🔥F.E.A.R.🔥

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⚡️What. The. Hell.⚡️

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This week was a complete and utter sh*tshow. There’s no sugar-coating it. As fears about coronavirus rose, the stock market got absolutely annihilated — the S&P dipped over 11% for the week (one of the most severe declines in history) and the Dow dropped approximately 4000 points — precipitating a rabid shift to safety in the markets: the 10-year treasury hit a record low, dipping below 1.2%. Leveraged loans, meanwhile, got napalmed.

Majors like Apple Inc. ($AAPL), Mastercard Inc. ($MA) and Microsoft Inc. ($MSFT) lowered guidance and Goldman Sachs Inc. ($GS) issued a report indicating lowered growth expectations for the year — to zero. Yep, zero. The VIX “fear index” jumped into the 40s after being virtually catatonic for years. Now there’s widespread speculation that the FED will lower rates to stimulate the market — a controversial strategy given (a) the sheer volume of money already flushing through the system and (b) the fear that the FED will be ill-equipped to then address any subsequent recession.

There are a lot of restructuring implications — on both sides of the fence. On one hand, lower interest rates ought to help a number of companies with floating-rate loans. It’s clear that the rising interest rate catalyst that many expected — and the FED quickly shot down last year — is nowhere near becoming reality. Secondly, oil and gas prices are getting smoked and given that those commodities constitute huge input costs, companies will see some savings there. Theoretically, lower oil and gas prices should also help stimulate the consumer which, we all know, had been carrying both the economy and stock prices to recent (clearly inflated) highs.

That is, unless they stay home and do nothing other than watch Netflix ($NFLX) and Disney+ ($DIS) and order bottled water and canned goods from Amazon ($AMZN) and Walmart ($WMT) — assuming, of course, that third-party fulfillment isn’t affected by supply chain disruption. Interestingly, both the consumer staples and discretionary spending ETFs are down over 10%. And the former more than the latter, which, when there’s a flight to safety pushing treasury rates down, doesn’t make much sense. So 🤷‍♀️. Corporations are, one by one, curtailing business travel, cancelling conferences, and encouraging stay-home work as advisories abound about congregating in mass group settings. This is impacting the airlines and movie theaters, naturally. The MTA ought to see a decline in ridership which ought to dig a bigger budget deficit hole (PETITION Note: Is NYC f*cked?).

Transports are getting smoked too. SupplyChainDive writes:

The COVID-19 outbreak and resulting quarantines have led to a record number of blank sailings, according to the latest figures from Alphaliner. Inactive fleet size has swelled to 2.04 million TEUs or 8.8% of global capacity. The decline is greater than the 1.52 million TEUs of canceled capacity during the 2009 financial crisis, the previous record, 11.7% of the total fleet at the time.

The Ports of Los Angeles and Long Beach are facing 56 canceled sailings over the first three months of the year, the ports told Supply Chain Dive.

Note that we had previously asked “Short the Ports?” in “🚛Dump Trucks🚛” here.

Here is The Washington Post highlighting a world of hurt at the ports:

…shipping container traffic both coming and going from the ports of Los Angeles and Long Beach has been sliding at an average rate of 5.7 percent a month since the beginning of last year….

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Pour one out for the shippers.

Of course, none of this is positive for sectors that are already massively struggling, i.e., restaurants. Nor retail. Per CNBC:

If the coronavirus spreads in the U.S., that could mean really bad news for U.S. mall owners, according to a survey taken this week.

The survey by Coresight Research found that 58% of people say they are likely to avoid public areas such as shopping centers and entertainment venues if the virus’ outbreak worsens in the United States. The group surveyed 1,934 U.S. consumers 18 and older.

The survey was taken Tuesday and Wednesday — before California said it was monitoring 8,400 people for COVID-19.

Back to energy. Energy bonds are getting smoked as massive outflows flee the sector.

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OPEC meets next week to discuss a massive production cut. From a restructuring perspective, it’s likely irrelevant at this point.

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We’re heading into redetermination season for oil and gas explorers and producers and, given the rapid decline in oil and gas prices, banks are likely to take a stern stance vis-a-vis borrowing base levels. That ought to help usher in another wave of oil and gas restructuring.

