Credit Default Swaps (Short Windstream’s Management, Puffery & Stupid F*cking Ideas)


Here
 is a late-to-the-party rant by William D. Cohan in the New York Times about the deleterious effect of credit default swaps and how they caused Windstream Holdings to file for bankruptcy. Here’s Cohan’s prescription to cure CDS ails:

What can be done about these perverse incentives? First, the Securities and Exchange Commission should immediately require greater disclosure of credit-default swap positions held by creditors. It’s the only way for a company, its investors and its employees to have a transparent understanding of a creditor’s motivations.

Ok, sure. What form would this disclosure take? How often would it have to be made? To whom should it be made? Is there a distinction to be made between CDS to hedge a debt position or naked CDS? So many questions.

He continues:

Once those positions are disclosed, the S.E.C. should help companies protect themselves from hostile creditors. The agency could, for example, allow companies to revise the terms of their bond agreements so that creditors with credit-default swaps don’t have the same voting rights as creditors who want a company to succeed. The definition of “failure to pay” and other conditions that might set off a default could also be revised to make it harder for a hedge fund to push a company into technical default. Judges can also play an important role, by taking the creditors’ motivations into account as more of these cases inevitably wind up in the courts.

What. The. F*ck.


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🏦How are the Investment Banks Doing? Part II.🏦

You didn’t think we’d just stop at Evercore and Greenhill, did you?

Moelis & Company ($MC) recently reported “disappointing” financial results reflecting a dramatic decline in M&A activity in Q1, which affected revenues significantly. Reported revenue was $138mm, down 37%. “This compares to the overall M&A market in which the number of global M&A completions greater than $100 million declined 18% during the same period. The decline in revenues was primarily driven by fewer transaction completions.” Restructuring activity “declined slightly.” MC guided towards softness in the first half of the year with a relatively stronger second half.

Some key takeaways:

  • Brexit and a number of shaky elections in Europe are having some effect on M&A activity in Europe.

  • Expected continued chill of cross-border M&A that involves China due to “underlying weariness” of “significant Chinese ownership of American companies.”

  • The melt down in late Q4 certainly affected M&A chatter in the C-suite as people are cautious about price volatility.

Asked what happens at MC if the M&A volume remains down, Moelis unabashedly indicated that costs would have to come out of the business, i.e., travel expense and headcount. That must’ve been a bit chilling for MC employees. Sheesh.


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🏦How are the Investment Banks Doing? Part I.🏦

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There was a barrage of earnings over the last two weeks and they can sometimes be a bellwether of things to come for the economy so we figured we’d dig in. Here’s what we learned…

Evercore Inc. ($EVR) was among the first investment banks to report Q1 ‘19 earnings back in late April (though the Q was only filed on May 2) and, man, they came out of the gate fast and furious on the earnings call with all kinds of braggadocious talk about being fourth highest in global advisory revenue in ‘18, and how they’re kicking a$$ and taking names in ‘19 already, etc. Only then, however, to say that YOY results were down. Hahaha. Totally buried the lede. Revenues were $419.8mm, down 10% YOY. Investment banking fees were down 14%. This despite 59 fees greater than $1mm, as compared to 53 in the year ago period.

Regarding, M&A volume and Europe:

…if you look at the M&A environment generally the dollar volume of announced transactions in the first quarter was down mid teens and the number of announced transactions globally was down in the high 20s. In Europe there was actually a little bit more pronounced. The interesting thing is if one looks at our backlogs they're not really consistent with the announced activities in the first quarter and to be completely blunt about is we expect this year could be a pretty good year. We certainly don't see anything in our dialogues with clients that suggests that it won't be.

Some EVR-specific highlights include (i) increased emphasis on “liability management” as a source of revenue generation and (ii) in turn, no increased emphasis on coverage of smaller cap companies (like certain competitor banks). EVR says that is not a focus: the focus is on bigger deals or deals with “high quality companies that may not be big.” In other words, they don’t want quals for quals sake. They want to get paid. And get paid well.

Specifically relating to restructuring, this is what EVR had to say:

…our advisory revenues last year were up in every category including restructuring notwithstanding the fact that default levels are at almost all time lows. So I think we've been able – we've added talent in the restructuring area. We think we are well positioned to capitalize on a pickup of activity when that inevitably happens. But other than relatively isolated sector activity like retail or like we saw in energy two or three years ago, there certainly is no broad scale pick up in distressed companies at this point in time.

No sh*t. Though it does seem like things have picked up a notch, no?

*****

Greenhill & Co. Inc. ($GHL) reported only $51.2mm of revenue, down 42% on a “dearth of large completions and generally slower deal activity,” and a “decline in EU revenue” more than offsetting increases in other regions. Noticing a Euro-centric theme here?


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🥛How’s Steak ‘N Shake Doing? (Long Horrific Corporate Governance)🥛

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Back in July 2018 in “Casual Dining Continues to = a Hot Mess,” we noted that certain lenders were agitating to engage Steak N’ Shake in restructuring discussions, which is owned by Biglari Holdings ($BH). At the time, the casual dining chain (i) had somewhere between 580 and 616 locations, (ii) was pivoting towards franchisee-owned stores rather than company-owned stores (even though, at the time, the overwhelming majority were company-owned), and (iii) had $183.1mm outstanding on a $220mm term loan due 3/21 that had dipped into the mid-80s, dangerously close to stressed levels. Significantly, the term loan is NOT guaranteed by Biglari Holdings. A big cause for concern? The company also had consecutive years of declining same store sales. We wrote:

In a February shareholder letterBiglari Holdings Chairman Sardar Biglari channeled his inner-Adam Neumann (of WeWork), stating:

We do not just sell burgers and shakes; we also sell an experience.

And if by “experience” he means getting shotbeing on the receiving end of an armed robbery or getting beat up by an employee…well, sure, points for originality

Given all of the above and the perfect storm that has clouded the casual dining space (i.e., too many restaurants, the rise of food delivery and meal kit services, the popularity of prepared foods at grocers), lender activity at this early stage seems prudent.

(Shaking heads).

Biglari reported Q1 earnings on May 3, 2019, and revenues for “restaurant operations” were down by over $20mm. Why? Good question. Allow us to show you:

That is some serious hemorrhaging. Same-store sales were down 7.9% with a 7.7% decrease in customer traffic. On the costs side, higher wages and benefits led to costs increasing as a percentage of sales by 3.6%.

