🍎Apple is Really Sticking it to Facebook, Snap, and More🍎

Who would’ve guessed that a company as large and pervasive as Apple Inc. ($AAPL) could affect so many other companies whenever it takes action. 🤷‍♀️

We’ve talked about Apple’s new iOS feature called “App Tracking Transparency” in the past (here, here and here), highlighting how it was going to complicate things for Facebook Inc. ($FB) and, in turn, all of the small and medium-size businesses that rely on the social media platform for customer acquisition.

And indeed it has complicated things.

Recently a SF-based company called Moloco Inc. — an adtech company that strives to empower mobile businesses to thrive by turning data into ad performance — released a report that…

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🔥Johnson & Johnson Doesn’t Get a Southern Welcome in Bankruptcy Court🔥

Last week we listed “Talc Claimants” in our “Losers” section since Johnson & Johnson Inc. ($JNJ) had gone ahead with its cynical maneuver to dump its talc liabilities in bankruptcy court while leaving the rest of the enterprise a presumed beneficiary of the automatic stay. Supporting the view that the automatic stay would apply not just to the bankrupt entity, LTL Management, but also to non-debtor JNJ, generally, is the choice of forum, a bankruptcy court in North Carolina, which falls under the Fourth Circuit. We’ll spare you a lot of boring legal jabber, but there’s precedent in the Fourth Circuit for…

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💥They're Real and They're SPACtacular. Part II.💥

According to SPAC Research, there were 248 SPAC IPOs in 2020 totaling $83.4b in proceeds. While it may seem that SPACs aren’t as much of a thing in 2021 – President Trump’s new media company notwithstanding – SPAC issuance is hotter than ever (even if PIPE financing may not be). 489 SPACs have IPO’d already in 2021, raising $136.7b.

Not to state the obvious here, but there are an army of vehicles out there with a boat load of money chasing deals. 608 vehicles to be exact. 608 SPACs are “active,” meaning they’re either pre-deal or “live deal,” which means the de-SPAC merger hasn’t happened yet. 🤯

A. How Are “Distressed SPACs” Doing?

While it may seem like 607 of those 608 SPACs are what we’ve dubbed “distressed SPACs” — i.e., SPACs that purport to be focused on identifying and completing a business combination with companies emerging from a reorganization or distressed situation — they’re not quite THAT ubiquitous.

Which is not to say that this isn’t a busy time for those vehicles. This week the BowX Acquisition transaction with WeWork Inc. ($WE) reached its logical conclusion with WE finally hitting the public markets. Even though it’s not a tech company that just merged with a SPAC targeting a tech company, investors seemed to overcome the cognitive dissonance:

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⚡️Update 3: The China Evergrande Group⚡️

The China Evergrande Group drama has been solid fodder for capital markets over the past several weeks. You can see our previous coverage here:

• 💥What the Bloody Hell is Happening with Evergrande?💥

• 🔥Evergrande Ghosts its Foreign Bondholders LOL🔥 (Paywall)

• ⚡️Update: China Evergrande Group⚡️

• ⚡️Update 2: China Evergrande Group⚡️ (Paywall)

• 💥Evergrande Skips Another Payment, Stokes Contagion Fears

Its moves this week are somewhat emblematic of the restructuring world these days: a seemingly hopelessly distressed player that was garnering a lot of distressed investor and bankruptcy professional interest conjured up money out of nowhere to avoid its imminent day of reckoning. Indeed, a month ago, The Evergrande Group failed to pay multiple interest payments across multiple issuances, triggering the 30-day clock towards potential default scenarios. To compound matters, the company (and the Chinese government) went quiet for a very long time, providing no guidance whatsoever as to whether or how it would deal with millions upon millions of payments. Well, this week, the group avoided an immediate default by

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🔥It's Interest Payment Day for Evergrande LOL🔥

Despite Mr. Kopits’ concern, the market seems to have moved on from the short-lived shock that was China Evergrande Group to even more depressing (domestic) crises such as the debt limit, infrastructure, and inflation. Despite ghosting its foreign bondholders and triggering a 30-day grace period, the company is acting as if its business as usual. Should a bit of a financial crisis thwart plans to build one of the world’s largest soccer stadiums, for instance?

 Of course not.

Make no mistake: this sh*t is still ugly. Note some of the stories out on the subject this week:

• There are signs of intra-Chinese contagion. Another major Chinese developer, Sunac China Holdings, saw its capital structure get napalmed this week. Per the WSJ, “Its U.S.-dollar-denominated bonds also retreated, with 7% bonds due in July 2025 quoted at about 81 cents on the dollar by late afternoon Monday in Hong Kong, according to Tradeweb. This debt was quoted above 98 cents on the dollar at the start of the month, and as recently as July Sunac was able to raise $500 million of new debt funding from bond investors.” 😬

• Back here at home, the Federal Reserve is, to be safe, questioning big US banks about their exposure to Evergrande. Similarly, the Office of the Comptroller of the Currency and the Securities and Exchange Commission have reportedly been probing banks to determine whether there is any and to what degree there is any risk.

• We recall seeing a funny skit years and years back about the construction workers toiling away while building the second Death Star and how crappy it must have been for them to be collateral damage in the Rebellion’s war against the Empire. There’s a similar dynamic here at play in Evergrande — though hardly anyone is laughing. While the Chinese government purportedly attempts to shift projects away from one developer to another so as to salvage the entire property market and rescue depositors from a catastrophic loss, it's unclear what will happen to the unpaid bills of those working those jobs. Here is a Reuters article about the owner of a cleaning business owned $3.1mm by Evergrande. His company employs 100 people and uses 700-800 contractors to clean apartments before they hit the market. To pay off his own debts and wages, the poor guy had to sell off his Porsche Cayenne and put his apartment on the market. We imagine stories like these are pervasive across China.

• This sh*t about shadow banking “trusts” is bananas. Much like in the US, financing is potentially available from shadow banking trusts when regular-way banks aren’t an option. The trust industry in China is $3t large. Apparently tens of thousands of Chinese households provided financing to Evergrande by way of these trusts and — ⚡️surprise!⚡️— Evergrande hasn’t made payments on the funds provided by these trusts. This is the company’s single biggest source of debt, people. This is insane. Apparently now the trusts themselves are going out of pocket to finance investor payments. How long will they be able to do so? The numbers are staggering. Per Bloomberg, “The clock is ticking for Evergrande to make these investors whole. The cash-strapped firm faces repayments in the fourth quarter on $1.8 billion of high-yield products sold through trusts to wealthy clients and institutions. Another $4 billion is due next year, according to data provider Use Trust.” YIKES. This is not good: “Evergrande’s dependence on trusts and other asset management products began growing after banks were directed to cut back on their lending to the property sector. By the end of 2019, Evergrande had done business with most of the 68 trust companies in China, which accounted for 41% of its total financing, based on the last borrowing disclosure.” But the trusts were completely devoid of risk protocols; they began reducing their exposure in the first half of ‘21, decreasing loans by 17%. Remember those stories about Evergrande’s wealth management products? Well once the shadow banking trusts decided that Evergrande was a deadbeat and reduced funding, Evergrande just went out with their own products to their employees, acting like predatory d*ckwads with no regard for the fact that they might be ruining the life savings of many an unsuspecting loyal employee. This story just gets worse and worse as more details come out.

• China Evergrande New Energy Vehicle Group issued the equivalent of a going concern warning. HAHAHAHAHA. NO FRIKKEN SH*T. Just so you understand the magnitude of this absolute dumpster fire of a sh*tshow, a mere five months ago this thing had a market cap of $84b which makes it valued more than Ford Motor Co. ($F) — despite never producing a working frikken automobile!! You can’t make this stuff up.

• Evergrande has another interest payment due today on its 9.5% ‘24 dollar-denominated bond. Oh. My. Whatever may happen with that? 🤔 😂

In closing, here is an intentionally provocative piece by Niall Ferguson which, in a nutshell, says that China is f*cked and therefore overrated. If so, it’s hard, given the interconnected nature of the global economy, to imagine a scenario where this all goes south in China and remains contained.

But employing logic hasn’t been the most fruitful way to make money for years. So 🤷‍♀️.

💥What the Bloody Hell is Happening with Evergrande?💥

To read our coverage of The Evergrande Group, please check us out here.

☠️Judge Isgur Doesn't Dig the DeathTrap☠️

Texas Judge Signals a Potentially Worse Outcome for $WPG Common

Maybe, just not the way this ⬆️ schmo means….

For those of you who are new to us, Washington Prime Group Inc. ($WPG) is an owner, developer and manager of retail real estate, including enclosed and open air malls. Set up as a real estate investment trust (“REIT”), the company’s portfolio includes 102 shopping centers across the US, totaling 52mm square feet. You can find a whole bunch of previous coverage on it here…

• 😬Is More Mall Pain Ahead? Continued.😬

• ⚡️Update: Washington Prime Group ($WPG)⚡️

• 😬Is More Mall Pain Ahead?😬

• 🤪Malls, Malls, Malls (Long Eccentric High-AF CEOs)🤪

• New Chapter 11 Bankruptcy Filing - Washington Prime Group Inc. ($WPG)

• ⚡️Update: Washington Prime Group ($WPG)⚡️

…but the general upshot is that even pre-COVID-19, this sucker was struggling. Ultimately the pandemic was the icing on the cake and, well, here we are talking about a chapter 11 bankruptcy case.

The bankruptcy case is predicated upon an equitization transaction pursuant to which the WPG debtors will equitize a slug of unsecured notes and hand the holders of that debt the keys to the kingdom in the form of equity in the post-bankruptcy reorganized WPG entity to its pre-petition lender and plan sponsor, SVP Global. That said, the WPG debtors leave the door slightly ajar for a buyer to come in a la Hertz and make a play for the company. As of now, there hasn’t been a whole lot of noise about someone actually coming in and doing so. And so the WPG debtors are moving forward in an effort to expeditiously exit chapter 11 and focus on the future. Of course, to exit chapter 11, the WPG debtors will need to send out a disclosure statement and solicit votes on their proposed plan of reorganization and, thereafter, get bankruptcy court approval of the process and result.

On Monday, July 12, 2021, the Washington Prime Group Inc. ($WPG) debtors held a status conference and conditional disclosure statement approval hearing before Judge Isgur in the Southern District of Texas and it’s probably fair to say that it didn’t go the way the debtors had anticipated. We’re not sure they were expecting to hear phrases like “non-confirmable plan,” “unduly coerced,” and “really hard call coming up.” Yet they did.

Source: GIPHY

Without getting too into the weeds of the bankruptcy code, suffice it to say that most observers of bankruptcy situations are familiar with the “absolute priority rule” which spells out whether and how creditors are entitled to recoveries from a debtor’s estate. It is this provision in the bankruptcy code — 🙄 fine, we’ll cite it … section 1129(b)(2)🙄 — that requires that claims of a senior class of creditors be paid in full before any junior class of creditors may receive or retain any property in satisfaction of its claims. More plainly, secured creditors must get paid in full before unsecured creditors get paid a dime and so forth and so on down the capital structure such that unsecured creditors ought to get paid in full before stockholders get a penny. Similarly, preferred stockholders are senior in line to common stockholders.

And that’s where the rubber meets the road because usually — and we emphasize usually — stockholders don’t get f*ck all in bankruptcy. Recently, however, they have. And now “The Hertz Effect” looms large over other pandemic-era bankruptcies because, as the WPG debtors acknowledged out of the gate, it is awfully hard to value some of these businesses in light of potentially long-lasting pandemic-induced effects. The over-arching question here is: does WPG have equity value? And, if not, should equity be getting any sort of recovery whatsoever?

On the first question, the WPG debtors are clearly proceeding as if they don’t think so. The WPG debtors gave absolute no indication that any White Knight was close to galloping into bankruptcy court with a higher or better offer that takes out SVP Global and allows for value to flow through the capital structure.

Recognizing all of these factors and in a commendable attempt to avoid a big fight down the road, the WPG debtors here conjured up a scheme whereby both preferred and common shareholders are eligible for a recovery anyway — a “gift” of sorts, from the senior impaired consenting class. That eligibility, however, is contingent upon a multi-level “death trap” provision — a blatant quid pro quo where the prefs and common will only get something if they go along with SVP Global, the debtors, and the proposed equitization transaction by voting “yes” on the plan of reorganization.

Source: Primo GIF

A preferred shareholder took issue with this coercive tactic this week and found a sympathetic ear in Judge Isgur. Here are the scenarios at issue:

• The preferred shareholders vote no on the plan. In this case, both the preferred shareholder class (Class 10) and the common shareholder class (Class 11) get bupkis. It doesn’t matter what the common do in that scenario.

• If, however, the preferred shareholders vote yes on the plan and the common vote note no, the preferred will get either $40mm in cash or approximately 6% equity (subject to other caveats and dilution mechanisms).

• If the preferred shareholders vote yes on the plan AND the common vote yes, the two classes will split the proposed “gift” recovery and each get $20mm in cash or approximately 3% equity.

It’s that last bit that concerned Judge Isgur. Notwithstanding the WPG debtors’ argument that anything either of these classes get is a “gift” in the equitization scenario, he suggested that the bankruptcy code may nevertheless preclude the last option because it fails to take into account the preferred shareholders’ liquidation preference over and above common equity. As he put it: the prefs either vote no and get nothing (lose) or vote yes and forfeit their liquidation preference and provide common with some sort of return (lose again). He indicated difficulty squaring that with Bankruptcy Code section 1129(b)(2)(C)(i) which, he argued, protects the liquidation preference before common is entitled to anything. The question then becomes: does that apply to a gift? This is where that “really hard call” statement comes in.