Hold on to your hats, folks.

🎢Weeeeeeeeeeeeeee🎢

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⚡️Update: WeWork⚡️

This was us covering the hourly news diarrhea that came out about WeWork in the last 48 hours alone:

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Which, we suppose, is better than how the company’s equity and existing noteholders must be managing:

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Or the fine bankers over at JPMorgan Chase ($JPM) who are tasked with finding capital markets suckers…uh…investors…who’d be so kind as extend this steaming pile a lifeline:

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So, sifting through the constant headlines, where are we at?

Okay, right. The hot mess of a liquidity profile and limited amount of debt capacity to get a deal done.  Nothing to see here. All good.

Reminder: it is widely believed that WeWork will run out of cash by the end of the year without a new deal in place. Axios reports:

The company reported $2.4 billion of cash at the end of June, with a first-half net loss of $904 million. At that pace, it should have been able to survive at least through the middle of 2020. But I'm told that it significantly increased spend in Q3, partially due to the lumpy nature of real estate cap-ex, believing it would be absorbed by $9 billion in proceeds from the IPO and concurrent debt deal. One source says that there's probably enough money to get through Thanksgiving, but not to Christmas.

Riiiiiight. So here are the options:

  • A Softbank Group new equity and debt bailout pursuant to which they get control of WeWork and napalm Masa’s former boy, Adam Neumann, in the process. This would reportedly be an aggregate $3b package “to get through the next year” — repeat, TO GET THROUGH THE NEXT YEAR — with the equity component coming significantly cheaper than the previous self-imposed $47b valuation (at a $10b valuation); or

  • JPM arranges some hodge-podge debt package and tests the market’s never-ceasing thirst for yield, baby, yield. The early reports were that the financing package would be $3b, comprised of $1 billion of 9-11% secured debt, $2b of unsecured PIK notes yielding 15% (1/3 cash pay, 2/3 PIK), and letter of credit availability. Wait, 15%?! How does a company with no liquidity even pay that? That’s why the PIK component is so critical: it would simply add 2/3 of the interest due to the principal of the debt. Said another way, the debt would compound annually and creep past $2.5b in two years. Per Bloomberg, “The $2 billion of proposed unsecured debt may carry an additional sweetener for investors: equity warrants designed so that investors could boost their return to around 30% if the company gets to a $20 billion valuation, according to the person who described the structure.” Because debt won’t dilute equity like Softbank’s equity-heavy proposal would, WeWork insiders (read: Neumann) apparently prefer the JPM approach. Regardless of what insiders prefer, however, is whether the market will be receptive to what one investor dubbed, per Bloomberg, “substantial career risk.”

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We’re old enough to remember when WeWork’s notes rebounded a mere five days ago for reasons that were wildly inexplicable to us then and even more so now.

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So, to summarize, who are the big winners? IWG/Regus ($IWGFF)(long?). We’re pretty sure they’re loving what’s happening here; we have to imagine that the inbound calls have to be on the upswing. Also, the restructuring professionals. Whether you’re Weil Gotshal & Manges LLP (Softbank), Houlihan Lokey ($HLI)(Softbank), or Perella Weinberg Partners (WeWork’s Board of Directors), you’re incurring more billables/fees than you expected to mere days weeks ago. Somehow, some way, the restructuring pros always seem to come out ahead. And, finally, Goldman Sachs ($GS). Because there’s nothing more Goldman-y than them selling their prop stock right out from under a proposed IPO.

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💨WeWork (Long Death Spirals & Cascading Effects)💨

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The Co-Working Giant Spirals Amidst Liquidity Crunch Sparking Landlord and CMBS Worries

Alison Griswold’s Oversharing newsletter has been all over the WeWork mess and this recent missive includes a solid and stunning collection of links-all-things-WeWork. Things could get even worse if a financing doesn’t get done. Like, soon. Per The Financial Times:

WeWork’s bankers are scrambling to complete a new debt financing package as soon as next week to buy time to restructure after the company’s failed initial public offering left it running short of cash at a faster rate than expected.