*****

And, now a quick break for PETITION’s Opportunity of the Week:

Source: “Nation’s Restaurant News

Wow. That’s almost too good to refuse! As noted above, a key component of Sardar Biglari’s turnaround plan for Steak ‘N Shake is the conversion of company-owned restaurants to franchises. Because, like, there’s nothing like offloading exposure and suckering some poor saps into a franchisee arrangement to stabilize revenues and lessen exposure. 🖕🖕

And, yet, interestingly, franchise royalties and fees were also down. That conversion plan, therefore, must not be going so well — even with the company having 12 more franchisee-owned locations as of March 31, 2019 than it did on March 31, 2018. For what it’s worth, the company also has 48 fewer company-operated stores (44 of which are in limbo, “temporarily closed until such time that a franchise partner is identified.”). Given the deterioration of the Steak ‘N Shake enterprise, those locations may be closed for a long time.

*****

We don’t typically lend much credence to SeekingAlpha content but when someone entitles a post, “The Fyre Festival of Capitalism” — a clear riff on the “Woodstock of Capitalism” moniker conferred upon Warren Buffett’s Berkshire Hathaway annual meeting — we have to take a gander. AND. BOY. WAS IT WORTH IT. The piece is a summary of the Biglari Holdings investor meeting that recently took place.

Some choice bits describing “perhaps, the worst corporate governance in America”:

One shareholder asked if Steak n Shake would introduce “vegan hamburgers.” Another questioner asked for applause for the company’s management, a request which was greeted with awkward silence. One shareholder was displaying a copy of John Carreyrou’s Theranos book “Bad Blood” and was asking if people thought Biglari Holdings’ board was like Theranos’ board and if Sardar Biglari was like Elizabeth Holmes (and another shareholder then referenced this in a question).

My perception of Sardar Biglari’s attitude towards Biglari Holdings shareholders reminded me of John Updike’s great line about Ted Williams refusing to respond with a hat-tip to the pleading ovation of Red Sox fans after Williams’ home run in the last at-bat of his career: “Gods don’t answer letters.” This meeting made this point crystal clear: Sardar does not answer to shareholders, nor does he work for them. You [shareholder] want me [Sardar] to buy stock back to close what you perceive as a price-value gap, too bad, I’m not going to do it. If you are upset because the share price went down 58% last year and then the board increased my compensation, sell your shares in the company. If you have any questions about me [Sardar] earning something like $80 million over the previous few years while the market cap of the company is like $250 million, or the employment of Sardar’s family members for “consulting services”, or the company’s Netjets membership, or the opening of Biglari Café so Sardar can spend time in the Port of Saint-Tropez, or anything else for that matter – then sell your shares. If you wonder if he should be spending more time on Steak n Shake after a year in which it lost 7% of its customer-traffic and a three-year period in which it lost 12% of its business – and you have some doubt that his plan to install new milkshake machines (yes this is his turnaround plan) will succeed in stopping the bleeding – then you just don’t believe in his vision and you should sell your shares. If you bought your shares seven years ago and have a significantly negative return on them and suggest to Sardar that it would be great to get a positive return on them at some point, then you just don’t share the same time horizon as Sardar. If you wonder why he calls Biglari Holdings an acquirer but they have only ever done a couple of tiny deals and haven’t made an acquisition of any size in over five years, then you just don’t understand his “program of conglomeration.”

While there is no mention of this in the company’s SEC filings, the second prong to Mr. Biglari’s turnaround strategy for SNS is…wait for it…new milkshake equipment!! That’s right. New milkshake equipment. And it will onlycost $40mm to implement (or $100k per store). Super compelling! Sign us up for one of those available franchises stat!!

So after losing over 7% of their customers last year, 13% of its customers since 2015, and over three straight years of negative customer-traffic and same-store-sales numbers during which time Steak n Shake went from profitable to unprofitable, what is Sardar’s plan to turn around Steak n Shake? What he said at the meeting is that he has a plan to turnaround Steak n Shake and one of the main elements of it is fixing the milkshake making process – so they are creating a new milkshake making process. This is not a joke, this is what his plan is. They are also trying to make homemade ice cream at Steak n Shakes. They think this and other similar improvements is the crux of the turnaround plan (along with the franchise partner plan).

It gets better:

One shareholder commented on how last year, his turnaround plan to fix Steak n Shake was thicker cheese and better bacon – but then they lost 7% of their customers in that year. And the year before his turnaround plan was a new menu launch, but that seemed to accelerate the customer-traffic and same-store-sales losses, or at least did not halt them. Why was this year’s turnaround plan – new milkshake processes and homemade ice cream – going to work when the last few did not?

Spoiler alert: it won’t.

But…maybe cut some cherries?

Sardar Biglari at one point said that Steak n Shake spends $1 million per year on cherries for milkshakes and that he would love to get rid of that $1 million. Three different shareholders pointed out, in conversations, how ridiculous that sentiment is. Decrying having to spend $1 million for cherries on milkshakes while spending $8.4 million on administrative expenses to manage the Lion Fund, spending lavishly on hiring his brother and father at Steak n Shake consultants, maintaining an office in Monaco, the company’s opening of Biglari Café on the Port of Saint-Tropez and the Netjets memberships that the company apparently pays for – anyway, given all of that, shareholders were pointing out that maybe there is a better way to save $1 million rather than eliminating cherries from Steak n Shake’s milkshakes.

More from the shareholder meeting:

The bottom line to me is it seems that Steak n Shake’s problems have not abated – but probably have gotten worse in 2019. He refused to say how they were doing so far in 2019. He just said, “The turnaround is going to take a while.”

How could that be?! With such a rock solid strategy of new milkshake equipment, selling melting ice cubes to franchisees, and cutting cherries?!?

This should be a lightning fast turnaround.


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💰Retail Roundup (Long $FB, Long $RILY, Short Retail)💰

 
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In “Thanos Snaps, Retail Disappears“ and “Even Captain America Can’t Bring Back This Much Retail (Long Continued Closures)“ we listed out the stupendous volume of retail closures that have transpired already in 2019. As we’ve stated before, there are no signs of this trend abating. Indeed, since the second piece shipped on April 28, 2019, several more companies have announced closures.

