numbers also sank the U.S. fertility rate to a record low.
Not since 1986 has the U.S. seen so few babies born. And it's an ongoing slump: 2018 was the fourth consecutive year of birth declines, according to the provisional birthrate report from the Centers for Disease Control and Prevention.
Birthrates fell for nearly all racial and age groups, with only slight gains for women in their late 30s and early 40s, the CDC says.
These statistics must really suck for any business that generates revenue off of the maternity cohort.
Enter Destination Maternity Corporation ($DEST), a retailer of maternity apparel with a nationwide chain of specialty stores. As of May 4, 2019, the Moorestown New Jersey company had 998 retail locations, including 452 stores in the US, Canada and Puerto Rico, and an additional 546 leased departments located within department stores (eg., Macyâs, Boscovâs) throughout the US and Canada. It has also been kicking around on distressed retail lists for quite some time now. Unfortunately, the business keeps deteriorating: last week the company joined a recent retail wave and reported some truly dogsh*t numbers.
The company reported Q1 â19 results that included (i) $94.2mm in sales, a $9mm YOY decrease (-8.7%), (ii) a 5.2% comp store sales decline, (iii) an 12.5% e-commerce sales decline, (iv) increased inventory (+$5.7mm), and (v) increased debt levels and interest expense (up ~$300K). Sales declines permeated throughout the enterprise, including leased department store sales. The only uptick in sales was in wholesale, which is primarily done through Amazon Inc. ($AMZN). On the plus side, the company enjoyed increased gross margin and meaningfully decreased SG&A (down 6.5%). Gross margin increased due to a pullback in promotional activity; nevertheless, gross profit declined by 6.9% due to the overall decrease in sales. As for SG&A, the reduction is attributable to employees getting the shaft and the company shedding leases like its 2019. Indeed, the company cut 32 stores and 88 leased department locations in the twelve month period. While the company wouldnât articulate its portfolio strategy going forward, the company did expressly state that it expects additional store closures through the end of 2019.
So, whatâs the debt look like? Well, for starters, this is a public company and so we donât have a private equity sponsor strangling the company with too much debt, dividend recapitalizations, management fees and any of that other fun stuff. So, here, the company doesnât have a patsy to blame for its woeful performance. Only itself and its revolving door of management teams.
The companyâs capital structure looks like this:
$50mm â23 Revolving Credit Facility (of which $26.2mm is funded and $6.297mm is outstanding as letters of credit)(Agent: Wells Fargo Bank NA). The company has $10.1mm of availability pursuant to its borrowing base limitation. In other words, the companyâs lenders are increasingly minimizing their exposure by limiting the companyâs ability to borrow the full extent of the committed facility. Indeed, the facility was, in connection with a 2018 amend and extend exercise, ratcheted down from $70mm. The lenders arenât fooling around here. The weighted interest rate is 4.53%.
$25mm â23 Term Loan Facility (Agent: Pathlight Capital LLC). The interest rate is LIBOR plus 9%.
The company has a couple of other financing agreements totaling approximately $4mm.
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âĄïžUpdate: Trickle-Down Healthcare Distress (Long Electronic Beds, Short Nana). Part I.âĄïž
We scoured far and wide to see whether there might be some businesses that would get hammered by the uptick in healthcare distress weâve all witnessed of late. In early June, we took a bit of a stab in the dark (Membersâ-only access):
There has been notable bankruptcy activity in the healthcare industry this year â from continuing care retirement communities to the acute care space. When end users capitulate and need to streamline operations and cut costs, who gets harmed farther down the chain? Itâs a good question: after all, thereâs always some trickle down effect.
Our internal search for answers to this question recently brought us to Charlotte-based Joerns Healthcare, a âpremier supplier and service provider in post-acute care.â The company sells supportive care beds, transport systems, respiratory care solutions and more.
