☠️R.I.P. Sears (Finally)?☠️

Sears, Malls & Shorting the "End of the #Retailapocalypse" Narrative (Short Karl).

It’s official: the media apparently cares more about Sears Holding Corp. ($SHLD) than consumers do. Sure, it’s a public company and so “investors” may also care but, no offense, if you’re still holding SHLD stock than you probably shouldn’t be investing in anything other than passive index funds. If anything at all (not investment advice).

Anyway, the internet is replete with commentary about what went wrong, what the bigbox retailer did and didn’t do right, what plans may not have ever existed, what could have happened and what’s going to happen (video). It didn’t build an online brand OR invest in stores! It was mismanaged! Choice bit:

Ted Nelson, CEO and strategy director at Mechanica, agreed that financial management played a big role. He believes the story of Sears and its downfall isn’t a brand story at all. “[It’s one of] financial engineering and hedge-fund manager hubris gone awry,” he said. “There are a lot of places that brand [and collection of owned brands] could have evolved to. But that would have required a savvy, cross-functional and empowered leadership team, which isn’t what Sears got.”

Oh my! It’s such a shame that Sears may liquidate!

Meetings with lenders only lasted one hour!

Maybe it will get itself a DIP credit facility and last through Christmas! Either way, it is likely to immediately shutter up to 150 locations! This is all such a shame! Look at what it used to be!

From Bloomberg:

“The handwriting has been on the wall for years,” said Allen Adamson, co-founder of Metaforce, a marketing consultancy. “It’s been like watching an accident. You can’t look away, but you know it’s coming.”

Right. We’re over it. We honestly could not care less about Sears at this point. Bankruptcy professionals will make money and this thing finally…FINALLY…may get the burial it deserves. Like we previously said, “This thing is like ‘Karl’ in Die Hard.” Even Karl did, eventually, die.

That all said, we do care about how Sears’ demise affects malls.

First, a bit about malls generally…

On October 7, AxiosFelix Salmon wrote “Retailpocalypse Not,” and highlighted a Q2 2018 retail report from CBRE, concluding “The death of shopping malls is exaggerated: They are currently 94% occupied, according to CBRE.” Yet, he missed key parts of CBRE’s report:

Screen Shot 2018-10-12 at 11.15.19 AM.png

And mall rents are on the decline:

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Other reports substantiate these trends. Per RetailDive:

It's still not a pretty picture on the ground, however. Second quarter mall rents fell 4.6% from the first quarter and 7.1% year over year, hit by major store closures from Toys R Us, Sears and J.C. Penney, according to a trend report from commercial real estate firm JLL. Mall vacancy rates hit 4% during the period, JLL said. The retail sector suffered its worst quarter in nine years with net absorption of negative 3.8 million square feet, which pushed the regional mall vacancy rate up by 0.2% to 8.6% as the average mall rent increased 0.3%, according to another report from commercial real estate firm Reis emailed to Retail Dive.

And things have gotten worse since then. On October 3, four days before the Axios piece, The Wall Street Journal reported on Q3 numbers:

Mall vacancy rates rose to 9.1% in the third quarter, their highest level in seven years. Many of the older shopping centers that lack trendy retailers, lively restaurants, or other forms of popular entertainment continue to lose tenants, or even close down.

But many lower-end malls are still struggling to benefit from the economic revival, especially in some of the more economically depressed areas in Pennsylvania, Ohio and Michigan. They suffer from a glut of shopping centers but not enough consumers.

The average rent for malls fell 0.3% to $43.25 a square foot in the third quarter, down from $43.36 in the second quarter, according to data from real-estate research firm Reis Inc. The last time rents slid on a quarter-over-quarter basis was in 2011.

What sparked the vacancy jump? Bankrupted Bon-Ton Stores closing and, gulp, Sears closures too. Which, obviously, could get a hell of a lot worse. Indeed, Cowen and Company recently concluded that “we are only in the ‘early innings’ of mass store closures.” As noted in Business Insider:

"Retail square footage per capita in the United States has been widely sourced and cited as being far above most developed countries — more than double Australia and over four times that of the United Kingdom," Cowen analysts wrote in a 50-page report on the state of the retail industry. The data "suggests that the sector remains in the early innings of reduction in unproductive physical retail."