All of which begs the question: what does this mean for WPG common stockholders? Well, it ain’t good. Any WPG common shareholder who was of the view that there was a strong chance that they’d see some recovery may want to pay closer attention. It was clear that, as we initially took “pen to paper” here after market close on July 12, this already-ugly-AF chart may get a bit uglier if this issue doesn’t get sorted out (PETITION Note: even without this latest controversy, the stock appeared to be priced generously for some inexplicable reason. Markets be like 🤷‍♀️.).

Not that the memers comprehended that:

$WPG: Sounds like Judge Isgur will have an Official Equity Committee appointed to battle "unduly coercive equity deathtraps" in ongoing Ch 11 case 🚀🚀🚀💥💥💥🔥🔥🔥 #Hertz'd https://t.co/6e6MaD7rBH

— rowerburn (@rowerburn) July 13, 2021

On July 13, the market got a bit wiser and the stock fell ~9%:

Interestingly, Judge Isgur — typically a champion for the little guy — insisted that the debtors file a revised disclosure statement that expressly acknowledges the possibility of a judicial finding that the proposed death trap violates the bankruptcy code. With that new language, he conditionally approved the disclosure statement. Ironically, his issue here, though, has the affect of screwing over the little guy, i.e., the common shareholders, and potentially precluding them from obtaining any recovery in the case. So, there’s that.

And so now we’re headed for a fairly vicious game of chicken going into a confirmation hearing. First, it goes without saying that the case is potentially setting up for a pretty rigorous valuation fight — especially if shareholders get organized (PETITION Note: the Office of the United States Trustee is currently soliciting interest in a committee and it sounds like there’s interest). Beyond that, the Judge showed an activist bent here, sparked in part by a preferred shareholder complaining about recovery going to common. Of course, there’s a beggars can’t be choosers element to this in that the WPG debtors could just decide that, given a valuation fight is on tap anyway, it may just make sense to pull a Lucy and rip that death trap option and any recovery right out from under all shareholders. After all, if there’s gonna be war anyway, why bother with dubious gestures for peace?

💥It's Over: Hertz is Already Deal of the Year💥

⚡️Update: Hertz Global Holdings Inc., LOL.⚡️

It all comes back to Hertz Global Holdings Inc. ($HTZGQ), the unofficial poster child for COVID-19 era markets.

Let’s recap the bona fides:

The company filed for bankruptcy in May 2020 after the pandemic sparked governments around the world to shut down air travel. No business trips and vacations quickly destroyed the rental car market as revenue fell off a cliff. The precipitous decline in sales triggered a margin call on debt backing the Hertz Debtors’ car fleet — a margin call that they could not satisfy. In other words, the chapter 11 bankruptcy filing was in no way tied to near-term structural business reasons that merely got uber-accelerated (word choice purposeful) by the pandemic (like many other bankruptcy filings at the time); it was as pure a COVID-19 filing as they came at the time.

The entire capital structure capitulated but a month later the stock mysteriously rose to over $6/share. The markets were incredulous and lots of really smart people using decades of historical precedent cast shade on Robinhood bros and memers for being dumb enough to buy shares in a bankrupt company with loans trading at levels (30 cents) that reflected significant impairment higher up in the capital structure. In other words, Hertz became sort of like an analog meme stock before more-digitally oriented meme stocks (e.g., GameStop Inc.) became a thing.

Needing additional funding, the Hertz Debtors sought to capitalize on the good fortune conferred upon them by WallStreetBets and partake in an at-the-market equity offering, a strategy viewed by most as a cynical maneuver to take advantage of willing fools. This sent the Twittersphere into a tizzy but ultimately (and predictably) got approved by the Delaware Bankruptcy Court. Shortly thereafter, however, the SEC put the kibosh on this plan which probably had something to do with the Hertz Debtors acknowledging that they were knowingly and intentionally feeding pigs what they reasonably thought to be sh*t. The Hertz Debtors did squeak out a small allocation of shares, though (at just over $2/share).

Hertz then flooded the market with used cars as it sought to raise cash in a depressed travel environment; from June 1, 2020 through December 31, 2020, Hertz disposed of more than 199,000 vehicles.

During that time, there was a torrent of car purchases as people were wary of air travel. Meanwhile, auto OEMs had to curtail production — first because of COVID-19 and then due to semiconductor shortages (PETITION Note: production cuts of new cars now total a reported 1.2mm vehicles). Large customers like Hertz also ceased volume orders. Used car prices quickly recovered. As just one way of illustrating the “torrent” point, take a look at Carvana Co’s ($CVNA) revenue:

Fast forward to a miraculous economic recovery (Jay POW-ell!) and as borne out by Avis Budget Group Inc. ($CAR), car rentals came back. Consequently, the Hertz Debtors decided to put the pedal to the metal and get the hell out of bankruptcy. Who knew whether this would all last? Better to take advantage of this momentum now, the thinking went.

You know about the back-and-forth by this point. First there were one group of plan sponsors (Knighthead Capital Management LLC and Certares Opportunities LLC) and then there was a “pivot” (a group consisting of Centerbridge Partners L.P., Warburg Pincus LLC, Dundon Capital Partners LLC and an ad hoc group of the Hertz Debtors’ unsecured noteholders) and then another “pivot” and then another “pivot” and then a 36-hour auction and, ultimately, the initial sponsors, supported by reinforcements (Apollo Management Group), ended up back on top. Each time the outlook for general unsecured creditors and, more importantly, shareholders improved. Some noteholders absolutely crushed it.

Now — NOW! — shareholders are the big winners too! The mainstream media tripped all over itself to declare the memers the victors and the shadecasters as pessimistic boomers who didn’t understand the recovery potential (though some also pointed out the luck involved). And there’s probably some truth to the latter though we highly doubt that 99% of the former were running complex recovery analyses enough to know whether the equity had value.

But some well-known public market money managers were! And they combined with Knighthead and Certares to push through with the winning bid. The media celebrated $8 a share.

Hertz investors snag $8 a share in surprise bankruptcy win https://t.co/DbU13fozfk pic.twitter.com/rZ7qmw022t

— New York Post (@nypost) May 12, 2021

Hertz shares ripping on news shareholder group wins auction for bankrupt firm. Shareholders get near $8/shr distribution. One participant tells me outcome and relief is "truly historic" for existing shareholders. Still must be approved by Judge. More deets on @HalftimeReport

— Scott Wapner (@ScottWapnerCNBC) May 12, 2021

But is it really $8 a share? Or even “near $8/shr?” Bloomberg’s Matt Levine pays this point short shrift though at least, to his credit, he does note that there’s more there there:

“That $8 number isn’t quite real — you have to decide how much you value the warrants and reorganized equity — but certainly the equity is getting something. And if you believe, or partly believe, the $8 post-bankruptcy valuation, then $6.25 a year ago was a bargain. If you bought Hertz stock at $6.25 last June, that was a reasonable bet. Not necessarily a great bet — you’re down about 20% over the last year, and of course you’d have been better off buying Dogecoin — but a reasonable one, and if a few more things break your way you’ll have a nice little profit. And if you paid under $3 for Hertz — which is where it traded for most of last June — you did great.”

But that’s the thing. The entry point matters. And the details matter. Shareholders will get (a) $239mm in cash, (b) common stock representing 3% of the shares of the reorganized Company (subject to dilution from warrants and equity issued under a new management incentive plan); and (c) 30-year warrants for 18% of the common stock of the reorganized Company (subject to dilution by a new management incentive plan) with a strike price based on a total equity value of $6.5 billion, or the opportunity, for eligible shareholders, to subscribe for shares of common stock in the $1.635 billion rights offering at Plan equity value. As if that doesn’t sound complicated enough, shareholders could also elect to participate in the rights offering but, kinda sorta not. Instead, they could sell their rights pursuant to an auction and receive their pro rata share of proceeds of the rights sale instead of warrants. Thoughts and prayers to the retail investor trying to figure what the bloody hell that actually means for them.

So what does it mean? It means — NOT INVESTMENT ADVICE, DO YOUR OWN WORK! — $1.53 in cash per share. It means, with the 3% piece, another $1 per share. So, ~$2.53 is a guaranteed recovery. Beyond that, it depends upon what the shareholder opts to do and how they might value the warrants. And on that point we say, “good luck with that.” Why are we so flippant? Because this entire analysis depends on how you run your — 😳gulp 😳— Black-Scholes model (lol), which, among other inputs, requires an assessment of volatility (LOL). This volatility assessment could get you anywhere between $2/share to $5.50/share (LOL!!) and so going shorthand with $8/share isn’t exactly telling the whole story (despite making a good story). The Hertz Debtors note a volatility range of 50-65%. At its midpoint, the warrant value comes to ~$769mm or $4.92/share. Applying additional inputs might get you to $5.47/share. You could be forgiven for thinking that some Managing Director was spinning around in his chair ordering an analyst to somehow “land around $8/share” and then some excel monkey made some magic happen (adding an extra penny at the end to make things look more optically kosher). The bottom line is that along with entry points and details, the inputs matter too. And so there must be a whole lot of people running some B/S models this week (LOL!!!):

Of course, that’s a whole bunch of nuance that today’s equity market doesn’t exactly have time for. But 🤷‍♀️.

*****

On Wednesday, Consumer Price Index data pushed the market into a swoon with CNBC coming about an inch away from this:

Headline year-over-year inflation came in around 4.2%, a somewhat misleading number since it factored in oil prices that, on a relative basis, were over $100/barrel higher than the year before.

Drilling down further into core CPI (excludes volatile food and energy) and the clear outlier is used car prices. Per the U.S. Bureau of Labor Statistics:

In other words, while other indices also increased, used cars/trucks were the largest contributor to the CPI number that freaked everyone the hell out.

Which brings us back to Hertz. The company is out in the market trying to stock back up on cars pushing prices up in a supply-constrained auto environment. It would be the greatest irony of all time if inflation fears decimated the personal trading accounts of all of the new retail entrants into the market on the same day that they experienced a win on their Hertz stock. The Lord giveth and the Lord taketh away.

Taking this a step farther, it would be amazing if the Fed felt compelled by inflation or perceived inflation to tighten monetary policy (read: raise rates) in part because Hertz vomited nearly 200,000 cars into the market and then, months later, had to go back to that market and buy its sh*t back. (PETITION Note: the inflation argument sure didn’t spook markets for long as momentum swung back fast and furious to the upside on Thursday and Friday. Markets today are fickle AF.).

Regardless of what happens with the Fed and inflation later, Hertz has already established itself as a founding member of a lot of special clubs all at the same time:

✅the pandemic-induced bankruptcy club;
✅the meme stock club; and
✅the inflation club.

Which makes us wonder: what’s next for Hertz? Is it going to NFT something? Or will it announce that it plans to carry Bitcoin on balance sheet? How long until it issues new debt into the market for the sole purpose of paying Knighthead and Certares a big fat dividend?

Nothing would surprise us at this point.

⚾️Are "Distressed SPACs" Still a Thing?⚾️

Our coverage of Mudrick Capital LP’s second SPAC began with a detailed analysis of his first, Hycroft Mining ($HYMC).

TLDR: Mudrick’s first SPAC engineered a path forward for one of his long-held illiquid holdings in the 11th hour before the fund would have needed to return cash to investors. We tuned into a YouTube interview with Mudrick’s CIO, Jason Mudrick, where he speculated about a second SPAC vehicle, but insisted that his focus was “on making Mudrick Capital Acquisition I a success” before launching SPAC II.

Reasonable people can disagree on the definition of “success.” Success could be simply launching a SPAC in the first place. Or it could be successfully de-SPAC’ing into a viable merger candidate. Or it could be the post-merger entity shooting to the moon a la Draftkings Inc. ($DKNG). Pick your barometer but suffice it to say that many people wouldn’t choose “down 60% post-IPO” topped with “weak FY 2021 guidance” as their winning metric.

But past performance is not indicative of future performance. Nor is one investment enough to taint what otherwise appears to be an impressive investing run. And so surely Mudrick wasn’t going to let the absolute dumpster fire that is HYMC get in the way of launching SPAC II and then, in impressive short order, making a big announcement.

On April 6, 2021, Mudrick Capital Acquisition Corporation II announced the purchase of The Topps Company, Inc. Topps is a NY-based manufacturer of collectibles, chewing gum, and candy. A slide from the merger presentation breaks down the company’s mix of offerings:

A. Ownership Structure

Founded originally in 1938, Topps was acquired in October 2007 by The Tornante Company LLC (run by former Disney CEO Michael Eisner) and Madison Dearborn Partners, LLC for $385mm. The NYTimes stated that the original Tornante x MDP collab was “a bet on a brand that elicits an “emotional connection” as strong as Disney…” Topps’ content partners certainly fit that strategy; the company’s roster includes organizations and brands such as MLB, UEFA, The Formula One Group ($FWONA), Star Wars, Marvel, and World Wrestling Entertainment, Inc. ($WWE). Tornante Chairman Michael Eisner’s connections were no doubt invaluable in helping Topps make inroads. Disney properties include Star Wars and Marvel, and Tornante owns an equity stake in Portsmouth Football Club.

Pro forma for the Mudrick acquisition, Tornante retains 36% equity ownership in Topps. MDP and the existing management team will own 8%. Mudrick Capital will own 7% of the “Founder Shares,” while SPAC investors will own 28%. Filling out the cap stack is a $250mm PIPE offering, which accounts for 21% of the equity. Per the press release, the PIPE is led by Mudrick and names GAMCO Investors, Inc. and Wells Capital Management as co-investors. Based on merger presentation financials, Mudrick and friends are recapitalizing Topps at a 12.5x Pro Forma 2021 Adj. EBITDA multiple.

