Feedback: Is a Lot of Fraud-based Bankruptcy on the Horizon?

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A number of you seemed surprised and impressed by Anne Eberhardt’s Notice of Appearance. We asked and Anne answered,

PETITION: What is one notable trend you expect to see in ’18 that not enough people are talking about?

The fallout from the effects of the collapse of trust. When even the auditors of the auditors’ audits are cheating (see DoJ’s press release of January 23, 2018, announcing the arrest of several former partners of a Big Four CPA Firm, accused of hiring PCAOB staff to provide confidential regulatory information to help the Firm improve its audit inspection results), you know we’re headed for a disaster of biblical proportions: fire and brimstone, rivers and seas boiling, forty years of darkness, human sacrifice, dogs and cats living together…mass hysteria.

There has been a rash of thematically-on-point news on this front in the past week.

Regarding General Electric ($GE),

“The two largest proxy-advisory firms are recommending that General Electric Co. fire KPMG LLP as its auditor after 109 years, in light of accounting issues at the industrial giant.”

Regarding PriceWaterhouseCoopers,

“The Federal Deposit Insurance Corp. could collect the largest damage award ever against a global public accounting firm when a federal judge decides what to award the agency after a verdict against PricewaterhouseCoopers.”

Relating to Longfin ($LFIN), a charade among charades in the blockchain/cryptocurrency space:

“But in the last 10 days, the shares have fallen about 80%. There were several triggers: A number of prominent short sellers made public attacks on Longfin; the company’s shares were added and then days later removed from the Russell 2000 Index; and on Monday the company said the SEC was conducting an investigation called In the Matter of Trading in the Securities of Longfin, which hasn’t resulted in any conclusions.”

And Mozido, a once-high-flying tech startup:

“Michael Liberty advertised that Mozido, the start-up he founded which once boasted a valuation of $5.6 billion, would revolutionize mobile payments and bring financial services to 2 billion unbanked adults worldwide. But securities regulators claim Liberty hyped up Mozido while raising $55 million that mostly went into his own pocket.

The Securities & Exchange Commission has sued Liberty for fraud in federal court in Maine, saying Liberty stole most of the $55 million he purportedly raised for Mozido from 200 individual investors.”

And then there is Theranos, the fraudulent “unicorn” helmed by Elizabeth Holmes that has fallen on some tough times of late. Per The Wall Street Journal last night,

“Blood-testing firm Theranos Inc. laid off most of its remaining workforce in a last-ditch effort to preserve cash and avert bankruptcy for a few more months, according to people familiar with the matter.”

And:

Once its cash falls under that threshold, the terms of the Fortress loan agreement allow the New York private-equity firm to seize the company’s assets and to liquidate them, she said.”

What exactly did Fortress Investment Group LLC lend Theranos $100 million against? Is there even IP here? The blood testing tech was a fraud; the Zika test isn’t working. What gives here?

At least Ms. Holmes has been focused on “burn rate” and conserving cash with an eye towards giving the Zika trials a fighting chance:

“Until Tuesday, Ms. Holmes still had two personal assistants and two security guards who drove her around in a black Cadillac Escalade SUV, according to the people familiar with the matter.”

What. The. F*ck.

We are sure that there will be at least a handful of high profile fraud-based bankruptcies that emerge in due time. Mark our words: 60% of the time it happens every time.

⚡️A Quick Update⚡️: The Bon-Ton Stores

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On Monday, The Bon-Ton Stores filed a motion seeking permission to pay a $500k diligence fee to a combination of DW Partners, Namdar Realty Group, Washington Prime Group Inc. ($WPG) and AM Retail Group Inc. in connection with a signed letter of intent to purchase the company’s assets. The former three firms would seek to own all of Bon-Ton’s assets other than a distribution center, which would go to AM Retail. The company also postponed its sale auction to April 16. The purchase price is:

“…no less than (i) an aggregate purchase consideration sufficient to have a minimum excess availability of 22.5% at closing; and (ii) a minimum aggregate cash payment of no less than $128,000,000.00 (the “Baseline Bid”), a sufficient portion of which shall be funded into an escrow account to pay fees and expenses (including professional fees) associated with the wind-down of the Debtors’ estates after the Closing.”

