🔥F.E.A.R.🔥

⚡️What. The. Hell.⚡️

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.

About a month ago 60% of the $1.2T in outstanding US #leveragedloan debt was priced at 100 or better. A week ago it was 38%. After today just 10% of that debt is priced at par #COVID19US #economy pic.twitter.com/1PcVaWjzbU

— Leveraged Loans (@lcdnews) February 27, 2020

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….

Port of Los Angeles is projecting a 25% drop in container volumes this month, as the economic impact of the coronavirus spreads across shipping operations and foreign supply chain. Imagine if 1 in 4 goods imported from Asia suddenly stopped coming. Impact just starting.

— Eric Lipton (@EricLiptonNYT) March 1, 2020

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.

Some violent moves in energy junk bonds. One example: Whiting Petroleum bonds have lost almost half their value in a month, losing 12.5 cents on the dollar today alone. pic.twitter.com/8Neb8ltmz0

— Lisa Abramowicz (@lisaabramowicz1) February 27, 2020

Today it's like the Sorcerer's Apprentice here, with alerts flooding in every few minutes on outsized drops and new record lows for #distresseddebt bonds. The drought for the #restructuring and #bankruptcy advisers may be over.

— Rick Green (@RickGreenNYBiz) February 28, 2020

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

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.

💣Diebold. Disrupted.💣

Are Point-of-Sale & Self-Checkout Systems Effed (Short Diebold Nixdorf)?

Forgive us for returning to recently trodden ground. Since we wrote about Diebold Nixdorf Inc. ($DBD) in “💥Millennials & Post-Millennials are Killing ATMs💥,” there has been a flurry of activity around the name. The company…

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The Great Escape

"The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds." - John Maynard Keynes, The General Theory of Employment, Interest and Money (13 December 1935).

This past week, Michael Batnick, from Ritholtz Asset Management deployed a version of this quote to make a point about investing; he provided a nice callback to Blockbuster and an equity analyst's repeated bad calls vis-a-vis Netflix (which popped this week after impressive subscription growth - despite negative free cash flow (-$600mm+) and an increasingly levered balance sheet). TL;DR: don't be too wed to your ideas. 

This applies to the actual businesses that investors pour money into too. In today's rapidly transforming environment, businesses must now, more than ever, pivot, and innovate. They can't be too wed to legacy ideas. Recognizing that is the first step. It then becomes a question of execution in the face of constraints.  

Enter Avaya Inc., a privately-held provider of contact center, "legacy" unified communications and networking products and services with 176 global entities, $940mm of adjusted EBITDA, 200,000 customers and 9700 employees. To Avaya's credit, the company pivoted in 2009 away from its historical hardware-based operating model - recognizing the shift towards software-based and cloud-oriented services solutions. It undertook a massive reinvention, adapting its revenue model and streamlining operating performance in a manner that cut $700mm in costs since 2014. To some degree, the company's private equity overlords - TPG Capital and Silver Lake Partners - deserve some credit, too, for working with management and reconciling the need to pivot. After all, they had a $8.2 billion LBO to rationalize. 

But sometimes the constraints are insurmountable. Avaya has $6 billion of debt on its balance sheet; it has $440mm of annual interest expense along with an additional $180mm nut for annual pension and OPEB obligations. And it faces stiff competition from the likes of Microsoft, Cisco, and others, necessitating another ~$400mm in expenditures to fund R&D and other investments. It's been bleeding cash, losing over $505mm in the fourth quarter and over $750mm in fiscal '16.

And so the company is now a bankruptcy filer. Notably, the papers accompanying the filing have zero specificity about the company's go-forward business plan. Its one small victory is a robust DIP financing commitment and milestones intended to achieve a rapid turn in bankruptcy court. But then what? 

We rarely see big freefall bankruptcy cases anymore. Clearly there seems to be disagreement among the various constituencies about how best to proceed with this business in the face of competition and technological headwinds. That said, the company was able to secure $425mm of its proposed DIP facility at the "First Day" hearing on Friday. So there's that. 

"Software is eating the world," we noted last week (per Marc Andreesen). We'll see very soon whether Avaya gets swallowed along with TPG and Silver Lake's investment. Yes, they pivoted. But was it too little too late?

Thoughts? Opinions? Let us know at petition@petition11.com. 

Odd ad to place in the WSJ on the day after bankruptcy.