B. Segment Breakdown

Physical Sports & Entertainment is Topps’ largest segment. At $314mm of 2020 revenue, the segment makes up 55% of Topps’ total full year revenue. The business focuses on trading cards, stickers and “curated experiences” such as experiential events in partnership with UEFA Champions League.

In FY 2020, the Physical S&E segment grew 50% YoY. Topps’ estimates the segment will hit $398mm and $454mm in revenue for FY21 and FY22, growing 27% and 14% respectively. Topps has been able to quickly capitalize on the hot consumer flavor of the month, whether it was Star Wars: The Mandalorian, the WWE, Bundesliga, or Godzilla, aligning with the most recent film release. Additionally, Topps has driven margin growth through some preeetty aggressive pricing strategies. FinTwit was all over it:

Alright, which one of you suckers is the one buying this $25k box of cards on the bottom right?$MUDShttps://t.co/SSwWuLf7tE pic.twitter.com/dSQGdXjhdP

— 1 Main Capital (@1MainCapital) April 6, 2021

Topps’ Confection Segment printed $198mm of revenue in FY 2020 and was ~35% of the business. Topps calls its brands, including Bazooka Gum, RingPop, PushPop, Baby Bottle Pop, and Juicy Drop Pop, “Edible Entertainment.” (This compilation for Baby Bottle Pop ads triggers all the early-90s nostalgia we can handle.) These brands are sold in major retail locations in the U.S. and Internationally, including 7-Eleven, Inc., BJs Wholesale Club Holdings Inc. ($BJ), Dollar Tree, Inc. ($DLTR), Kroger Co ($KR), Walmart Inc. ($WMT), Target Corporation ($TGT), Walgreens Boots Alliance Inc. ($WBA), and Carrefour S A F, REWE Group, and Tesco PLC. Topps confections are outperforming the broader confections category, and three of Topps’ products are in the top 5 best-selling non-chocolate items in U.S. Retail.

In 2020, the Confections segment was down 10% YoY, likely impacted by COVID-19: apparently the category gets some tailwinds from screaming toddlers demanding candy in the checkout aisle of the local grocery store. Damn you DoorDash Inc. ($DASH). Anyway, Topps sees that segment bouncing back 14% in FY21 before moderating to 5% in FY22.

C. Steak & Sizzle

Topps’ Digital Sports & Entertainment and Gift Cards together make up 10% of Topps’ total revenue. We’ve previously shared our thoughts on gift cards; we find it fascinating that between 6 - 10% of prepaid gift cards are never used by the customer, resulting in ‘breakage income’ at 100% margin to the business. But if Topps’ Physical S&E and Confections are the ‘steak’ of the investment thesis, Digital is certainly the “sizzle.”

Digital Sports & Entertainment provides app-based, digital collectibles and games with the ability to print on-demand. This segment grew 72% YoY as Topps directly monetized the Intellectual Property of its partnerships through its mobile apps. Per the merger presentation, daily active users on Topps’ apps have grown at a ~50% CAGR from January 2019 to January 2021. Per a NYTimes article, Tornante, MDP, and company management have been prioritizing this shift:

“In the years since Mr. Eisner’s initial purchase, Topps has focused on a shift to digital, starting online apps for users to trade collectibles and play games. It also created “Topps Now,” which makes of-the-moment cards to capture a defining play or a pop culture meme. (It sold nearly 100,000 cards featuring Senator Bernie Sanders at the presidential inauguration in his mittens.) And it has moved into blockchain, too, via the craze for nonfungible tokens, or NFTs.”

While we have no f*cking clue what’s going on with NFTs, there’s no question pandemic lockdowns have fueled a resurgence across all of memorabilia. The article continues with some comments from Mr. Mudrick and Topps’ current CEO Michael Brandstaedter:

“The secondhand market is particularly hot, with a Mickey Mantle card recently selling for more than $5 million. “Topps probably made something like a nickel on it, 70 years ago,” said Jason Mudrick, the founder of Mudrick Capital. NFT mania will allow Topps to take advantage of the secondhand market by linking collectibles to digital tokens. Topps is also growing beyond sports, like its partnerships with Marvel and “Star Wars.”

It continues to see value in its core baseball-card business, as athletes come up from the minor leagues more quickly. “The trading card business has been growing for the last several years,” Michael Brandstaedter, the chief executive of Topps, said. “While it definitely grew through the pandemic — and perhaps accelerated — it did not arrive with the pandemic.” (emphasis added)

Topps’ foray into NFTs through its collaboration with Wax Blockchain on ‘Garbage Pail Kids’ has been wildly successful, selling out in 27 hours with $100k+ in revenue. But the reported numbers indicate Topps derives limited value from digital today:

But that looks set to change. Perhaps quickly. It looks highly likely that Topps is going to do some exciting digital things with the likes of the Anaheim Angels’ Mike Trout and Shohei Ohtani, among others; it signed both to long-term card and autograph deals that, while the details are not entirely clear, likely includes some sort of digital element to it (at least with Trout given the timing).

Topps is innovating in real time. The Verge reported on Major League Baseball’s latest initiative earlier this week:

Major League Baseball has announced its latest move to cash in on the NFT craze: official blockchain-based versions of classic Topps baseball cards. Topps is selling the new NFT baseball cards through the WAX blockchain, which the company has used for its earliest blockchain-based collectibles.

The first “Series 1” cards will be sold starting on April 20th, with 50,000 standard packs (containing six cards for $5) and around 24,000 premium packs (offering 45 cards for $100) set to be sold in the first wave. Topps is also offering a free “exclusive Topps MLB Opening Day NFT Pack” to the first 10,000 users who sign up for email alerts for new releases.

It’s a similar idea to the NBA’s white-hot Top Shot NFTs, which offer fans purchasable video clips (called Moments) in card-like packs. Top Shot Moments are already a massive business — some have sold for upwards of $200,000, and more than 800,000 accounts have yielded over $500 million in sales so far.

Not too shabby.

While the future may be digital, Mudrick’s investment thesis as outlined in the NYTimes’ article is focused on the longevity and stability of the physical business.

“That resilience is part of the bet that Mudrick Capital is making on the 80-year old Topps. It’s a surer gamble, Mr. Mudrick said, than buying one of the many unprofitable start-ups currently courting SPAC deals.”

PETITION and other public investors only have a limited period of financials to digest, so we can’t refute Mr. Mudrick’s claims of Topps’ financial resilience. From the financials we can see, Topps is growing and profitable. FY20 revenue of $567mm represented growth of 23% from prior year levels, and the company projects — ah, the beauty of SPACs, go-forward projections! — those trends to continue. FY21 and 2022 are estimated to grow to $692mm and $777mm, or 22% and 12% respectively. EBITDA margins expanded considerably in 2020, from 11% to 16%, and CapEx is incredibly low.

The largest part of Topps’ business is growing with the highest EBITDA margins – a positive sign.

But is Topps really the sort of business Mudrick Capital intended to acquire with MUDS II? On one hand, the S-1 spins a different story:

“Our business strategy is to identify, combine with and maximize the value of a company that has either recently emerged from bankruptcy court protection or will require incremental capital as part of a balance sheet restructuring. In particular, we believe that many post-restructured companies suffer from a valuation discount due to their opaqueness, complexity, non-long term ownership base and overall illiquidity. We believe that our in depth understanding of restructurings and post-restructuring company analysis, coupled with the more liquid publicly traded vehicle the company offers in an initial business combination, could result in significant value creation for our stockholders. Creating value for our stockholders is the ultimate goal of this business strategy.” (emphasis added)

It's clear from the language that Mudrick Capital Acquisition Corporation II was intended to be a distressed-oriented SPAC. But Mudrick & Co. went in the complete opposite direction. Comparing Topps and Hycroft Mining, this couldn’t be a more divergent duo of companies; we liken the two businesses to ‘apples and napalm grenades’. The market seemingly concurs. Juxtapose this ⬇️ with the Hycroft chart ⬆️:

Par owners have less and less reason to sell. Turning into Restructuring as a Service (RaaS).

to reclaim distress for the edgier investor we will need some really unfavorable rulings https://t.co/U9jrHJRL1f pic.twitter.com/ax6h9K1lIw

— Halcap (@HalCapLLC) April 8, 2021

Just to piss in everyone’s faces, Ares Management Corp’s CEO Michael Arougheti added (in a conversation with Bloomberg’s Kelsey Butler):

“There’s underlying stress that will find its way into the markets but I don’t think that’s anytime soon,” Arougheti said at a virtual Bloomberg News event this week. Default rates are “artificially low” and asset prices are buoyant because “there’s so much liquidity masking that default rate that we’ve all grown accustomed to seeing at this point in the cycle that we’re probably two to three years out before we start seeing a traditional default cycle play out.”

And so maybe Topps should be viewed in the same lens as the infamous Howard Marks’ ‘Something of Value’ investor letter — a sign of capitulation among notable distressed managers. We’re taking a more passive view on this. From our perspective, turning around a distressed businesses today requires a significant investment in both capital and time. And there’s huge terminal value risk – many distressed businesses models are structurally challenged and may not exist in the next 5 – 10 years. In that context, Mudrick’s move to acquire a stable, healthy business at a full valuation makes intuitive sense. Why not sacrifice a few basis points of alpha to write a big check that doesn’t cause heartburn for a decade? (Side note: we think Starboard Value’s acquisition of Cyxtera ties back to this theme, which we previously covered here).

As times change, so must distressed managers. In our humble opinion, Topps and Hycroft are worth paying attention to not only as interesting businesses in their own right, but as bellwethers for capital flows.

Of course, as we continue to evaluate all of this, we may get some additional data points:

From late yesterday: Mudrick Capital Management is mulling a third SPAC, which could be $300-400m, to invest in a distressed or restructured company. Scoop with @KatLeighDoherty pic.twitter.com/vJw1NsrcCp

— Allison McNeely (@allisonmcneely) April 13, 2021

⚡️Update: National CineMedia Inc ($NCMI)⚡️

Much like other companies tied to movie theaters, National CineMedia Inc ($NCMI) has experienced a bit of a stock run-up since we wrote about it in September 2020. Back then the stock price was around $3.45/share and today its around $4.50/share. While this is apropos of nothing, really, other than an equity market commentary where equity prices and market capitalizations are (mostly) detached from reality, it is especially fascinating when considered in the context of recent earnings results.

On March 8, 2021, NCMI reported Q420 and full year ‘20 results. They were a massive turd. It’s hard to make money selling advertising in movie theaters when movie theaters aren’t open and, to the extent they are open, they’re not really showing anything that anyone deems important enough to go out and see while risking contracting a deadly virus. Go figure.

The company, therefore, spent the majority of 2020…

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⚡️Update: GTT Communications Inc. ($GTT)⚡️

Continuing our prior reporting on GTT Communications Inc., it seems safe to say that things appear a bit uncertain.

On March 8th, Bloomberg News reported that GTT had entered into bankruptcy negotiations with its creditors:

“GTT Communications Inc. has started formal talks with creditors around a restructuring plan that would see its unsecured debt holders take ownership of the telecommunications company through a bankruptcy filing. McLean, Virginia-based GTT is presenting creditors a proposal on Monday that would hand term loan holders a large cash payment from the $2.15 billion sale of its infrastructure unit, according to people with knowledge of the matter, who asked not to be identified discussing confidential negotiations.

Lenders would also get new debt with a coupon in the 7% to 9% range and a portion of the reorganized equity. GTT’s unsecured creditors would receive the majority of the new equity under the proposal, becoming the owners of the reorganized company, the people said. Lenders and creditors are becoming restricted from trading in anticipation of the formal talks, the people said. Negotiations are in the early stages and the terms could change, they added.”

For weeks, the market has been anticipating an update on either the infrastructure asset sale process or fundamentals (or both). On March 13, GTT essentially signaled that the market will have to wait a little longer. In an SEC filing, GTT notified the market that its YE 2020 10-K would be delayed; management outlined a host of new accounting and reporting issues as far back as 2017. If this sounds like déjà vu, it is: accounting issues first emerged in September 2020 during the diligence phase of the asset sale process.

Per Bloomberg, GTT “had promised to deliver a deleveraging plan by March 8 and faces a March 31 deadline to reach an agreement with its creditors.” Well — 🗓 checks calendar 🗓 — it’s March 31 and there’s officially no agreement. Instead, there’s yet another forbearance extension (which, we suppose, is an agreement of sorts) through April 15. In connection with the extension, GTT agreed to pay the fees and expenses of lender and agent advisors.

The stock has gotten pummeled since our initial report; it is currently trading at 1/3 the price it was back in late October 2020 (now around $1.85/share).

Similarly, the $575mm 7.875% Unsecured Notes due 2024 were trading around 47 cents on the dollar then and are languishing now in the high teens, though meaningfully up off of March 12 lows (as of 3/30/21 it was at 17 cents on the dollar versus 5 cents earlier in the month). On the other hand, the company’s term loan was one of last week’s biggest winners, ending last week up 2.3% around 81 cents on the dollar.

Whatever happens, one thing is clear: GTT’s broken roll-up story is an incredible fall from grace for a company that promised so much.