Two people briefed on the fundraising efforts said the office company’s cash crunch was so acute that it had to raise new financing no later than the end of November. Fitch Ratings downgraded WeWork’s credit rating last week to CCC+, warning that the lossmaking company’s liquidity position was “precarious”.

Fitch estimates WeWork’s current funding arrangements might only carry it through another four to eight quarters unless it rapidly reduced the rate at which it has been burning cash.

Interest payments are, of course, small potatoes relative to massive lease obligations but WeWork has $702mm of 7.875% unsecured notes with biannual interest payments. Its next payment is due 11/1/19. That would be a $27.9m nut. The timing couldn’t possibly be worse.

This barrage of bad news has the haters drooling:

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In other words, nearly 10% of the outstanding unsecured bonds are short. Man, the vibe around this thing isn’t exactly Kibbutz-like.

Some other bits here: (i) JPMorgan Chase & Co. ($JPM) is trying to get other banks to participate in the “emergency financing package” but the-always-winning-to-the-point-of-the-game-seeming-rigged Goldman Sachs Group Inc. ($GS) is currently not in talks to participate, effectively walking away from an earlier IPO-based commitment to the company; and (ii) Softbank may sink more money into this pit but is renegotiating the price of its earlier issued shares in the process (read: this is leverage baby).

If you’re wondering why a senior lender might be hesitating to join JPM in a syndicated senior secured loan, the issue may very well be this: secured by what, exactly? In terms of assets, the company has roughly $15b in leases (which, obviously, have an offsetting liability, and the quality of which will be variable and in need of examination) and $7b of property and equipment, i.e., desks, chairs, barista equipment, yogababble, etc. Given all of the beer swilling and hooking up that occurs at these places, equipment has a questionable lifespan and, by extension, value.

Compounding matters is the fact that enterprise tenants — a key component to WeWork’s go-forward viability — appear to be balking. Per The Information:

“We were looking at doing a couple deals [with WeWork], and thinking about it quite differently now. Are they going to invest in the market?” said Robert Teed, vice president of real estate and workplace for ServiceNow, a publicly traded cloud computing company that puts some of its employees in WeWork spaces. “It’s making us stop and think. It’s awfully noisy. Will they do what they say they’re gonna do?”

And, so, people are beginning to fear what happens if…uh…as?…WeWork falls. Here is a Wall Street Journal article about the President of the Federal Reserve Bank of Boston’s concerns about WeWork, co-working and CRE. It seems his concerns may not be misplaced: cracks are beginning to form in Boston’s commercial real estate market, generally. Here is a Financial Times piece about WeWork halting new lease agreements, a move that “will rattle commercial property owners across the globe who rented to WeWork, which often upgraded the spaces so the group could re-let the buildings to its own customers.” This change in pace will “cut[] out a significant source of demand in large urban property markets where it operates.” Landlords are battening down the hatches. Per Financial Times:

Two landlords of large WeWork sites in London, who asked not to be named, said they would not sign new leases for the foreseeable future and were making contingency plans for their existing WeWork offices in the event of a restructuring.

“It would not be prudent for us to do anything [new] with them until we see how the new management will operate,” one landlord said.

The magnitude of this cannot be overstated. WeWork accounts for over 7mm square feet of office space in New York City alone — making it the largest tenant in the Big Apple. Its $47b in lease obligations is well-documented — including $2.3b in obligations due in 2020 — but to put that in perspective, that figure puts WeWork in third in terms of lease commitments IN THE WORLD.

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So, the first question is, “what happens to the existing money-losing properties if WeWork cannot sure up liquidity?”

Back to the FT:

Alex Snyder, assistant portfolio manager at CenterSquare Investment Management in Philadelphia, said: “WeWork has structured many of its leases so that they can simply collapse the special purpose entity it’s trapped in and walk away. This vacancy pressure on the market [would] be painful.”

This ⬆️ is a nuance that a lot of the media — quick to push a sensationalist bankruptcy narrative — seems to miss. The company is set up like a REIT with each individual property non-recourse to the parent. If properties fail, WeWork will just “mic drop” the keys and walk away, leaving landlords with large spaces to fill. What happens then is anyone’s guess. Another co-working space takes over? 🤔

Which gets us to the second question, “if WeWork is no longer expanding, who will fill CRE supply?” These charts ought to give you a sense of the magnitude of WeWork’s reach ⬇️. With this halting, landlords will need to start looking elsewhere.

