đź’ŞCan You Spot Me, Bro? Part II.đź’Ş
🏋️‍♂️New Chapter 11 Bankruptcy Filing - Town Sports International LLC🏋️‍♂️
In Sunday’s Members’-only briefing, we discussed the plight of brick-and-mortar gyms. As anticipated, on Monday, Town Sports International LLC, the company behind, among other brands, Johnny’s beloved New York Sports Club, filed for bankruptcy in the District of Delaware (along with 161 affiliates, the “debtors”). Pre-COVID, the debtors employed 9,200 people and serviced over 605,000 members across 183 locations primarily in the Northeast and Mid-Atlantic regions — proof-positive, given the disturbing lack of cleanliness Johnny experienced at those hell holes, of why this country is so susceptible to a pandemic.
Jokes (“jokes”) aside, this is, no doubt, in large part a COVID story. COVID shut down gyms, COVID spikes delayed re-openings, COVID has customers skittish about returning, and COVID is causing a complete re-evaluation of what it means to provide fitness services to customers while keeping them safe. The latter part has culminated in the debtors’ “COVID Plan,” which, in turn, translates into “…significant costs related to increased training, more comprehensive cleaning, disinfecting, and health screening protocols, and enhanced facilities maintenance.” It also means “…modifying activities, restricting programs, adjusting hours of operation, travel restrictions, telecommuting opportunities and virtual communication platforms.” And so it’s a pretty rudimentary calculus: customer revenues (and satisfaction) ⬇️ + operating expenses ⬆️. With no options for revenue generation and few reasons for optimism, the debtors spent the last few months trying to navigate its expenses and carve a path forward: they fired thousands of people; they negotiated with their landlords; they engaged their lenders and third parties on strategic alternatives. None of it could stave off bankruptcy.
Bankruptcy avails the debtors of two very powerful tools. First, in light of failed negotiations with landlords over lease concessions, they can use section 365 of the bankruptcy code as a hammer and reject those leases and free themselves from ongoing obligations thereunder (relegating the landlords to general unsecured creditors which, per an absolute priority waterfall, puts them behind senior lenders but in front of the equity for any recovery coming out of the bankrupt “estate”). The debtors already have a motion on file seeking to reject 35 leases.
Second, bankruptcy code section 364 can confer certain benefits upon lenders willing to provide new financing — including, among other things, “priming” of pre-petition debt and super-priority lien and claim status. The debtors go into the bankruptcy with approximately $167.5mm of funded secured debt, inclusive of accrued and unpaid interest: $12.5mm under a revolver that matured on August 14, 2020 and $155mm under a term loan facility that matures on November 15, 2020. Behind that, they have approximately $74mm in outstanding trade and other unsecured liability. Given its liquidity challenges, the debtors have spent the last several months trying to find new financing alternatives while parallel-pathing a potential sale of substantially all of their assets.
Two options emerged. Pre-petition lender Kennedy Lewis Investment Management LLC, a middle-market focused opportunistic credit investor,* owns over 45% of the total amount of pre-petition secured debt and offered a $80mm DIP credit facility and expressed a desire to credit bid its debt for the debtors’ assets. The other lenders, however, said “thanks but no thanks,” blocking this proposal purportedly because the credit bid component wouldn’t lead to a suitable recover for them to (PETITION Note: at the time of this writing, the loan is quoted at or around 16.5 cents on the dollar). Rather, those other lenders — which, significantly, account for the majority needed to consent to priming liens — currently support a third-party proposal from private equity firm, Tacit Capital.** That proposal involves a (i) $17.5mm DIP, (ii) commitment for an additional $47.5mm in exit financing and (iii) credit bidding their debt.
And so you have a lender game of chicken.
Or so they say. But they’re not exactly staying neutral here. They also say they believe the KLIM proposal is the better one. It provides more liquidity; it provides for the potential assumption and assignment of 94 of the debtors’ leases — a greater number than that contemplated by Tacit Capital and the other lenders. That would, obviously, preserve more jobs, tax revenue, yada yada yada. So they need KLIM and the other lenders to come together and kumbaya around a go-forward plan. The debtors indicate that discussions are ongoing and the debtors have established a special committee of independent directors to help facilitate.
