🎟Disruption Hits CEC’s Supply Chain (Short Arcade Tix)🎟

Chuck E Cheese Wants to Incinerate Prize Tickets

Back in February 2018, when Cenveo Inc. filed for chapter 11 bankruptcy, we wrote the following:

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express ($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

As an old school business, we noted that it was ripe for new school disruption. We wrote then:

Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo.

We were reminded of Cenveo when we read a September 14th motion filed by CEC Entertainment (Chuck E. Cheese) seeking entry of an order authorizing CEC to enter into settlement agreements with three large suppliers.

Here’s the situation…

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🥈Second Order Effects Are Real (Long #retailapocalypse Victims)🥈

We’ve spent a considerable amount of time discussing the possible and/or actual second order effects of disruption. For instance, waaaaaaay back in December 2016, we queried to what degree the scanless technology that Amazon Inc. ($AMZN) had then launched in its AmazonGo concept might affect grocers and quick service restaurants. We noted the following possibilities:

[Our] list of losers: manufacturers of conventional scanners...plastic separator bricks...cash registers...conveyer belts; landlords (maybe? - less square footage required without the cashier and self-checkout stations); print media/candy manufacturers/gift cards - all things that benefit from lines and impulse buys at checkout; human capital; people on the wrong end of income inequality.

Three years later, you don’t hear much about AmazonGo. Sure, it’s grown: there are now reportedly 20 locations with more on the way, but it hasn’t exactly taken the world by storm and caused mass disruption to either grocers or QSRs. It’s still worth watching though: the possible second order effects are countless.

An example of actual second order effects is Cenveo Inc., which filed for bankruptcy in February 2018. At the time we wrote:

…it's textbook disruption. Per the company, 

"In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns." 

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you're effing Cenveo.

To close the trifecta, we’ll again highlight the recent pain in the SMA space. Catalina Marketing and Acosta Inc. both became chapter 11 filers while Crossmark Holdings Inc. narrowly avoided it. Why? Because CPG companies are taking it on the chin from new and exciting direct-to-consumer e-commerce brands, among other things, and have therefore shifted marketing strategies.

So, on the topic of second order effects, imagine being in the C-suite of a company that, among other things:

• Prints signage, displays, shelf marketing and other promotional-print-material for brick-and-mortar retailers including the likes of, among others, struggling GNC Inc. ($GNC), Gap Inc. ($GPS), and GameStop Inc. (GME), all of which are shrinking their brick-and-mortar footprint;

• Creates menu boards, register toppers, ceiling danglers and more for QSRs and fast casual restaurants who are competing with food delivery services more and more every day; and

• Services consumer packaged goods companies by creating end cap promotions, shelf marketing, floor graphics and more.

Uh….YEAAAAAAAAAH. Some high risk exposure areas right there, folks.😬 And, so you’ve got to imagine that revenues of this “hypothetical” C-suiter’s company are declining, right? Particularly given that print is a highly competitive price-compressed industry?

Luckily, you don’t have to stretch the imagination too far.

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More Retail Dominos Fall

Tax Credits Can't Save Failing Bon-Ton Stores

We're going to stay thematically on-point. If you missed us last week, we recommend that you go back and read our take on the Cenveo bankruptcy. In fact, we owe an apology to some of you: there were about 400 of you who did not get our a$$-kickingness at all due to an inexplicable Mailchimp screw-up. Mailchimp ≠ a$$-kicking (more on this soon). Anyway, here is a link to the entire newsletter.

A quick preface:

Protection of dying industry extends beyond federally-imposed #MAGA (see, e.g., coal, solar tariffs), and trickles down to local communities. Indeed, local-level legislators are looking at tax credits to prop up industry in the wake of, among other things, Appvion’s chapter 11 bankruptcy (and job cuts) and Kimberly-Clark’s reorganization (and mass job cuts). This is familiar: tax incentives to prop up industry aren’t extraordinary. Sheesh, just look at all the governors getting bent in the hope of drawing Jeff Bezos’ attention. The question is, though, how sound is the social contract? How many dying industries can we as taxpayers prop up all at once? We don’t have an answer. But keep reading.

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Inside and outside of the startup context, people often ask stupid questions about companies. "How many employees does it have?” That’s a regular one. Or “How many locations?” Also common. “What’s revenue?” Irrelevant on its own. Uber makes a ton of revenue but is still bleeding cash. Netflix has gobs of revenue but is free cash flow negative. Cenveo, as we noted last week, had $1.59 billion of gross revenue in ’17. Now it’s in bankruptcy court. 