💥Will the Biden Administration Disrupt Private Prisons? Part II.💥

🚨Geo Group Inc. ($GEO)🚨

We dug deep into the private prison space with our coverage of Corecivic Inc. ($CXW) a few weeks ago so it’s only fair we discuss Geo Group Inc. ($GEO) — the second largest operator of private prisons and immigrant detention centers in the US. Per Geo’s FY 2020 10-K, Geo’s operations consist of 93,000 beds across 118 facilities (including 11 idle facilities).

As we stated with CXW, sentiment for private prisons is incredibly negative. Government officials are applying political pressure (see here and here), and major Wall Street banks have gone on record saying they would stop financing private prisons over ESG concerns (even though sometimes they still do).

Adding in the impact from COVID, the situation for private prisons seems downright dire. Disclosure from Geo indicates that over the course of 2020, the Federal Bureau of Prisons decided not to renew three of the company’s active contracts expiring during Q121. We noted that Corecivic also saw some contract non-renewals. Yet through it all, both Corecivic and Geo have been managing both their operations and their capital structures quite effectively.

On Geo’s Q4 2020 conference call, CFO Brian R. Evans stated those three contracts totaled $100mm of revenue, but clarified that not all of it will impact the company’s 2021 figures. Mr. Evans commented:

As I said, the BOP facilities that are expected to roll off this year is about $100 million in revenue between the three of them, but all of that revenue won’t impact this year. Some of the revenue that will impact is the facilities that have already been announced for termination plus these others that we expect to terminate, offset by the facilities that are coming online which are mainly the facilities in California and the US Marshals facility in Texas.

Geo appears to be beating its own guidance. On that Q420 conference call, Noble Capital Markets Inc. analyst Joe Gomes asked:

The first question I wanted to ask, you guys had a nice beat on adjusted basis for the guidance you provided in the third quarter, even in such a difficult operating environment. And I just wondered if you could expound a little bit more on how you guys ended up beating the third quarter guidance – the guidance made in the third quarter. Pardon me.

To which Mr. Evans replied:

Sure. So, I think two main issues, we’ve consistently during the pandemic perform better in a number of cost categories in the facilities. And we continue to see that during the fourth quarter. And going into next year, we’ve – we haven’t necessarily assumed that all that benefit will continue. So, we’ve been conservative with regards to that benefit that we’ve been able to experience and manage, and then we also saw some modest improvement in some of our occupancy levels at some of our facilities.” (emphasis added)

Geo has certainly been hurt by COVID. Inmate populations have declined amid pandemic lockdowns, and management has needed to implement costly sanitation and testing procedures to keep both employees and inmates safe amid the pandemic. Mr. Zoley pegged the overall COVID impact to Geo’s financial profitability at a “15% to 20% reduction.”

In response, Geo is prioritizing debt paydown and shoring up liquidity. On Geo’s conference call, CEO & Founder George Zoley announced that, over the course of 2020, Geo paid down approximately $100 million of net debt and cut quarterly dividend payments. It also raised new money. On February 17, 2021, Geo tapped the new issue debt markets with a private offering. Bloomberg covered the effort:

“Geo Group Inc., one of the largest operators of private prisons and immigrant detention centers in the U.S. that has been snubbed by much of Wall Street, is planning to sell at least $200 million of convertible bonds to refinance debt maturing next year.

The company has tapped StoneX Group Inc. to run the sale amid increasing political scrutiny over the for-profit prison industry, according to people with knowledge of the matter, who asked not to be identified because details of the transaction are private.

If successful, the deal will help Geo refinance its 5.875% unsecured notes due in January 2022, according to a statement Wednesday. It could also help alleviate concerns about the company’s ability to raise capital from institutional investors.

It appears there’s a bank for every deal. Bloomberg continues:

“The sale comes at a challenging time for Geo. Its earnings have been hit by lower occupancy rates at its facilities during the pandemic, while the entire industry remains under heavy political pressure. President Joe Biden instructed the Justice Department last month not to renew contracts with private-prison operators, dealing the latest blow to the sector.

The offering was a big hit. In its 2020 10-K, Geo announced that on February 24, 2021, Geo closed on “$230.0 million…of 6.50% exchangeable senior notes due 2026,” $30.0 million ahead of launch.

The ratings agencies, however, are unimpressed. S&P Global Ratings slapped a vicious two-notch downgrade on the company (and also downgraded CoreCivic for sh*ts and giggles). Per Bloomberg:

Geo suffered a two-notch downgrade to B, a junk rating five steps below investment-grade, in spite its having sold a convertible bond last month. S&P said the company may struggle to refinance $1.7 billion of debt maturing in 2024 and warned that it may cut the company’s rating further over the next 12 months if Geo doesn’t make progress in lowering that risk.

Restructuring professionals are on the hunt for everything and anything these days. While the fundamentals clearly suggest there’s still room for these businesses to run, there’s some writing on the wall. And having nothing better to do, restructuring professionals are agitating and, consequently, they’re chatting up various lenders in the capital structure and now they, too, are agitating and, presumably, the company will need to engage with those lenders at some point. The downgrade all but nudges that scenario into action.

Geo’s capital structure is … robust. It looks something like this:

• $704mm of 1L Revolving Credit Facility due 5/24;

• $770mm of 1L Term Loan B due 3/24 (trading at roughly 88 cents);

• $281mm of 5.125% ‘23 senior unsecured paper (trading at roughly 88 cents);

• $242mm of 5.875% ‘24 senior unsecured paper;

• $350mm of 6% ‘26 senior unsecured paper; and

• the new $230mm of 6.5% ‘26 convertible notes (trading at 105).

Obviously, given the refi, Geo’s nearest-term maturing tranche, the 5.875% Senior Notes due January 2022, went out as effectively par paper. The longer dated 6% unsecured paper maturing in April 2026 has been a bit dicier, dipping down into the 60s back in November. Notably, however, it now trades higher now (~72) than it did on Election Day (though it is down 10% since the new year, which reflects President Biden’s directive regarding private US prison companies). The unsecured notes maturing in October 2024 follow the same pattern (and currently trade at ~79.5).

Like we said, these businesses aren’t going away tomorrow; they’re even raising fresh capital in the face of some notable headwinds. Despite peak negative headlines, it’s clear that market participants haven’t given up on private prisons. The pertinent question is whether that trend will persist as the negativity surrounding these names continues to grow and lenders up and down the stack coalesce in an attempt to engage the company on its still-over-levered balance sheet.

⚡️Update: AMC Entertainment Inc. ($AMC)⚡️

AMC Entertainment Inc. ($AMC) has had one hell of a stretch that’s culminated in a major extension of its runway. According to the company's annual report, which it filed March 12, the company estimates that it has enough cash to make it through the end of March 2022. "This requires that the Company achieves [sic] significant increases in attendance levels beginning in the third quarter of 2021 and ultimately reaching 90% of pre COVID-19 attendance levels by the fourth quarter of 2021 and through the first quarter of 2022, as the vaccine rollout continues and more Hollywood product is released in its theatres." In other words, the company’s assumptions haven’t changed much since January.

Indeed, when we discussed AMC in January, we pointed out how management assumed the following just to make it through 2021:

Specifically, the company estimated that, together with proceeds from continued at-the-market equity programs and additional landlord concessions, it would require the following attendance levels:

10% of Pre-COVID 2019 attendance during Q121

15% of Pre-COVID 2019 attendance during Q221

65% of Pre-COVID 2019 attendance during Q321

90% of Pre-COVID 2019 attendance during Q421

Here’s what that looks like:

Source: PETITION LLC

And, luckily, there’s been some (relatively) good news on that front! Management’s comments on the Q420 earnings call suggest that attendance has, in fact, been growing in recent weeks…

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⚡️Update: Washington Prime Group ($WPG)⚡️

As new retail looks out onto the horizon, old retail struggles to survive.

We’ve been following the beleaguered Washington Prime Group Inc. ($WPG) for years (see here and here). Our last update indicated that WPG’s tenants are struggling to pay rent, which is making it tough on the mall operator to manage its ~$4b of debt. WPG reported Q4 and FY 2020 earnings on March 16, and they were NOT good. For a high level recap:

• Revenue down 12% for the quarter and 21% annually, YoY;

• Adj. EBITDA (EBITDAre) down 22% for the quarter and 33% annually, YoY; margins absolutely CRUSHED; and

• Comparable NOI down 14% for the quarter and 24% annually, YoY.

Exactly one month earlier, WPG announced it wouldn’t be making its $23.2mm interest payment on its Senior Notes due 2024 and entered into a 30-day grace period. With the grace period set to expire on March 17th and ripen into a full-blown Event of Default, WPG and its lenders needed to get back to the table.

Included in its earnings release was an announcement by WPG that it had entered into a forbearance agreements with “certain beneficial owners of more than 67% of the aggregate principal amount” of the 2024 Senior Notes and with respect to its Credit Agreements. The forbearance period expires “on the earlier of March 31, 2021 and “the occurrence of any of the specified early termination events” including “negotiations of the terms and conditions of a financial restructuring…of the existing debt of, existing equity interests in, and certain other obligations of the Company and certain of its direct and indirect subsidiaries.” WPG warns that a restructuring “may need to be implemented…under chapter 11 of the United States Bankruptcy Code.”

Management provided neither 2021 guidance nor a conference call. And on March 17 S&P downgraded WPG’s issuer credit rating to 'D' from 'CC'. Can’t say we’re surprised.

None of that fundamental weakness stopped the retail speculators from getting into the action.

I have been following $WPG for a while. I believe in the CEO Lou Conforti. He is changing the town centers, to provide a unique experience. Including sports and events. I can already see sharks (SPAC) already preparing for normalization. Undervalued stock ready to blow up.

— Ersin (@ersindemirtas) March 11, 2021

“Blow up,” sure, but not in the way @ersindemirtas expected. On the day of the ⬆️ prognostication, the stock was trading at $3.39/share. After the earnings report, the stock dipped below $3/share only to pop back 10% and close slightly over $3/share. Maybe because, as this guy ⬇️ astutely points out, things are kinda backwards these days:

$WPG now watch this dumpster fire pop like Hertz pic.twitter.com/Ze67nON8gE

— FoxCap (@FoxCapital1) March 16, 2021

On Monday, however, Bloomberg reported that WPG is in the market for a DIP loan:

Guggenheim, the company’s investment bank, has asked prospective lenders to indicate their interest in providing a potential $150 million debtor-in-possession loan, according to one of the people, who asked not to be identified discussing confidential talks. The negotiations are ongoing and the terms could change, the people said.

Which is where the WPG story is these days. It’s not a question of ‘if’ or ‘when.’ It’s a question of ‘how much.’

The stock initially dropped over 12% on the news, regained some ground to end Monday down 7.6% before rallying slightly after the market closed. Because, like, 🤷‍♀️.

Source: Yahoo! Finance

Of course, that small rally didn’t hold. The company got smoked by over 10% in trading on Tuesday:

Source: Yahoo! Finance

While — ⚡️shocker⚡️ — the market appears to be acting rationally for once, there are, of course, certain participants who appear unfazed.

$WPG Volatility theatre. I'm holding. #MallsAreMarketsToo

— Max Value (@MaxValue1) March 23, 2021

There’s not much suspense left in this story beyond just how wrong @MaxValue1 will be.

👕thredUP: Resale Goes Mainstream👕

For years, PETITION has been covering the emergence of resale as a new and growing retail category (see here, here, here and here). If VCs can write self-aggrandizing social media posts whenever one of their investments goes public, surely we can take a small victory lap too. On March 3, 2021, thredUP Inc. (“thredUP”) filed its S-1 ahead of an IPO. The S-1 allowed us to dig deep into a major player in the resale market.

thredUP claims to be one of the world’s largest online resale platforms for second-hand women’s and kid’s apparel, shoes and accessories. Founded in 2009, the business currently boasts 428,000 Active Sellers and 1.24 million Active Buyers who come to the platform to find items at an up to 90% discount to their estimated retail price. thredUP claims its platform is loved by both parties; buyers love shopping value, premium and luxury brands all in one place, while sellers love the convenience of unlocking value for either themselves or the charity of their choice. thredUP sees a huge opportunity in the resale market — according to the GlobalData Market Survey, the resale market is expected to grow from $7b in ‘19 to $36b by ‘24, representing a compound annual growth rate of 39%.

How Does thredUP’s Business Work?

thredUP’s entire end-to-end chain works as follows:

A seller signs up for thredUP and orders a Clean Out Kit. She fills thredUP’s ‘Clean Out Kit’ with items from her closet that no longer spark joy:

Sellers on thredUP’s platform benefit from an extremely low touch platform: thredUP essentially does all the work. The seller’s only decision to make prior to shipping their clothing is whether they want to sell their clothing for cash, store credit, or donate the proceeds to charity. Once that decision is made, the seller fills the Clean Out Kit bag and leaves it on their doorstep for a mail carrier pick up, or drops it off at a retail or logistics partner location for shipping, free of charge. Once the items are shipped, the seller’s work is finished. thredUP’s proprietary platform manages item selection and pricing, merchandising, fulfillment, payments and customer service. thredUP uses an internal software algorithm to “predict the demand for an item and determine a listing price for it, along with setting the seller payout ratio, with the aim of optimizing sell-through, gross profit dollars and…unit economics.” Seller payout ranges from 3% to 15% for items listed at $5.00 to $19.99, and up to 80% for items listed at $200 and above. For the year ended 12/31/20, that resulted in an average seller payout of 19% of the item sale price with an average seller payout per bag of $51.70. thredUP is clearly working with small dollars, but on significant volume.