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To add an another layer to this, all of this has people concerned about CMBS exposure. Trepp recently issued a report on this issue. They conclude:

WeWork is certainly a growing exposure for the CMBS market; one that concerns people. The volume of WeWork loans in CMBS, post 2010, is approaching 1% of the entire CMBS market and about 4% of loans backed by offices, so that exposure is meaningful.

The biggest issue is not the pulling of the IPO per se, but the broader concerns about the firm’s viability. The worst-case scenario would be that the firm continues to burn through cash and can no longer support all of its lease obligations. If that were followed by a period of non-payment of rent by WeWork, but physical occupancy and current payments by the firm’s sub-lessees, that would make for some interesting work for landlords and special servicers. Stay tuned.

Wolf Richter — someone who has a reputation for alarmist takes — adds:

These “special servicers” may already be licking their chops. When a CMBS loan defaults, or sometimes even when the building loses a critical tenant but the loan hasn’t defaulted yet, servicing gets switched from the master servicer to a special servicer, as laid out in the pooling and servicing agreement (PSA). The special servicer’s role is to figure out if the borrower can become current via a loan modification or a debt workout. Under many PSAs, special servicers have the right to purchase the building at a discount if the very same special servicer decides the loan cannot be brought current. So, yeah — this might get interesting.

And there are additional complications. WeWork is so large in some markets that a reduction in leasing demand from WeWork, or an outright unwinding of its leases, would put downward pressure on rents and prices in those markets, making it that much more difficult to sort through the fallout in the market from problems at WeWork.

Stay tuned indeed.

*****

More on WeWork: here is a provocative thread about WeWork’s effect on the venture system and what its failure presages for other unicorns in growth-at-alls-costs-even-if-the-business-model-is-faulty mode; here is the WSJ and here is Bloomberg’s Matt Levine, respectively, discussing the personal loans to Adam Neumann; and here is a pointed must-read Harvard Business School study discussing the company’s business model. We particularly enjoyed this bit:

Fundamentally, WeWork engages in “rent arbitrage” by signing long term leases, generally 15 years, at one rate and subleasing the space to SMEs and Enterprise members at with shorter durations. While the cost per desk is lower for the member, the aggregate rent WeWork receives is higher for the space due to the density.

The practice obviously creates a duration mismatch which leaves WeWork, or the special purpose vehicle that entered into the lease, exposed to market fluctuations in the event of a downturn. The short duration of the subleases leaves WeWork exposed to the risk that tenants might abandon the space on short notice leaving WeWork liable for the master lease obligation. They are also exposed to the credit risk of the SME subleasees.

WeWork does not believe a market downturn will impair their business. To the contrary, WeWork maintains that as businesses contract, they will be attracted to WeWork’s business model as it will offer SMEs and larger Enterprises the needed flexibility and lower cost structure per employee during a recession. Indeed, Neumann highlights that the Company was founded during the Great Recession and attracted tenants. Time will only tell if this will be accurate, but it is worth noting that their main competitor, Regus, now IWG, went bankrupt during the Great Recession. (emphasis added)

BURN.

⛅The Rise of the Cloud. (Long Cloud Usage. Short Debt-Laden Intermediaries).⛅

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The “cloud” is such a fundamental business component today that cloud considerations inform various aspects of business planning. Look no farther than Amazon Inc. ($AMZN), Microsoft Inc. ($MSFT), Cisco Inc. ($CSCO), and Google Inc. ($GOOGL), and you’ll see cloud computing providers who are minting money on a quarterly basis for providing services that alleviate the server and storage burden of businesses across all kinds of industry verticals. Underscoring the importance of the cloud, IBM Inc. ($IBM) spent a fortune — $34 billion! — acquiring Red Hat Inc. to boost its cloud-for-business offering. Furthermore, recent IPOs have illustrated just how important cloud services are: Pinterest Inc., Snap Inc. ($SNAP), Lyft Inc. ($LYFT), and many other high-flying companies pay hundreds of millions in fixed contracts for cloud computing services that power their applications in ways that everyday end users almost certainly don’t recognize and/or appreciate.

