💥Sycamore Partners is a B.E.A.S.T. Part I(b).💥

 
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Speaking of feedback, one investor wrote us that the Twitterati — and PETITION to a lesser extent — had the Sycamore/Staples story all wrong. The dividend recapitalization doesn’t affect the retail story one way or another. That is because Sycamore did, in fact, separate the Staples business into multiple businesses, with the debt remaining at the Staples North American Delivery (“NAD”) entity. Staples U.S. Retail and Staples Canada Retail, as the other two units are now called, aren’t on the hook for the billions of dollars of debt. And, so, other than a bitchin’ new logo, Staples Retail isn’t really the story.* Once again, Sycamore is.

The Staples NAD lender presentation is an enlightening (and somewhat propagandist) look at the fast, furious and savage nature of the private equity model. In less than two years, Sycamore has (i) completed its intended business separation, (ii) improved EBITDA by $160mm “through stable top-line performance, expanded merchandise margins, and SG&A reductions, (iii) identified an additional $185mm of additional cost opportunities beyond 2019, (iv) bolted on some acquisitions, and (v) recruited 8 new members of the senior leadership team. Adjusted EBITDA is $1.2b (providing for certain acquisition-related addbacks). How the hell did Sycamore achieve all of this?

In part, by squeezing. The company has increased merchandise margins through “vendor negotiations.” Eat it vendors! Private equity is in the HOUSE!! The company reduced fiscal year ‘18 SG&A by over $100mm “through restructuring initiatives.” Eat it employees!! Private equity is in the HOUSE!! 900 of you can pack yo’ bags!! And hey you. Yeah you. Sales force employee #901 who thinks she’s safe. Well, newsflash: you’re not. Sycamore predicts another $19mm in sales force savings in 2019.

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What about you, Mr. IT guy? That’s right:

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Sycamore has another 70 full-time employees in the IT department slated for termination to the tune of $6mm in headcount savings. How? “Order management system consolidation.” Read: tech is replacing humans. Another $20mm of savings will come from robotics within Staples’ facilities. And yet another $10mm will come from outsourcing support from internal to low cost contractors (PETITION Note: short the US; long India). When talking heads say that PE strips out costs like a bawse, they’re not kidding. Is this dude on payroll?

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NAD has fiercely competed to retain revenue and promote existing customer growth. Staples NAD now purportedly has ~2x as much revenue as Office Depot and ~3-4x more than Amazon Inc. ($AMZN). These guys sell a f*ck ton of office supplies, ink/toner and paper — about $5b worth. That’s insane. And they’re getting after the private label space, where the company has margins over 50%.

To put a finer point on this, look at this slide:

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These guys aren’t messing around. These guys did their thing and now they’ve got an eye towards an IPO or a sponsor-to-sponsor transaction. And then it — and its 4.5x net debt ratio — will be someone else’s problem potentially heading into a downturn. There is no coincidence here from a timing perspective. Vicious.

*****

You’ll recall that Staples NAD went out to market shopping Sycamore’s scraps….uh…we mean a new $3.2b first lien term loan and a package of secured and unsecured notes to refinance its capital structure and give Sycamore one hell of a check to cash out its equity:

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Well, the market reaction was…uh…interesting. Rather than issue $3.25b of senior secured term loans, the company will complete a $2.3b term loan, splitting the rest of the capital structure between secured ($2b) and unsecured notes ($1b). And the company did have to upsize the secured note piece relative to the unsecured piece. While the yield on the secured bit was mildly tighter than anticipated, the yield on the unsecured piece priced slightly wider than initially expected, indicating that the appetite for the unsecured notes was cautious — even at nearly 11% yield. Looks like certain investors didn’t buy in to the propaganda. Or Sycamore’s reputation precedes it. Either way, Sycamore reportedly took down 18% of the unsecured allotment and apparently agreed not to trade the notes for several months to help push the deal through. 

That said, will Sycamore’s dividend get paid? Well, duh, of course. The market’s reaction to the issuance has no bearing on that whatsoever. Which is not to say the reaction isn’t telling — especially when the paper immediately trades lower as it did here. Short Sycamore’s scraps.

*This thread about Staples’ new logo, however, is pure comedy:

Just imagine how amped Sycamore must be to pull out all of its equity and just ride an option for the next few years.

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💥Sycamore Partners is a B.E.A.S.T. Part I.💥

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🔥Rinse Wash & Repeat (Long Sycamore Partners)🔥

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Sycamore Partners is a private equity firm that specializes in retail and consumer investments; it “partner[s] with management teams to improve the operating profitability and strategic value of their businesses.” Back in the summer of 2017, Sycamore Partners acquired Massachusetts-based office retailer Staples Inc. for $6.9b — a premium to the company’s then-trading price but a significant discount from its 2014 high. Your office supplies, powered by private equity! The acquisition occurred shortly after Staples ran afoul of federal regulators who prevented Staples from acquiring Florida-based Office Depot Inc. ($ODP)(which, itself, appears to just trudge along).