Harvard Business School covered thredUP’s origins as “a peer-to-peer online clothes sharing site for adults.” In the words of co-founder and CEO James Reinhart, “It was a great story. And a bad business…Customer adoption and use of the product wasn’t nearly what we had hoped.” In 2009, acceptance of secondhand clothing was not mainstream. In 2012, thredUP pivoted to the children’s market. Per Mr. Reinhart, “[thredUP] realized there was a huge opportunity in kids because there’s the forced obsolescence of kids’ clothing.” thredUP was able to scale the business quickly from less than 20,000 adults to more than 300,000 parents, adding at a rate of 500 to 1,000 per day. thredUP discloses in its S-1 that the company shifted again in mid-2019, de-prioritizing its product sales in favor of consignment sales. As thredUP’s S-1 indicates, consignment may be a vastly superior retail business model. Per the S-1:

“We believe that operating primarily on consignment also gives us the ability to drive stronger future margins than traditional inventory-taking business models because we incur minimal inventory risk and benefit from favorable working capital dynamics. Our buyers pay us upfront when they purchase an item. For items held on consignment, after the end of the 14-day return window for buyers, we credit our sellers’ accounts with their seller payout. Our sellers then take an average of more than 60 days to use their funds.”

In other words, thredUP presumably derives a kind of “float” benefit as well, generating interest income off of that 60-day average. In addition to those positives, thredUP preserves a degree leverage over its sellers. Once a customer ships its items to thredUP, thredUP can decide which goods will ultimately be passed through to the marketplace, and at what price they will be listed at, therefore locking in platform product quality and margin.

thredUP - A Contrarian Strategy

In a letter to potential shareholders, Mr. Reinhart outlines the criticism thredUP faced from its earliest days:

“Since the earliest days of thredUP, we have been told that our strategy was contrarian. That our commitment to cracking the hardest infrastructure, supply chain and data challenges in the service of a better customer experience was risky or could lead to failure. “Touching things” is hard. “Low price points” are hard. “Single SKUs” is just plain crazy. Yes...We are doing the hard things that meaningfully expand this opportunity and enhance our leadership position. I have been willing to be misunderstood and even underestimated in taking this approach, driven by my belief that businesses that are harder to build in the short-term can have extraordinary long-term impact.”

In its S-1, thredUP outlines various proprietary technologies and processes it utilizes to execute its “contrarian” strategy. thredUP operations are “purpose-built for “single SKU” logistics, meaning that every item processed is unique, came from or belongs to an individual seller, and is individually tracked….” As there are no barcodes on clothing, moving all these unique SKUs can only be accomplished through technology. thredUP’s technological aids cover i) visual recognition of items, ii) supply acceptance and itemization, iii) pricing and merchandising, iv) photography, and v) storage and fulfillment.

Photography is one of the largest and most expensive pain points when prepping an item for online sale. thredUP claims it “utilizes machine learning and artificial intelligence” and “software that automatically selects the optimum photo to drive buyer engagement…[a] specialized photo selection capability” which enables thredUP to produce hundreds of thousands of high-quality photos a day without a professional photographer.

As Mr. Reinhart alludes to in his letter, one key to managing thredUP’s volume is reliable distribution. thredUP has leased five different distribution centers in Arizona, Georgia, and Pennsylvania, with total capacity of 5.5 million items (the company has plans to expand that to 6.5 million by the end of 2021). On current capacity, thredUP has the ability to process more than 100,000 unique SKUs per day. thredUP’s engineering team has developed and implemented automation technology, which the company believes results in reduced labor and fixed costs while increasing storage density and throughput capacity. thredUP also claims their software matches buyers to the closest distribution center, while personalizes the assortment potential buyers they see on the marketplace to items that are physically closest to them. This geographical personalization enables buyers to find items that are lower priced (the closer the item, the lower the price) and more likely to arrive quickly. Underlying all this is thredUP’s trove of data. thredUP’s business captures large volumes of data from touch points throughout the resale process, including transactional and pricing data from brands and categories, as well as behavioral data from buyers and sellers, which is fed directly into thredUP’s pricing algorithm.

thredUP’s website is a disruptive model which dramatically improves the resale shopping experience for both buyers and sellers. thredUP believes resale is on pace to overtake the traditional thrift and donation segment by 2024. For buyers, thredUP offers depth of selection and ease of browsing. The company claims it lists an average of more than 280,000 new secondhand items each week, with 35,000 brands across 100 categories and across price points. There’s no question thredUP offers a dramatically improved shopping experience versus traditional brick & mortar thrift stores. In comparison to traditional thrift stores where buyers sift through reams of clothing, thredUP undergoes a “rigorous twelve-point quality inspection” which they believe prevents low-quality items from being listed. In the S-1, the company discloses that only 59% of the items it received from sellers were listed on the marketplace after curation and processing. thredUP offers evidence this quality inspection produces results: of thredUP’s 12% return rate for total items sold, returns due to poor item quality accounted for less than 2%.

Per thredUP’s market report, online thrifting growth estimates are dramatically outperforming both brick & mortar thrifting as well as broader retail.

The Growth of Thrifting – Illustrated

In 2019, resale grew 25x faster than the broader retail sector…

…a growth trend that was aided by COVID, as shoppers found value and entertainment in thrifting…

Secondhand retail is taking market share…

…fueled in part by celebrities who believe secondhand is the future of retail.

Thrift is now mainstream, and thredUP’s new brand image is treating it as such:

thredUP’s brand pivot along with commentary by Mr. Reinhart was featured in an October 2020 CSA article:

“The perception of thrift has changed. Consumers are not only open to shopping secondhand, but they are wearing it proudly. ThredUP’s brand evolution acknowledges this shift from stigma to status, and celebrates our community of thrifters who are thinking secondhand first.”

thredUP - What’s the Risk?

If thredUP is a retailer with uniquely positive dynamics that also plays in an ESG-positive part of the consumer market that’s growing tremendously among Millennials and Gen Z, what’s the risk in this business model?

To start, cash flow out of the gates isn’t great:

Source: PETITION LLC

On a CFO – CapEX basis, thredUP burns more than $38mm of cash per annum. Taking a look at the income statement, thredUP’s Operating Expenses have been growing at a faster rate than Sales.

Source: PETITION LLC

Part of that slowdown may be due to the company’s forced revenue mix shift towards a consignment model. But COVID certainly didn’t help. thredUP notes that gross profit dollar growth and average contribution profit per order in 2020 both were lower than company estimates as a result of its COVID-19 response, which included higher levels of discounts and incentives and higher fixed costs per order. A Glossy interview with Fashionphile founder Sarah Davis indicated that resalers weren’t immune to lockdown-driven retail woes:

“According to Sarah Davis, founder of the Neiman-Marcus-invested resale platform Fashionphile, sales dipped considerably in March, but have risen each week in April, rebounding by more than 300% so far; sales are on track to be back at pre-coronavirus levels by May. But product from sellers has slowed to a standstill for a simple reason: Sellers don’t want to bring their bags of unwanted pieces to the post office while quarantined.

“Like all resellers, we are supply-constrained,” Davis said. “When things closed down, we thought people would have nothing better to do and use the time to clean out their closets. And that’s true. But the actual process of getting the product is the much harder task. Acquiring new product came to a crashing halt when we closed our warehouse [in March], which made it impossible to receive new product and really hard to process product that had already come in. And once it was back open, it was still hard to get people to go the post office to drop things off. So people had product they wanted to get rid of, but no way to get it to us. That was the big problem to solve.”

Whether thredUP’s logistics network is truly a groundbreaking, competitive advantage is up for debate. For one, the company doesn’t own its distribution centers and cannot guarantee supply, which in a space as competitive as resale may be problematic. Ms. Davis’ comments are telling:

“Luxury resale will always be supply-constrained,” Davis said. “People will always buy a Dior bag at a reduced price; the hardest thing is keeping the supply coming. It’s honestly a miracle that we have 20,000 items on the site, but each one of them came from individual people, so we absolutely need people to keep selling to us, whether it’s individual customers or even small business resellers, which sell to us sometimes. I would bet that for any reseller right now, the seller is where their focus is.”

A core strength of companies such as Amazon.com, Inc. ($AMZN) and recent IPO Coupang Inc. ($CPNG) is their logistics networks, which serve their customers quickly and efficiently. thredUP appears to be on the verge of successfully disrupting brick and mortar thrift. However, thredUP’s competition is fierce, including publicly traded resellers such as The RealReal Inc. ($REAL) and Poshmark Inc. ($POSH). The winner in the space is likely to be the reseller that best manages the supply constraint, and is able to create a friction-free environment for buyers and sellers. Logistics is the lynch pin of the resale business.

However, thredUP’s business model does differentiate it from other resale platforms. For example, thredUP’s total active management system is ideal for sellers who want a zero touch experience. This is a sharp contrast to Poshmark, which enables a seller to effectively run their own e-commerce consignment storefront. On Poshmark, sellers upload their own photos of the items they want to sell and determine their own pricing. These sellers can also leverage social media followings to drive sales.

Regardless of which platform is in vogue, we continue to think resale is a retail trend that has legs. Every dollar that goes into retail is coming out of online fast fashion like Zara Industria de Diseño Textil, S.A. ($IDEXF) and H & M Hennes & Mauritz AB ($HM-B.ST) or brick and mortar. Resale’s mainstream acceptance is being fueled by sustainability motives and endorsed by both celebrities and trendsetting, high fashion brands. Retail platforms are engaging with resale platforms like thredUP to explore new cross-selling opportunities. These drivers are accelerating growth. In its 2018 resale report, thredUP estimated the resale market to grow at a 15% annual CAGR from 2017 - 2022. In the 2020 resale report, the resale market is now expected to grow at a 39% CAGR from 2019 - 2024. If these estimates hold up, the HBS case studies of thredUP will need to be rewritten again to incorporate the foresight of its founders and a business ahead of its time.

And the narrative that brick and mortar retail destruction starts and stops with Amazon will need to become more inclusive of other factors. Just like we’ve been arguing since our inception.

💥Will the Biden Administration Disrupt Private Prisons Like CoreCivic Inc?💥

🚨CoreCivic: A Stable Business with a Clouded Future🚨

As we’ve made more than abundantly clear lately, there is a relative dearth of distressed names relative to ten months ago. Bankruptcy professionals remain on the hunt, however — Daddy needs to get paid, after all — and that hunt entails digging a bit deeper for mandates. With the Biden Administration now several weeks in, we can’t help but wonder whether new policies may disrupt the status quo, potentially creating distress out of thin air. One potential area of interest is for-profit private prisons.

*****

CoreCivic Inc. ($CXW) is the nation’s largest owner of partnership correctional, detention and residential reentry facilities a/k/a ‘private prisons’. Headquartered in Nashville, Tennessee, CXW claims to be one of the largest prison operators in the United States, and believes it is the largest private owner of real estate used by U.S. government agencies. CoreCivic management also believes the company serves a public good through corrections and detention management, a network of residential reentry centers to help address America’s recidivism crisis, and government real estate solutions.

CXW operates its business through three segments: (i) Safety, (ii) Community, and (iii) Properties:

• Safety. As of Q320, CoreCivic Safety operated 49 correctional and detention facilities, 42 of which are owned, 7 of which are leased, with a total design capacity of approximately 72k beds. Management believes they own 58% and lease 39% of all privately-owned prison beds in the US. In 2019, 24% of CoreCivic’s revenue came from states and 66% from the Federal government. 51% of CXW’s revenue was derived from the Bureau of Prisons, 29% derived from the U.S. Immigration and Customs Enforcement (ICE), 17% from the US Marshals Service, and 5% from the Federal government.

• Community. In 2019, CoreCivic Community owned and operated 27 residential reentry centers with a total design capacity of approximately 5k beds.

• Properties. In 2019, through its CoreCivic Properties segment, the Company owned 57 properties for lease to third parties and used by government agencies, totaling 3.3mm sqft.

CXW’s geographic presence spans 21 states, with a predominant footprint in Colorado (14), Texas (14), Oklahoma (7), Tennessee (7), Arizona (5), Georgia (5), California (4), and New Mexico (3), among others.

Since Q116 occupancy at CXW facilities has been relatively stable but has been negatively impacted in recent quarters by COVID-19.

Near the end of Q120, in an attempt to contain the spread of COVID-19, the Federal government decided to deny entry at the United States southern border to asylum-seekers and anyone crossing the southern border without proper documentation or authority. This negatively impacted CoreCivic, as the number of people apprehended and detained by ICE declined significantly. CXW also cites in its filings that disruptions to the criminal justice system have also contributed to a sequential reduction in the US Marshals Service offender population, as the number of courts in session declined rendering prosecutions impossible. If COVID-19 border restrictions and pandemic-enforced criminal justice delays continue, CXW could see a greater negative impact on their inmate populations. Further, increased expenses associated with maintaining higher health standards during the pandemic could have a negative impact on CXW’s profitability. Now just imagine what happens if they have to offer organic food to all of their inmates too!!

Source: Getty Images

*****

Private prisons have been scrutinized by both government participants and the media over the years for an undue focus on cash flow at the expense of both their inmates and employees. A 2016 Department of Justice report found that private prisons had (i) higher violence and (ii) lack of adequate security and healthcare in comparison to federal facilities. We’re not in a position to evaluate that claim one way or another: what we can say is that CXW is a fairly stable, cash flow generating business. Revenues from 2012 – 2020 help illustrate that stability. CXW revenue grew throughout most of the Trump Administration.