Among other things, we noted how the Joernsâ term loan maturing May 2020 âwas among one of the worst performing loans in the month of May â quoted in the low 70s, down approximately 15% since April.â We insinuated that a bankruptcy filing may not be too far away.
We didnât expect it to be in court a mere six weeks later.
On Monday, Joerns WoundCo Holdings Inc. and 13 affiliated entities filed a prepackaged bankruptcy in the District of Delaware. Among other reasons provided to explain its capitulation into bankruptcy court is âpost acute sector disruption.â Now thatâs music to our ears.
âĄïžUpdate: FuelCell Energy Inc.âĄïž
In Mayâs âđFuelCell Sucks Wind (Long Distressed Power)đ,â we closed by saying:
ââŠwe suspect weâll be seeing this thing in Delaware sometime soon.â
The day of reckoning appears to have been stalled a bit.
FuelCell Energy Inc. ($FCEL) recently filed its Form 10-Q with the SEC. Across the board, the numbers were dogsh*t. This company is pretty darn good at losing money, apparently. Year-over-year revenues are WAY down and operating losses are mounting. The company retained Huron Consulting Group as CRO, paying them upwards of $1025/hour and an (elective) success fee:
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đRestoration Hardware B.R.I.N.G.S. IT (Long Shade)đ
There was so much that happened last week that we didnât get a chance to report on RHâs stellar earnings report. We often report on sh*tty retail and so weâd be remiss not to highlight it: after all, RH crushed the home furnishing space this past quarter and fiscal year. It had record revenue, solid margins and strong go-forward guidance â despite headwinds such as tariffs (the costs of which the retailer unabashedly states will be passed on to the consumer). There were a number of interesting bits in the companyâs earnings release.
In the midst of delineating successful initiatives, the company highlights:
Moving from a promotional to a membership model, elevating our brand and streamlining our business while developing a more intimate relationship with our customers.
Thatâs right. RH has one of the more shameful membership models out there: become a member and instantly benefit from meaningfully discounted prices. Then, forget that you became a member after your furnishing needs are satiated and continue to pay annual recurring membership fees to the retailer anyway. This annual membership isnât like a media subscription or golf club dues: the chances of you purchasing furniture from RH every year are probably pretty low. As are the chances of you remembering to cancel your membership. Which, clearly, RH is banking on. One retailerâs promotion is another retailerâs flipped-upside-down membership model.
Second:
Opening architecturally inspiring and immersive physical experiences that render our products and services more unique and valuable, while doubling our retail revenues and earnings in every market.
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đ„Mary Meekerâs âState-of-the-Internetâ Slide Presentationđ„
Another year, another banner âState-of-the-Internetâ presentation from Mary Meeker. There are some bits that we thought would be of particular interest to the restructuring community.
For all we hear about Amazon and e-commerce destroying retail, e-commerce growth is slowing. It constitutes 15% of retail versus 14% a year ago.
There is a stark shift in time spent on various forms of media and, by extension, the use of ad budgets. This chart ought to frighten the sh*t out of print and radio content producers. Time spent on print and radio is down BIG. Even more disconcerting for print? All of the other mediums appear to have reached an equilibrium between time spent and ad spend but print, however, still enjoys a disproportionate amount of ad dollars. Said another way, print media outlets may still have some pain heading their way.
Weâve made recent mention of rising customer acquisition costs and how that might derail many retailersâ business plans. To reduce CAC, many streaming services (e.g., Zoom, Spotify) use free tiers at the top of their funnel to get potential customers in the door and familiar with their products and then focus primarily on making those potential customers happy instead of otherwise deploying effort to market wholesale (PETITION Note: similarly, this is what we do). That said, CACs are indeed increasing. Ms. Meeker has a chart for this:
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đ©Coal Country is Busy. NooooâŠnot Mining. Filing. For Bankruptcy (Short #MAGA!)đ©
Pour one out for the fine folks of eastern Kentucky and western Virginia. They canât seem to catch a break.