For instance, Francesca’s announced the closure of 20 stores. Regis Corporation ($RGS), the owner of Supercutsis shedding 330 locations and, like so many other corporates, offloading risk onto unsuspecting franchisees. While its stock performance is strong, Carter’s Inc. ($CRI) closed a net 10 stores amid negative 3.7% comps. Sally Beauty Holdings Inc. ($SBH) closeda net 69 stores in the last year, primarily under its Sally Beauty Supply outlet. Outside of the conventional retail space, CVS Health Corporation ($CVS) is closing 46 locations this quarter.

One beneficiary of all of this: the liquidators. We can put some numbers around this.

Back in March, B. Riley Financial Inc. ($RILY) reported fiscal 2018 earnings. On the earnings call, the company noted the following:

Last year was also a banner year for our Great American Group retail liquidation division. We successfully completed the liquidation of the inventory assets of Bon-Ton Stores. For a sense of scale Bon-Ton was one of the largest U.S. liquidations in retail history by inventory value.

We completed the liquidation of over 200 stores with associated inventory value at approximately $2.2 billion. In 2018, we also participated in the liquidation of Toys "R" Us which contributed to our strong results in the segment. Momentum in this business is carrying forward into 2019 as a liquidation of Bon-Ton real estate assets continues to be under way and with our recently announced participation in the liquidations of Gymboree and Payless Shoes.

The Payless store closing event, which began on February 17, is the largest liquidation by store count in retail history with sales being conducted at approximately 2,100 stores and associated inventory value at over $1 billion. In January, the firm announced participation in the liquidation of 798 Gymboree and Crazy 8 stores across the U.S. and Canada.

RILY reported Q4 revenues of $10.1mm, a meaningful uptick from the $4.2mm the company reported in Q4 ‘17. Income rose from $0.1mm to $2.3mm YOY. For the year, revenues were $55mm and income was $27mm, a solid 49% margin. As for guidance, the company foreshadowed:

…momentum has already carried over into 2019. We expect to realize significant contributions from the Bon-Ton liquidation results for the first half, in addition to the results from our current involvement in Gymboree and Payless liquidations. We expect to see high levels of market activity to continue through Q2 as distressed retailers continue to focus on retail – real estate consolidation and purging excess inventory.

Last week, RILY reported Q1 ‘19 earnings and Great American Group continued to crush it. The “auction and liquidation segment” generated $20.7mm in revenue — double what it did in Q4 and more than 25% better YOY. Income increased to $11.5mm, or approximately 5x the income reported in Q4. This adds up to a margin of 55%.

Think about those numbers for a second: while retail employees are getting steam-rolled, stores are closing everywhere, malls are undeniably shaken and CMBS investors are, by necessity, vigilantly monitoring credit with a watchful eye, here is Great American Group absolutely rolling in dough on account of these retail liquidations. Great revenue, great income. Stellar margins.

Now, as we’ve discussed previously, there is an anti-competitive element in all of this. Rather than face off against one another and compress those beautiful margins, the liquidators all continue to engage in club deals for these big retailers. If the revenue, income and margin is THAT good, doesn’t that mean that debtors — and by extension, creditors thereof — are leaking a significant amount of value?🤔

****

Meanwhile, the news out of Facebook Inc. ($FB) probably had the liquidators over at Great American Group licking their chops. This week, Instagram is rolling out the ability for influencers to tag specific products in their photos, enabling consumers to click a photo, see what’s for sale, and purchase that product without ever leaving the Instagram feed. For those of you with zero design sensibility, suffice it to say that this is a big deal. No more friction of going back and forth between Instagram and external check out pages. This is going to mint tons of cash by the Kardashian and other influencer-influenced faithful.

Taylor Lorenz at The Atlantic writes:

Millions of users rely on influencers to sift through products and make recommendations. But until now, figuring out, for instance, exactly what shade of lipstick an influencer is wearing has been hard. Apps such as LikeToKnowIt, which allows you to shop influencers’ posts by taking screenshots, have garnered millions of users by providing a stopgap solution. Brand-specific social-shopping platforms such as H&M’s Itsapark have also stepped into the market. Still, many would-be consumers spend hours commenting on influencers’ Instagram posts asking for more product information, or fruitlessly attempting to locate a product online.

Interestingly, the influencers “won’t receive a cut of the sales their posts generate.” They will, however, get access to advanced metrics that may (or may not, as the case may be) arm them with leverage in negotiations with ad buyers. More from Lorenz:

“As an influencer, I don’t care if I don’t get a cut [of the sales] at the moment,” Song continued. “If it makes my followers’ life easier and they don’t have to message me asking ‘Where do you get that product?,’ I’m okay with doing it for free for now.” Many influencers are also betting that the increased engagement and spike in followers they’ll likely get by incorporating shoppable posts will more than pay off in the short term.

Color us skeptical. Much like the media is grappling with having a more direct relationship with its readers and that notion is pushing more and more writers to newsletters/subscriptions and away from advertising, we can’t help but to wonder how long influencers will be okay peddling other people’s products without getting a cut. With products like Shopify Inc. ($SHOP) enabling basically anyone the ability to create a direct-to-consumer business, it doesn’t stretch the imagination to conclude that a number of influencers are going to start getting into their own private label wares, if they haven’t already. It’s not like Kylie Jenner was having trouble moving product before: this gives her a shot of steroids.

What does this mean for retail? For starters, they’re going to be paying Facebook an awful lot of money out of their advertising budgets in the short term. In the longer term, however, they may find newfound competition from the likes of various Gen Z influencers that Gen X may have never even heard of. If malls are having trouble drawing traffic now, just imagine how much harder it will be when its easier for teen age Molly to just click on Instagram, scroll to her favorite influencer, and click through to some makeup without even interrupting continued scrolling. Facebook is savage.

Reminder: Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.