The “cloud,” however, subsumes various other services in addition to computing/storage. There are connectivity-focused applications (provided by the likes of AT&T Inc. ($T), Comcast Corporation ($CMCSA), and others) unified cloud communications applications (i.e., Vonage Holdings Corp. ($VG)), and point solutions (e.g., Citrix Systems Inc. ($CTXS)). One could be forgiven for thinking that everything and anything touching cloud would be gold in this environment. Imagine, for instance, if one firm could serve as an intermediary linking together various cloud-based solutions for other small, medium and large businesses!! Cha Ching!! 

Apparently that’s not the case.

New York-based Fusion Connect Inc., “a provider of integrated cloud solutions, including cloud communications, cloud connectivity and business services to small, medium and large businesses” is bucking the hot cloud trend and barreling quickly towards a bankruptcy court. This begs the question: what the holy f*ck? How is that even possible?

Per a January investor presentation, this is Fusion’s cloud services revenue:

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The 2018 revenue is annualized: revenue in Q3 ‘18 was actually $143.4mm with gross margins of 49.1%. Net operating income was $4mm. Yet the company lost $0.23/share. How does that work? Well, the company had $21.6mm in interest expense.

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The weighted-average rate of interest across the company’s credit facilities is approximately LIBOR + 7.7%. 😬 Not exactly cheap. Compounding matters is that the debt isn’t exactly cov-lite (shocking, we know): rather, the company is subject to all kinds of affirmative and negative covenants. Yes, once upon a time, those did exist.

The company’s recent SEC reports constitute a perfect storm of bad news. On April 2, the company filed a Form 8-K indicating that (i) a recently-acquired company had material accounting deficiencies that will affect its financials and, therefore, certain of the company’s prior filings “can no longer be relied upon,” (ii) it won’t be able to file its 10-K, (iii) it failed to make a $7mm interest payment on its Tranche A and Tranche B term loan borrowings due on April 1, 2019, and (iv) due to the accounting errors, the company has tripped various covenants under the first lien credit agreement — including its fixed charge coverage ratio and its total net leverage ratio. Rounding out this horror show of news, the company disclosed that it may need to seek a chapter 11 filing (combined with a CCAA in Canada) and has hired Weil Gotshal & Manges LLP, FTI Consulting Inc. ($FTI) and Macquarie Capital USA Inc. to advise it vis-a-vis strategic options. B.Riley/FBR ($RILY) analyst Josh Nicholsimmediately downgraded the company from “buy” to “neutral” (huh?!?) with a price target of $0.75 from $9.75. Uh, okay:

This is why you should never listen to equity analysts. This is the stock chart from the past year:

Like, the stock has been nowhere near $9.75, but whatevs.

On Monday, the company filed another Form 8-K. The company and 18 of its affiliated bankrupt US debtors…uh, we mean, guarantors…entered into a forbearance agreement with lenders under the Wilmington Trust NA-agented first lien credit agreement. The lenders will forbear from exercising rights and remedies stemming from the company’s defaults until April 29. The company had to pay 200 bps for the time to try and work this all out and agree to pay a slew of lender professionals, including Greenhill & Co. Inc. ($GHL) and Davis Polk & Wardwell LLP for an ad hoc group of Tranche B term lenders, Simpson Thacher & Bartlett LLP for the lenders of Tranche A term loans and the revolving lenders, and Arnold & Porter Kaye Scholer for Wilmington Trust.

The company’s Tranche B term lenders include East West Bank, Goldman Sachs, Morgan Stanley, Onex Credit Partners, Oppenheimer Funds and a whole bunch of CLOs. The latter fact may make a debt-for-equity swap interesting (PETITION Note: most CLOs are unable to hold equity securities).

The clock is ticking on this one.

