Retail Roundup (Long Tourniquets, Long Headwinds).

The retail bloodbath continues.

Earlier this week, Abercrombie & Fitch Co. ($ANF) joined Ralph Lauren Corp. ($RL)Gap Inc. ($GPS), and Calvin Klein ($PVH) by ditching “flagship” stores situated in expensive parts of town. The stock got crushed on earnings. But the “Peace Out Flagship Square Footage” club didn’t stop growing there. To the contrary, it is expanding. Rapidly.

On Wednesday, J. Crew announced that it plans to shutter 20 flagship and outlet stores. “Why might it be trying to shrink its footprint,” you ask? Good question. And the comps give you all the answers you need. While total revenue rose 7% across the enterprise, J.Crew sales fell 4% with comps down 1%. In contrast, Madewell sales rose 15% and comps rose 10%. 


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💰The United States Trustee (Long Perverse Incentives).💰

The Wall Street Journal reports that the UST fund is approximately 75% short of its funding goal for the year.* Currently, the fund gets fed by quarterly fees paid by bankrupt companies with over $1mm in operating expenses. As with all things bankruptcy, the new federal law mandating the fee increase has a number of holes in it. Consequently, various cases implicating the law are winding their way through the courts.


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Trickle-Down Healthcare Distress (Long Electronic Beds, Short Nana).

Nana’s Post-Acute Care, Powered by Private Equity.

There has been notable bankruptcy activity in the healthcare industry this year — from continuing care retirement communities to the acute care space. When end users capitulate and need to streamline operations and cut costs, who gets harmed farther down the chain? It’s a good question: after all, there’s always some trickle down effect.

Our internal search for answers to this question recently brought us to Charlotte-based Joerns Healthcare, a “premier supplier and service provider in post-acute care.” The company sells supportive care beds, transport systems, respiratory care solutions and more.

Now, all of that sounds well and good and even with operational and budgetary issues and rising healthcare costs, one could be forgiven for thinking that a business like this might be insulated to some degree — especially as baby boomers get older. Healthcare is not something people tend to skimp on. Yet, that simplistic thinking fails to take private equity into account. That’s right: your Nana’s post-acute care, powered by private equity.


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📺TV Content Distribution is in a State of Flux📺

Callback to the Fuse Media LLC chapter 11 bankruptcy filing in which we wrote:

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.

The company illustrates all of this nicely:

“…the overall pay-TV industry is in a period of substantial transformation as the result of the introduction into the marketplace in recent years of high quality and relatively inexpensive and consumer friendly content alternatives (e.g., Netflix, Hulu and others). The ongoing marketplace changes have resulted in, and will continue to cause, a material decline in pay-tv subscribers and related affiliate fee revenue as a result of a declining number of new subscribers, "cord-cutting" (the cancellation of an existing pay-tv subscription), and "cord-shaving" (the downgrading of a pay-tv subscription from a higher priced package to a lower priced package). Each quarter the Company receives less revenue from its traditional pay-tv distribution partners as the result of the decline in subscribers receiving the Company's networks. And new sources of revenue for the Company, although developing and in progress, have not grown sufficiently to offset revenue declines in the legacy business. As a result of these trends, the refinancing of the Company's debt was not viable.”

The Information recently confirmed (paywall) what Fuse was saying and we all know is true from our own experience with the myriad subscription-related bills we’re all getting: pay-TV is, indeed, in the midst of some substantial transformation. They write:

Cable channels have long been the cash machine for the entertainment industry thanks to a quirk in their business model. Cable and satellite TV firms pay channels fees for each subscriber who has the channels available in their service package, regardless of whether anyone watches the channels. AT&T, owner of DirecTV, is trying to change that—with far-reaching implications for the TV industry’s profitability.

AT&T wants to pay channels based on how many people actually watch, rather than the number of subscribers who have access to the channels. The idea is driven by two major trends. Firstly, a growing number of consumers are canceling their expensive cable and satellite packages in favor of cheaper streaming services. Meanwhile, TV channels are charging distributors like DirecTV more for the right to carry them even as the channels’ audiences are shrinking….

Note:

What a model! Fewer and fewer end users but higher and higher costs nonetheless. More from The Information:

If AT&T can shift to paying for channels based on their audience size, it could reduce programming costs for its DirecTV and phone-based TV service U-verse and potentially lead other cable and satellite operators to follow suit, sparking a revolution in television. For years, cable and satellite services have complained that programming costs were too high. They can account for more than 60% of video-related revenue.

AT&T’s effort to get entertainment companies to agree to get paid for actual viewers of their shows is in its infancy and it faces long odds. “This is probably the greatest negotiating friction in all the businesses,” AT&T Communications CEO John Donovan told The Information last summer when asked about the company’s discussions around so-called engagement pricing.

These efforts — while currently a longshot — are worth monitoring. Content providers and distributors look headed for a collision.

⚡️Earnings Season Ushers in More Bad News for Retail⚡️

In “Thanos Snaps, Retail Disappears👿,“ “Even Captain America Can’t Bring Back This Much Retail (Long Continued Closures)“ and “💸The #Retailapocalypse is a Boon for...💸,” we’ve chronicled the seemingly endless volume of retail store closures that continue to persist in the first half of 2019. As we’ve said time and time again, there are no signs of this trend disappearing. In fact, it continues to get worse.