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💥Sungard Napalms the United States Trustee💥

New Chapter 11 Filing - Sungard Availability Services Capital Inc Part I

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Pennsylvania-based Sungard Availability Services Capital Inc. — a provider of “critical production and recovery services to global enterprise companies,” with $977mm of net revenue and $203mm of EBITDA in fiscal 2018 — filed a prepackaged chapter 11 plan in the Southern District of New York on Wednesday. And, if you blinked, you may have missed its residency in bankruptcy. Indeed, some lost their minds because Kirkland & Ellis LLP was able to shepherd the case in and out of bankruptcy in less than 24 hours — breaking the previous record only recently set in FullBeauty. Yes, people care about these things.*

The upshot of this expeditious bankruptcy case is that (a) the company shed nearly $900mm of debt from its balance sheet (reducing debt down to approximately $400-450mm) and (b) transferred 89% ownership to a variety of debt-for-equity swapping funds such as GSO Capital PartnersFS InvestmentsAngelo Gordon & Co., and Carlyle Group (who will also receive $300mm in senior secured term loan paper). Major equity holders — Bain Capital Integral Investors LLCBlackstone Capital Partners IV LPBlackstone GT Communications Partners LPKKR Millennium Fund LPProvidence Equity Partners V LPSilver Lake Partners II LPTPG Partners IV LP — had their equity wiped out (we had previously highlighted KKR’s investment here in “A Hot-Potato Plan of Reorganization. Short BDC Retail Exposure,” discussing the broader context of BDC lending).

This is what the capital structure looked like and will look like:

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That balance sheet is the driver behind the bankruptcy filing. Per the company:

This legacy capital structure was created based upon the Company’s historical operating model and performance and is unsustainable under current market conditions. When the capital structure was put in place, the Company benefited from a larger revenue base with substantially higher free cash flow. As business conditions evolved and the Company’s revenue declined, cash flow available to service debt and invest in products and services substantially declined. Consolidated net revenue declined by approximately 18% from approximately $1.2 billion in 2016 to approximately $977 million in 20188 while adjusted EBITDA margins remained within a range of approximately 20% to 22%. Negative net cash flow from 2016 to 2018 was approximately $80 million.

In other words, this is as clear-cut a balance sheet restructuring that you can get. Indeed, general unsecured claims are — as you might expect from a prepackaged plan of reorganization — riding through unimpaired. This consensual restructuring is clearly the right result. Getting it in and out of court so quickly is a bonus.


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🌋FuelCell Sucks Wind (Long Distressed Power)🌋

Fuel Cell Power Plant Manufacturer Struggles

Amazon is not too big to fail… In fact, I predict one day Amazon will fail,” Jeff Bezos said back in November. He makes a salient point: even once-uber-successful companies are subject to disruption and questions of sustainability over long periods of time. This is an industry-agnostic notion. 

We can debate the definition of “successful” but it seems fair to say a company that once had a market capitalization of $1.5b falls into that category. One such company that fits that bill, FuelCell Energy Inc. ($FCEL), is now a shell of its former self, teetering on the brink of chapter 11 bankruptcy. 

Connecticut-based FCEL designs, manufactures, installs, operates and services “ultra-clean” efficient and reliable stationary full cell power plants to an end market of commercial, industrial, government and utility customers. It’s mission is a worthy one: to deliver clean innovative power solutions, utilizing environmentally responsible fuel cells. There’s just one problem with all of that: it doesn’t make money. And it hasn’t since its fiscal year ended October 1997.

The company — not the first to experience distress in the power sector in recent times — is getting battered on all sides. Wind and solar have stolen a lot of the company’s mojo. Competitors such as the controversial Bloom Energy Corp. ($BE)have taken market share even while it, too, has seen its market cap shrink from over $4b to just over $1b. New order volume has been elusive. 

All of this shows in the company’s numbers. Revenues have declined from $190mm in 2013 to $90mm in 2018. LTM revenue is only ~$70mm. The company’s Quick Ratio and Current Ratio — both measures of the company’s ability to cover short-term financial obligations — are .6x and 1.3x respectively, versus industry comps of 1.1x and 1.5x. And, thanks to these numbers, capital sources may no longer be available.

The company’s historical financial channels included sales of equity (including a NUMBER of preferred equity issuances), corporate and project level debt financing, and local or state government loans or grants. Here is a snapshot of the company’s debt sitch:

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In the light of this debt, $41.6mm of debt at the corporate level, and the company’s declining revenue predicament, the company is focused on liquidity. Per the company’s most recent 10K:

The Company’s future liquidity will be dependent on obtaining a combination of increased order and contract volumes, increased cash flows from the Company’s generation and service portfolios and cost reductions necessary to achieve profitable operations.

To grow its generation portfolio, the Company will invest in developing and building turn-key fuel cell projects which will be owned by the Company and classified as project assets on the balance sheet. This strategy requires liquidity and is expected to continue to have increasing liquidity requirements as project sizes increase.

Which, you might appreciate, creates a bit of a circularity problem. The company needs to spend more to make more which means cash flow in the near term is highly unlikely.

Consequently, the company just sh*tcanned 135 people to save approximately $11.5mm. To the extent those employees held stock, well:

Bloomberg recently noted:

NRG, the largest independent U.S. power producer, has also been a key backer. It owned 1.4 million shares in the company, based on the latest holding data compiled by Bloomberg, and provided a $40 million revolving credit facility to help FuelCell build power plants. But that credit line may expire this year, and without another large investor willing to throw more money at the company's technology, FuelCell faces a grim future, [an analyst] said.

“Their only hope,” he said, “is to find someone who wants to finance this.”

We find it highly unlikely that any financing occurs outside of bankruptcy court. Notwithstanding a recently-announced new purchase power agreement with the City of San Bernardino Municipal Water Department, we suspect we’ll be seeing this thing in Delaware sometime soon. 

☁︎More Dark Clouds (Short Debt-Fueled Acquisition Sprees)☁︎

TierPoint LLC Gets a Beat Down from Moody’s

In “⛈A Dark "Cloud" on the Horizon⛈,” we noted, in the context of Fusion Connect Inc’s recent troubles ($FSNN), that not all cloud businesses are created equal. This week, another cloud-company, TierPoint LLC, came into view after Moody’s changed the company’s outlook to negative from stable. The private, Missouri-based company provides “colocation, cloud computing, backup and business continuity, managed security, firewall, and professional services,” creating an “Infrastructure-as-a-Service” stack for its customers in the education, energy, financial, healthcare, legal, manufacturing, retail and tech industries.

