💥Tupperware Update: More than 'A Good Quarter'💥

⚡️Update: Tupperware Brands Corp. ($TUP)⚡️

In last Wednesday’s “💥 Royal Caribbean Collapses. Tupperware Thrives. Friendly's Melts.💥,” we provided a brief update on the Tupperware Brands Corp. ($TUP) situation, highlighting how the company has been a clear-cut beneficiary of COVID-19.  Profit quadrupled to $34.4mm in the company’s most recent quarter and equity that hovered around $1/share back in March jumped to the high 20s (and even breached $30/share) after the earnings announcement. This is an astounding rebound for a company that, back in February, was i) operating with an interim CEO, ii) struggling in a variety of geographies including Brazil, China, Canada and the US, iii) dealing with accounting issues, and iv) badly missing revenue, EPS, and cash flow targets. On Wednesday, we credited the pandemic with the turn-around. But there was more to the story. A lot more.

In April 2020, Tupperware Brands announced weak Q120 earnings, with sales down -23% YoY and FCF burn of roughly $55mm in the quarter. Already struggling due to changing consumer habits and now also contending with coronavirus lockdowns, management elected to pull their FY20 guidance and increased their previously announced cost reduction target to $75mm (up 50%). But the company needed to do more:  

“[Tupperware Brands]…amended its Credit Agreement during [Q120] and agreed to changes to the permitted debt to Adjusted EBITDA ratio, which increases to 5.75 for the first and second quarter of 2020, tightening to 5.25 in the third quarter of 2020, and again decreasing to 4.50 in the fourth quarter…”

For the uninitiated, an increased EBITDA ratio gives a company additional breathing room in a situation like this one where debt (usually) remains static in the face of dramatically decreasing sales and FCF declines. The relief, however, clearly contemplated that the company’s COVID-related problems would be short-lived as the ratio ratcheted down meaningfully in subsequent quarters. Management’s feet were to the fire.

But they had levers to pull:

The Company has taken certain measures in response to the COVID-19 situation, designed to enhance its liquidity position, provide additional financial flexibility and maintain forecasted financial covenant compliance, including reductions in discretionary spending, revisiting investment strategies, and reducing payroll costs, including through organizational redesign, employee furloughs and permanent reductions. Additionally…on March 30, 2020, the Company drew down $225 million under its Credit Agreement, $175 million of which was drawn as a proactive measure given the uncertain environment resulting from the COVID-19 pandemic. In addition, the Company has approximately $600 million of Senior Notes outstanding with a maturity date of June 2021 and is proactively working with advisors to evaluate its options relative to this maturity. (emphasis added)

Tupperware’s $600mm 4.75% Senior Notes due June 2021 were increasingly becoming a problem for the company. Given the rapidly declining earnings and elevated leverage, junior bondholders were (understandably) concerned how their principal might get paid. The trading price on the bonds reflected those concerns, with the notes trading well into distressed territory at below 50 cents on the dollar.

This is where the governing credit docs had a role to play. Tupperware realized an alternative “use of proceeds” for its revolver draw: under the credit agreement, the company could use the monies to permissibly tender the market for an early redemption of the outstanding notes. Per the WSJ:

The publicly listed company launched on May 26 an offer to repurchase at a deep discount about one-third of a $600 million bond that falls due a year from now. The strategy is to ease financial pressure on the company, increasing its chances of repaying the bond on time and helping it meet guidelines for its various bank loans, a person familiar with the matter said.

Tupperware offered to buy back $175 million face amount of the debt at a price of 45 cents on the dollar and gave bond investors a June 22 deadline to take part in the deal. If it achieves full participation, the company would spend about $79 million to retire the debt early.

But the company didn’t stop there. It subsequently launched a second tender to take out even more of the notes. When all was said and done, the company (a) struck a deal with a large percentage of its disillusioned junior creditors for cents on the dollar, (b) deleveraged the balance sheet by $220mm of debt principal for only $164mm of (the revolving lenders’) cash, and (c) prevented any equity dilution (including, of course, that held by management). Significantly, this maneuver also cured the company of a potentially serious financial maintenance covenant issue. Talk about “robbing Peter to pay Paul”!

Consider: if the revolver lenders had their way, the company would have engaged in a full-blown restructuring pursuant to which the bondholders would be forced to swap their bonds for equity and wipe out the equity. The company would come out with less leverage and, in turn, lower interest expense. This would obviously lower the risk profile. But even better, the banks could have used the restructuring to provide a DIP and ultimately slither into a much higher yielding piece of exit paper. Alas, not.