In filing the motion, the Debtors champion that this bid is the only bid it received by its bid deadline that would allow for the Debtors to continue to operate as a going concern rather than liquidate; it is the only bid that would have the effect of:

“saving over 20,000 jobs and preserving a 120-year-old business that is a significant customer for its vendors, an anchor tenant for many of its landlords, and the leading hometown department store for millions of consumers in local communities throughout twenty-three (23) states.”

This will, no doubt, be a controversial course of action as certain creditors have been pursuing liquidation since the petition date.

Four things of note:

1. The minimum cash consideration offered — the $128mm — is INCLUSIVE of professional fees to fund the wind-down of the case. With only one Operating Report on file with no professional fees paid to date, it’s unclear how much of that consideration will actually inure to the benefit of the estate.

2. The offer is contingent upon a “[d]emonstrable commitment…by a substantial number of the Debtors’ existing landlords and trade vendors…to support the Company’s liquidity needs at close and through a period of no less than one year from the closing date….” In other words, this is very much pay-to-play: if landlords and vendors want to benefit from Bon-Ton remaining a going concern, they have to agree, upfront and for one year, to engage in rent and receivables forgiveness. What do they do? This is the quintessential “cutting off the nose to spite the face” dilemma.

3. The Official Committee of Unsecured Creditors filed a “Statement” last night supporting the proposed diligence fee; it analogizes this case to Aeropostale and notes how the work fee there helped encourage a going concern transaction. It said the diligence fee and a going concern offer “…is the last and only hope to save Bon-Ton from the fate of so many retailers that have filed for bankruptcy during this ‘retail apocalypse.’” Dark and stormy. We dig it.

4. Morgan Stanley Research analysts are bullish on the transaction for the mall operators. Per CoStar,

“If they were to lose Bon-Ton as a tenant, cap rates for their malls would likely widen if given the risk of co-tenancy and capex requirements to redevelop. 

But it could also be somewhat of an offensive move. It's possible that the landlords could place Bon-Ton stores in malls where they have a big box vacancy. 

’We can't help but think this would be a competitive advantage for these two mall landlords relative to their peers,’ the two analysts said. ‘First, they could choose to keep open stores at their properties while closing others at competing locations. Second, it could provide them an opportunity to buy malls from their competitors at more attractive valuations if there is a risk of losing a major tenant.’”

This is retail today, ladies and gentlemen.

Restaurants (Short Kitchens, Long Bikes)

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Options abound for food these days - particularly if you live in an urban area. You can get your food sent to you in kits (Hello Fresh and Blue Apron), as groceries (Amazon Fresh, Fresh Direct) or from restaurants via the gazillion delivery services that are duking it out with one another AND capitalizing upon the rise in co-cooking kitchens (Caviar, Postmates, Grubhub and UberEats). We could fill 6 minutes of a$$-kicking reading just by continuing the list.

Here's the thing: much like the consumer products e-commerce space - where shipping is cutting into retail margins bigly - food delivery is killing your favorite restaurant. Why? Well, Captain Obvious, there are too many hands in the pot. As The New Yorker highlights (must read), "over-all profit margin has shrunk by a third, and that the only obvious contributing factor is the shift toward delivery." Ruh roh.

The piece is shocking in how ignorant every seems to be about the effect of delivery services on restaurant margins. This bit also struck us, "It’s worth noting that, even while charging restaurants steep rates, most delivery platforms are not yet profitable, either. Their hope is that order volumes will one day become high enough—and couriers will deliver enough orders per hour—to push them into the black." The alleged answer? A kitchen within a kitchen. Uber "is nudging restaurants to embed “virtual restaurants” inside their kitchens—picture a burger joint housing, at Uber Eats’s behest, a cookie company that exists only as a menu on the delivery provider’s site. DoorDash, an Uber Eats competitor, has started to experiment with leasing remote kitchen space to restaurants so that they can expand their delivery radii. If such practices catch on, it’s easy to imagine a segment of the restaurant economy that looks a lot like, well, Uber, with an army of individual restaurants designed to serve the needs of middle-man platforms but struggling to make a living themselves." This is "progress" folks. 
 

Toys R Us Fallout

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Mattel Inc. Reported Dogsh*t Numbers

It sure may seem like we have it out for the big box toy retailer. We don't. We just call it like we see it. Last week we called the company a "dumpster fire" on account of the string of emerging negative news. Subsequently, CNBC reported that "poor holiday sales cast doubt on its future" adding, "The poor holiday numbers may require Toys R Us to renegotiate the terms of its debt with its lenders, sources say. They will hover over Toys R Us as it works with debtholders over the next couple of weeks to draft its plans for moving forward. The lenders will have to determine if the Toys R Us business plan is supportable, said the sources." Is it getting hot in here?

