💸Goldman Sachs Hops Aboard the Mall Short💸

Mall Shorts Gather Steam

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.

*****

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.

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”):

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.

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.

Nine West Finally Bites It

Another Shoe Retailer Strolls into Bankruptcy Court

A few weeks back, we wrote this in “👞UGGs & E-Comm Trample Birkenstock👞,”

“Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect ‘not a hell of a whole lot’.”

Now we know: $123 million. (Frankly more than we expected.)

Consistent with the micro-brands discussion above, we also wrote,

“Saving the most relevant to Nine West for last,

Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.

Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages. Query whether this factor will be featured in Nine West’s First Day Declaration with such specificity. Likely not.”

Now we know this too: definitely not.

But Nine West Holdings Inc., the well-known footwear retailer, has, indeed, finally filed for bankruptcy. The company will sell the intellectual property and working capital behind its Nine West and Bandolino brands to Authentic Brands Group for approximately $200 million (inclusive of the above-stated $123 million allocation to IP, subject to adjustment) and reorganize around its One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments. The company has a restructuring support agreement (“RSA”) in hand with 78% of its secured term lenders and 89% of its unsecured term loan lenders to support this dual-process. The upshot of the RSA is that the holders of the $300 million unsecured term loan facility will own the equity in the reorganized entity focused on the above-stated four brands. The case will be funded by a $247.5 DIP ABL which will take out the prepetition facility and a $50mm new money dual-draw term loan funded by the commitment parties under the RSA (which helps justify the equity they’ll get).

Regarding the cause for filing, the company notes the following:

“The unprecedented systemic economic headwinds affecting many brick-and-mortar retailers (including certain of the Debtors’ largest customers) have significantly and adversely impacted the operating performance of the Debtors’ footwear and handbag businesses over the past four years. The Nine West Group (and, prior to its sale, Easy Spirit®), the more global business, faced strong headwinds as the macro retail environment in Asia, the Middle East, and South America became challenged. This was compounded by a difficult department store environment in the United States and the Debtors’ operation of their own unprofitable retail network. The Debtors also faced the specific challenge of addressing issues within their footwear and handbag business, including product quality problems, lack of fashion-forward products, and design missteps. Although the Debtors implemented changes to address these issues, and have shown significant progress over the past several years, the lengthy development cycle and the nature of the business did not allow the time for their operating performance within footwear and handbags to improve.”

Regarding the afore-mentioned “macro trends,” the company further highlights,

“…a general shift away from brick-and-mortar shopping, a shift in consumer demographics away from branded apparel, and changing fashion and style trends. Because a substantial portion of the Debtors’ profits derive from wholesale distribution, the Debtors have been hurt by the decline of many large retailers, such as Sears, Bon-Ton, and Macy’s, which have closed stores across the country and purchased less product for their stores due to decreased consumer traffic. In 2015 and 2016, the Debtors experienced a steep and unanticipated cut back on orders from two of the Debtors’ most significant footwear customers, which led to year over year decreases in revenue of $16 million and $46 million in 2015 and 2016, respectively. These troubles have been somewhat offset by e-commerce platforms such as Amazon and Zappos, but such platforms have not made up for the sales volume lost as a result of brick-and-mortar retail declines.”

No Allbirds mention. Oh well.

But wait! Is that a POSITIVE mention of Amazon ($AMZN) in a chapter 11 filing? We’re perplexed. Seriously, though, that paragraph demonstrates the ripple effect that is cascading throughout the retail industrial complex as we speak. And it’s frightening, actually.

On a positive note, The One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments, however, have been able to “combat the macro retail challenges” — just not enough to offset the negative operating performance of the other two segments. Hence the bifurcated course here: one part sale, one part reorganization.

But this is the other (cough: real) reason for bankruptcy:

Source: First Day Declaration

Soooooo, yes, don’t tell the gentlemen mentioned in the Law360 story but this is VERY MUCH another trite private equity story. 💤💤 With $1.6 billion of debt saddled on the company after Sycamore Partners Management LP took it private in 2014, the company simply couldn’t make due with its $1.6 billion in net revenue in 2017. Annual interest expense is $113.9 million compared to $88.1 million of adjusted EBITDA in fiscal year 2017. Riiiiight.

A few other observations:

1. Leases. The company is rejecting 75 leases, 72 of which were brick-and-mortar locations that have already been abandoned and turned over to landlords. Notably, Simon Property Group ($SPG) is the landlord for approximately 35 of those locations. But don’t sweat it: they’re doing just fine.

2. Liberal Definitions. As Interim CEO, the Alvarez & Marsal LLC Managing Director tasked with this assignment has given whole new meaning to the word “interim.” Per Dictionary.com, the word means “for, during, belonging to, or connected with an intervening period of time; temporary; provisional.” Well, he’s been on this assignment for three years — nearly two as the “interim” CEO. Not particularly “temporary” from our vantage point. P.S. What a hot mess.