Having survived their covenant concerns, Tupperware approached its remaining junior bondholders. Those noteholders, who had not cashed out their bonds in the prior two tenders had organized with their own advisors, and were attempting to use the upcoming maturity and their holdout status as a negotiating ploy to exchange into structurally senior, high coupon rescue financing. We don’t know all the details of those negotiations, but given most COVID-driven rescue financing deals are somewhere in the 12-15% area, we imagine it would have been a very expensive deal for Tupperware.

But then the company cancelled those negotiations! Performance saved them. As we noted on Wednesday, the company reported absolute blowout Q3 earnings, with sales up 14% (up 21% in local currency), $60mm of positive FCF, and commentary that Tupperware had realized 2/3, or $120mm of its $180mm cost-reduction target. Management also entered into a binding commitment for a sale leaseback of its corporate HQ for $86mm, further improving liquidity. Tupperware’s newly minted CEO Miguel Fernandez provided his thoughts on the stellar quarter:

“The 21 percent growth in local currency revenue reported today reflects a rapid adoption of digital tools by our sales force to combat the social restrictions surrounding COVID-19, and the increased consumer demand for our innovative and environmentally friendly products, as more consumers cook at home and are concerned with food safety and storage…The improved performance of both top and bottom line these past two quarters are a positive sign that our Turnaround Plan is working.”

CFO Sandra Harris’ comments indicated the company wasn’t stopping there:

“We are pleased with the rate of improvement in right sizing the business, improving our liquidity and making permanent structural changes that will ensure the success of our Turnaround Plan…These efforts, including sales of non-core assets, will help us continue to improve the health of our balance sheet as we pursue the refinancing of [the remainder of their] June 2021 obligations.”

On Monday, November 2nd, while we at PETITION were fretting over the possibility of an election-induced civil war, Tupperware came to market with a refinancing of its remaining junior 2021 bonds. The company entered into a commitment letter with Angelo, Gordon & Co., L.P. and JP Morgan Strategic Situations Initiatives for a two tranche secured term loan facility, consisting of a $200mm “Parent Term Loan” facility and a $75mm “Dart Term Loan facility.” Based on the commitment papers, the new loans are priced at 7.75%, but future interest rate is determined on a leverage-based grid. The loans can step down to L + 7.25% if leverage is below 2.75x, or step up to L + 8.75% if leverage is above 2.75x. Use of proceeds of the new loans will be used to fully repay the junior 2021 notes.

The market has certainly rewarded new management for their efforts ⬇️.

In “💥Oaktree's Howard Marks: "I don't think of it as 'screwing'"💥,” we highlighted the TriMark USA situation, quipping “Long Creditor-on-Creditor Violence”. We subsequently discussed the theme in the ongoing adventures of Revlon Inc. ($REV). Here, though, instead of senior creditors getting primed by structurally senior debt, the company and its consenting bondholders inflicted violence – TupperWAR, if you will -- on the revolving banks.

You gotta love restructuring!

🔥F.E.A.R. Part Two.🔥

⚡️What. The. Hell. Part. Two.⚡️

Pardon us: it’s a little hard to write with a neck brace on. This week’s whiplash has us all sorts of flummoxed.

On Monday, the stock market surged 1000 points because … well … who the hell knows? Was President Trump correct last week when he suggested that some of last week’s negative market price action had to deal with the rise of Bernie Sanders? Maybe. On Monday, while the mainstream media simultaneously reported on the consolidation of the moderate democrat lane and new coronavirus-related deaths, the stock market somewhat-inexplicably rocketed higher. Apparently the thought of 2% of the US population succumbing to a painful pneumonia-like death was no longer so frightening now that “the establishment” was rallying against good ol’ Bernie. We know, we know, you’re wondering: is this really the reason? The answer: we have no f*cking idea. But whatevs 🤷‍♀️. The market was green!

Enter the FED. The market was looking mighty volatile again yesterday when the FED came out of nowhere and lowered its benchmark FED Funds rate by 50 bps — acting between meetings for the first time since 2008. We all know what happened that year. Why couldn’t the FED wait two weeks? Chairman Powell said:

“The committee judged that the risks to the U.S. outlook have changed materially. In response, we have eased the stance of monetary policy to provide some more support to the economy.”

In other words, the FED must be seeing some disturbing-AF data that we aren’t privy to yet. Less likely though equally plausible: Jerome Powell continues to be Reek to President Trump’s Ramsey Bolton.