Last week brought us a deluge of retail news and earnings. And, indeed, along with earnings came more store closure announcements and more indications of who are the “haves”* and the “have nots.”

Let’s start with department stores where there’s a lot of pain to go around in “have not”-ville.

Macy’s ($M) kicked things off with a surprise increase in same-store sales and so it was ONLY down approximately 0.9% on the week. In contrast, Kohl’s ($KSS)Dillard’s ($DDS)J.C. Penney ($JCP) and Nordstrom ($NWN) all got hammered — each down more than 7% — after across-the-board dismal earnings. Kohl’s performance was particularly interesting given its acclaimed experimentation, including partnerships with Amazon ($AMZN) and, coming soon, Fanatics. The company reported a 2.9% revenue decline and a same-store comp decline of 3.4%. Adding fuel to the fire: the company cut its full-year earnings guidance, citing…wait for it…tariffs(!) as a massive headwind.

Kohl’s wasn’t alone there. Home Depot ($HD) also indicated that new tariffs on China might cost it $1b in revenue — on top of the $1b it already anticipated from the prior round of tariffs. 😬

Other have nots in retail? Party City ($PRTY) is closing 45 storesTuesday Morning Corp. ($TUES) is closing a net 12 storesFred’s ($FRED) announced 104 more closures in addition to the 159 previously announced closures. Burberry Group Plc ($BURBY) is closing 38 storesTopshop is now bankrupt and will close 11 stores in the US (and more abroad). Hibbett Sports ($HIBB) is adding 95 store closures to the pile (despite otherwise nice results). Of course, we’d be remiss if we didn’t mention the dumpster fire that is Dressbarn:

Finally, all of the pain in retail already has at least one ratings agency questioning whether David’s Bridal is out of the woods post-bankruptcy. We can’t wait to add that one to our “Do We have a Feasibility Problem?” series.

All of this has people scattered wondering what’s the next shoe to drop (more tariffs!) and, in turn, what can possibly stop the bleeding? Here is a piece discussing how private brands are on fire.

Here is to hoping that Generation Z saves malls. What draws them to malls? Good food. Malls with great food options apparently experience more sales. Now Neiman Marcus and H&M are going the resale routeUrban Outfitters ($URBN) is experimenting with a monthly rental service. Startups like Joymode look to benefit from the alleged shift from ownership to “access.”

As for continued bleeding, here is yet another sign that things may continue to worsen for retail:

Notably, production of containerboard — a type of paperboard specially manufactured for the production of corrugated board (or cardboard) — is suffering a YOY production decline. Is that indicative of a dip in e-commerce sales to boot? 😬

*On the flip side, there have been some clear winning “haves.” Take, TJX Companies Inc. ($TJX), for instance. The owner of T.J. Maxx reported a 5% increase in same store sales. Target Inc. ($TGT) and Walmart Inc. ($WMT) also appear to be holding their own. The former’s stock had a meaningful pop this week on solid earnings.

Subscriptions ⬆️. Ownership ⬇️.

We’re old enough to remember when talking heads pontificated about how the “sharing economy” was going to end ownership. There was an AirBnB or Uber for everything: musical instruments, handyman tools, you name it. Let some other sucker spend the money for a static instrument that will be used once a year: you can be the smarter one by just renting those things from them. Extra benefit: not as much need for storage!

Only, most of those businesses failed. SHOCKINGLY, people realized that the lack of predictability and poor unit economics involved in such a as-demanded-on-demand model simply didn’t work. After tens if not hundreds of millions of lost venture capital flushed down the drain, you don’t hear much about X for X companies anymore.

Instead, all you hear about are subscriptions. Here is Amanda Mull taking stock of the rise of the subscription economy for The Atlantic:

Today, things that can routinely show up at your doorstep include: misshapen vegetables, personalized vitamin cocktails, dog toys, a vast wardrobe of clothing and accessories, and even a sofa. In a consumer market of disposable fast fashion and cheap assemble-at-home furniture, the idea of wasting less while getting to use nicer, higher-quality things for a monthly fee is a compelling sell.

(PETITION Note: this must be precisely what the private equity owners of Petsmart Inc. must be thinking as they pave the path towards a Chewy.com IPO).

Ms. Mull continues:

A subscription, at its base, is simply a schedule of recurring fees that gives consumers continual access to goods or services. A car lease is a subscription, but so is your gym membership and the way you use Microsoft Office. Subscription creep dates to at least 2007, when Amazon launched Subscribe & Save, a service that lets shoppers pre-authorize periodic charges for thousands of consumable goods, such as sandwich bags or face wash (or toilet paper), usually at a slight discount over individual purchases. Then, in 2010, came Birchbox, which provides women with miniature portions of beauty products on a monthly basis for $15. At its peak, the company was valued at more than $500 million.

Both Amazon’s and Birchbox’s models have been widely copied, and their success underscores the appeal of subscriptions to businesses and consumers alike, according to Utpal Dholakia, a marketing professor at Rice University. “The pain of payment and the friction of how a person is going to pay is totally gone,” he says. Consumers receive things they need or want without having to make any decisions, and that creates more stable and predictable revenue streams for the businesses they patronize.

Subscriptions, though, are not just relegated to, say, dog food, toilet paper, and your favorite a$$-kicking newsletter about disruption from the vantage point of the disrupted. In this time of greater job mobility, people relish more flexibility.

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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