CXW carries $2.1b of debt, but the capital structure is far from unsustainable. On a LTM basis, CXW does ~$1.9b of revenue, ~$374mm of EBITDA, ~$400mm of Adjusted EBITDA, and Normalized Funds from Operations (a proxy of CFO less CapEx) of $265mm. Despite Q320 revenue of $470mm and Q320 Adjusted EBITDA of $95mm down 8% and 19% year-over-year, respectively, CXW managed to print $62mm of cash flow. On an LTM basis, Net Leverage is 4.9x on an unadjusted EBITDA figure (4.5x when including adjustments). Liquidity isn’t an issue either; CoreCivic has ~$282mm of unrestricted cash on balance sheet and ~$329mm of availability under its $800mm Revolving Credit Facility. The market appreciates CXW’s strong cash flow position, moderate leverage, and ample liquidity as the bonds trade between the mid-90s and par.

Source: Company Filings

Source: Getty Images

*****

The key question for CXW is what happens to the private prison industry now that those in power are focused on shutting it down. On January 26, 2021, the Biden White House distributed a fact sheet and statement outlining the President’s vision and agenda for advancing racial equity. Included in that agenda is reforming private prisons. Per the fact sheet:

“This afternoon, President Biden will outline his vision and new elements of his agenda for advancing racial equity for Americans who have been underserved and left behind…President Biden will sign four executive actions this afternoon to advance racial equity and take first steps to root out systemic racism in housing and criminal justice…The President will sign an Executive Order to end the Department of Justice’s (DOJ) use of private prisons.” (emphasis added)

The fact sheet elaborates further:

“Reform our Incarceration System to End the Use of Private Prisons. More than two million people are currently incarcerated in the United States, and a disproportionate number of these individuals are people of color. Mass incarceration imposes significant costs on our society and communities, while private prisons profiteer off of federal prisoners in less safe conditions for prisoners and correctional officers alike. President Biden is committed to reducing mass incarceration while making our communities safer. That starts with ending DOJ’s reliance on private prisons. The Order directs the Attorney General not to renew Department of Justice contracts with privately operated criminal detention facilities.” (emphasis added)

CoreCivic’s stock fell from a pre-election high of $7.51/share on November 3rd to $6.00 on November 6th but trades at $7.96 today. It jumped nearly 5% on Monday and another 4.3% yesterday. This suggests to us two things: i) it’s possible the market has already priced the Biden Administration order into a base case forecast, and/or ii) the order won’t alter the status quo or create much of a discernible impact on CXW’s business. Said another way, restructuring professionals who go around saying “keep an eye on the private prison space” may very well be sending you on a wild goose chase.

We dug into CXW’s filings and learned that the DOJ has been directing the Federal Bureau of Prisons (BOP) to cut back on private prisons since August 2016. Per the Q320 10-Q:

“In a memorandum to the Federal Bureau of Prisons ("BOP") dated August 18, 2016, the Department of Justice ("DOJ") directed that, as each contract with privately operated prisons reaches the end of its term, the BOP should either decline to renew that contract or substantially reduce its scope in a manner consistent with law and the overall decline of the BOP's inmate population. In addition to the decline in the BOP's inmate population, the DOJ memorandum cites purported operational, programming, and cost efficiency factors as reasons for the DOJ directive.”

But a 2016 change of administration got in the way…

“On February 21, 2017, the newly appointed U.S. Attorney General issued a memorandum rescinding the DOJ's prior directive stating the memorandum changed long-standing policy and practice and impaired the BOP's ability to meet the future needs of the federal correctional system.”

Commentary from the company’s Q320 earnings call suggests that over the past 7 – 8 years, CXW’s management has been anticipating prison reform and positioned the business accordingly:

Joseph Gomes:

“Okay. And kind of big broad from the 10,000 foot…if we look at your guys' stock price with what's been going on here with the election, there is a huge portion of the investor base saying, the feeling is that with -- if Biden was to win the election, that is a huge negative for the company, just based on what's happened to the stock price here…what actually can Biden do from a regulatory standpoint in terms of changing immigration or the U.S. Marshals? I know the Bureau of Prisons has reduced its populations over time. I don't know if that gives them excess capacity, can that allow the government to transfer detainees that are currently being helped by the private sector to the Federal Bureau of Prisons? Are those facilities just not set up to handle detainees versus inmates? It's my understanding, correct me if I'm wrong, please, ICE and the U.S. Marshals own minimal amount of beds at all. So that, again, the alternatives for the federal government to house these detainees is extremely limited.

Damon Hininger, CEO of CoreCivic:

“Absolutely, Joe. Thank you for the question. So yes, let me give a little color on all three federal partners. Let me start with the Federal Bureau of Prisons. So that was…about 10 years ago…15% of our revenue...This year, on the safety side, it's going to be about 2%. So we started a conversation with our Board about 7, 8 years ago, noting that the need and the trends for the BOP was going to change because they, at that time, were going through some sensing reform and changed some policies on sensing for different criminal offenses. And so we went through a process to -- as we saw contracts come up, exploration most notably, the most recent one here, Adams County, just thinking about maybe alternatives for those facilities. So that 15% revenue from the BOP back in 2010, now it's down to 2%. So we think if there is a change in policy directed towards the BOP about utilization of the private sector, again, we think our risk is pretty minimal there just because we're down to one contract.” (emphasis added)

Further, it appears that CoreCivic benefits from the fact that neither the U.S. Marshals nor U.S. Immigration and Customs Enforcement (ICE) own any of their own facilities, and rely completely on private prison service providers such as CXW. Mr. Hininger explains the setup:

 “Going to ICE and Marshals Service…[both] those agencies are law-enforcement focused. And so Marshals Service do not have any facilities they own or they operate. So unlike the BOP, where they've got 100 facilities around the country that they own and they operate, Marshals Service doesn't have that luxury. And so they have no alternative. They either rely on us, the private sector or city and counties for space. So if they are asked to look at either buying or building a new capacity, that will be a very large capital commitment and probably would take anywhere from 5 to 10 years to happen. So obviously, it's not something they could affect overnight. And again, depending on what the leadership is within the Congress that obviously would require also some concurrence with Congress on federalizing the workforce to operate those facilities. So several different steps that also they would have to take. So we think our 40 years' work with the Marshals Service and with ICE, too, we have been able to be very closely aligned with the mission, which has changed over time, provide high quality, good solutions that are very efficient for their mission.” (emphasis added)

And from what we gather, it’s not just about having an empty prison that’s important, but also having the right ancillary facilities in the right locations. Mr. Hininger continues on the Q320 call:

“Notably, and again, it goes a little bit of question about BOP potentially providing capacity to those agencies, the capacity has to be in the right location. So for example, our city in San Diego, which is about 1.5 mile from the Southwest border, that facility has not only capacity, but it's got court rooms, it's got space for lawyers and for case managers, and that BOP doesn't have anything nearby that could support them. So our facilities are not only efficient from a design perspective, but they're very strategically located that makes the mission of both agencies, Marshals and ICE, very, very, very effective. So that's an important point on that piece.”

Lastly, Mr. Hininger describes how standard government operating procedure has turned the U.S. Marshals into price takers:

“Marshals Service…[has] to provide capacity anytime a federal judge directs into holding federal prisoner. So they -- regardless of the budget situation, U.S. attorney, if they're prosecuting someone and the judge says, this person needs to detain, and they produce this individual to the Marshals Service, they have to house that individual. They don't have the luxury to say, they don't have the dollars or maybe the policy to house that population. So they're, again, beholden to what's being directed by the Federal Judiciary….“

And despite all the negative headlines, CXW cites that ICE funding over the past 15-years and 3 different administrations has “either been flat or has grown.”  

“…again, you've got 3 different administrations, and you've had multiple changes in leadership, both on the House and the Senate side. So we think that indicator is probably a pretty good sign of kind of regardless of what the outcome here of this week's election, ICE mentioned is they have a need for capacity, they rely on the private sector or local facilities, and funding has been either stable or has grown over the last 15 years. And we have constantly shown not only a high-quality solution in strategic locations, but also we've continued to apply and advocate that ICE continue to raise the standards, have appropriate oversight so all these different reforms and improvement in standards and quality of operations we've advocated for, and we've met the bar.” (emphasis added)

CXW also appears to have a bit of a moat around its business:

“Our facilities meet what they call the performance-based national detention standards that the alternative in a public sector facility, where they house them in county jails, just oftentimes cannot meet those facilities because of physical plant limitations. So where our facilities, our newer facilities, they meet all of those standards. In many cases, the alternative use in a public sector facility just can't meet those standards because of the physical plan. And then last point…I'd make is, many of our facilities also have courts within the facilities.And…we have hundreds -- literally hundreds of ICE officials that when they get up in the morning, they report to their place of work. It's at one of our facilities that -- in the case where they have courts, is an extremely efficient -- much more efficient use of the space when -- as opposed to having to round them up from county jails and get them to court. So a lot of critical needs we provide within our real estate that's very challenging to replicate. (emphasis added)

*****

A concern for any debt-laden company with contracted revenue is how quickly the business is able to replace contract churn with newly signed business. While revenue in Q2 and Q3 2020 was primarily lower due to COVID-19 accelerating the reduction in inmate populations, CoreCivic had several facilities moved to “idle” status as states struggled to manage their prison budgets. So far, CXW management appears to be on top of the situation.

During Q320, CXW and the State of Oklahoma agreed to idle the 1,692-bed Cimarron Correctional Facility and the 390-bed Tulsa Transitional Center However, on its earnings call, CXW’s management highlighted three new contracts representing the potential for an incremental utilization of approximately 3,000 beds. The Cimarron Correctional Facility in Oklahoma, the 1,896-bed Saguaro Correctional Facility in Idaho, and the 289-bed Turley Residential Center in Tulsa all entered into new contracts with various government agencies, while utilization at the 494-bed Reentry Opportunity Center in Oklahoma City was projected to increase.

While reduced inmate population in recent quarters has been a key risk to CXW’s underlying business, commentary on the earnings calls suggests some of these contracts were below historic operating margins, and this new incremental business “approximates the average CoreCivic safety operating margin” with potential for upside as utilization scales.

The other key concern for CoreCivic is managing its debt stack. CXW’s largest maturity wall is 2023, where more than half of its funded debt comes due. Per the company’s Q320 earnings call, management is focused on debt paydown:

Damon Hininger, CEO of CoreCivic:

“Last quarter, we announced our intention to revoke our election as a real estate investment trust or REIT and convert to a taxable C corporation effective January 1, 2021. Revoking our REIT election provides us much more flexibility in how we allocate our substantial free cash flow. This was evident in our third quarter because we were able to allocate $107.2 million of net cash provided by operating activities in the quarter to debt reduction. We're paying over $100 million of net debt during the quarter, bringing our total recourse debt net of cash down to approximately $1.4 billion. We believe continued on this path of prioritizing debt reduction with a target total leverage of 2.25x to 2.75x will meaningfully improve our overall credit profile and lower our cost of capital.” (emphasis added)

While public outcry and renewed government efforts to shut down private prisons may rattle the cages, it doesn’t appear like CoreCivic’s business is going away anytime soon. CoreCivic reports its Q420 earnings at market close on February 10, 2020. We anticipate the market will be particularly focused on management’s commentary on the first few days of the Biden Administration, as well as any new contract wins or inroads.

💥Tupperware Update: More than 'A Good Quarter'💥

⚡️Update: Tupperware Brands Corp. ($TUP)⚡️

In last Wednesday’s “💥 Royal Caribbean Collapses. Tupperware Thrives. Friendly's Melts.💥,” we provided a brief update on the Tupperware Brands Corp. ($TUP) situation, highlighting how the company has been a clear-cut beneficiary of COVID-19.  Profit quadrupled to $34.4mm in the company’s most recent quarter and equity that hovered around $1/share back in March jumped to the high 20s (and even breached $30/share) after the earnings announcement. This is an astounding rebound for a company that, back in February, was i) operating with an interim CEO, ii) struggling in a variety of geographies including Brazil, China, Canada and the US, iii) dealing with accounting issues, and iv) badly missing revenue, EPS, and cash flow targets. On Wednesday, we credited the pandemic with the turn-around. But there was more to the story. A lot more.

In April 2020, Tupperware Brands announced weak Q120 earnings, with sales down -23% YoY and FCF burn of roughly $55mm in the quarter. Already struggling due to changing consumer habits and now also contending with coronavirus lockdowns, management elected to pull their FY20 guidance and increased their previously announced cost reduction target to $75mm (up 50%). But the company needed to do more:  

“[Tupperware Brands]…amended its Credit Agreement during [Q120] and agreed to changes to the permitted debt to Adjusted EBITDA ratio, which increases to 5.75 for the first and second quarter of 2020, tightening to 5.25 in the third quarter of 2020, and again decreasing to 4.50 in the fourth quarter…”

For the uninitiated, an increased EBITDA ratio gives a company additional breathing room in a situation like this one where debt (usually) remains static in the face of dramatically decreasing sales and FCF declines. The relief, however, clearly contemplated that the company’s COVID-related problems would be short-lived as the ratio ratcheted down meaningfully in subsequent quarters. Management’s feet were to the fire.

But they had levers to pull:

The Company has taken certain measures in response to the COVID-19 situation, designed to enhance its liquidity position, provide additional financial flexibility and maintain forecasted financial covenant compliance, including reductions in discretionary spending, revisiting investment strategies, and reducing payroll costs, including through organizational redesign, employee furloughs and permanent reductions. Additionally…on March 30, 2020, the Company drew down $225 million under its Credit Agreement, $175 million of which was drawn as a proactive measure given the uncertain environment resulting from the COVID-19 pandemic. In addition, the Company has approximately $600 million of Senior Notes outstanding with a maturity date of June 2021 and is proactively working with advisors to evaluate its options relative to this maturity. (emphasis added)

Tupperware’s $600mm 4.75% Senior Notes due June 2021 were increasingly becoming a problem for the company. Given the rapidly declining earnings and elevated leverage, junior bondholders were (understandably) concerned how their principal might get paid. The trading price on the bonds reflected those concerns, with the notes trading well into distressed territory at below 50 cents on the dollar.