The result? Well, the market rallied for about 1.2 hot seconds and then puked all over itself. It subsequently tumbled 2.8%. The energy sector is now down 23% YTD. The Ten-year treasury yield dipped below 1% for the first time in history.

FOR THE FIRST TIME IN HISTORY. Yes, folks, sh*t is getting real. We’d opine as to “how real” but, again, this is THE FIRST TIME IN HISTORY that this has happened. So, literally nobody knows.

To the extent this extraordinary measure was meant to calm markets, well…

``It’s doubtful that when JP left home this morning he thought ‘50 bp will really crush the stock market.’ So it goes.'' #coronaclientnotes pic.twitter.com/ZuptQoK5Bu

— Eliza Ronalds-Hannon (@ElizaHannon) March 3, 2020

A generation of investors believes that Central Banks are omnipotent and that pre-emptive strikes on financial stress are the solution to every crisis.

Today, that world view is being tested. It could represent a profound shift in the collective consciousness and a new regime.

— Christopher Cole (@vol_christopher) March 3, 2020

Time to extract that gold tooth: it’s going up in value.

You know what else is going up in value? Food. As coronavirus reports spread to multiple cases in NYC, North Carolina and other places, people are stocking up like crazy with an eye towards a potential quarantine situation. Lots of marriage about to get tested, y’all. Netflix and…KILL?!? 😬 Long divorce lawyers.

*****

What does all of this coronavirus disruption mean for restructuring professionals? It’s still far too early to tell. But this doesn’t bode well:

This shows that supplier delivery times are slowing due to China-related issues.

This doesn’t help either:

Ooof. No bueno. Like 2009-level no bueno. Stating the obvious, JPMorgan noted that “…demand, international trade and supply chains were severely disrupted by the COVID-19 outbreak.”

Bottom line: it’s hard to generate revenue (and service debt or comply with covenants) when you don’t have product.

🎢Weeeeeeeeeeeeeee🎢

⚡️Update: WeWork⚡️

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

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

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:

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

At most, WeWork has the capacity to issue a little more than $1 billion in secured debt and $2.56 billion of unsecured debt: @XtractResearch This is substantially less than some of the estimates floating out there regarding potential loan commitments.

— Lisa Abramowicz (@lisaabramowicz1) October 14, 2019

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.”

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.

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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💥What to Make of the Credit Cycle. Part 30. (Long Signs of Coming Pain?)💥

This week the market got qualitative and quantitative signals that were decidedly mixed.

On Tuesday, the ISM U.S. manufacturing purchasing managers’ index registered 47.8% for September, the lowest reading since June ‘09, and the second straight month of deceleration. A number below 50% suggests economic contraction. Economists all over Wall Street bemoaned tariffs for diminished activity, with one Deutsche Bank economist noting “the recession risk is real.” President Trump, of course, parried, saying that higher relative interest rates and the strong dollar are to blame.

As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected. Fed Rate too high. They are their own worst enemies, they don’t have a clue. Pathetic!

— Donald J. Trump (@realDonaldTrump) October 1, 2019

Similarly, pundits dismissed this data’s importance, noting that the US economy is more services-based (70% of growth) than manufacturing-oriented. In addition, a competing survey from IHS Markit showed some positivity, reflecting that “though the sector remains in contraction, the index rose for the second straight month.” It concluded that the US, China and emerging markets are all simultaneously improving. Ah, qualitative reports. Insert grain of salt here. 😬

On Thursday, the ISM non-manufacturing index — a widely watched measurement of the services sector — came out and the numbers were 💩. Like weakest in 3 years 💩💩💩 .

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Is Delivery Killing Fast Casual Too? (Long Busted Narratives)

Zoe's Kitchen is Latest Restaurant Showing Signs of Trouble

Fast casual is supposed to be a bright spot for restaurants. But as the segment has grown in recent years, there are bound to be winners and losers. Zoe’s Kitchen Inc., a fast casual Mediterranean food chain with 250 locations in 20 states ($ZOES), is increasingly looking like the latter.

Last week the company reported sh*tty earnings. Comp restaurant sales declined by 2.3% despite rising prices pushed on to the consumer. The decline is attributable to the usual array of externalities (e.g., weather) but also location cannibalization. Apparently, the company’s growth strategy is pulling consumers from previously established locations. Moreover, the company noted “inflationary pressures in produce and freight costs, that are expected to impact cost of goods sold for the balance of the year.” Wages also increased 3.3%, an acceleration from the 2.9% realized in Q4 ‘17. Accordingly, adjusted EBITDA decreased 30.9%. The net loss for the quarter was $3.6mm or -$0.19/share. The company lowered guidance. The stock tumbled.