Sycamore’s reported thesis revolved around Staples’ delivery unit, a B2B supplier of businesses. Accordingly, per Reuters:

Sycamore will be organizing Staples along three lines: its stronger delivery business, its weaker retail business and its business in Canada, two sources familiar with the deal said. This structure will give Sycamore the option to shed Staples’ retail business in the future, one of the sources said.

The retailer had 1255 US and 304 Canadian stores at the time of the deal. The business reportedly had 48% of the office supply market, generating $889mm of adjusted free cash flow in 2016.

*****

Fast forward 18 months and, Sycamore is already looking to take equity out of the company. According to Bloomberg, the plan is for Staples to issue $5.2b of new debt ($3.2b in term loans and $2b of other secured and unsecured debt), which will be used to take out an existing $3.25b ‘24 term loan and $1b of 8.5% ‘25 unsecured notes (which Sycamore reportedly owns roughly $71mm or 7% of).* This is textbook Sycamore, so much so that it’s actually cliche AF — or as Dan Primack said, “…this sort of myopic greed gives ammunition to private equity’s critics.” Like this guy:

And this gal:

Talk about reputations preceding…

Anyway, here’s what the deal would look like once consummated:

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That $1b difference is the equity that Sycamore is taking out of the company. What does the company get in return? F*ck all, that’s what. Zip. Zero. Dan Primack also wrote:

Dividend recaps are a mechanism whereby private equity-owned companies issue new debt, and then hand proceeds over to the private equity firm (as opposed to using it to grow the business). Sometimes they don't matter too much. Sometimes they form leveraged anchors around a company's neck. (emphasis added)

Yup. That about sums it up. Here is Sycamore placing a leveraged anchor on…uh…improving “the strategic value” of Staples:

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This is the market reacting to Sycamore’s strategy for Staples:

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If the above GIF looks familiar, that’s because this is like the Taken series: Sycamore has a very particular set of skills. Skills it has acquired over a very long run. Skills that make them a nightmare for retailers like Staples. They look poised to deploy those particular skills over the course of a repetitive trilogy: the first chapter centered around Aeropostale. And here’s how that ended:

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The sequel was Nine West and this is how that ended:

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And, well, you get the point. Staples looks like it may be next to experience those very particular skills.

———

Okay, so the above was a bit unfair. In Aeropostale, the company went after Sycamore Partners hard, seeking to ding Sycamore, among others, for equitable subordination and recharacterization of their (secured) claims. Why? Well, Sycamore was not only the company’s term lender (to the tune of $150mm), but it was also a major equity holder with 2 board seats and the majority-owner of Aeropostale’s largest (if not, second largest) merchandise sourcer and supplier, MGF Sourcing Holdings Ltd.

NERD ALERT: for the uninitiated, equitable subordination is an equitable remedy that a bankruptcy court may apply to render justice or right some unfairness alleged by a debtor (or some other party in the shoes of the debtor, if applicable). It is generally VERY DIFFICULT TO WIN on this argument because the burden of proof is on the movant and there are multiple factors and subfactors that the accuser needs to satisfy — because, like, this is the law and so everything has a test, a sub-test, and a sub-sub-test and maybe even a sub-sub-sub-test. Judges love tests, sub-tests, and multi-pronged sub-tests. Three-prongs. Four-prongs. Everywhere a prong prong. Just take our word for it. It’s true.

Recharacterization is another equitable remedy that, if satisfied and granted by the court, would have resulted in Sycamore’s $150mm secured term loan position being reclassified as equity. This is a big deal. This would be like Mike Trout being on the verge of winning the MVP and the World Series AND securing a $350mm 10-year contract only to, on the eve of all of that, get (a) caught partying with R. Kelly til six in the morning with enough PED needles lodged in his butt to kill a team of horses, (b) suspended from baseball, (c) exiled into an early retirement a la Alex Rodriguez or Barry Bonds, and (d) forced into personal bankruptcy like Latrell Sprewell or Antoine Walker. Or, more technically stated, since secured debt is way higher in “absolute priority” than equity, this would instantaneously render Sycamore’s position worthless and juice the potential recovery of unsecured creditors. Then there is the practical side: for this remedy to apply, the bankruptcy court would have to make a “finding” that prong after prong has been satisfied and issue an order saying you’re the shadiest m*therf*cker on the planet because you’re actually dumb and careless enough to have met all of the prongs. So, as you might imagine, this is pretty much the worst case scenario for any secured party in bankruptcy and a career ender for the poor schmo who orchestrated the whole thing.

In Aeropostale, the Debtors argued that Sycamore and its proxy MGF engaged in inequitable conduct prior to Aeropostale’s filing, including (a) breach of contract, (b) “a secret and improper plan to buy Aeropostale at a discount” and (c) improper stock trading while in possession of material non-public information. This one had the added drama of arch enemies Kirkland & Ellis LLP (Sycamore) and Weil Gotshal & Manges LLP (Aeropostale) duking it out to the ego-extreme. Just kidding: this was all about justice! 😜

Anyway, there was a trial with fourteen testifying witnesses over eight presumably PAINFUL days that, in a nutshell, went like this:

WEIL GOTSHAL: “Sycamore are a bunch of conspiratorial PE scumbags who ran this company into the ground, your Honor!”