The company has been on an acquisition spree over the years, gobbling up data center company, Cosentry, data services provider, AlteredScale, and the data services business of Windstream Holdings in 2016. The company, by virtue of the Consentry deal, is a TA Associates Management LP portfolio company.

As you might imagine, with great acquisition sprees come great loads of debt. The company’s balance sheet sports a $700mm first lien term loan, a $220mm first lien revolver and a $220mm second lien term loan. Moody’s points to near-term challenges that might affect the company’s ability to delever including, among other things, “unexpected customer churn volatility in late 2017” proving difficult to overcome. Moreover, margins and growth are down, further complicating efforts to drive the debt leverage down — yes, down — to 7x.

👄Retail Partnerships Blossom Everywhere (Long Limiting Lease Exposure)👄

SmileDirectClub Expands its Reach with CVS Health Corp. Partnership

In “Retail Partnerships Abound (Long Survival Instincts),” we noted how Birchbox had entered into a partnership with Walgreens Boots Alliance Inc. ($WBA) and CVS Health Corp ($CVS) with Glamsquad. We concluded:

People need drugs. People need food. So why not go where the customers are rather than try to generate independent traffic through your own brick-and-mortar location? Use someone else’s lease rather than incurring the liability. This all makes sense. And so there’s every reason to believe that this trend will continue — particularly where a company brings real brand cache to bear.

This week CVS announced another partnership: SmileDirectClub will be bringing its teeth-straightening services to hundreds of locations over the next two years. Per CNBC:

CVS is trying to keep up with its changing customers. People are shopping online more, especially on sites like Amazon, hurting CVS and other drugstores’ sales of everyday items like vitamins and toilet paper. CVS thinks focusing on health and beauty products and services will be a way to draw people in.

This is a trend that we very much expect to continue. Is it beyond question that, ultimately, we’ll start seeing “health courts” much like we see “food courts?” We can see it now: a murderers’ row of previously direct-to-consumer retailers like Warby Parker, Ro, Hims and SmileDirectClub all in one place so that you can cover your health and wellness needs all in one fell swoop.

Casual Dining is a Hot Mess. Part VI. (Short Franchisees).

We’ve previously written about Kona Grill Inc. ($KONA) and Luby’s Inc. ($LUB) here. Indeed, we marked the former’s now-inevitable descent into bankruptcy as far back as April 2018. Subsequently, we’ve followed each quarter with interest only to witness the conflagration get bigger and bigger along the way. This sucker is certainly headed into bankruptcy.

Here is what’s new: Kona hired an Alvarez & Marsal Managing Director as its CEO — its fifth CEO in less than a year. It publicly indicated that it may have to file for bankruptcy. And Nasdaq delisted it. Stick a fork in it.

Likewise, we first highlighted Luby’s in July 2018. In a follow-up in January, we wrote:

And then there is Luby’s Inc. ($LUB)We featured the chain back in July, highlighting continued overall same store sales and total sales decreases. We did note, however, that the company has the advantage of owning a lot of its locations and that asset sales, therefore, could help buy the company time and assuage lender concerns. Real estate sales have, in fact, been a significant part of the company’s strategy. And so the lenders haven’t been its problem. Activist shareholders have been.

But that’s not entirely the full picture. We also noted that the company’s numbers “suck.” Which begs the question: now that another quarter has gone by, has anything changed?

On the performance side, not particularly.

Same store sales decreased 3.3%. Restaurant sales were down 12.1% (offset slightly by culinary contract services sales). Every single restaurant brand performed poorly: Luby’s Cafeterias were down 6.1%, Cheeseburger in Paradise (TERRIBLE name) down 76%, F*cked-ruckers…uh, Fuddruckers, was down 19%, and combo locations were down 7%. Basically this was an absolute bloodbath. Fuddruckers same-store sales were -5.3%. Analysts don’t even bother covering the stock. The company trades at $1.50/share at the time of this writing.

But things have changed a bit on the cost side. The company has closed 27 underperforming restaurants and sold $34.7mm in assets. It has also moved forward with its plans to refranchise many company-owned Fuddruckers, converting five units to franchisors who are clearly gluttons for punishment. The company has also engaged in food and operating cost cutting initiatives. Who is helping them out with this? Duh…the new CEO and Alvarez & Marsal’s “performance improvement” group

PETITION Note: we always find “PI” projects spearheaded by divisions out of large turnaround advisory firms to be interesting beasts. Imagine the conversations behind closed doors:

PI Managing Director: “Yeah, bro, we just took $0.2mm of SG&A out of the business and we believe there is more room to run there once we beat up the supply chain a bit, postpone repairs and maintenance, adjust employee hours, and make food cuts.

Restructuring Managing Director: “Food cuts, huh?

PI Managing Director: “Yeah, we DEFINITELY wouldn’t recommend you eat there.

Restructuring Managing Director: “Got it. So, uh, this is obviously a bit delicate but, uh, here’s the real question: how can you guys continue to take SOME costs out of the business and look like heroes…without…uh…improving performance…you know…TOO MUCH?

Boisterous bro-tastic laughs, winks and secret handshakes ensue.

Now, sure, sure, that’s cynical AF and not at all fair here: we’re not at all saying that anyone is doing anything untoward here. Yet, we wouldn’t be surprised, however, if conversations such as these happen though. Just saying.


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Fast Forward: Boy Scouts of America & More Potentially Coming to a Bankruptcy Court Near You

Boy Scouts of America. As talk of bankruptcy ramps up, so do the number of potential claimants. According to the Texas Standard:

“Recently, over 200 people have come forward with new sexual abuse allegations against the Boy Scouts of America. The Irving, Texas-based organization is one of the largest youth groups in the country, and has already dealt with numerous charges of abuse over the years. One expert estimates some 7,800 hundred individuals allegedly abused more than 12,000 children.”