Wait. Hold on. This is bankruptcy so of course there have to be allegations of shady-a$$ sh*t transpiring. In fact, an ad hoc group of “other” lenders allege that attempts to discuss and negotiate have been rejected by the debtors; they allege that this is an inside job by KLIM (which also happens to be a large shareholder) and board member Kennedy Lewis himself; and they assert that this is all supported by the debtors. In a response to the cash collateral motion, they wrote:
…after months of the Ad Hoc Term Lender Group trying to bring the Debtors to the table, this filing makes clear what we suspected all along—the Debtors never had any real intention of providing access to information, running a marketing process, or reaching out to third parties. Instead, the Debtors have been solely focused on pursuing a deal with Kennedy Lewis Investment Management, LLC (“Kennedy Lewis”), the second largest shareholder of the Debtors’ parent entity (“Parent”) at 14.1%, which contemplates a priming debtor in possession (“DIP”) financing facility and a sale transaction pursuant to a credit bid. Based on currently available information, the Kennedy Lewis deal would then provide the shareholders of the Parent with a material recovery by virtue of a post-sale merger whereby certain non-Debtor entities (the “Unrestricted Group”) owned by the Parent would be merged with the reorganized Debtors in exchange for providing the Parent shareholders with a material percentage of the overall reorganized Debtor equity, all while the existing lenders would receive little or no recovery.
They continue:
The largest shareholder of the Parent is Patrick Walsh, the Debtors’ Chief Executive Officer and Chairman of the Parent board of directors (the “Board”). The second largest shareholder of the Parent is Kennedy Lewis itself. The conflict of interest here is clear and explains the Debtors’ insistence on preventing third parties from accessing information, failing to run any kind of sales or marketing process, and continuing to insist that the non-consensual Kennedy Lewis transaction is in the best interests of the Debtors and their estates.
Which explains the appointment of the independent directors. This potential “conflict of interest” wasn’t entirely clear from the debtors’ papers.
So the upshot is that the debtors do not have a definitive DIP, do not have a stalking horse purchaser and, for now, don’t even have consent to use the lenders’ cash collateral. Good times. To make matters worse, the ad hoc group foreshadows dark times ahead if these issues aren’t resolved pronto:
While the Ad Hoc Term Lender Group is working with the Debtors on the terms of a limited duration, consensual cash collateral order, this is a short-term bandage for a much larger problem—the Debtors need a new source of capital. The Debtors’ budget demonstrates that they cannot run these chapter 11 cases on the use of cash collateral only.
While all of that fun stuff is happening behind the scenes, gym-goers are looking at all of this and wondering “WTF.” They were outraged to see charges in March and April for their gym fees while clubs were closed. The subsequent social media backlash caught the attention of New York Attorney General Letitia James, who forced the gym operator to temporarily stop charging members and introduce flexible cancellation policies. Recently, Bloomberg reported that the debtors billed their members for full September dues despite the gyms’ limited operating hours and reduced capacity.
Members are pissed; they’re staring down the barrel of paying effectively the same amount going forward for fewer fitness services and more administrative hassle to get through the door; they’re requesting credits and refunds. Clearly this is credit negative for the business.
As part of their motion seeking the ability to continue various customer programs, the debtors indirectly acknowledge these challenges:
The Debtors do not issue any cash payments on account of the Member Satisfaction Credits, and estimate that approximately $1.9 million worth of Member Satisfaction Credits have accrued, but not been applied, as of the Petition Date.
Particularly following the onset of COVID-19, certain customers may hold contingent claims against the Debtors for refunds and other credit balances (collectively, the “Refunds”). In addition, certain customers may dispute certain charges with their credit card issuer, and the Debtors may be obligated to refund to such issuer the disputed amounts, subject to certain adjustments (the “Chargebacks”). As of the Petition Date, the Debtors estimate that approximately $225,000 is owed and outstanding on account of the Refunds and Chargebacks, respectively. This estimate does not include additional Refunds or Chargebacks that relate to the prepetition period, but which have not yet been requested. The Debtors believe that the increase in customer loyalty generated by the Refunds and Chargebacks far outweighs the costs thereof. Accordingly, the Debtors seek authority to continue to issue Refunds and Chargebacks, in their discretion, in the ordinary course of business, whether related to payments made before or after the Petition Date.
If the above doesn’t make this clear, members ought to be sure to affirmatively request a refund. Even better to request the refund from the debtors while also initiating a process with credit card companies.
Finally, there’s the employees. As of the petition date, the employee ranks are down to 2,169 people. That’s a 7,000 employee reduction! What was once a $5.6mm bi-weekly payroll dropped down to $1.2mm over the last three months and is expected to recover less than halfway to $2.5mm. This demonstrates in real quantifiable terms the impact of COVID.
So we are left with two big questions.
Will the parties come to an agreement such that Town Sports will be able to avoid liquidation?
And given the wave of gyms that have capitulated into bankruptcy to this point, are there any gyms that can avoid chapter 11?
*KLIM is also the largest creditor of Flywheel Sports Inc., a spin boutique that was once wildly popular. Earlier this year, Town Sports, likely at the behest of KLIM, explored an acquisition of Flywheel. On Monday Flywheel filed a chapter 7 bankruptcy proceeding in NY.
**If this name rings a bell, it may be because Tacit Capital was also in the mix to buy Rudy’s Barbershop Holdings, which filed for bankruptcy back in April.