Earlier this week, Cambrian Holding Company Inc. (and its affiliate debtors) joined a long line of coal producers/processors (e.g., Cloud Peak Energy, Westmoreland Coal, Mission Coal) who have recently filed for bankruptcy. The company employees approximately 660 people, none of whom are members of a labor union (in contrast to bigger, more controversial, coal filings, i.e., Westmoreland) and most of whom must be fretting over their futures. They must really be getting tired of all of the post-election âwinningâ thatâs going on in coal country.
The companyâs problems appear to start in 2015, at the time the company acquired TECO Coal LLC and assumed $40mm of workersâ compensation and black lung liabilities that TECO had previously self-insured. The company sought to leverage its broader scale to increase production but it failed to raise the working capital it needed to live up to its obligations and sustain production at levels necessary to service the companyâs balance sheet. Post-acquisition, the company doubled revenues, but it couldnât sustain that progress and nevertheless recorded net losses from 2015 through 2018. In turn, the company triggered financial covenant and other defaults under its ABL Revolver and Term Loan.
In other words, the company has been in a state of emergency ever since the acquisition. Almost immediately, the company âundertook various efforts to return to a positive cashflow,â which, as you might expect, meant idling or closing certain mining operations, stretching the usable life of equipment, and laying off employees.* Its efforts proved fruitless. Per the company:
Notwithstanding these efforts, the Debtors have been unable to overcome the pressures placed on their profit margins from steadily declining coal prices (along with burdensome regulations and the accompanying decline in demand for coal), all of which have contributed to the Debtorsâ substantial negative cashflow and inability to consummate a value-enhancing transaction.
So, what now? The company, with assistance from Jefferies LLC, will attempt to find a buyer willing to catch a falling knife: the plan is to âcommence an expeditious sale and marketing processâ of the companyâs assets (call us crazy, but shouldnât it be the other way around?). To fund this process, the company has a DIP commitment from affiliates of pre-petition lenders for $15mm.**
*Interestingly, it was in March 2016 when Hilary Clinton infamously stated, âBecause we're going to put a lot of coal miners and coal companies out of business.â At the time, Cambrian was already struggling, laying off people in an attempt to generate positive cashflow. That message really mustâve struck a chord down in coal country. WHOOPS.
**The Term Lenders swiftly objected to the terms of the DIP and the use of cash collateral.
âœïžEven the Permian Isnât Infallible (Long Heaps of Oil & Gas Distress)âœïž
Even at 95 years old, you canât get one past Charlie Munger. #Legend.
The Permian Basin in West Texas is where itâs at in the world of oil and gas exploration and production. Per Wikipedia:
As of 2018, the Permian Basin has produced more than 33 billion barrels of oil, along with 118 trillion cubic feet of natural gas. This production accounts for 20% of US crude oil production and 7% of US dry natural gas production. While the production was thought to have peaked in the early 1970s, new technologies for oil extraction, such as hydraulic fracturing and horizontal drilling have increased production dramatically. Estimates from the Energy Information Administration have predicted that proven reserves in the Permian Basin still hold 5 billion barrels of oil and approximately 19 trillion cubic feet of natural gas.
And it may be even more prolific than originally thought. Norwegian research firm Rystad Energy recently issued a report indicating that Permian projected output was already above 4.5mm barrels a day in May with volumes exceeding 5mm barrels in June. This staggering level of production is pushing total U.S. oil production to approximately 12.5mm barrels per day in May. That means the Permian now accounts for 36% of US crude oil production â a significant increase over 2018. Normalized across 365 days, that would be a 1.64 billion barrel run rate. This is despite (a) rigs coming offline in the Permian and (b) natural gas flaring and venting reaching all-time highs in Q1 â19 due to a lack of pipelines. Come again? Thatâs right. The Permian is producing in quantities larger than pipelines can accommodate. Per Reuters:
Producers burned or vented 661 million cubic feet per day (mmcfd) in the Permian Basin of West Texas and eastern New Mexico, the field that has driven the U.S. to record oil production, according to a new report from Rystad Energy.