Meanwhile, Toys' closure of 180 locations has reportedly exposed 20 CMBS loans with a combined balance of $500mm. 

Finally, in our "Dumpster Fire" piece, we also threw shade all over Bloomberg's rosy view for Mattel Inc. ($MAT). Rightfully so, it seems. The company reported dogsh*t holiday numbers: net sales were down 11%, gross sales were down 9%, and North America was the biggest disappointment with net and gross sales were down 17%. The company straight-up blamed the Toys bankruptcy for some of the poor performance as the company reportedly accounts for 20% of Mattel's U.S. sales and 11% of its international sales. Consequently, Mattel is suspending its dividend, shedding non-core underperforming brands, and targeting $650mm in cost reductions. Read: job cuts.

BigLaw Entrepreneurship & Innovation

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Quinn Emanuel Pioneered Themselves to Millions

This profile about Quinn Emanuel Urquhart & Sullivan LLP is eye-popping. Putting aside the profits for partner figures - also eye-popping - the story captures the thinking of a few entrepreneurs disguised as biglaw attorneys. Here you have a couple of lawyers who were comfortably earning "one or two million dollars in revenue per year" from the big banks deciding that they could multiply that if they were to sue the banks rather than represent them. In other words, go where no one else is going. Amazing. 

Elsewhere in biglaw innovation, we couldn't help but chuckle at this sequence of events. On January 25, The American Lawyer reported that Reed Smith LLP "is the latest Big Law firm to implement health and wellness programs to combat the stresses often linked with life in the legal profession." And then on January 26, Bloomberg reported, "Workplace wellness programs have two main goals: improve employees’ health and lower their employers’ health-care costs. They’re not very good at either, new research finds."Womp womp. We're not knocking health and wellness and we are well aware that lawyers, in particular, suffer from high rates of depression (and alcoholism). But "not very good" isn't a great description for an expensive initiative. Maybe it helps with recruiting?

Hollywood (Long Data)

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We previously wrote about Moviepass and how its controversial subscription service - now apparently at 1.5mm members (PETITION Note: it was at 1mm merely two weeks ago when we wrote about it) - seeks to make the most out of an industry in apparent decline by leveraging data. Now the company says that it has weaponized that data to influence movegoers to go to certain films - an equally tantalizing and scary proposition. And, so, by extension, the company now wants to get into the moviemaking business to capture some of the upside of those efforts. Moreover, it is getting into the targeted ad business. The company is funded by Helios and Matheson Analytics Inc. ($HMNY), which just happens to be the second most shortest stock on the NASDAQ Composite. Clearly investors don't think that Moviepass' business model is real. 

Ski Season (Long the Short-Term; Short the Long-Term)

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It's ski season and so we imagine a number of our readers will be heading out West for some client boondoggles. We thought you'd be interested in knowing that, this past week, Sonnenblick-Eichner arranged a $60mm set of construction and financing loans for the joint venture that owns the St. Regis hotel in Park City, Utah. It's a 10-year financing consisting of separate loans secured by hotel revenue and condo inventory. Use of proceeds? Takeout existing debt on the property (Deer Valley) and construct more condos. The funds came from a domestic life-insurance firm.

Wait, what? A life-insurance firm funded $60mm worth of loans secured by hotel revenues and condo inventory? NOW...when there is, like, virtually no snow on the ground? Apropos, the Commercial Observer notes "some experts argue that climate change threatens to erode the ski industry's profits - although perhaps not over this loan's 10-year term. Last year, a group of researchers from the Arctic and Mountain Regions Development Institute and the University of Colorado, among other institutions, used a climate model to predict that the length of the Rocky Mountains ski season could decline by more than 50 percent over the next three decades, resulting in tens of millions of fewer recreational visits to the area." We hope the owners of those new condos enjoy Spring hikes and Sundance movies.