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💸Goldman Sachs Hops Aboard the Mall Short💸

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Mall Shorts Gather Steam

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In last Wednesday’s “Thanos Snaps, Retail Disappears👿,” we included a LOOOOOONG list of retailers that are shutting down stores. Subsequently, J.Crew Group announced that it is closing a net 10 stores (20 J.Crew locations offset by 10 Madewell openings), Williams-Sonoma Inc. ($WSM) announced that it plans to close a net total of 30 stores, Hibbett Sports Inc. ($HIBB) announced approximately 95 stores will close this year, and Tommy Hilfiger closed its global flagship store on Fifth Avenue (Query: is New York City f*cked?) and its Collins Avenue store in Miami.

The point of the piece, however, wasn’t to wallow in retail carnage: rather, it was to make the point that there’s no way the malls — or at least certain malls — could continue business as usual.* With thousands of stores coming offline, we argued, there have to be malls that start feeling the pain and, eventually, run afoul of their lenders. We used $CBL as our poster child and closed by stating that Canyon Partners was shorting mall-focused CMBS via a CDS index, the Markit CMBX.BBB- (and lower indices).

Apparently Goldman Sachs Inc. ($GS) is in on the action. Late last week, Goldman urged“clients join the "big short" bandwagon by going short CMBX AAA bonds (while hedging in a pair trade by going long five-year investment-grade corporate CDX).” ZeroHedgesummarizes the Goldman report as follows:

Citing the bank's recent review of potential areas of financial imbalance across the US corporate and household sectors, [the Goldman analyst] notes that stretched CRE valuations ranked near the top in terms of risk level; and while a large and immediate commercial property price downturn is not the bank's baseline forecast, "a scenario with falling commercial property prices in the next 1-2 years is one to which we would attach non-negligible probability" the analysts caution.

And, then, in customary hyperbolic form, Zerohedge concludes:

Why is this notable? Because regular readers will recall that the 2007/2008 financial crisis really kicked in only after Goldman's prop desk started aggressively shorting various RMBS tranches, both cash and synthetic, in late 2006 and into 2007 and 2008, with the trade eventually becoming the "big short" that was popularized in the Michael Lewis book.

Will Goldman's reco to short CMBX-6 AAA be the trigger that collapses the house of cards for the second time in a row? While traditionally lightning never strikes twice the same place, the centrally-planned market is now so broken that even conventional idioms have to be redone when it comes to the world's (still) most important trading desk. In any case, keep an eye on commercial real estate prices: while residential markets have already peaked with most MSAs sliding fast, commercial may just be the first domino to drop that unleashes a tsunami of disastrous consequences across the rest of the market.

It is far from certain that all of this noise about shorting CMBS is anything more than isolated trades. One thing that is certain? Zerohedge is better at drumming up fear than Jordan Peele.

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*****

Speaking of J.Crew, S&P took a dump all over it yesterday as it downgraded the issuer credit rating to CCC and simultaneously downgraded its “intellectual property notes” — ouch, that must sting some (short asset stripping?) — and its secured term loan facility. The ratings agency maintains a “negative outlook” on the company, saying that “operating results deteriorated considerably in the most recent quarter,” and “approaching maturities of the company’s very high debt burden could lead J.Crew to restructure its debt in the next 12 months.” S&P provides a damning assessment:

We think the company continues to face significant headwinds to turn around operations which haven’t meaningfully improved since the J Crew brand relaunch in 2018. These threats include fast fashion and online retail, as well as continued declines in mall traffic and greater price transparency across the apparel industry. We believe these trends are especially heightened for U.S. mid-priced apparel retail players as consumers shift apparel spending toward brands with a consistent customer message or more appealing prices, given the continued preference for value, freshness, and convenience.

Tell us how you really feel, S&P.

*****

Speaking of damning assessments, there was this flamethrower of a press release issued by Legion Partners Holdings LLC, Macellum Advisors GP LLC, and Ancora Advisors LLC regarding Bed Bath & Beyond Inc. ($BBBY). Burn, baby, burn.