On point, one category that had largely remained (relatively) unscathed in the last 2 years of retail carnage is the home goods space. But, now, companies like Pier 1 Imports Inc. ($PIR) and Bed Bath & Beyond Inc. ($BBBY) appear to be in horrific shape. Bloomberg’s Sarah Halzack writes:

Two major companies in this category, Bed Bath & Beyond Inc. and Pier 1 Imports Inc., are mired in problems that look increasingly unsolvable. Bed Bath & Beyond saw its shares tumble 21 percent on Thursday after it reported declining comparable sales for the ninth time in 10 quarters. And Pier 1’s stock fell nearly 20 percent in a single day last week after it saw an even ghastlier plunge in same-store sales and discontinued its full-year guidance.

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The struggles of those two retailers ought to compound problems in the overall retail environment. Pier 1 has 1000 stores. Bed Bath & Beyond has 1024 stores.

Still, not all malls are created equal.

Barron’s writes:

Sears’ poor performance has long been an issue for owners, but landlords are split between those that are probably cheering the possibility of reclaiming its locations for more profitable tenants and those that see its potential bankruptcy as a negative tipping point.

Wells Fargo’s Jeffrey Donnelly compiled a list of REIT exposure to Sears, ranking various REITs by how much revenue exposure there is to Sears.

Seritage Growth Properties (SRG) is at the top of the list, with 167 properties, or 72% of its space and 43% percent of its revenue. Urban Edge (UE) has four properties for 3.5% of space and 4.2% of revenue. Next comes Washington Prime Group (WPG) with 42 locations, or 9.8% of space and 0.9% of revenue, followed by CBL & Associates(CBL) with 40 properties, a negligible amount of its space and 0.8% of revenue. Brixmor (BRX) has 11 locations for 1.4% of its space and 0.6% of revenue, Kimco (KIM) has 14 locations, 1.9% of its space and 0.6% of revenue. Simon Property Group (SPG) is at the bottom of the list with 59 locations, 5.3% of its space, and 0.3% of revenue.

Among the companies he covers, he says, CBL & Associates is the most at risk because the “low productivity and demographics of its mall portfolio could make re-leasing challenging and extended vacancies could trigger co-tenancy.” By contrast, Macerich (MAC) is the best positioned, Donnelly argues, due to its “negligible exposure and industry-leading productivity of [its] portfolio.”

Here (video) is Starwood Capital Group ($STWD) CEO Barry Sternlicht opining on the demise of Sears. He says about Sears filing:

“Probably a net positive. So, in our malls that we own…the income that comes near the Sears store is 3% of the mall’s income. Nobody wants to be in front of the Sears because there’s nobody in the Sears. So, we take it back and make it an apartment building or a Dave & Busters or a Kidzania or…a theater…so honestly its good for the owners to get on with this…and we’ll see what happens with Penney’s too….”

In “Sears Exit Would Leave Big Holes in Malls. Some Landlords Welcome That,” The Wall Street Journal noted:

Mall owners with trendy retailers, lively restaurants and other forms of popular entertainment have continued to prosper. Many of these landlords would welcome Sears’ departure, mall owners and analysts said. The department store’s exit would allow them to take over a big-box space and lease it to a more profitable tenant.

In malls where leases were signed decades ago, Sears rents could be as low as $4 a square foot. New tenants in the same space could bring as much as six times that amount.

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J.C. Penney ($JCP) and Best Buy ($BBBY) are other theoretical beneficiaries (though that would STILL require people to go to malls).

Who is not benefiting? Apparently those hedge funds that famously shorted malls.

Looks like Sears won’t be the last loser playing in the mall space.

💤Sears 💤

Eddie Lampert, ESL & Shenanigans

BREAKING NEWS: SHORT SEARS HOLDING CORP.

We’re old enough to remember when Sears Holding Corp. ($SHLD) was last rumored to file for bankruptcy. In 2017. 2016. 2015. 2014. 2013. 2012. 2011. And 2010 (the last year it turned a profit). This thing is like “Karl” in Die Hard.