Advertising & Media (Desperate Times Call for Desperate Measures)

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It's one thing to see a flying car whisk by a Coca-Cola ($KO) sign in Blade Runner 2049. Or Vin Diesel crush a Corona ($BUD) before crushing a skull in Fast and the Furious 2049 (how many of these are there?). Or Mark Wahlberg mention a motorcycle he likes in Big Daddy. It's pretty obvious that those are placement ads. But its an entirely different story when a large corporate partner like Proctor & Gamble ($PG) purchases a plot line and dialogue. That isn't so obvious. But so it is. This week, Variety reported that P&G has done precisely that in a "unique advertising pact" with American Broadcasting Company ($DIS). The network will create an episode of "black-ish" that will - as a central plot device - discuss a P&G-produced short film and its implications on race merely because that's "an issue that the advertiser is trying to burnish." Well, ok, then.

Cord-cutting is getting aggressive and we get that Disney needs to act in-kind to ensure revenues. ESPN is under siege, Netflix ($NFLX) has a head start on stand-alone streaming, and even Star Wars toys have underperformed. But how this is handled will be a bellweather of things to come.

For instance, Instagram influencers are under strict guidance from the FTC on how to handle sponsored posts. Failure to comply has gotten various influencers - the Kardashian's being one notable example - in hot water. Remember the Fyre Festival? Riiiiiiight. To what degree are P&G and DIS required to alert viewers that the dialogue they are listening to is paid for? To the extent there is an alert, should it be noted at the bottom of the screen at the time of the dialogue (makes sense) or noted in the end credits (doesn't make sense). This may very well be another instance where regulation has to play catch-up to innovation.

Meanwhile, there's been a notable rise in corporate venture capital (CVC) arms over the last several years. What we haven't noticed, however, is the blatant weaponization of the CVC's distribution channels to help scale product. Yet. We wouldn't be surprised to see a rise in (shameless) native plugs of new apps or hardware in future mainstream broadcast content. And that - on the basis of scale opportunity alone - could be a real competitive advantage for corporate-backed startups relative to venture-backed startups. Query, however, what that would do to the viewing experience. Netflix ($NFLX) and HBO ($TWX) don't serve ads for a reason. Yet. We'd be shocked, though, if it doesn't come eventually (our money is on NFLX first). 

P.S. Elsewhere in advertising, Amazon is coming ($AMZN) and coming fast with ad revenue growing faster than Google ($GOOGL) and Facebook ($FB). 

Co-working Spaces (Holy WeWork Batman)

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Brookfield Asset Management Inc. and Onex Corp. are reportedly prepping a $3.7b offer to purchase IWG Plc, a commercial real estate company and office space owner. Those who have been around the restructuring industry long enough will recall that IWG is the successor entity to Regus, which filed for bankruptcy nearly 15 years ago after it expanded too quickly in the midst of the dot-com boom. Now, putting aside "location location location," which, admittedly, is, uh, we guess kind of a big deal in real estate, it's important to note that IWG actually owns its office space. It also has nearly 3k locations. Its main competitor, WeWork, in contrast, does not own most of its 283 lease rejections...uh, oops, we mean, locations. Which, naturally, means that it is valued at 7x BAM and Onex's offer for IWG. Because, you know, pixy dust. 

Since we're on the topic of WeWork, we might as well note that news out of its WeLive division has been scant ever since Bloomberg reported a few months ago that the concept wasn't gaining traction. Notably, however, Node, a co-living company based in London and New York just launched its third Bushwick-based location. Things are only going to get harder for WeWork as it tries to justify its lofty valuation.

Labor (Long Ramen, BigLaw & Banking, Short Family/Fun?)

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Michael Moritz, a Partner at Sequoia Capital, stirred quite a tizzy this week with his hot take in the Financial Times that Silicon Valley - relative to China - is full of a bunch of whiny snowflakes. And, then, ironically, the whiny snowflakes whined about Mr. Moritz seeming distaste for "work/life balance." His overall message - while delivered in about as insensitive and out-of-touch a manner imaginable - rings true, however, in that China is undeniably a force to be reckoned with; his piece is yet another warning signal that U.S. dominance is being threatened by China's ambitions. 

While fawning over China's work ethic, Mr. Moritz says, "...the pace of work is furious. Here, top managers show up for work at about 8am and frequently don’t leave until 10pm. Most of them will do this six days a week — and there are plenty of examples of people who do this for seven. Engineers have slightly different habits: they will appear about 10am and leave at midnight. Beyond the week-long breaks for Chinese new year and the October national holiday, most will just steal an additional handful of vacation days." To which we reacted, "That's it?" Chinese managers ONLY work from 8am to 10pm? They get a day off every week!? They take a handful of vacation days?! Sh*t. These lionized Chinese engineers would NEVER make it on Wall Street or in BigLaw. 