The Permianâs first-quarter flaring and venting level more than doubles the production of the U.S. Gulf of Mexicoâs most productive gas facility, Royal Dutch Shellâs Mars-Ursa complex, which produces about 260 to 270 mmcfd of gas.
The Permian isnât alone in this, however. The Bakken shale field in North Dakota is also flaring at a high level. More from Reuters:
Together, the two oil fields on a yearly basis are burning and venting more than the gas demand in countries that include Hungary, Israel, Azerbaijan, Colombia and Romania, according to the report.
All of which brings us to Legacy Reserves Inc. ($LGCY). Despite the midstream challenges, one could be forgiven for thinking that any operators engaged in E&P in the Permian might be insulated from commodity price declines and other macro headwinds. That position, however, would be wrong.
Legacy is a publicly-traded energy company engaged in the acquisition, development, production of oil and nat gas properties; its primary operations are in the Permian Basin (its largest operating region, historically), East Texas, and in the Rocky Mountain and Mid-Continent regions. While some of these basins may produce gobs of oil and gas, acquisition and production is nevertheless a HIGHLY capital intensive endeavor. And, here, like with many other E&P companies that have recently made their way into the bankruptcy bin, âsignificant capitalâ translates to âsignificant debt.â
Per the Company:
Like similar companies in this industry, the Companyâs oil and natural gas operations, including their exploration, drilling, and production operations, are capital-intensive activities that require access to significant amounts of capital. An oil price environment that has not recovered from the downturn seen in mid-2014 and the Companyâs limited access to new capital have adversely affected the Companyâs business. The Company further had liquidity constraints through borrowing base redeterminations under the Prepetition RBL Credit Agreement, as well as an inability to refinance or extend the maturity of the Prepetition RBL Credit Agreement beyond May 31, 2019.
This is the companyâs capital structure:
The company made two acquisitions in mid-2015 costing over $540mm. These acquisitions proved to be ill-timed given the longer-than-expected downturn in oil and gas. Per the Company:
In hindsight, despite the GP Boardâs and managementâs favorable view of the potential future opportunities afforded by these acquisitions and the high-caliber employees hired by the Company in connection therewith, these two acquisitions consumed disproportionately large amounts of the Companyâs liquidity during a difficult industry period.
WHOOPS. Itâs a good thing there were no public investors in this thing who were in it for the high yield and favorable tax treatment.*
Yet, the company was able to avoid a prior bankruptcy when various other E&P companies were falling like flies. Why was that? Insert the âdrillcoâ structure here: the company entered into a development agreement with private equity firm TPG Special Situations Partners to drill, baby, drill (as opposed to acquire). Whatâs a drillco structure? Quite simply, the PE firm provided capital in return for a wellbore interest in the wells that it capitalized. Once TPG clears a specified IRR in relation to any specific well, any remaining proceeds revert to the operator. This structure â along with efforts to delever through out of court exchanges of debt â provided the company with much-needed runway during a rough macro patch.
It didnât last, however. Liquidity continued to be a pervasive problem and it became abundantly clear that the company required a holistic solution to its balance sheet. Thatâs what this filing will achieve: this chapter 11 case is a financial restructuring backed by a Restructuring Support Agreement agreed to by nearly the entirety of the capital structure â down through the unsecured notes. Per the Company:
The Global RSA contemplates $256.3 million in backstopped equity commitments, $500.0 million in committed exit financing from the existing RBL Lenders, the equitization of approximately $815.8 million of prepetition debt, and payment in full of the Debtorsâ general unsecured creditors.
Said another way, the Permian holds far too much promise for parties in interest to walk away from it without maintaining optionality for the future.