Before you get too excited, note that this is a debt-light company: it currently has a ‘22 $50mm revolving credit facility with JPMorganChase Bank NA, of which $16.5mm is outstanding (with $3.7mm of cash on hand, net debt is only $12.8mm). It also, believe it or not, has covenants — leverage and interest coverage, among others — and the company is in compliance as of April 16, 2018. It also plans to continue its expansion: in the sixteen weeks ended 4/16/18, the company opened 11 company-owned restaurants with a plan to open approximately 25 (inclusive) over the course of fiscal year ‘18. That said, it does intend to rationalize existing locations (and expects some impairment charges as a result), cut G&A and take other operational performance improvement measures to combat its negative trends. There’s a potential opportunity here for low-to-middle-market FAs and real estate advisors.

For our part, we found this bit intriguing (unedited):

We are definitely seen more competitive intrusion, more square footage growth in some of those smaller kind of mid to kind of large markets where we've been there for some time now that's a little bit of what we're seeing in those markets.

We've also seen more competitive catering competition as every ones ramped up catering. And also the value and discounting as we spoke to in the call, in the prepared remarks we've seen that $10 check with that single user kind of moving around and we think that's so from the new competition square footage growth, the value and discounting and then the delivery interruption, we've seen or felt that in many of our markets.

There’s a lot to unpack there. Clearly competition, as we noted upfront, is increasing in the $10-check size cohort of fast casual. Catering is always a competitive business for restaurants like this too. But, the point that really got out attention was that about delivery. The company says pointedly, “We also believe that disruption from delivery and discounting has created headwinds.” The company further states,

Digital comps were 26% positive in Q1 as we leverage improvements from last year's investments in web and mobile platforms to build greater convenience for our guests. Early in Q2, we relaunched and upgraded our loyalty program, which is expected to help drive traffic by making it easier and clearer for our guest to earn and redeem rewards. Delivery sales grew in both our non-catering and catering businesses by 155%. And we have a clear plan to build out the channel for more profitable growth in 2018.

The impact of mobile food ordering and the need for delivery cannot be overstated. Companies need to act fast to activate delivery capabilities that makes sense to a mobile consumer who, more and more, goes to Postmates, Caviar, UberEats and other food delivery services for discovery. This is precisely why Shake Shack ($SHAK) is now on Postmates and Chipotle Mexican Grill Inc. ($CMG) is now available on Doordash. Others, like privately-owned Panera Bread are taking a step farther by building out its own delivery infrastructure in an attempt to own all its data and deliver without owing a cut to a middleman. Query whether this is far too much dependence on the likelihood of people to go directly to Panera’s app when they’re hungry…?

It sounds like the Zoe folks are increasing their focus on delivery. The question is whether they can execute fast enough to offset in-store dining declines. And whether they can do it on their own.

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.

Elizabeth Warren vs. the Bankruptcy Bar

A Reminder That Disruption Takes on Many Forms

PETITION is, broadly speaking, a newsletter about disruption. As loyal readers have surely noticed, the predominant emphasis, to date, has been tech-based disruption. But, spoiler alert, there are other forms. Earlier this week, Senators Elizabeth Warren and John Cornyn proposed a bill that swiftly reminded a cohort of (mostly Delaware) legal professionals that legislation, if passed, can be an even more immediate, powerful and jarring form of disruption.

Let’s take a step back. Shortly before Christmas, the Commercial Law League of America (CLLA) indicated that the U.S. Senate should consider a new bankruptcy venue reform bill. The gist of the proposal is that a debtor should have to file for bankruptcy in its principal place of business (or where their principal executive offices reside) - as opposed to, as things currently stand, its state of incorporation (the "Inc Rule"), where an affiliate is located (the "Affiliate Rule"), or where a significant asset is located (the "Abracadabra Rule"). Notably, a large percentage of companies are incorporated in Delaware, a state with well-established and well-developed corporate laws and legal precedent. Consequently, thanks to the "Inc Rule," Delaware is typically the most sought after venue by debtors, perennially topping annual lists with the most bankruptcy filings. In other words, the state of Delaware is the biggest beneficiary of the status quo. 

