Mmmmm...Food

The media is feeding us a confusing narrative.  

On one hand, restaurants should be benefiting from recent low gas prices and food deflation - with meat, chicken, and egg prices, in particular, depressed.  

Depressed food prices are not inuring to the benefit of restaurants...or grocers.

One the other hand, we've seen that restaurant chains are suffering from increased rent, healthcare and employment costs and, thus, more than a dozen restaurants have filed for Chapter 11 or 7 this year alone. While there are some outliers, e.g., Olive Garden, traffic at restaurants has fallen in 10 of the last 11 months (this includes the once-hyped fast casual segment, which is experiencing a customer count decline so far in 2016). And a U.S. Labor Department regulation increasing overtime pay for managers may still take effect and potentially make matters worse - despite a recent 11th hour injunction issued by a Texas District Court judge halting, at least temporarily, the December 1 effective date. 

Some argue that grocers are benefitting from the restaurants' pain. Are they? The numbers reflect that grocers' margins and stock prices are also taking a hit from this wave of food deflation. A number of publicly-traded grocers like Sprouts Farmers Market, Smart & Final Stores Inc., and Kroger Co. have lowered full-year '16 guidance. WholeFoods reported its first annual comparable sales decline since 2009. Randalls, Jewel-Osco, H-E-B, Albertsons and even WholeFoods are slashing prices like crazy in a race to the bottom. And others have fallen victim to bankruptcy - A&P (the second time), Fresh & Easy (the second time), Haggen, Fairway, Garden of Eden - or been bailed out.

Much of this is just natural competition. Discounters like Family Dollar and big box stores like Target and Walmart are sacrificing margin in exchange for foot traffic. Indeed, Dollar General reported lower comp-store sales this week and a 10% decrease in its bottom line (and initiated a wholesale marketing process of various rental properties). WholeFoods and KMart are aiming to offer food to lower scale markets. Amazon Fresh, Munchery, Maple, Blue Apron, Zakara Life, Caviar (owned by Square and on the market), Hello Fresh, UberEats, and a seemingly endless array of other app-based food distribution and/or delivery services are also complicating matters. With free introductory experiences, consumers can have at least a week's worth of food subsidized by Silicon Valley: this isn't helping grocers in major markets.

What does this all mean in the end? For starters, we are likely to see continued stress and distress in both the restaurant and grocery space. As we get there, there will likely be job losses  - at the highest levels of management and beyond - and additional technological advancement.  Touchscreens are likely to proliferate and, where possible, broader-based automation deployed. To point, McDonalds this week announced the launch of its touchscreen self-service ordering kiosks in its 14,000 locations. While MCD's CEO Steve Easterbrook indicated that this would not reduce costs/jobs - merely alter them - do we really believe that? So he proposes to pay workers more to effectively do less? Not with Eatsas of the world expanding - now at 5 locations. 

The space has come a long way and there are more drastic changes in store.

We Have a Feasibility Problem

We're thankful this week for Judge Sonchi's decision last week in the Paragon Offshore bankruptcy cases. The decision was more than just a victory for the company's term loan lenders: it was a much-needed warning signal to the restructuring industry. 

First, a quick synopsis of the opinion. In short, Judge Sonchi sustained most, but not all, of the term lenders objections on the basis that the Debtors' (i) deployed unrealistic rig utilization and day rate assumptions and (ii) failed to take into consideration macro considerations that would affect the Debtors' eventual ability to refinance debt upon maturity in 2021 (if they didn't run out of cash before then). 

With respect to the former, the opinion underscores some dire trends (particularly provided correlations: rig supply up + price of oil down = dayrates down). Some highlights:

• "E&P companies are currently seeking to drive excessive costs out of the supply chain and are working to sustain this reduced cost environment to avoid over-inflation and 'boom and bust principle' that has been seen in recent years and in the current cycle." (emphasis added)
• "This 'vast oversupply' of rigs is creating a 'challenging commodity price environment' that is expected to last at least an additional 3.2 years...." (emphasis added)
• "The oversupply of rigs is 'historical' even excluding newbuild rigs; and the only prior comparable downturn occurred in 1986, which had less of an overhang and did not have the additional newbuild overhang." (emphasis added)

Clearly, this is no bueno for revenue/EBITDA go-forward. Accordingly, an investment banker performing an analysis maybe ought to consider all publicly available resources to configure proper assumptions. Clearly, that didn't happen here and Judge Sonchi made it known. The term lenders' expert testified that, with respect to ongoing projected flat day rates, there wasn't "a single analyst that took a contrary view." But the Managing Director for the Debtors did. Curious.