What if we told you about a particular business that had 23,000 employees and that those employees had an average tenure of 12 years? That had 256 locations. That owned 22 properties. That made $2.55 billion - yes, BILLION - in revenue in 2017. That would sound like a pretty damn successful company wouldn’t it? 

It’s not. 

We omitted some key data points: like the company’s capital structure and business vertical. 

Here’s the capital structure:

• a Tranche A revolving credit facility of up to $730mm
• a Tranche A-1 term facility of up to $150mm

The interest rate on the debt is a formula but, if we understand it correctly, it was no less than 9.5%. Funded debt as of Monday was $339mm under Tranche A (ex-interest), $150mm under Tranche A-1 (ex-interest of $3.9mm), and millions more in letters of credit.  

The company also has $350mm of 8% senior secured notes outstanding (Wells Fargo Bank NA) and due in 2021. Combined with the above debt, that’s a hefty interest expense. Oh, and the company is publicly-traded. Because this particular company is NOT successful - and with equity ranking in “absolutely priority” below debt - we reckon that there are a lot of Moms and Pops eating sh*t right now in their personal accounts. They won’t be the only ones.

The problem is that this company operates in an “increasingly challenging retail environment.” And, therefore, its story  - The Bon-Ton Stores story - is wildly unoriginal. In the company’s words, "Like many other department store and retail companies, the Debtors have been subjected to adverse trends in the retail industry, including consumers’ shift from shopping in brick-and-mortar stores to online retail channels. Bon-Ton, with a significant geographic operating footprint and operating presence, is dependent on store traffic, which has decreased as customers shift increasingly toward online retailers. In addition to competing against online retailers, Bon-Ton faces competition from other established department stores, such as J.C. Penney, Kohl’s and Macy’s.” It's like a zombie cage fight.

More specifically, it continues, "The department store segment of the U.S. retail industry is a highly competitive environment that has evolved significantly in response to new and evolving competitive retail formats, such as the increased prominence of mass merchandisers and increased competition among national chain retailers, specialty retailers and online retailers, as well as the expansion of the internet and, most significantly, the ubiquitous role that mobile technology and social media now play in the retail consumer shopping experience. The Debtors’ results and performance (and that of their competitors) has been significantly impacted by the aforementioned factors in the U.S. retail industry. Presently, numerous business and economic factors affect the retail industry, including the department store sector. These include underemployment and the low labor participation rate, fluctuating consumer confidence, consumer buying habits and slow growth in the U.S. economy and around the globe.” But, but…#MAGA?!?

Given these factors, the company has been engaged in a tug-of-war with its senior creditors for the better part of months. We’ll spare you the back-and-forth but suffice it to say, no concrete long-term plan that would’ve avoided bankruptcy came to pass. Only the retention of a liquidation agent to close 42 stores. And acquisition of a new $725mm credit facility to fund the cases while the company scrambles to find a buyer. Or liquidate.

Remember all of those shiny, positive numbers up above? Um, yeah. 

It gets worse. Though they were ultimately shot down - at least for now - in court yesterday (Feb 6), the bondholders argued “that the best and only available path for the Debtors to maximize value for their creditors in these freewill bankruptcy cases is to conduct an immediate orderly liquidation of the Debtors’ inventory and other assets. The Second Lien Noteholders made this determination after conducting their own due diligence, and following repeated missteps by the Debtors and their various boards and management teams, who proved themselves unwilling and/or unable to adapt to the fierce headwinds facing brick and mortar retailers and in particular, department stores”(emphasis in original). Savage.

Unwilling. Or unable. To adapt. Sadly, this seems to sum up a lot of distressed retailers these days. 

Even sadder, remember those long-tenured 23k employees we mentioned above? Per the company, “[Bon-Ton] has been part of its employees’ and customers’ lives in their communities for years.”

Probably not for much longer. At this point, no tax credits can change that. 

Cenveo Inc. = Poster Child for Disruption

Envelope Manufacturer Succumbs to Technology. And Debt.

As loyal PETITION readers know, our tagline is “Disruption, from the vantage point of the disrupted.” After its Chapter 11 bankruptcy last week, Cenveo Inc. may very well be the poster child for disruption.

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

And, yet, it sells a lot of product. In fiscal year ended December 31 2017, Cenveo generated gross revenue of $1.59 billion with EBITDA of $102.8mm. Those are real numbers. But so are those on the other half of the company’s balance sheet.