*Investors got burned multiple times along the way here. How did management do? Here is one view (view thread: itâs precious):
đŹ
âïžFuture First Day Declaration: Forever21âïž
We figured we'd take the first crack at the First Day Declaration for Forever21 Inc.'s potential bankruptcy* and spare the company some professional fees.
******
"Preliminary Statement in Support of Forever21's Chapter 11 Petition"
As you know, retail sucks. The list of bankrupted retailers is long and âiconicâ and so we got FOMO and decided, what the heck! Everyoneâs failing, so we might as well also!
But first, we did want to make sure that we could explain to our uber-loyal fanbase (who clearly isnât buying enough of our sh*t) that we did everything in our power to stay out of bankruptcy court. And so we did what all retailers today do: we focused on omni-channel; upped our Insta spend; updated the lighting in our stores and refurbished our âlookâ; stretched our vendors; sh*tcanned some employees; negotiated extensively with our landlords; closed a few underperforming locations; negotiated with our lenders, and more! According to Bloomberg, weâve hired Latham & Watkins LLP to deal with this hot mess, including our $500mm asset-backed loan. Weâve been busy bees!!
We had one Hail Mary trick up our sleeves that we thought would really save the business: partnerships. With first class brands. Like Cheetos. Thatâs right Cheetos!! GET PUMPED!!! Everything is so đ„đ„đ„.
This sh*t got ~45k likes (âworst things since the Kardashians!â haha). Which pales compared to this doozy, which got ~47k likes:
âThis is the most ridiculous clothing line Iâve ever seen.â
Nothing drives sales sales sales like thoughts of âball cheeseâ (PETITION Note: sorryâŠwe had to). #Fail.
But, wait! Thereâs more. We brought back Baby Phat too!!
May G-d have mercy on all of us.
*Sources tell us that the company may not be as close to a bankruptcy filing as some previous media reporting implied. Nevertheless, the name has been kicking around for some time now within the lender community and it does appear that the company is focused on some operational fixes. This âmockâ first day declaration should not be construed as indicating that a bankruptcy is, in fact, imminent.
Retail: DTC Disrupting DTC (Short the Notion of Long-Lasting Iconic Brands)
First, as we've harped on time and time again, enough with the "iconic" nonsense. Charlotte Russe is NOT an iconic brand. Read "Shoe Dog" by Phil Knight and then you'll get a sense of a truly iconic brand.
But speaking of brands, here is a feature by Noah Brier and Colin Nagy about Tracksmith, an upstart fitness apparel brand geared towards serious-but-still-amateur runners. They take the general view that other players in the space have watered down running apparel with the hope of appealing more broadly to the masses; these folks are more old school, a bit snobby about running, and unapologetic about it.
We found this bit particularly interesting (check links â 100% spot on):
With the gold rush of direct-to-consumer brands, you get the sense that everyone is trying to quickly slap something together using the same agencies, the same colors, and the same paid Instagram strategy. But building strong core muscles and doing something that can stand for a long period of time requires taking some deliberately contrarian positions.
It's true. The ease with which one can start a business today with virtually no infrastructure (PETITION Note: yes, we get that this comment is mildly meta), has created a deluge of purported âbrandsâ all seeking to leech hard-earned dollars out of your pockets as you have a fleeting moment of insecurity-inducing scroll-based FOMO upon the umpteenth picture of your ex-boyfriend with his goddess new girlfriend tanning on a yacht off the coast of Costa Rica clanking bottles with f*cking Jennifer Lawrence as you dive into the misplaced hope that retail therapy will help you feel better(!) about how you're "living the dream" -- but, like, not, really -- because your existence is literally accounted for in six minute increments while you're red-lining changes to the memo that you submitted when it was due two weeks ago and the partner only just now got around to reviewing it despite it being oh-such-an-emergency when it forced you to miss your bestie's birthday party, all the while wondering âwhatâs the f*cking pointâ considering you have no clue how youâre possibly going to compete to make partner against that trust-fund broheim who rowed crew at Princeton, with whom the Department Head (who is on his fifth wife) isnât #MeToo-afraid to go out to drinks and dinner with, who neednât worry, five years from now, about going through IVF while also working bone-crushing hours or, if successful, ducking off into a dark dank closet to pump while on a conference call leaning up against a bucket and mop set with a stronger personality than the junior partner who is still single, still living in his one bedroom West Village apartment he had in law school, and has an empathy quotient on par with a bowling ball, all while it's 75 degrees outside, there's not a cloud in the sky, and there are people far worse-paid-but-far-happier enjoying their life out in Madison Square Park. Damn Instagram feeds with those damn shiny photos of DTC brands. There goes $4,279. đđđđđđ
But we digress.