😬😡


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⚡️Update: Pier 1 Reports Horrific Numbers⚡️

And then there is the “ghastly” sh*tshow that is Pier 1 Imports Inc. ($PIR). Back in January, we asked “Is Pier 1 on the Ropes? (Short “Iconic” Brands)” — a question that a lot of retail analysts now seem to be asking in the wake of a horrendous earnings report. How horrendous was it? Comp sales decreased 13.7% YOY, net sales decreased 19.5% YOY, and the company had a net loss of $68.8mm (or $0.85/share). And apropos to the discussion above, the company indicated that it’s considering closing 45 stores in fiscal 2020 due to lease expirations — a number that could rise by upwards of 15% if the company’s new cost-cutting action plan (to the tune of $110mm) doesn’t bear fruit. The company hired A&G Realty to help with this initiative.

So, about that action plan. Here’s what the company has to say about it:

Pier 1 is implementing an action plan designed to drive benefits in fiscal 2020 of approximately $100-$110 million by resetting its gross margin and cost structure. Approximately one-third of the benefits are expected to be realized in gross margin, with the remaining two-thirds coming from cost reduction. After reinvesting in the business, the Company believes it will be positioned to recapture approximately $30-$40 million of net income and $45-$55 million of EBITDA in fiscal year 2020. The Company expects to capture efficiencies and drive improvement in the following areas: 1) Revenue and Margin; 2) Marketing and Promotional Effectiveness; 3) Sourcing and Supply Chain; 4) Cost Cutting; and 5) Store Optimization.

As part of the $100-$110 million of benefits discussed above, the Company has identified approximately $70-$80 million of selling, general and administrative (“SG&A”) savings opportunity for fiscal 2020, the majority of which is expected to be realized in the second half of the year. This SG&A savings opportunity for fiscal 2020 reflects an expected annual run-rate of approximately $95-$105 million.

The subsequent earnings call was…uh…interesting. Led off by an outside investor relations firm, the company’s interim CEO then took over the call by sharing, in the first instance, that an AlixPartners’ restructuring MD is now serving the company as interim CFO. Awesome start. Recent retail quals include Bon-Ton Stores and Gymboree. The team then went on at length about all of the various improvements they hope to instill in the business.

The analysts on the call were…shall we say…NOT EVEN REMOTELY convinced.

Beryl Bugatch, an analyst from Raymond James & Associates pounded the team with questions…

What is the guidance? The company declined to guide.

Where is the delta between the $100mm in cost savings and the $55mm in EBITDA improvement going? The company abstractly answered “we are reinvesting a portion of the savings back in the business.

Where though? Marketing? The company responded, “assortment strategy, our talent and capability and efficiencies and things to drive efficiency in the plan.” READ: HIGH PRICED ADVISORS.

What’s liquidity look like? The company said it had $55mm in cash, $50mm in the FILO tranche and an undrawn revolver — enough to get through fiscal 2020.

But how clean is the inventory?

By this point the company was like:

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Even Captain America Can’t Bring Back This Much Retail (Long Continued Closures)

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Retail has been, to state the obvious, a hard topic to avoid in distressed circles. In “Thanos Snaps, Retail Disappears — one of our most-read a$$-kicking briefings to date (PETITION Note: you’re all bigger nerds than we thought) — we delineated a long list of retailers that were liquidating and/or closing stores, making 2019 a pretty brutal year thus far for the industry.*

The brutality ensues.

In the mere 4 weeks since we wrote that post, more and more retailers have reported downsizing efforts. Even — shocker! — SearsSears has closed at least four stores in the last few weeks — including, notably, its “store of the future” concept in Oak Brook Illinois. Per Business Insider:

The failure of the store, which was viewed as a prototype for future Sears locations, casts considerable doubt over the company's recovery post-bankruptcy, according to Neil Saunders, managing director of GlobalData Retail.

"It underlines the fact that Sears does not have a credible plan for its long-term survival," Saunders said. "Making stores a bit nicer and reducing space are sensible steps, but they do not represent a holistic solution."

DAMN IT. We had drafted Sears #1 in our Fantasy Retail Survival All-Star Draft! There goes another season down the drain.

Elsewhere, JD Sports Fashion Plc, the company behind Finish Line in the United States, reported strong numbers, in part, behind its Finish Line segment; nevertheless, it shuttered 23 locations and 26 in-store spaces located within Macy’s Inc. ($M) stores in the last year. Office Depot Inc. ($ODP) is closing 50 stores under is OfficeMax banner. Francesca’s Holding Corp. ($FRAN) is in the midst of an attempted turnaround and store closures are coming: the company just hasn’t indicated how many yet. Famous Footwear ($CAL) is closing a net 30 stores. The Vitamin Shoppe Inc. ($VSI)indicated that it’ll close somewhere between 50-70 stores (net). G-III Apparel Group Ltd. ($GIII), the company behind washed up…uh…”ICONIC” brands like DKNY and Karl Lagerfeld reported 43 stores closures this year. Destination Maternity Corporation ($DEST) reported 116 closures in fiscal 2018 (31 store closures and 85 leased departments) and an aim towards 42-67 additional store closures in fiscal 2019. And Vera Bradley Inc. ($VRA) intends to close 10 stores this year and 20 more next year.

In total, the picture just gets uglier and uglier:


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Disruption, Illustrated. Fuse LLC Files for Bankruptcy. (Long Netflix).

California-based Fuse LLC, a multicultural media company composed principally of the cable networks Fuse and FM, filed a prepackaged chapter 11 along with 8 affiliated debtors in the District of Delaware to effectuate a swap of $242mm of outstanding secured debt for (a) $45mm in term loans (accruing at a STRONG 12% interest and maturing in five years), (b) new membership interests in the reorganized company and (c) interests in a litigation trust. General unsecured creditors will recover nothing despite being owed approximately $10mm to $25mm.

The company is well known to millions of US homes: approximately 61mm homes get Fuse, an independent cable network that targets young multicultural Americans and Latinos. FM’s music-centric content reached approximately 40.5mm homes “at its peak.” The company has three principal revenue streams: (a) affiliate fees; (b) advertising; and (c) sponsored events; it generated $114.7mm in net revenue for the fiscal year ended 12/31/18 and “had projected affiliate fees of approximately $495 million through 2020.

Why is it in bankruptcy? In a word, disruptionDisruption of content suppliers (here, Fuse) and content distributors (the traditional pay-tv companies). Compounding the rapid changes in the media marketplace is the company’s over-levered balance sheet, an albatross that hindered the company’s ability to innovate in an age of “peak TV” characterized by endless original and innovative content.