Or maybe they would. "JPMorgan has changed its pitch to the MBA students it targets for recruitment, focusing more on the quality of the roles available than the generosity of the remuneration package." Indeed, there is now "a stronger emphasis on the quality of life, with guarantees to protect weekend leave and holiday time and the opportunity to swap with counterparts based in offices overseas...." Clearly, Moritz and Jamie Dimon ($JPM) haven't been hanging out. 

Anyway, our favorite reaction to Moritz? This thread by David Heinemeier Hansson: "What a f*cking toad."

Amazon is Coming for Your Ad Revenue

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Companies are struggling and a debate is raging over whether ad-revenue dependent media companies can grow and thrive in the age of advertising behemoths like Google ($GOOGL) and Facebook ($FB). Amazon ($AMZN), meanwhile, grew its advertising revenue by 60% with analysts pegging its advertising revenue at $4.5b in 2018 - larger than combined revenues of Twitter ($TWTR) and Snapchat's ($SNAP) ad business. David Carey of Hearst Magazines has some thoughts about the future (audio).

GoPro is in Trouble

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Long the "Hardware is Hard" Narrative

GoPro Inc. ($GPRO) announced extreme guidance this past week. Extremely bad guidance. The hardware-manufacturer-wouldbe-software-developer-wannabe-content-provider-aspiring-drone-player lowered guidance for revenue and gross margin and offsetting measures like job cuts, exec compensation cuts, and discontinued products (discounted drones anyone?). Disputed reports abound that JPMorgan has been hired by Nick Woodman to shop the company. Doesn’t sound like he’ll be doing many guest Shark Tank appearances anytime soon. The company has a $300mm credit facility and $150mm in converts. With negative operating cash flow and and increasingly bad trends, Woodman may soon be fielding pitches from restructuring bankers. 

But at least he's still in business. Luma, a home WiFi system maker reportedly had to effectively sell for parts to First Alert. Investors included Andreesen Horowitz, Accel Partners and, get this, Amazon Alexa Fund. Similarly, Eero, the mesh Wi-Fi router startup, laid off 20% of its workforce. It has raised $90mm in VC. Yes, hardware is hard.

But not all tech is "busted" and not ALL hardware is "hard." Apparently 16% of Americans now own a smart speaker. In case you weren't convinced that "voice" may be a VERY big piece of the future. As we noted around this time last year on PETITION, mass adoption of voice has the potential to disintermediate brands and cause more retail distress. 

Trickle Down from Auto Disruption (Short Insurance)

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We’ve spent a good amount of time in the last year discussing the second order effects of autonomous cars. But, clearly Google is thinking ahead. This week Waymo LLC, the driverless-car unit of Alphabet Inc., partnered with an insurance-tech startup called Trovto nail down the mechanics of “micro-duration” insurance for riders. This would be “usage-based” insurances, covering riders for very discreet periods of time and very particular use cases. Risk could be assessed based on the duration of the ride (and, presumably, the trajectory?). This could be a game changer as far as insurance revenues go. Choice quote: “As much as 80% of the premiums paid to car insurers are at risk of disappearing in coming decades if autonomous vehicles make driving safer and prompt big changes in car ownership.” Yikes.

Proctor & Gamble's Consumer Products (Long DNVB Disruption)

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Proctor & Gamble Co. ($PG)announced that its Gillette brand will be releasing new razors that, counter to previous new product launches, won't include another blade and a higher price point. Thank G-d. We're old enough to remember when the three-blade razor was a big deal, let alone the 179-blade razors that are in the market today. Clearly PG is yet another example of a large incumbent company suffering from Innovator's Dilemma while hungry nimble startups nip at its heels. Notably, Gillette's sales fell 6% in the current quarter and U.S. sales of razorblades fell 18% YOY in the TTM. Why? Well, we have Harry's and Dollar Shave Club product users here. The big innovation? A new five-blade razor that will cost "roughly the same" as those sold by the aforementioned up-and-comers. Who ship direct-to-consumer. So, hmmm. If the cost is "roughly the same" and one can just show up in my mailbox, why would we even bother with this new product? No wonder Nelson Peltz is up in arms.