Back to DTC...
The first wave of DTC were disruptive and interesting. The Caspers and Warbys of the world. The second wave were perhaps a bit more opportunistic, chasing the gold rush of capital and seemingly less interested in the intangible magic that makes a long-standing and iconic brand. (See: the inherent contradiction with things like Brandless.) But perhaps a third wave of these types of brands can balance a heartbeat with the spirit that goes into a category disruptor.
And as more and more of these zombie, grown-in-a-lab DTC brands pile up (and subsequently drive up the CPMs of social advertising even more), those companies that actually have a vision will be the ones around to be handed down.
We have no crystal ball and cannot predict what will be handed down but the "drive up the CPMs of social advertising even more" bit is on point and potentially devastating to all of those retailers out there whose stated strategy is to deploy more resources to social marketing. The cover charge for that is getting far more onerous as Facebook Inc. ($FB) limits supply amidst fervent demand. Indeed, the over-saturation of social is leading to a dramatic shift in customer-acquistion-strategies, with DTCs spentding $3.8b on TV ads last year â an increase of 60% over 2017. It's gotten so hard to stick outâŠâŠ..
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đAuto is Effed (Short the Supply Chain)đ
AlixPartners LLP cautions, âAuto Suppliers Have a Critical Window to Take Action Before the Slowdown.â The preface:
It may be spring in North America, but for the automotive industry, winter is coming. The industry is on the cusp of a potential cyclical slowdown, which is compounded by changes in technology and evolving consumer preferences. For automotive playersâparticularly suppliersâitâs critical to start examining worst-case scenarios in their planning and taking decisive action today to ensure that they can ride out the storm.
Storm? What makes Alix think one is imminent? For starters, weâre due. Weâre due for a recession and when it comes, itâll hit the cyclical auto industry hard. Second, technology. Youâre either dumb or living in a cave if you havenât noticed that every OEM is focused on what Alix dubs the âC.A.S.E.â ecosystem â connected, autonomous, shared mobility and electric cars. IHS Markit recently projected that fully electric vehicles will account for 7.6% of US vehicle sales in 2026. Per Axios:
"By 2023, IHS Markit forecasts 43 brands will offer at least one EV option â this will include nearly all existing brands as well as new brands entering the market â compared to 14 brands offering EVs in 2018.â
As weâve discussed previously, that will have a devastating effect on the supply chain as parts critical to the combustion engine are no longer necessary. EVs require a fraction of the parts that combustion engine-based vehicles do. And, then, finally, Alix predicts this:
Overall, leverage among suppliers is still low compared to the financial crisis, but 2018 saw an increase, with a few large suppliers piling debt on top of weaker EBITDA. Several have already seen credit downgrades, earnings misses, or revisions to their earnings projections for 2019. The coming volume declines may leave some vulnerable suppliers unable to cover their debtâleading either to balance-sheet restructurings or more chapter 11 filings. Strong demand covers up a lot of issues, but in the current market, even a small drop in demand will have a dramatic impact on a capital intensive sector like automotive.
Coming volume declines? What is Alix referring to?
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President Trump Kills More Guns (Long Unintended Consequences).