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PETITION readers will recall our previous discussion of BBBY. In January in “Is Pier 1 on the Ropes? (Short “Iconic” Brands),” we included discussion of BBBY and declared:

Bed Bath & Beyond swam against the retail tide last week as the company’s stock showed huge gains after it said that it is ahead of its long-term plan and that it is successfully slowing down declines in operating profit and net earnings per share. Which is interesting because, putting forward guidance aside, the ACTUAL numbers weren’t all that great. In fact, the company’s trend of disappointing same-store sales continues unabated (negative 1.8%, worse than forecast). EPS and revenue numbers were slightly better and slightly worse, respectively, than expected. Which means that to drive the higher EPS, the company must be taking costs out of the business. We have no crystal ball and this is in now way meant to be construed as investment advice, but we’re not seeing justification for a massive stock price increase (up 15% from when we wrote about it and 30% from its December 24 low).

Suffice it to say, the aforementioned investors were far from impressed. The press release kicks off with:

“Magnitude of value destruction necessitates wholesale board and leadership changes. CEO Steven Temares has overseen the destruction of more than $8 billion in market value over his 15-year tenure, with total shareholder returns of negative 58%. Since early 2015, the stock has lost over 80% of its value.”

Certainly not mincing words there, that’s for sure.

It then follows with:

Failed retail execution and strategy. Apparent inability to prioritize a long list of poorly implemented initiatives and management’s lack of success in adapting its business model to a changing retail landscape, has resulted in stagnant sales and adjusted EBITDA margins declining from 18% in fiscal 2012 to 7% in the last 12-month period ending November 2018.

Deeply entrenched board lacking retail experience is an impediment to serving shareholder interests. Average director tenure is approximately 19 years and the lack of retail expertise and stale perspectives on the board have hindered proper oversight of the management team.

We mean…those are just cold. Hard. Facts. And they’re not wrong about the board: it strains credulity to think that the Head of the TIAA Institute, a pensioned partner at Proskauer Rose LLP, and an EVP for Verizon Communications Inc. know f*ck all about the travails afflicting retail these days (to be fair: it seems the founder and CEO of Red Antler, a reputable branding agency that has helped build the likes of Casper, Keeps, Boxed, Google, allbirds and Birchbox makes sense…if anything has value here…and, yes, we’re REALLY stretching here…its the, gulp, brand…like, maybe??…or, like, maybe not???).

Seriously, it’s not really difficult to argue with this (even if the investors take some liberties in defining companies like Restoration Hardware ($RH) as “retail peers”):

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Problematically, however, the three firms own merely 5% of the outstanding common stock so there’s not a ton that they can do to agitate for change. The market, though, doesn’t seem to give a sh*t: it just wants something…anything…to happen with this business.

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More significantly, investors simply cannot sit on the sidelines anymore and watch retail management teams flail in the wind. We discussed certain management teams that really seem to be skating to where the puck is going, see, e.g., $PLCE. But many others aren’t and those that aren’t act at their own peril. Here, at least, investors are putting management and the board of directors on notice.

Expect to see other investors act similarly in other cases.

*There are a number of malls, however, that do seem to be continuing business as usual. This piece makes the point that apocalypse is not as bad as the media makes out.

💰Goldman Sachs Has its Cake and Eats it Too💰

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Short GNC Holdings Inc. Long Care/of. 

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We’ve written extensively here, here, here and here about GNC Holdings Inc. ($GNC) and the challenges that the company faces. We won’t revisit all of that here other than to note that GNC was, upon information and belief, preparing for a bankruptcy filing prior to it amending and extending its term loan, entering into a new ABL, and obtaining $275mm of asset-backed FILO term loans. We quipped that this was the quintessential “kick-the-can-down-the-road” transaction. Goldman Sachs ($GS) advised the company on the entire capital structure fix. Suffice it to say, then, that Goldman Sachs is intimately familiar with the GNC business.

Which, naturally, makes the fact that Goldman Sachs Investment Partners (a division of Goldman Sachs Asset Management) served as the lead investor in vitamin startup Care/of’s Series B financing all the more interesting.

Now, of course, we know Goldman is a big shop. They’re probably talking to WeWorkabout how to design their spaces to balance the sheer volume of “Chinese walls” with the need for an aesthetic that appeals to the millennial mindset. And, surely, Goldman Sachs’ capital advisory arm is entirely different and separate from Goldman’s asset management and venture arm.