A Look Forward

Right before the holidays, Benedict Evans of the venture capital firm Andreesen Horowitz released a fascinating presentation called "Mobile is Eating the World." It's a long presentation - roughly 31 minutes - but well worth reviewing if you have the time. We here at PETITION think there are a lot of nuggets within it relevant to the restructuring industry. After all, technological advancement and disruption help create the industry's client pipeline. Here is a brief summary with some editorial mixed in:

Overview

• We are halfway to connecting everybody. There are 5.5 billion people over 14 years old, close to 5 billion people with mobile phones, and about 2.5 billion smartphones. The latter number is quickly headed to 5 billion.
• Mobile has accelerated past the PC, which is now flat-lining at around 1.5 billion units.
• Each new technology follows an S-curve (creation-to-deployment) and is then passed by a new technology. Mobile is transitioning now from creation to deployment. 
• With this transition comes a new kind of scale. Google, Apple, Facebook and Amazon ("GAFA") have 3x the scale ($450b annual revenue) that Microsoft and Intel had in their heyday ($150b annual revenue). Microsoft saw 14x growth when it was dominating tech in the 90s and subject to mass regulatory scrutiny; GAFA's growth is 10x that now. 
• In 1995, Microsoft was not even the biggest company on the stock exchange. Now Microsoft and GAFA are the top five companies on the exchange. 
• This size drives more capex: $1b of capex in 2000 vs. $30b of capex in 2015. Tech has so much more scale now: GAFA are giants of the ENTIRE economy, not just tech. 
• Which has implications: Apple is the 10th largest retailer in the world with $53b in revenue across e-commerce and 500 stores. Netflix has the fourth largest entertainment production budget in the world. Amazon has the sixth - even though its content is just a feature to drive its core product: Prime. These "tech" companies, therefore, are fundamentally impinging upon other industries. Another example: Google, Amazon and Apple are now making custom chips for their own products rather than sourcing externally from the likes of Intel. 

New Ways to Compete - Artificial Intelligence & Machine Learning

• The scale of 5 billion mobile users and the scale of GAFA are leading to new ways to grow and compete.
• And machine learning is steroids. As just two examples of the rapid progress in machine learning, image recognition has gone from a 28% error rate to 7% and speech recognition from a 26% error rate to 4%. This is all enabled by mass data and more powerful computing power. 
• And so everything in tech is being refocused from mobile to mobile+AI, particularly with the realization that there are cameras everywhere, capturing images that serve as data that are now more intepretable than ever.
• GAFA is rushing to build the engineering and cloud storage systems to enable optimization of this data. 
• Meanwhile, technology design is removing friction, questions and administration which, in turn, changes choices. Think Amazon Echo. So, better design and frictionless decision-making is feeding more and more data.
• All of this gives GAFA the power to (further) change other industries...

Example 1: E-commerce

• Everything the internet did to media will happen to retail, where there'll be a breakup of old bundles and aggregators (albums, magazines, newspaper, store, shopping district, mall). And so now we consume in different ways.
• So far ecommerce mostly just gives consumers stuff we already knew we wanted.
• E-commerce is 10-12% of US retail revenue, with Amazon representing at least 2-6% of that: but it mostly just gives you what you already know you want. Despite this limitation, Amazon is now the fourth largest apparel retailer in the USA: not online, OVERALL. Walmart, Macy's, TJ, Amazon, Gap, Kohls, Target, L Brands, Nordstrom, JC Penney (by '15 revenue). And those reading PETITION regularly know how well some of these names are faring - or NOT. 
• The internet lets you buy, but it doesn't let you shop. No real suggestion or discovery.
• To fill this gap, the first response to this is advertising and marketing which is $1 trillion a year, $500mm is ads (digital and Google ads).
• But now we ask the Amazon Echo to buy more soap and this means we may never make a brand decision again. This disintermediates the ad agency, Walmart and P&G, etc, and changes the whole chain of how something gets to you, the consumer.
• Meanwhile, new businesses can get something to you with way less investment.
• Machine learning can give you "scalable curation" based on the data that you feed it.
• Today you have to go to a store to know what you'd like without seeing it. Now you can use machine learning to give this to you.
• Data is working through retailing: supply chain and logistics moved to advertising and digital metrics and then demand based on data, social, etc. Walmart used logistics to change what retail looked like. Amazon now doing that with AI. $20b retail opportunity potentially disrupted. 

Example 2: Cars

• Cars are becoming like phones with all of the important aspects becoming commoditized and the key being the software.
• Removing the engine and transmission destabilizes the car industry and its suppliers - but it doesn't change how cars are used much.
• Autonomy, however, changes what cars are and changes cities.
• Electric is about the battery cost curve. Complex proprietary gasoline engines and transmissions disappear and replaced by simple commodity batteries and motors, 10x fewer moving parts: all aspects of auto manufacturing and energy use are implicated by this development. 
• Scale, design and brand still matter but the real value moves up the stack into the software and move to autonomy. Leading tech companies now spend as much on capex as car OEMs. 
• Where are we now on the 1-5 autonomy scale: we are at Level 3. Level 5 is 5-10 years away. Batteries and sensors increasingly are commodities. The key is the software and the AI-powered data to feed it.
• Once you have that and take the steering wheel and engine out you have totally new types of vehicles and new uses. Obvious impacts: oil production and safety (1.25mm annual road deaths). Second order effects: what happens to engine servicing industry, machine tooling industry, storage, gas stations, gasoline taxes, municipal parking revenues, police forces? What happens if there's no parking or congestion? What happens to housing, logistics, commercial real estate, trucking, ownership of cars, insurance? 
• And what incumbent companies and municipalities file for bankruptcy as a consequence? This is not science fiction: society will soon need to address these questions...