Callback to four previous PETITION pieces:
The first one â which was a tongue-in-cheek mock First Day Declaration we wrote in advance of Remington Outdoor Companyâs chapter 11 bankruptcy â is, if we do say so ourselves, AN ABSOLUTE MUST READ. The same basic narrative could apply to the recent chapter 11 bankruptcy filing of Sportco Holdings Inc., a marketer and distributor of products and accessories for hunting, which filed for bankruptcy on Monday, June 10, 2019. Sportcoâs customer base consists of 20k independent retailers covering all 50 states. But back to the âMUST READ.â There are some choice bits there:
Murica!! F*#& Yeah!!
Remington (f/k/a Freedom Group) is "Freedom Built, American Made." Because nothing says freedom like blowing sh*t up. Cue Lynyrd Skynyrd's "Free Bird." Hell, we may even sing it in court now that Toys R Ushas made that a thing.
Our company traces its current travails to 2007 when Cerberus Capital Management LP bought Remington for $370mm (cash + assumption of debt) and immediately "loaded" the North Carolina-based company with even more debt. As of today, the company has $950mm of said debt on its balance sheet, including a $150mm asset-backed loan due June '19, a $550mm term loan B due April '19, and 7.875% $250mm 3rd lien notes due '20. Suffice it to say, the capital structure is pretty "jammed." Nothing says America like guns...and leverage.
Indeed, this is true of Sportco too. Sportco âsportsâ $23mm in prepetition ABL obligations and $249.8mm in the form of a term loan. Not too shabby on the debt side, you gun nuts!
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đ·Scumbaggery, Litigation and Decreased Liquidity Force Opioid Manufacturer into Bankruptcy (Long Soap on a Rope)đ·
Within a week of entering into a massive settlement with the United States Department of Justice, Insys Therapeutics Inc. ($INSY) and six affiliates filed for bankruptcy in the District of Delaware.* The company is a specialty pharmaceutical company that commercializes drugs and drug delivery systems for targeted therapies (read: it manufactures opioids); it has two marked products. These products, if prescribed and used in the right way, arenât in and of themselves evil (though former management is another story). In fact, one drug, Subsys, is used for cancer patients and is delivered in the (non-invasive) form of an under-the-tongue spray. The companyâs other main drug, Syndros, is used to treat loss of appetite and anorexia associated with weight loss in people with AIDS as well as nausea and vomiting caused by anti-cancer medicine. Not one to miss out on all the latest fads, the company also apparently has cannabinoid-based formulations in its pipeline. Because, like, to the extent the company wants to pursue a sale, nothing will get investor juices flowing like cannabinoid! Will its marketing get done via Snapchat and its sales conducted via the blockchain? Maybe it ought to package its formulations with non-meat meat. Lit!!
All in, the company owns 94 worldwide patents and 62 patent applications with expiration dates ranging between 2022 and 2039. In other words, it does have some potentially valuable intellectual property.
The companyâs synopsis of why it is now in bankruptcy court reflects the world of opioid producers today:
âŠthe Debtors are facing extensive litigation relating to their SUBSYSÂź product (âSubsysâ), which is a prescription opioid. As of the Petition Date, one or more of the Debtors have been named in approximately one thousand lawsuits, and the Debtors anticipate that additional lawsuits may be commenced in the future. Some of the litigation they are facing is common to all opioid manufacturers, while other claims are based on particular alleged activities of the Debtorsâ former executives, many of whom either pleaded guilty to or were convicted after trial of federal criminal activity relating to such activities. The expenses and settlement costs resulting from such litigation have been substantial, consuming large portions of the Debtorsâ revenue and liquidity.