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⛅The Rise of the Cloud. (Long Cloud Usage. Short Debt-Laden Intermediaries).⛅

 

The “cloud” is such a fundamental business component today that cloud considerations inform various aspects of business planning. Look no farther than Amazon Inc. ($AMZN)Microsoft Inc. ($MSFT)Cisco Inc. ($CSCO), and Google Inc. ($GOOGL), and you’ll see cloud computing providers who are minting money on a quarterly basis for providing services that alleviate the server and storage burden of businesses across all kinds of industry verticals. Underscoring the importance of the cloud, IBM Inc. ($IBM) spent a fortune — $34 billion! — acquiring Red Hat Inc. to boost its cloud-for-business offering. Furthermore, recent IPOs have illustrated just how important cloud services are: Pinterest Inc.Snap Inc. ($SNAP)Lyft Inc. ($LYFT), and many other high-flying companies pay hundreds of millions in fixed contracts for cloud computing services that power their applications in ways that everyday end users almost certainly don’t recognize and/or appreciate.

The “cloud,” however, subsumes various other services in addition to computing/storage. There are connectivity-focused applications (provided by the likes of AT&T Inc. ($T)Comcast Corporation ($CMCSA), and others) unified cloud communications applications (i.e., Vonage Holdings Corp. ($VG)), and point solutions (e.g., Citrix Systems Inc. ($CTXS)). One could be forgiven for thinking that everything and anything touching cloud would be gold in this environment. Imagine, for instance, if one firm could serve as an intermediary linking together various cloud-based solutions for other small, medium and large businesses!! Cha Ching!! 

Apparently that’s not the case.

New York-based Fusion Connect Inc., “a provider of integrated cloud solutions, including cloud communications, cloud connectivity and business services to small, medium and large businesses” is bucking the hot cloud trend and barreling quickly towards a bankruptcy court. This begs the question: what the holy f*ck? How is that even possible?

Per a January investor presentation, this is Fusion’s cloud services revenue:

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The 2018 revenue is annualized: revenue in Q3 ‘18 was actually $143.4mm with gross margins of 49.1%. Net operating income was $4mm. Yet the company lost $0.23/share. How does that work? Well, the company had $21.6mm in interest expense.

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The weighted-average rate of interest across the company’s credit facilities is approximately LIBOR + 7.7%. 😬 Not exactly cheap. Compounding matters is that the debt isn’t exactly cov-lite (shocking, we know): rather, the company is subject to all kinds of affirmative and negative covenants. Yes, once upon a time, those did exist.

The company’s recent SEC reports constitute a perfect storm of bad news. On April 2, the company filed a Form 8-K indicating that (i) a recently-acquired company had material accounting deficiencies that will affect its financials and, therefore, certain of the company’s prior filings “can no longer be relied upon,” (ii) it won’t be able to file its 10-K, (iii) it failed to make a $7mm interest payment on its Tranche A and Tranche B term loan borrowings due on April 1, 2019, and (iv) due to the accounting errors, the company has tripped various covenants under the first lien credit agreement — including its fixed charge coverage ratio and its total net leverage ratio. Rounding out this horror show of news, the company disclosed that it may need to seek a chapter 11 filing (combined with a CCAA in Canada) and has hired Weil Gotshal & Manges LLPFTI Consulting Inc. ($FTI) and Macquarie Capital USA Inc. to advise it vis-a-vis strategic options. B.Riley/FBR ($RILY) analyst Josh Nicholsimmediately downgraded the company from “buy” to “neutral” (huh?!?) with a price target of $0.75 from $9.75. Uh, okay:

This is why you should never listen to equity analysts. This is the stock chart from the past year:

Like, the stock has been nowhere near $9.75, but whatevs.

On Monday, the company filed another Form 8-K. The company and 18 of its affiliated bankrupt US debtors…uh, we mean, guarantors…entered into a forbearance agreement with lenders under the Wilmington Trust NA-agented first lien credit agreement. The lenders will forbear from exercising rights and remedies stemming from the company’s defaults until April 29. The company had to pay 200 bps for the time to try and work this all out and agree to pay a slew of lender professionals, including Greenhill & Co. Inc. ($GHL) and Davis Polk & Wardwell LLP for an ad hoc group of Tranche B term lenders, Simpson Thacher & Bartlett LLP for the lenders of Tranche A term loans and the revolving lenders, and Arnold & Porter Kaye Scholer for Wilmington Trust.

The company’s Tranche B term lenders include East West BankGoldman SachsMorgan StanleyOnex Credit PartnersOppenheimer Funds and a whole bunch of CLOs. The latter fact may make a debt-for-equity swap interesting (PETITION Note: most CLOs are unable to hold equity securities).

The clock is ticking on this one.

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Ferrellgas Partners LP Lights Money on Fire

 
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Kansas-based Ferrellgas Partners LP ($FGP) is an old school business. For nearly 80 years, it has been a nationwide home and business propane provider with propane demand driven primarily by users of space and water heaters, and large engine operators (i.e., forklifts, mowers, and generators). According to the EIA, “[a]bout 5% of all U.S. households heat primarily with propane, and many of those households are in the Northeast and Midwest.” The market for the product, however, is fairly static, thereby limiting the company’s go-forward growth prospects. Accordingly, a few years back, it sought to supplement its core business and diversify its revenue streams via acquisition.

In 2015, therefore, the company acquired Bridger Logistics, a midstream services business involving the shipping and storage of oil, for approximately $837.5mm. The company paid nearly $563mm in cash (read: issued debt to pay cash) and the rest in stock: this elevated purchase price represented a 8.4x multiple on estimated next twelve months EBITDA of $100mm. The company noted the following at the time of the acquisition:

"The move positions Ferrellgas to significantly expand its midstream platform and is expected to be immediately accretive to Ferrellgas and supportive of future distribution growth.”

Only it wasn’t. Rather than being accretive, the transaction became the epitome of (i) haphazardly reaching beyond a core competency, (ii) stretched economics during a frothy seller’s market, and (iii) bad timing. Shortly after the transaction, the midstream services sectors got napalmed. And never recovered. In 2018, the Company reported that Bridger and other accumulated midstream asset gross margin decreased an astounding 75% to $12.6mm. Burdened by an over-levered capital structure, the company reversed course and rather than attempt to fit a square peg into a round hole, decided to start shedding assets to paydown debt. Indeed, the company sold the same acquired assets for a total of $92mm — which amounts to an absolutely BRUTAL level of value destruction.