This is where the governing credit docs had a role to play. Tupperware realized an alternative “use of proceeds” for its revolver draw: under the credit agreement, the company could use the monies to permissibly tender the market for an early redemption of the outstanding notes. Per the WSJ:

The publicly listed company launched on May 26 an offer to repurchase at a deep discount about one-third of a $600 million bond that falls due a year from now. The strategy is to ease financial pressure on the company, increasing its chances of repaying the bond on time and helping it meet guidelines for its various bank loans, a person familiar with the matter said.

Tupperware offered to buy back $175 million face amount of the debt at a price of 45 cents on the dollar and gave bond investors a June 22 deadline to take part in the deal. If it achieves full participation, the company would spend about $79 million to retire the debt early.

But the company didn’t stop there. It subsequently launched a second tender to take out even more of the notes. When all was said and done, the company (a) struck a deal with a large percentage of its disillusioned junior creditors for cents on the dollar, (b) deleveraged the balance sheet by $220mm of debt principal for only $164mm of (the revolving lenders’) cash, and (c) prevented any equity dilution (including, of course, that held by management). Significantly, this maneuver also cured the company of a potentially serious financial maintenance covenant issue. Talk about “robbing Peter to pay Paul”!

Consider: if the revolver lenders had their way, the company would have engaged in a full-blown restructuring pursuant to which the bondholders would be forced to swap their bonds for equity and wipe out the equity. The company would come out with less leverage and, in turn, lower interest expense. This would obviously lower the risk profile. But even better, the banks could have used the restructuring to provide a DIP and ultimately slither into a much higher yielding piece of exit paper. Alas, not.

Having survived their covenant concerns, Tupperware approached its remaining junior bondholders. Those noteholders, who had not cashed out their bonds in the prior two tenders had organized with their own advisors, and were attempting to use the upcoming maturity and their holdout status as a negotiating ploy to exchange into structurally senior, high coupon rescue financing. We don’t know all the details of those negotiations, but given most COVID-driven rescue financing deals are somewhere in the 12-15% area, we imagine it would have been a very expensive deal for Tupperware.

But then the company cancelled those negotiations! Performance saved them. As we noted on Wednesday, the company reported absolute blowout Q3 earnings, with sales up 14% (up 21% in local currency), $60mm of positive FCF, and commentary that Tupperware had realized 2/3, or $120mm of its $180mm cost-reduction target. Management also entered into a binding commitment for a sale leaseback of its corporate HQ for $86mm, further improving liquidity. Tupperware’s newly minted CEO Miguel Fernandez provided his thoughts on the stellar quarter:

“The 21 percent growth in local currency revenue reported today reflects a rapid adoption of digital tools by our sales force to combat the social restrictions surrounding COVID-19, and the increased consumer demand for our innovative and environmentally friendly products, as more consumers cook at home and are concerned with food safety and storage…The improved performance of both top and bottom line these past two quarters are a positive sign that our Turnaround Plan is working.”

CFO Sandra Harris’ comments indicated the company wasn’t stopping there:

“We are pleased with the rate of improvement in right sizing the business, improving our liquidity and making permanent structural changes that will ensure the success of our Turnaround Plan…These efforts, including sales of non-core assets, will help us continue to improve the health of our balance sheet as we pursue the refinancing of [the remainder of their] June 2021 obligations.”

On Monday, November 2nd, while we at PETITION were fretting over the possibility of an election-induced civil war, Tupperware came to market with a refinancing of its remaining junior 2021 bonds. The company entered into a commitment letter with Angelo, Gordon & Co., L.P. and JP Morgan Strategic Situations Initiatives for a two tranche secured term loan facility, consisting of a $200mm “Parent Term Loan” facility and a $75mm “Dart Term Loan facility.” Based on the commitment papers, the new loans are priced at 7.75%, but future interest rate is determined on a leverage-based grid. The loans can step down to L + 7.25% if leverage is below 2.75x, or step up to L + 8.75% if leverage is above 2.75x. Use of proceeds of the new loans will be used to fully repay the junior 2021 notes.

The market has certainly rewarded new management for their efforts ⬇️.

In “💥Oaktree's Howard Marks: "I don't think of it as 'screwing'"💥,” we highlighted the TriMark USA situation, quipping “Long Creditor-on-Creditor Violence”. We subsequently discussed the theme in the ongoing adventures of Revlon Inc. ($REV). Here, though, instead of senior creditors getting primed by structurally senior debt, the company and its consenting bondholders inflicted violence – TupperWAR, if you will -- on the revolving banks.

You gotta love restructuring!

🍿Hollywood Fails, Theater Operators Quiver (Short Movie Magic)🍿

Will Theater Pain Hurt National CineMedia Inc.?

If reality followed fiction, President Trump’s assertion that COVID-19 would magically disappear would come true at the waving of a wand. Unfortunately, magic doesn’t exist outside of the cinema and, lately, it doesn’t exist inside the cinema either.

The good news? Approximately 70% of US movie theaters are back open.

The bad news? They’re open in zombie form, key markets like NYC and LA remain shuttered, and theaters don’t exactly have a ton of inventory to exhibit. Those theaters that are open couldn’t max out revenue if they wanted to as safety restrictions include, among other things, staggered seating. And so you’ve got the same formula for theater operators as that afflicting gym operators: little-to-no revenue and increasing operating expense. AMC Entertainment Holdings, Inc. ($AMC), Cinemark Holdings, Inc. ($CNK), and Regal owner Cineworld Group plc ($CINE) are feeling it; they find themselves stuck between the government shutdowns, the COVID-19 induced movie delays and, to add insult to injury, the forced acceleration of "alternative delivery methods" that will compete on the supply side. Studios are leveraging studio weakness to better position themselves for the future too: Universal Pictures secured a smaller theatrical window so it could stream titles via its on-demand platforms earlier than they’ve historically been able to. All of this creates the perfect storm for theaters.  

Looking for a reprieve from the deluge of bad news, operators eagerly awaited the long-postponed US release of Christopher Nolan’s “Tenet.” Nolan is among, if not the, most popular directors in Hollywood today. Operators hoped that people looking to return to some form of normalcy would be jacked up to see his latest mind f*ck. Like Tom Cruise was. And Casey Neistat. And this guy who bought out an entire theater. Unfortunately, for the studio and for theaters, the film’s results were lukewarm at best. 

Hollywood execs are acting accordingly…

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💥PETITION's Hot Take And Potentially Regrettable Statement on Hertz' Shenanigans💥

On May 26, 2020, Hertz Global Holdings Inc. ($HTZ) and a number of affiliates filed massive chapter 11 bankruptcy cases. The company’s publicly-traded stock dropped to $0.56/share. Thereafter, the stock inexplicably started to rise. On Thursday June 4, HTZ stock experienced a sudden and mysterious surge that had everyone who knows anything about chapter 11, the absolute priority rule, and the typical bankruptcy treatment of equity (read: it typically gets wiped out) a bit befuddled. The surge continued through the beginning of this week — reaching as high as $5.53/share on Monday, June 8th. The Twitterverse, in particular, went apesh*t as Dave Portnoy and other gamblers … uh, investors … took aim at HTZ and several other cheap stocks on the (un)sound (un)fundamental basis of their … well, cheapness.

Most folks could predict that it wouldn’t end well. After all, HTZ is, to state the obvious, BANKRUPT!, its debt trades like dogsh*t and its equity is currently the subject of a delisting notice. Still, folks like Jim Cramer and Josh Brown all but encouraged the behavior, back-handedly claiming that it’s a good “learning opportunity” for these (predominantly new) market participants. As of market close on June 11, the stock has fallen back down to earth, trading at $2.06/share leaving many a now-learned investor in its wake.

Still, one’s foolishness is another’s opportunity.

In a motion filed June 11 (along with a complementary motion seeking shortened notice and an emergency hearing), the HTZ debtors seek authority to enter into a sale agreement with Jefferies LLC to issue up to and including 246,775,008 shares of common stock through at-the-market transactions under HTZ’s existing shelf-registration — a move designed “to capture the potential value of unissued Hertz shares for the benefit of the Debtors’ estates.” The debtors opportunistically note:

The recent market prices of and the trading volumes in Hertz’s common stock potentially present a unique opportunity for the Debtors to raise capital on terms that are far superior to any debtor-in-possession financing. If successful, Hertz could potentially offer up to and including an aggregate of $1.0 billion of common stock, the net proceeds of which would be available for general working capital purposes. Unlike typical debtor-in-possession financing, the common stock issuance would not impose restrictive covenants on the Debtors and would not impair any of the creditors of the Debtors. Moreover, the stock issuance would carry no repayment obligations, and the Debtors would not pay any interest or fees to those who provide the funding by buying shares at the market. Hertz would include disclosure in any prospectus used to offer common stock highlighting that an investment in Hertz’s common stock entails significant risks, including the risk that the common stock could ultimately be worthless. (emphasis added).

Congratulations people. The very folks that Cramer and Brown talked about have been marked as fools. And people erupted:

Who says innovation is dead 🇺🇸🇺🇸🇺🇸 pic.twitter.com/IZpUuoPTvv

— modest proposal (@modestproposal1) June 12, 2020

I haven't yet truly comprehended the words that @beckyyerak put to paper on $HTZ but here they are.
https://t.co/eaOK3umODm

— Charley Grant (@CGrantWSJ) June 11, 2020

They should do an offering exclusively on Robinhood pic.twitter.com/LxHr9J98u2

— Hipster (@Hipster_Trader) June 11, 2020

Today: "Bankruptcy could wipe out Hertz stock, but the car-rental company is looking to sell up to $1 billion in shares"

Me last week: https://t.co/nJaAuWmOIG

— Barbarian Capital (@BarbarianCap) June 12, 2020

Our inbox immediately flooded with messages reflecting incredulousness and lost faith in humanity. We get it. This is next level sh*t right here. Dumb motherf*ckers are about to get taken advantage of.*

But you know what? Maybe we just want to be contrarian, but we are impressed with this move.** Look, for the last week the market has been awash with commentary about how nothing makes sense anymore and how “the Fed put” has introduced all kinds of bubble-like behavior. Idiots off of Robinhood have been (maybe) getting rich off of $HTZ stock and $CHK stock and $WLL stock while legends like Ray Dalio, Stanley Druckenmiller and Warren Buffett are eating sh*t. Like…this actually happened:

I’m sure Warren Buffett is a great guy but when it comes to stocks he’s washed up. I’m the captain now. #DDTG pic.twitter.com/WqMR89c7kt

— Dave Portnoy (@stoolpresidente) June 9, 2020

Proponents of efficient markets have been apoplectic. None of this makes any sense to them. For good reason.

But you know what does make sense? Basic supply and demand. And if there is enough demand for something as asinine as acquiring a portfolio of HTZ stock and HTZ alone can quench that demand, why wouldn’t and shouldn’t it issue those shares? Isn’t that efficient markets playing out in their harshest and most savage form? Isn’t it more efficient for the debtors to issue more stock than pay some usurious coupon on a DIP credit facility? Why get ripped off by lenders when you can rip off aspirational equityholders?

The HTZ debtors have a duty to maximize the value of their estates.*** To use or sell property of the estate, the debtors merely need to show that the use/sale is an exercise of sound business judgment. They write:

Here, the decision to enter into the Sale Agreement and to sell unissued shares of Hertz’s common stock is an exercise of the Debtors’ sound business judgment. The rise in the trading price of Hertz’s shares indicates that the market believes that the shares have significant value. The proposed sale of Hertz’s unissued shares would allow the Company to raise up to and including $1.0 billion in gross proceeds, the net proceeds of which the Debtors could use general working capital purposes. The sale would also allow the Debtors to raise capital on terms superior to any debtor-in-possession financing. The stock issuance would not impose restrictive covenants on the Debtors and would be junior to claims of the Debtors’ creditors. Moreover, other than the 3.0% fee that would be owed to Jefferies and related transactional costs, the issuance of the shares would impose no payment or repayment obligations on the Debtors. (emphasis added).

Do the debtors have some sort of duty to those prospective shareholders that are about to get dragged over the tracks? Do the debtors need to be concerned about the business judgment of the morons on the other side of the transaction?**** Does a prospectus describing the dangers eliminate any and all responsibility here? The debtors are clearly of the view that the answers are ‘no’ and ‘yes,’ respectively.

Notably, Jefferies ain’t no fool. In addition to getting 3% of the gross proceeds of any shares that are sold through the proposed ATM program, they’ll get a crucial indemnity from HTZ “…based upon or otherwise related to or arising out of or in connection with Jefferies’ participation, services or performance under the Sale Agreement or the sale of shares or the offering contemplated hereby, provided that the Company shall not be liable to the extent a court determines a claim resulted directly from Jefferies’ gross negligence or willful misconduct.” Moreover:

The Company will also agree to reimburse Jefferies for any and all expenses reasonably incurred by Jefferies in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action.

Jefferies saw the equity price action this week and be like…

…and immediately dusted off that same ATM pitch they’ve used in plenty of other situations. In the process, they make no mistake about it: they know they’re about to get dragged in some mud.