Regarding the latter refinancing point, the Judge highlighted that "$110 billion of debt associated with severely strained oilfield services and drilling (OFS) companies will mature or expire over the next five years" - hitting RIGHT at the time Paragon would need to tap the capital markets. $110 BILLION. The Debtors' banker explained this massive number away by indicating that there is a $1 trillion E&P market and financing, therefore, would be available. The Judge demurred - calling the analysis "superficial" - and agreed with the term lenders' expert that (a) the market for "asset-based" lending for drilling companies generally is smaller and more specialized and (b) the historical capital used to support the market is no longer as prevalent as it was in previous cycles. Indeed, as this Bloomberg piece notes, fears about refinancing are starting to gain traction in the market.

Putting aside the specifics of this case, the decision is important for another reason: it highlights the importance of feasibility. Now, granted, the term lenders had to object for Sonchi to arrive at his conclusion in Paragon but there is an increasing likelihood of Judges scrutinizing feasibility. This Fox Business piece notes, "Some critics say bankruptcy judges too often focus on hammering out an agreement without paying enough attention to companies' chances of long-term survival." Will this continue?

Maybe we need Judges to be activists and save us from ourselves. Deals are being cut, sure, but are they for the right reasons? Are they cut to ensure the viability of the companies underneath capital structures or to uphold "castles in the air" theory and line the pockets of distressed investors? Hard to say: seemingly, these deals aren't doing them any favors either. Without greater transparency to the markets, it's hard to know.

Here's what we do know. In the last several years, there have been a number of repeat restructurings: American Apparel LLC. Global Geophysical Services LLC. Hercules Offshore Inc. Essar Steel Algoma Inc. Fresh and Easy. A&P. Sbarro LLC. Revel Casino. Catalyst Paper. Perhaps we all -- judges included -- ought to ask ourselves why that might be.

Comeback Kids

Everyone loves a comeback. And Weil is most definitely back.

Post-Lehman and GM, Weil settled into a notable rut as Kirkland & Ellis and others stole market share and preeminence in the restructuring world. Though Kirkland & Ellis arguably remains the dominant player in the industry, Weil is swiftly climbing back up the ranks. How have they done it?

We're going to stay away from crediting any specific individuals here because it is difficult to say what is outside deal flow origination and what is platform-based. 

But one thing is clear: Weil has diversified its practice. Sure, debtor work - across an array of industries - remains its bread and butter and debtor work abounds: Golfsmith, Aeropostale Inc., Breitburn Energy Partners, Fairway, Halcon Resources, Basic Energy, American Gilsonite, Paragon Offshore, CHC Group, A&P, Vantage Drilling Company, and Chassix Holdings Inc. But now Weil is also doing lender, bondholder, and equityholder work as in Seventy-Seven Energy, Things Remembered, Aspect Software, Performance Sports Group and DirectBuy Holdings. And unsecured creditor committee work, e.g., SunEdison and Ultra Petroleum. Wait, what? Weil does UCC work now? 

It's not all sunshine, though. Last week, Weil's attempted confirmation of Paragon Offshore's plan of reorganization over the objection of crammed-up term lenders failed in a rare judicial recognition of the feasibility standard. Now exclusivity may be in danger. In Breitburn Energy Partners, equity holders (represented by Weil alumni) successfully argued for an equity committee over vehement Weil objection (in contrast, this week Kirkland & Ellis successfully defeated an equity holder attempt to form an official equity committee in C&J Resources). In Aeropostale, the Southern District of New York judge handily denied Weil's attempts to recharacterize and equitably subordinate Sycamore Partners' claims.  

As we near the end of 2016, PETITION offers a hearty congratulations to Weil: it's been a great year. 2017 appears promising too.