Putting aside the Inc Rule for a moment, the “Affiliate Rule” and “Abracadabra Rule,” respectively, have provided debtor companies with wide and crafty latitude to file in jurisdictions other than that of their principal place of business. Again, typically Delaware (and then, to a lesser extent, New York). Have a non-operating subsidiary formed in Delaware? Venue, check on the "Affiliate Rule." Got a random (unoccupied) office you set up last week in a WeWork in Manhattan? POOF, venue! Check on the "Abracadabra Rule." Got a bank account set up (a week ago) with JPMorgan Chase Bank in New York? Venue, again check on the "Abracadabra Rule". It is, seemingly, THAT optional. All of this is like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, General Motors ($GM) should file for bankruptcy in New York rather than Michigan. Oh, wait. That actually happened. Take two: that’s like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, Chrysler should file for bankruptcy in New York rather than Michigan. Damn. That also happened. Ok, here’s a good one: that’d be like saying it’s okay for the Los Angeles Dodgers to file for bankruptcy in Delaware rather than California. Wait, SERIOUSLY!?!? WTF. Who is to blame for this outrage? 

We'll keep this simple, lest this become a treatise absolutely nobody will want to read: federalism. Bankruptcy law is federal but every state has their own courts, circuit courts, and legal precedent. Some states have bankruptcy courts that are historically more favorable to debtors (cough, Delaware...need that incorporation business) - which, speaking commercially and realistically - are de facto clients of the state. Currently, debtors typically choose the venue so if you want to drive debtors to your courthouse steps, favorable corporate and debtor-favorable bankruptcy case precedent goes a long way towards filling court calendars. Not to mention hotels. In this regard, the bankruptcy court isn't all too dissimilar from a large tech company. Go fast and furious to market, aggregate a ton of users (here: debtors), acquire talent (read: judges), and build a database full of information (read: precedent) to then use against everyone else who tries to compete with you. That aggregation is the moat, the competitive advantage. Say, "we're the most sophisticated due to our talent, data, and predictability" and win. Boom. Dial up the Hotel Du Pont please!  

As a consequence of federalism, one jurisdiction's "makewhole provision" enriching bondholders is another jurisdiction's "no recovery for you" enraging bondholders. One jurisdiction's "restructuring support agreement" is another jurisdiction's "meaningless bound-to-be-blownup-worthless-piece-of-paper." That's the beauty of venue selection, currently. The system allows debtors to choose based on that precedent. Ask any of your biglaw buddies about "venue analysis" and watch their eyes roll into the back of their heads. That is, if you're even still reading this. They've all had to do it. It's a big part of the filing calculus. And everyone knows it. 

Enter Senators Warren and Cornyn. They're saying, "No way, Jose. This sh*t needs to stop." Okay, they didn't say that, exactly, but Senator Warren did say this, "Workers, creditors, and consumers lose when corporations manipulate the system to file for bankruptcy wherever they please. I’m glad to work with Senator Cornyn to prevent big companies from cherry-picking courts that they think will rule in their favor and to crack down on this corporate abuse of our nation’s bankruptcy laws.” The argument goes that the bill “'will strengthen the integrity of the bankruptcy system and build public confidence' by availing companies, small businesses, retirees, creditors and consumers of their home court." Ruh roh. 

A few years ago, a heavy hitter lineup of restructuring professionals were asked by The Wall Street Journal what they thought about this venue debate. The general upshot was "nothing to see here." With apologies for the paywall attached to the following links, you'll get the general idea. See, e.g., "the myth of forum shopping." See, also, "venue reform is a solution in search of a problem."; 
“allowing fiduciaries to exercise their business judgment about what filing location might maximize enterprise value or reduce execution risk or both.”; “If it ain’t broke, don’t fix it.”; "the current status quo of wide venue choice – should win out.”; “It’s not clear that these rules are problematic, so don’t apply a fix with its own set of unintended consequences.”; “The truth is that venue provisions are very appropriate and do not need to be adjusted”; "Letting debtors choose as they can now is 'good business sense.'"; and "current venue requirements 'strike a fair balance.'” In summary, you've got Senators Warren and Cornyn up against a LARGE subset of the bankruptcy bar. And those aren't all Delaware practitioners. That's a cross-section of the entire bar - with some financial advisors and investment bankers thrown in for good measure. Pop us some popcorn.

Now, we've been highlighting venue shenanigans since our inception. Not because it's wrong to leverage a favorable venue with uber-favorable precedent if you have that option; rather, because it has gotten so FRIKKEN OBVIOUS. Clearly an industry with $1750/hour billing rates isn't known for its subtlety. Want a third-party release to shield the private equity bros? St. Louis here we come! Have the opportunity to take advantage of a "rocket docket" and get those billable rates rubber stamped? Godspeed. Want to issue a "Standing Order" to divert bankruptcy traffic (back) into your court? May the Force be with you. 