3. Chinese Manufacturing. Putting aside China tariffs for a brief moment, if you're an aspiring shoe brand in search of manufacturing in China and don't know where to start you might want to take a look at the Chapter 11 petitions for both Payless Shoesource and Nine West. A total cheat sheet.

4. Chinese Manufacturing Part II. If President Trump really wants to flick off China, perhaps he should reconsider his (de minimus) carried interest restrictions and let US private equity firms continue to run rampant all over the shoe industry. If the recent track record is any indication, that will lead to significantly over-levered balance sheets borne out of leveraged buyouts, inevitable bankruptcy, and a top 50 creditor list chock full of Chinese manufacturing firms. Behind $1.6 billion of debt and with a mere $200 million of sale proceeds, there’s no shot in hell they’d see much recovery on their receivables and BOOM! Trade deficit minimized!!

5. Yield Baby Yield! (Credit Market Commentary). Sycamore’s $120 million equity infusion was $280 million less than the original binding equity commitment Sycamore made in late 2013. Why the reduction? Apparently investors were clamoring so hard for yield, that the company issued more debt to satisfy investor appetite rather than take a larger equity check. Something tells us this is a theme you’ll be reading a lot about in the next three years.

6. Athleisure & Casual Shoes. The fleeting athleisure trend took quite a bite out of Nine West’s revenue from 2014 to 2016 — $36 million, to be exact. Jeans, however, are apparently making a comeback. Meanwhile, the trend towards casual shoes and away from pumps and other Nine West specialties, also took a big bite out of revenue. Enter casual shoe brand, GREATS, which, like Allbirds, is now opening a store in New York City too. Out with the old, in with the new.

7. Sycamore Partners & Transparency in Bankruptcy. Callback to this effusive Wall Street Journal piece about the private equity firm: it was published just a few weeks ago. Reconcile it with this statement from the company, “After several years of declines in the Nine West Group business, part of the investment hypothesis behind the 2014 Transaction was that the Nine West® brand could be grown and strong earnings would result.” But “Nine West Group net sales have declined 36.9 percent since fiscal year 2015—from approximately $647.1 million to approximately $408 million in the most recent fiscal year.” This is where bankruptcy can be truly frustrating. In Payless Shoesource, there was considerable drama relating to dividend recapitalizations that the private equity sponsors — Golden Gate Capital Inc. and Blum Capital Advisors — benefited from prior to the company’s bankruptcy. The lawsuit and accompanying expert report against those shops, however, were filed under seal, keeping the public blind as to the tomfoolery that private equity shops undertake in pursuit of an “investment hypothesis.” Here, it appears that Sycamore gave up after two years of declining performance. In the company’s words, “Thus, by late 2016 the Debtors were at a crossroads: they could either make a substantial investment in the Nine West Group business in an effort to turn around declining sales or they could divest from the footwear and handbag business and focus on their historically strong, stable, and profitable business lines.” But don’t worry: of course Sycamore is covered by a proposed release of liability. Classic.

8. Authentic Brands Group. Authentic Brands Group, the prospective buyer of Nine West's IP in bankruptcy, is familiar with distressed brands; it is the proud owner of the Aeropostale and Fredericks of Hollywood brands, two prior bankrupt retailers. Authentic Brands Group is led by a the former CEO of Hilco Consumer Capital Corp and is owned by Leonard Green & Partners. The proposed transaction means that Nine West's brand would be transferred from one private equity firm to another. Kirkland & Ellis LLP represented and defended Sycamore Partners in the Aeropostale case as Weil Gotshal & Manges LLP & the company tried to go after the private equity firm for equitable subordination, among other causes of action. Kirkland prevailed. Leonard Green & Partners portfolio includes David's Bridal, J.Crew, Tourneau and Signet Jewelers (which has an absolutely brutal 1-year chart). On the flip side, it also owns (or owned) a piece of Shake Shack, Soulcycle, and BJ's. The point being that the influence of the private equity firm is pervasive. Not a bad thing. Just saying. Today, more than ever, it seems people should know whose pockets their money is going in to.

9. Official Committee of Unsecured Creditors. It’ll be busy going after Sycamore for the 2014 spin-off of Stuart Weitzman®, Kurt Geiger®, and the Jones Apparel Group (which included both the Jones New York® and Kasper® brands) to an affiliated entity for $600 million in cash. Query whether, aside from this transaction, Sycamore also took out management fees and/or dividends more than the initial $120 million equity contribution it made at the time of the transaction. Query, also, whether Weil Gotshal & Manges LLP will be pitching the committee to try and take a second bite at the apple. See #8 above. 🤔🤔

10. Timing. The company is proposing to have this case out of bankruptcy in five months.

This will be a fun five months.