After years of acquisitions (16 between 2006 and 2013, representing a strategic shift from print-focus to envelope manufacturing), Cenveo has more than $1 billion of funded debt on its balance sheet and a corresponding $99.4mm in annual debt payment obligations (inclusive of cash and “principle” payments). That’s the problem with a lot of debt: eventually you’re going to have to pay it back. And the only way to do that is to have sustained and meaningful cashflows that are, hopefully, trending upwards rather than down. Therein lies the problem with Cenveo. As liquidity gets tight, a business may start getting a bit looser with payments, a bit less reliable. Savvy trade creditors sniff this from a mile away. With the company (very) publicly struggling under the weight of its balance sheet, vendors started hedging by contracting trade terms and de-risking; they start throwing off business to Cenveo’s competitors, further challenging Cenveo’s liquidity — to the tune of a net liquidity reduction of approximately $20mm. Initiate death spiral.

But, wait! There’s more. And it’s textbook disruption. Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo. More from the company,

“As society has become increasingly dependent on digital technology products such as laptops, smartphones, and tablet computers, spending on advertising and magazine circulation has eroded, resulting in an overall decline in the demand for paper products, and in-turn lowering reliance on certain of Cenveo’s print marketing business. In addition, there is generally a decline in supply of paper products in the industry, such that only a handful of paper mills control the majority of the paper supply. As a result, paper mills and other vendors that sell paper products have a large amount of leverage over their customers, including Cenveo. The overall decline in the paper industry combined with the diminished supply in paper products has led to overall decline in the industry, dramatically impacting Cenveo’s revenues.”

Consequently, the company has spent years trying to implement an operational restructuring (read: streamline operations and cut costs). The company adds,

“Faced with an industry in transformation, Cenveo, beginning in 2014, commenced a strategic review of a significant portion of its businesses and concluded that it needed to focus its portfolio on profitable segments that would be better-positioned to grow in the future and to divest non-core, unprofitable segments. To implement this strategy, between 2014 and 2017, Cenveo applied a number of broad-based cost savings and profitability initiatives, which included downsizing its workforce, reducing its geographic footprint, and divesting certain non-core business segments, which was designed to reduce costs, minimize the possible effect of decreased sales volume for underperforming product lines, and remain competitive.”

While the company notes that it currently employs nearly 5200 people in the US, it is clear that many people have lost their jobs. 100 people in Orchard Park, New York. 108 people in Exton, Pennsylvania. 112 people in the Twin Cities. 91 people in Portland, Oregon. You get the point. You should read theGlassdoor reviews for this company. The employees sound miserable. The comment board is riddled with critiques of management, allegations of squandering, tales of job cuts and no raises. Even sexual harassment. We can’t wait for the uproar over the inevitable Key Employee Incentive Plan.

So what now? The company claims it’s ready for the e-commerce age and that it can make a ton of money on package labels. Provided that it can shed its debt. Accordingly, the company engaged the holders of its first and second lien debt and was able to secure a (shaky?) restructuring support agreement (RSA) and a commitment of $290mm in financing. The RSA exhibits the company’s intent to equitize the first lien holders’ debt. Notably, Brigade Capital Management — representing over 60% of the second lien debt and a meaningful percentage of first lien debt — isn’t on board with the RSA and noted in a filing that the bankruptcy may be “more contentious and protracted than indicated” by the company. Indeed, they are already agitating against the company and certain insiders alleging, among other things, that the Burton family has received approximately $80mm of disclosed compensation between 2005 and 2016 that ought to be investigated. And that the RSA seeks to enrich the insiders with a generous post-reorg equity grant of 12%. In other words, this could get ugly. Fast.

We should also note that the company will also need to address its underfunded pensions (approximately $97.3mm) and 18 active collective bargaining agreements. Funding contributions for 2018 are over $10mm. The pension plan(s) cover 5700 retirees and 734 active employees. And so while sophisticated funds duke it out over valuation and the corresponding value of their claims/recoveries, thousands of employees and retirees will be left in the lurch. Yikes.

As you can see, disruption is hard. Silicon Valley types love to talk about their big revolutionary products and how they’re going to change the world. That sexy stuff gets CEOs on magazine covers. Cameos in Iron Man movies. And more. The attorney from Kirkland & Ellis LLP representing Cenveo used an IPad in court. Symbolic.

But there is a dark underbelly to disruption too. As new technologies come online and habits change, long-standing businesses like Cenveo falter. People lose jobs — or struggle one day at a time to keep them. People lose pensions they’d planned to live on. Hopefully the professionals who make money managing these elements in-court don’t lose sight of these factors and work hard to optimize efficiency in the process. And hopefully the engineers and disrupters take note of what their “big revolution” may mean for others. Cenveo is a great reminder.