That last bit is particularly notable. Venue gaming got so blatant that even the courts got in to the game. That "Standing Order" is as patent an acknowledgement of venue manipulation as anything we've seen of late. Why did this happen? Take a look at the case trends. After a few early (small) oil and gas exploration and production companies (E&P) filed in Texas and things, uh, didn't go particularly well for professionals, a deluge of E&P debtors mysteriously started popping up in Delaware. That's basic cause and effect. The subsequent cascading secondary effect was the "Standing Order" which, in response, guaranteed professionals that they'd get one of two judges and that, effectively, the Texas courts were open for business. Once that Order came out, debtor traffic curiously reverted back to Texas. E&P management teams and creditors could be heard in their home jurisdiction. Local firms could become "local counsel." Delaware counsel's loss was Texas counsels' gain. (If only the same could be said for lead counsel). Naturally, then, both the Texas Bankruptcy Bar Association and Texas Hotel & Lodging Association back the proposed bill: it basically fortifies the Standing Order. Also, guess where Senator Cornyn is from? Alexa, please cancel that Hotel Dupont reservation. 

We're not taking a position in this debate. We have no skin in that game. But we can't help but to chuckle at the timing. Ironically, it seems that more and more debtors are filing near their principal place of business rather than Delaware anyway (cough, third party releases!). See, e.g., Toys R Us, rue21, Payless Shoesource. And so this has the potential to reinforce a recent trend and compound the issues that have already surfaced for Delaware professionals. 

This is nerdy sh*t. But it’s still big deal disruption. Just disproportionately for the Delaware bar and the city of Wilmington. It’s so big that even iHeartRadio released a podcast discussing it. Without irony. Dramatic disruption AND comedy. 

Who knew bankruptcy could be so entertaining?

Professional-Services.ai

Short junior attorneys...the machines are coming for them. And, frankly, why shouldn't they come for attorneys at ALL levels? After all, are there situations where there is "overzealous advocacy and hyperactive legal efforts"? When there are "so many attorneys and their respective billings"? "When the hourly rates and amount of time billed are simply unreasonable"? "Staggering," in fact?  Suffice it to say, you won't see Weil filing any cases in Southern District of Iowa anytime soon (see below). Frankly, "overzealous advocacy and hyperactive legal efforts" seems like it could have just as easily applied to the pissing contest that was the equitable subordination claim in Aeropostale but who are we to judge a grudge match between Weil and Kirkland & Ellis (which the the latter convincingly won)? We were too busy popping popcorn and putting our feet up. Switching gears and looking elsewhere in changing labor markets, here's to wondering: is the "gig economy" working? And what becomes of those 89,000 lost retail jobs?

Speaking of retail jobs, it looks like the bankers have all of them. Now there's M&A noise around Neiman Marcus, which is heating up with Hudson's Bay sniffing around hard but trying to avoid assumption of Neiman's substantial debt-load. Meanwhile Nine West Holdings has hired Lazard to figure out its capital structure. Elsewhere in retail, Macy's ($M), Kohl's ($KSS), Nordstrom ($JWN) and J.C. Penney ($JCP) all reported earnings that looked like a dumpster fire and the stocks promptly got decimated. We're sure the bankers are salivating. And speaking of retailers with jacked-up debt (and bankers), GNC Holdings Inc. and its agent bankers JPMorgan reportedly attempted but ultimately failed to extend GNC's $1.13b loan by three years. Now GNC says it will use its "strong" free cash flow to fund ops and deal with its '18 maturity. This is an interesting story on many levels. First, there have been a TON of share buybacks in recent years (the public equivalent of a dividend recap - our favorite) and so it was only a matter of time before one of them bit an uncreative and misled -- uh, we mean, generous shareholder-minded - management team in the bum. Second, the "Amazon-effect" apparently applies to meatheads too with vitamin sales allegedly shifting online. Who knew Biff could function in an m-commerce world? Go Biff. Third, despite a variety of downward trending financials, GNC's loan is still trading at a tick below par and so the proposed transaction might have affected the lenders' yield metrics (hence the rejection). Which gets us to #4: with crappy loans like GNC's ticking up so far upward, most distressed players can't stop complaining about a dearth of opportunities to target: everything is priced to perfection. Sadly, everyone needs the yield wherever they can get it hoping (praying?) that when the going gets rough, they'll be the first to hit eject. No, no (rate-fueled) bubble to see here.