JUDGE LANE: “Not credible. Good day, sir. I said GOOD DAY!”

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KIRKLAND & ELLIS/SYCAMORE:

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In the end, Sycamore fared pretty well. They got nearly a full recovery** and releases under the plan of reorganization. Relatively speaking, the company also fared well. It didn’t liquidate.*** Instead, two members of the official committee of unsecured creditors — GGP and Simon Property Group ($SPG)— formed a joint venture with Authentic Brands Group and some liquidators and roughly 5/8 of the stores survived — albeit as a shell of its former self and with heaps of job loss (improved strategic value!!). Sure, millions of dollars were spent pursuing losing claims but that’s exactly the point: when Sycamore is involved, they win**** and others lose.***** The extent of the loss is just a matter of degree.

———

Speaking of degrees, all the while Nine West was lurking in the shadows all like:

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WHOA. BOY. THIS ONE WAS A COMPLETE. AND UTTER. NEXT LEVEL. SH*TSHOW.

We’ve discussed Nine West at length in the past. In fact, it won our 2018 Deal of the Year! We suggest you refresh your recollection why (including the links within): it’s worth it. But what was the end result? We’ll discuss that and the (impressively) savage tactics deployed by Sycamore Partners therein in Part II, coming soon to an email inbox near you.

*At the time of this writing, the unsecured bonds last traded at $108.01 according to TRACE. This potentially gives Sycamore the added benefit of booking significant gains on the $71mm of unsecured notes in its portfolio.

**It’s unclear whether Sycamore recovered 100% but given that they got $130mm under the cash collateral order out of an approximately $160mm claim, it’s likely to have been close. Now, they did lose $53mm on AERO stock.

***A f*cking low bar, sure, but still. Have you seen what’s happening in these other retail cases?

****Putting aside nation-wide destruction, hard to blame LPs for investing in the fund. They get returns. Plain and simple. This ain’t ESG investing, people.

*****Sure, Weil “lost” its attempt to nail Kirkland…uh Sycamore…here but they got paid $15.3mm post-petition and $4.4mm pre-petition so that’s probably the best damn consolation prize we’ve ever heard of in the history of mankind. Weil has, to date, also avoided having a chapter 22 and liquidation in its stable of quals so there’s that too. In retail, you have to take the victories where you can get them.

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Amazon's Disruptive Force...

in ,

...Is Industry & Asset-Class Agnostic

Scott Galloway likes to say that Amazon simply needs to make a simple product announcement and the market capitalization of an entire sector - of dozens of companies - can take a collective multi-billion dollar hit. On a seemingly weekly basis, his point plays out. Upon the announcement of the Whole Foods transaction, all of the major grocers got trounced. Upon news of Amazon building out its delivery infrastructure, United Parcel Service Inc. ($UPS) and FedEx Corporation ($FDX) got hammered. Upon news that Amazon was getting into meal kits, Blue Apron's ($APRN) stock plummeted. This week it was the pharma companies that got battered on the news that Amazon has been approved for wholesale pharmacy licenses in at least 12 states. It was a bloodbath. CVS Health ($CVS) ⬇️ . Walgreens Boots Alliance ($NAS) ⬇️ . Cardinal Health ($CAH) ⬇️ . Amerisource Bergen ($ABC) ⬇️ . Boom. (PETITION NOTE: obviously impervious - for now - are the ad duopolists, Alphabet Inc. ($GOOGL) and Facebook Inc. ($FB), both of which, despite news that Amazon did $1.12b in ad revenue this quarter, had massive bumps on Friday).* Luckily there isn't an ETF tracking doorman and home security services because if there were, that, too, would be down this week. 

What Galloway has never noted - to our knowledge, anyway - is the effect that Amazon's announcements have on the leveraged loan and bond markets. Remember that Sycamore Partners' purchase of Staples from earlier this year? You know...that measly $6.9b leveraged buyout? Yeah, well, that buyout was financed on the back of $1b of 8.5% unsecured notes (issued at par) and a $2.9b term loan.Ah...leverage. Anyway, investors who expected that the value of that paper would remain at par for longer than, say, 2 months, received an unpleasant surprise this week when Amazon announced its "Business Prime Shipping" segment. According to LCD News, the term loan and the notes traded down "sharply" on the news - each dropping several points. Looks like the "Amazon Effect" is biting investors in a variety of asset classes.

One last point: this is awesome. Maybe the future of malls really is inversely correlated to the future of (livable) warehouses. 

*Nevermind that Amazon's operating income declined 40% due to a 35% rise in operating expenses. Why, you ask, are operating expenses up? How else could Amazon be poised to have half of e-commerce sales this year?