But still.

Earlier this week Care/of, a direct-to-consumer wellness brand that specializes in monthly subscriptions of personalized vitamins and supplements, announced the new round of $29mm. In addition to Goldman, investors included Goodwater Capital, Juxtapose, RRE Ventures and Tusk Ventures. Former President of GNC, Beth Kaplan, also invested and will be joining the Board. 🤔

Bloomberg notes:

Care/of, a startup selling vitamins and herbal supplements online, raised funds from investors including Goldman Sachs Group Inc.’s venture arm that value the company at $156 million, within striking distance of publicly traded retail chains that are among the industry’s leaders.

The startup’s $156 million valuation isn’t far from Vitamin Shoppe Inc., with 3,860 employees and a market capitalization of about $203.5 million, or GNC Holdings Inc., which has a market value of $254.2 million with 6,400 employees. Care/of has about 100 workers, Chief Executive Officer Craig Elbert said.

“Consumers are increasingly shifting spend online and so I think large retail footprints have the potential to be a liability,” Elbert said in an interview. “There’s a lot of growth ahead of us and lot of reasons why this should be an e-commerce business.”

This is so Goldman-y. Collect an advisory fee to extend the life of the dominant brick-and-mortar retailer with one hand while investing in a nimble direct-to-consumer upstart that will chip away on that very same retailer on the other hand. Even before the former requires capital markets advice from a Goldman-type in a few years — which, it undoubtedly will — it may be on the lookout for an M&A banker. Perhaps to sell itself. Perhaps to buy a start-up and build a moat against Amazon. How convenient that Goldman will have familiarity with both businesses. We’d say that maybe there’d be a conflict somewhere in there but, well…do those really even exist anymore??

GNC Holdings Inc. Kicks the Can

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The Rise of DTC Supplements Constitutes a Threat to GNC

Speaking of a concessions business, GNC Holdings Inc. ($GNC) is a big proponent (have you been to Rite-Aid lately?) and look how well…oh, wait…nevermind.

When we last wrote about GNC back in February, the company had reported surprising earnings, margins and free cash flow; it also paid down its revolving credit facility and seemed on the verge of amending and extending its term loan. It had also just received a cash infusion commitment from a Chinese investment fund in exchange for 40% of the company. Subsequently, the company was able to amend and extend the term loan to 2021. Concurrently, the company entered into a new $100 million asset-backed loan due August 2022 and engaged in certain other capital structure machinations to obtain $275 million of asset-backed “first in, last out” term loans due December 2022. Textbook. Kicking. The. Can. Which, of course, helped the company avoid Vitamin World’s bankrupt fate. 👊 Goldman Sachs!

Meanwhile, this is what the stock looks like:

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Pretty ugly. And it may get worse when you factor in what’s going on in the world of supplements, generally. What’s going on, you ask? A sh*t ton of venture capital investment, corporate cash infusion and growth.

Earlier in March, a company called Ancient Nutrition, producer of bone broth protein and collagen supplement, raised $103 million of funding from VMG Partners, Hillhouse Capital and ICONIQ Capital. Notably, the product is available throughout Chicago — just not at GNC. Rather, it is available at Whole Foods, Fresh Thyme Farmers Market and Heinan’s. Similarly, in New York City, it is predominantly found at Whole Foods, Fairway and Natural Green Market, among other places.

Supplements are going gangbusters elsewhere too. Earlier this month, Hims, an erectile dysfunction and hair loss company aimed at millennials and dubbed “Viagra, but for hipsters” (yup, you read that right), raised $40 million of funding at a $200 million valuation (kudos to GQ for creative photography). It’s distribution channel? Direct-to-consumer. Sorry GNC. Same goes for Roman and Keeps, two Hims-like competitors.

Meanwhile, The Clorox Company got into the game last week with an $700 million acquisition (3.5x sales) of Nutranext, a Florida-based wellness company that makes supplements and has a strong direct-to-consumer business. You know where you can’t get Nutranext…?

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That’s right: GNC.

Perhaps those restructuring professionals disappointed by Goldman Sachs’ success in securing the refinancing should just put that GNC file in a box labeled “2021.”