And so where does this leave us? It’s not a bankruptcy court’s jurisdiction to protect the Robinhood bros. They’re not parties in interest in the cases. The debtors will likely get authority pursuant to their motion and Jefferies will try and push shares into the market and, in turn, the market will prove whether there’s continued demand. If there’s more demand, the debtors will then have an option to sell more shares on the basis of that demand.*****

As to whether there is some mysterious way that the equity ultimately has value in the future? Not to cop out on the question but we simply don’t have enough information to opine on that. Likely, neither do the debtors. Nor the Robinhood traders. Will travel recover? Will the used car market sh*t the bed? In a pandemic, anything goes. And that’s the point of the debtors’ motion and precisely why, all the furor notwithstanding, it actually makes sound business sense for them to move forward with it.

A hearing on the motion is scheduled for tomorrow, June 12th, at 3pm ET. Pop your popcorn.

---

*Meanwhile, some HTZ directors are laughing their asses off after hitting the top right on the head:

meanwhile... two $HTZ directors hit the bid on Monday... open mkt sales pic.twitter.com/diYsmC6PuU

— Barbarian Capital (@BarbarianCap) June 12, 2020

**We fully acknowledge that we may regret this hot take at a later time.

***The debtors actually argue that, pursuant to certain case law, unissued shares may note even constitute property of the estate. They seek approval pursuant to this motion “out of an abundance of caution.”

****This assumes the debtors are actually insolvent. Remember: this case basically came out of nowhere thanks to COVID and what, in form, was a margin call.

*****The process leaves a lot of latitude:

From time to time, the Company may submit orders to Jefferies relating to the shares of common stock to be sold through Jefferies, which orders may specify any price, time or size limitations relating to any particular sale. The Company may instruct Jefferies not to sell shares of common stock if the sales cannot be effected at or above a price designated by the Company in any such instruction. The Company or Jefferies may suspend the offering of shares of common stock by notifying the other party.

✈️ Airlines, Airlines, Airlines ✈️

The Airline Bailout Debate Will Rage On

Over the last several weeks there has been a significant amount of discussion across the United States about the financial condition of the major airlines post-COVID-19 and whether and when air travel will resume in earnest. In parallel, there has also been fervent debate as to whether government assistance ought to be available to the airlines and, if so, what conditions ought to be attached (if any). One view against — that of Chamath Palihapitiya — went viral and sparked widespread debate that placed people firmly in one of two camps. That camp — the “f+ck the airlines and f+ck bailouts” camp, urged the federal government to let free markets be free markets, regardless of whether that might mean a wave of bankruptcies. On the other side, there are folks who think that, given the extraordinary externalities at play — including, significantly, worldwide government-mandated shutdowns — fairness dictates that the airlines ought to be given a lifeline to avoid costly and drawn out bankruptcy processes that will ultimately destroy a lot of value and potentially result in meaningful job losses. After all, a deal around a plan of reorganization and eventual emergence from bankruptcy requires some ability to determine a “fulcrum security.” Good luck doing doing that in this unprecedented environment.

Bankruptcy in normal circumstances is highly contentious, expensive and litigious. Suggesting that we wipe equity and save jobs sounds great in principle but in reality it’s Pollyanna. Everything is contingent upon where the value breaks which can’t be determined expeditiously

— Post M. (@Post_Market) April 13, 2020

Let’s make a bet. $1.

b/c of the Fed’s actions:

My side: Company’s won’t go bk now b/c of Fed. Will promise to keep employees but will fire them anyways. Will still go bk b/c revenues don’t reappear and credit still gets repriced in a few Qs after more bad news.

Your side?

— Chamath Palihapitiya (@chamath) April 13, 2020

For now the debate is moot. The United States government agreed to provide assistance with the understanding that jobs would be preserved. Much of this money has no strings attached:

So, to be clear: $DAL is going to get 77% grant, 23% low-interest loan and only give the federal government a nominal amount of warrants? Now THAT is the art of the deal. https://t.co/XTFdfrUike pic.twitter.com/U7OYK1lXC6

— 💥PETITION💥 (@petition) April 15, 2020

Similarly, United Airlines Inc. ($UAL) obtained $5b through the CARES Act split between $3.5b of direct grants and $1.5b of low interest loans. United noted at the time:

These funds secured from the U.S. Treasury Department will be used to pay for the salaries and benefits of tens of thousands of United Airlines employees. In connection with the Payroll Support Program, the airline's parent company also expects to issue warrants to purchase approximately 4.6 million shares of UAL common stock to the federal government.

Airlines are cash burning machines. No doubt, these funds are critical. To help matters further, certain airlines tapped the capital markets — some, like Delta Airlines Inc. ($DAL), successfully and others, like United, unsuccessfully. Per Bloomberg:

United Airlines Holdings Inc. abandoned a $2.25 billion sale of junk bonds because it wasn’t satisfied with the terms, said people familiar with the transaction.

The airline ultimately reached a deal but decided to pull it to seek more favorable terms and potentially a different structure later, said one of the people, who asked not to be named discussing a private transaction. The offering fell flat with investors on concerns about the planes backing the debt.

Enticed by the hot market for junk bonds, United had been planning to use the new debt to refinance a $2 billion one-year term loan that the company signed with a group of four banks on March 9. At a yield of 11% based on unofficial price discussions, the potential interest rate was significantly higher than that on the loan, which pays a rate of as much as 2.5 percentage points above the London interbank offered rate over the course of the year.

Whoops.

But that wasn’t the only news that United made last week. Per Barron’s:

United said Monday that it expected to cut its management staff by at least 30%, starting in October, according to a memo sent to employees. The cuts amount to about 3,450 workers. United is receiving $5 billion in payroll support under the government’s Cares Act program, which includes restrictions on compensation and layoffs. But the money doesn’t cover payrolls entirely and it will run out in September, giving United more flexibility to reduce its workforce.

Even with government support, “we anticipate spending billions of dollars more than we take in for the next several months, while continuing to employ 100% of our workforce,” United’s chief operating officer, Greg Hart, said in a memo to workers. “That’s not sustainable for any company.”

Moreover, news surfaced that United was effectively downgrading the status of its employees, circumventing the spirit of the CARES Act. This set a bunch of people off:

My letter to @united airlines CEO. Congress gave you money to pay your workers. So pay them. No tricks, no excuses pic.twitter.com/ZZ6OWgcXpu

— Josh Hawley (@HawleyMO) May 2, 2020

Here is crypto enthusiast Anthony Pompliano bemoaning this series of events (which, coming from a crypto fanboy, implies a certain level of government distrust to begin with):

At the end of the day, we are now seeing the downsides to bailing out corporations. A bailout is really the government trying to prevent a natural market correction. If they didn’t intervene, United Airlines would file for bankruptcy protection and the assets / equity would be bought by new ownership. That transition would hopefully land the company in better hands that would be better prepared in the future. This is the risk that equity holders take. By not allowing this natural market function to occur though, the government is changing the risk-reward framework for equity owners and actually incentivizing bad behavior.

We should have let the airlines fail, rather than bail them out and now force me to write this letter today about all the dumb and nefarious things that the companies are doing. The US government has a “God-complex” when it comes to the markets. They think they can do no wrong and they believe that they can solve any problem by interfering. The issue is that they are actually making the situation worse. They are preventing a free market from going through the natural cycle. The allure of a short term bandaid actually drives a much larger, long-term problem.

United Airlines should be forced to give the money back if they cut workers hours.

What Mr. Pompliano says should have happened in the US is EXACTLY what is happening in many other parts of the world.

*****

Like Colombia for instance. Per its recently filed bankruptcy papers, Avianca Holdings S.A. is “…the second largest airline group in Latin America and the most important carrier in the Republic of Colombia and in the Republic of El Salvador.” It is the largest airline in Colombia and is one of 26 members in the Star Alliance (along with United), the world’s largest global airline alliance. Its history goes back 100 years; it generates $3.9b of annual revenues and employs 21.5k people; and it, like many of the US-based airlines, was perfectly healthy prior to COVID-19 halting worldwide air travel. Despite “…Avianca’s importance to the Colombian domestic air transportation market…” and while “…the Debtors anticipate that the Republic of Colombia may be one of the key stakeholders in the Debtors’ restructuring efforts…,” no government stepped up to bail Avianca out. Hence the chapter 11 bankruptcy petition it (and its debtor affiliates, the “debtors”) filed on Sunday. No government. Not Colombia. Nor the Republics of El Salvador, Ecuador or Peru.

The debtors required the chapter 11 filing to preserve its cash in a non-operating environment; they have $275mm of unsecured trade payables and a boat load of debt secured up by all kinds of stuff — from credit card receivables to aircraft. The debtors incurred the debt in an effort to expand capacity in an increasingly competitive space beset by low cost carriers nibbling away at market share. One of the lenders? United Airlines. How poetic!

Back to the aircraft. Given what travel trends are likely to be and new aircrafts that the debtors are contractually on the hook for, it stands to reason that the debtors will use the bankruptcy to reject a number of aircraft lease agreements in addition to addressing their balance sheet. The market is about to be flush with planes for sale. Query what new airline may rise from the ashes.

Luckily, the debtors have a meaningful amount of unrestricted cash to fund their cases and so, at least for now, they’re not seeking a DIP credit facility. That may change, however, if the travel environment doesn’t improve and the cases drag on. Which they very well may given the uncertainty in the markets and the very real possibility that air travel doesn’t recover. Notably, tourism is a major driver of Avianca’s traffic. Something tells us that there aren’t a whole lot of people planning extensive getaways to Bogota at the moment. 🤔

This will be an interesting test case for a lot of other airlines that, unlike the US-based airlines, aren’t lucky enough to receive governmental intervention.

*****

Which “other airlines”? For starters, we know that Virgin Australia entered voluntary administration in Australia two weeks ago after the Australian government declined Virgin’s entreaties for a $888mm loan.

There will be others. Here is Bloomberg suggesting that, due to sovereign issues throughout Latin America, other Latin American airlines are in trouble. In the piece published before Avianca’s chapter 11 filing, they noted:

But while just about everyone agrees it will be up to governments to help save the industry, there’s a disconnect between what’s needed and what nations can -- or even want to -- do. Brazil and Colombia seem willing to step up; Mexico and Chile don’t. Latin America was already the lowest-growth major region in the world and budgets were stretched thin even before oil collapsed and the coronavirus crippled the global economy.

As we now know, Colombia didn’t step up. Which leaves Latin America’s other air carriers in a bad spot, including Latam Airlines Group SA (the finance unit of which has debt bid in the 30s and 40s), Gol Linhas Aereas Inteligentes SA ($GOL)(the finance unit of which has debt bid in the low 40s), and Aerovías de México SA de CV (Aeromexico)(which has debt bid in the 30s). Will one of these be one of the next airlines in bankruptcy court?

*****

The US isn’t the only country to entertain bailouts of airlines. In mid-March, Norway offered 6 billion Norwegian crown ($537mm) credit guarantees to Norwegian Air Shuttle SA ($NWARF). There are strings attached, though. Reuters noted:

To receive the full 3 billion, the company must first persuade creditors to postpone installment payments for loans and forego interest payments for three months.

DNB Markets analyst Ole Martin Westgaard said in a note the package was likely too small, calculating that it would only cover the total cost of grounding all Norwegian Air aircraft for one-and-a-half months.

“We are doubtful the company will be able to attract any interest from a commercial bank at interest rates that would make sense,” Westgaard said.

It is struggling to get it done. In late April, Bloomberg reported:

Norwegian Air Shuttle ASA, the low-cost carrier fighting to qualify for a bailout, presented a plan to relieve part of its heavy debt burden that would largely wipe out existing shareholders and warned most flights would stay grounded until next year.

The airline is racing against the clock to meet terms set by Norway to access the bulk of a 3 billion-krone ($283 million) package in loan guarantees. With most of its fleet grounded, the company has proposed a debt restructuring and capital increase by mid-May that would unlocking [sic] the cash it needs to survive the coronavirus crisis.

The company has debt bid in the low 20s as it attempts to address its conundrum.

*****

On Tuesday, Boeing Corporation ($BA) CEO Dave Calhoun came out blazing. Per Bloomberg:

Boeing Co.’s top executive sees a rocky road ahead for U.S. airlines, saying it’s probable that a major carrier will go out of business as the Covid-19 pandemic keeps passengers off planes.

The recovery is going to be slow, with air traffic languishing at depressed levels for months, Boeing Chief Executive Officer Dave Calhoun said in an interview to be aired Tuesday on NBC. Asked by ‘Today’ show host Savannah Guthrie if a major airline might have to fold, Calhoun replied, “Yes, most likely.” (emphasis added)

Take cover y’all. He continued:

“Something will happen when September comes around,” Calhoun added, referring to the month when the U.S. government’s payroll aid to the airline industry expires. “Traffic levels will not be back to 100%. They won’t even be back to 25%. Maybe by the end of the year we approach 50%. So there will definitely be adjustments that have to be made on the part of the airlines.”

If this happens, the sh*t storm that will be sure to unfurl from those who were anti-bailout will be hard to contend with (though there is something to be said for buying time to make a bankruptcy more “orderly”). The warrants the government received in exchange for the billions of dollars will become worthless exposing them for the mere window dressing they obviously were. Why didn’t the government take a more aggressive approach that both assisted the airlines and shunned moral hazard? Why didn’t it pursue a General Motors-style transaction and serve as effective DIP lender to the airlines in bankruptcy? These are questions that are sure to re-emerge.

*****

When all is said and done, we’re going to have a number of different data points to determine which approach was best. For the next several months, however, the question will remain salient all over the world: to bailout or not to bailout?