At the same time, over the last few years, the Debtorsâ revenues from Subsys have been declining rapidly as a result of the increased national scrutiny of prescription of opioids by healthcare professionals, the resulting high-profile political and legal actions taken against manufacturers and distributors of opioids, and the specific news relating to the former executivesâ criminal activity. Moreover, although the Debtors have promising products in the pipeline, those products are not yet approved for production, require significant additional investment to bring to market, and are not expected to generate revenue in the near term. As a smaller company than some other opioid manufacturers, with over 90% of its current revenue coming from the sale of opioids, Insys could not withstand the concurrent negative impact of massive litigation costs and significant opioid revenue deterioration. These factors have caused a substantial cash drain on the company to the point where, despite the Debtorsâ best efforts, they risk running out of cash in 2019. (emphasis added)
We quoted that bit at length because it captures the risk that a lot opioid manufacturers face today given what appears to be pervasive sales and prescription practices across the country, subsuming countless companies all seeking sales and profits oftenâŠ.
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đ„ The Evolution of Media: The Force is Strong with Podcasting (Long Monetization)đ„
Weâve been focused lately on content. In âDisruption, Illustrated. Fuse LLC Files for Bankruptcy. (Long Netflix),â we discussed the bankruptcy of Fuse Media LLC, a TV and radio content provider that got disintermediated, in part, by the evolving nature of content distribution and consumption. In âđșTV Content Distribution is in a State of Fluxđș,â we discussed how AT&T, from its vantage point as a distributor, was looking to combat the current trend of increased content costs despite lower content viewership. No doubt, content creation, consumption and distribution are evolving in real-time and there will be real winners and losers.
With respect to content consumption, Netflix Inc. ($NFLX) CEO Reed Hastings once notoriously said back in 2017:
âSometimes employees at Netflix think, âOh my god, weâre competing with FX, HBO, or Amazon,â said Hastings, âbut think about if you didnât watch Netflix last night: What did you do? Thereâs such a broad range of things that you did to relax and unwind, hang out, and connectâand we compete with all of that.â
More specifically, explains Hastings, there are only a certain amount of hours which humans can tend to activities, and Netflixâs goal is to occupy those momentsâand deliver the utmost joy to the consumer during that opportunity.
âYou get a show or a movie youâre really dying to watch, and you end up staying up late at night, so we actually compete with sleep,â he said of his No. 1 competitor. Not that he puts too much stock in his rival: âAnd weâre winning!â
Sleep, huh? Uh huh, sure. That makes total sense.
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đŹWhat to Make of the Credit Cycle. Part 27. (Short Private-now-Public BDCs).đŹ
Oh boy.
The S&P 500 has been on a wild ride. One month ago it was almost exactly where it is today. If you were too busy prepping oil and gas-related chapter 11 papers or chasing Forever21, you might not have noticed the nausea-inducing dip the S&P took to 2,744 as recently as June 3. Yet, the S&P rose 4.41% this week alone to wipe that dip away.
On the other hand, thereâs the 10-Year Treasury:
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Retail Roundup (Long Tourniquets, Long Headwinds).
The retail bloodbath continues.
Earlier this week, Abercrombie & Fitch Co. ($ANF) joined Ralph Lauren Corp. ($RL), Gap Inc. ($GPS), and Calvin Klein ($PVH) by ditching âflagshipâ stores situated in expensive parts of town. The stock got crushed on earnings. But the âPeace Out Flagship Square Footageâ club didnât stop growing there. To the contrary, it is expanding. Rapidly.
On Wednesday, J. Crew announced that it plans to shutter 20 flagship and outlet stores. âWhy might it be trying to shrink its footprint,â you ask? Good question. And the comps give you all the answers you need. While total revenue rose 7% across the enterprise, J.Crew sales fell 4% with comps down 1%. In contrast, Madewell sales rose 15% and comps rose 10%.
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đ°The United States Trustee (Long Perverse Incentives).đ°
The Wall Street Journal reports that the UST fund is approximately 75% short of its funding goal for the year.* Currently, the fund gets fed by quarterly fees paid by bankrupt companies with over $1mm in operating expenses. As with all things bankruptcy, the new federal law mandating the fee increase has a number of holes in it. Consequently, various cases implicating the law are winding their way through the courts.
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