Clearly that acquisition didn’t go as planned. After a brutal 18-month failure, the transaction left the most lasting impression on the company’s balance sheet:

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Bankruptcy, Transparency and the White Knight: McKinsey (Short Logic)

Another week, another chapter in the Jay Alix and McKinsey drama. And, seriously, folks, this sh*t is fiercer than a White Walker facing off against some dragons so hold on to your seats.

On Tuesday, Law360 reported:

Restructuring consultant Jay Alix again urged a New York bankruptcy court on Tuesday to let him investigate McKinsey & Co. over alleged conflicts of interest in the SunEdison Inc. Chapter 11 case, just days after McKinsey revealed that it paid $17.5 million to SunEdison’s estate to resolve nearly identical claims.

Tuesday’s motion comes as U.S. Bankruptcy Judge Stuart M. Bernstein is considering whether to take additional action in the SunEdison case, or let the $17.5 million settlement end matters as far as McKinsey is concerned.

And on Wednesday:

Alix’s filing in the SunEdison case comes as a Texas bankruptcy court rejected his pleas to dig further into McKinsey in the case of the Westmoreland Coal Company, which emerged from bankruptcy last month and is another McKinsey client.

The conflict of interest claims Alix raised in that case forced McKinsey to disgorge $5 million in fees in a settlement with Westmoreland’s estate, but on Wednesday U.S. Bankruptcy Judge David R. Jones shot down Alix’s request for an “emergency order” that would allow him to conduct further discovery.

Indeed, Mr. Alix sought an “emergency motion” for entry of an order compelling McKinsey to disclose all of the investments of its affiliate MIO Partners Inc. Mr. Alix wrote:

The time to move forward on Mar-Bow’s objection and determine whether McKinsey is qualified to serve as a professional in this matter is long overdue. It is notable that McKinsey has never denied the MIO’s holdings in the Debtors’ estates or in interested parties. Accordingly, this emergency motion seeks prompt and highly discrete relief: an order compelling McKinsey to (a) identify all equity or debt investments held or managed by it or any of its affiliates (including MIO) in any Debtor, or in any party in interest, competitor, customer, or supplier; and (b) disclose information sufficient to allow the Court to evaluate the amount and nature of those investments.

The judge — perhaps a bit miffed that his docket had been completely overrun by motion practice relating to the Alix/McKinsey dispute…you know, rather than issues specific to the actual Westmoreland Coal Company matter — summarily dismissed the motion. In an order issued on Wednesday April 10, 2019, he wrote:

At best, the motion represents a self-created emergency with no underlying substance. At worst, the motion constitutes an improper collateral attack on the Court’s prior order at Docket No. 1427 for an illegitimate purpose. Counsel are advised that they are responsible for the words and allegations contained in pleadings on which their names appear. Candor and professionalism must never be sacrificed in the name of overzealous advocacy.

ZING!

Of course, we find this language to be a wee bit hypocritical coming from a Judge who has skewered professionals of all types — lawyers, service providers, whomever — from his perch on the Bench. As just one example, recall this classy bit from an August 4, 2016 hearing in the matter of Sherwin Alumina Company LLC (that related to the Noranda Aluminum matter too):

You are on my radar screen. The financial transaction that ought to be being discussed a first-year business student can see. I’m not the smartest guy in the world, and I see it. I have been reading pleadings. And I cannot express the degree of disappointment that I have in the professionals that have been running these cases. If this case is going to fail, if the Noranda cases are going to fail, then so be it. But that’s going to create a block of time, and I’m going to use all of my education, all of my training, all of my experience in deciding where to lay the blame for this failure. That’s not a threat; it’s a promise. And if anyone wants to test my resolve, I encourage them to do it. Anyone doubts my commitment? Noranda’s local counsel spent a lot of years with me. They know exactly how I can be. You all are a talented group of people. I find it offensive that egos have gotten in the way. If we really want to try and have a contest as to who’s got the biggest set, I promise you I will win that battle.

“That’s not a threat; it’s a promise.” Really?

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🐶Petsmart Gets its Deal🐶

DON’T. MESS. WITH. DAISY. CHAPTER 5. (LONG ASSET STRIPPING AND COERCIVE CONSENT SOLICITATIONS).

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It's a beautiful day. You're walking down the street with your cute little puppy, Bacca, enjoying some much-needed serenity. The wind is blowing your hair back and the smell of flowers permeates the air. Life is good. You’re happy. Maybe you'll treat sweet lil' Bacca to some of that sweet organic sh*t today; after all, you're only a short walk to the local pet store. But then your phone rings.

"Bro. We need to make a decision."

"About what?" you ask, your chill vibes violently crushed by the voice of your excited junior analyst.

"PetSmart. They're doing an exchange. And it's coercive AF!"

Frikken Petsmart. You look down at Bacca and you swear you see a grimace on his cute little face as he stares back at you. You refocus your attention on your analyst, "Alright dude. Relax. What's the story?"

"Arnold & Porter Kaye Scholer is hosting an all hands term lender call soon. At issue is whether the group of term lenders will, in exchange for some enhanced economics, amend the credit docs governing the loan to post facto bless the company's absurd Chewy.com dividend." 

You reflect a bit on Petsmart as you continue your walk. Nearly exactly two years ago the company announced its whopper of a $3.35b Chewy.com transaction; it took on massive amounts of debt to fund the deal. It was the largest e-commerce acquisition ever — topping Walmart Inc’s acquisition of Jet.com. Venture capitalists instantaneously made a boatload of money (the pre-acquisition funding topped out at $451mm) but immediately the Petsmart capital structure looked wobbly after a two-part debt offering of (a) $1.35 billion of ‘25 8.875% senior secured notes and (b) $650 million of ‘25 5.875% unsecured notes. Rounding out the capital structure was a $750 million ABL, a $4.3 billion cov-lite first-lien term loan and $1.9 billion of cov-lite ‘23 senior unsecured notes. The company’s leverage ratio was approximately 8.5x.

You then reflect on June 2018. You recall reading this in PETITION:

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💥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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