Or this lady:

It just won’t die.

So this week’s reports that Sears’ CEO Eddie Lampert “Urges Immediate Action to Stave Off Bankruptcy” were met with, shall we say, a collective yawn. Lampert has been performing financial sleight-of-hand for years, all the while the five-year SHLD stock chart looks like this:

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This is what the Twitterati had to say about this: [ ].

Yes, that blank space is intentional. We’ve never seen Twitter so quiet. Grandma was like, “Sears? Sears? I last shopped in Sears when I was prom shopping…in 1956.” Mom was like, “I once bought you a Barbie at Sears…in 1989.” Some millennial somewhere was probably like, “Sears? What’s a Sears, brah?”

Just kidding: nobody is talking about Sears. That would imply mindshare. 🔥

Lack of mindshare notwithstanding, the company, despite a wave of closures over the years (including 46 unprofitable stores slated for closure in November ‘18), consists of 820 stores (including KMart). As of 2017, the company had 140,000 employees. Thats Toys R Usx 4.5. The company also has approximately $5.5 billion of debt, $1.1 billion of pension and post-retirement benefits, declining revenues, negative (yet improving) same store sales percentages, negative gross margin, and increasing net losses.

  Source: SHLD Q2 Earnings Release Presentation, September 13, 2018

Source: SHLD Q2 Earnings Release Presentation, September 13, 2018

It also had $941mm of cash available as of the end of Q2 2018.

On Sunday, Lampert filed a Schedule 13D with the SEC outlining his proposal to save Sears in advance of a $134 debt payment due on October 15. High level, the proposal was…

“…to the Board requesting Holdings to consider liability management transactions, real estate transactions and asset sales intended to extend near-term debt maturities, reduce long-term debt, eliminate associated cash interest obligations and obtain additional liquidity.”

The proposed liability management transactions…provide for exchange offers to eligible holders of second lien debt…and eligible holders of unsecured debt…. These potential exchange offers together could save Holdings approximately $33 million per year in cash interest and eliminate approximately $1.1 billion in debt.

More specifically, the proposal calls for, among other options, ‘19 and ‘20 second lien debtholders and ‘19 unsecured noteholders to swap into zero-coupon mandatorily convertible secured debt (no yield, baby?)(read the 13D link above for more detail). It also calls for the sale of $3.25 billion worth of real estate and assets, including Sears Home Services and Kenmore.

After all of this time, why now? Per Bloomberg:

Lampert and ESL acted after watching other retailers including Toys “R” Us Inc. and Bon-Ton Stores Inc. wind up in liquidation, according to people with knowledge of the plan. The aim is to get something done out of court to preserve value for shareholders, since they don’t usually fare well in bankruptcy proceedings, said the people, who weren’t authorized to comment publicly and asked not to be identified.

There’s something strangely poetic about Lampert and ESL using the ghosts of Toys R Us and BonTon past to coerce creditors into an exchange transaction now.

Anyway, Twitter may have been quiet, but naysayers abound.

From Bloomberg:

“It seems the next natural iteration of all the financial engineering the company has been engaging in over the last few years,” Bloomberg Intelligence analyst Noel Hebert said. “For non-bank creditors not named Eddie Lampert, there is a bit of prisoner’s dilemma -- maybe something more tomorrow, or the near certainty of very little today.”

“This is simply storing up trouble for the future,” according to a note from Neil Saunders, managing director of research firm GlobalData Retail. “Sears is focusing on financial maneuvers and missing the wider point that sales remain on a downward trajectory,” he wrote. “Even in a strong consumer economy, customers are still drifting away to other brands and retailers.”

From the Washington Post:

“Eddie Lampert is seeking permission from himself to keep Sears on life-support while he continues to drain every last remaining drop of blood from its corpse,” said Mark Cohen, director of retail studies at Columbia Business School and the former chief executive of Sears Canada. “The operation is a failure, and there is no plan to turn that around."

From the Wall Street Journal:

“Given Lampert’s shuffling of Sears assets in ways some creditors suspect was more to his benefit than theirs, there is a chance they will hesitate to let him reorganize unless it is under the watchful eye of a bankruptcy judge,” said Erik Gordon, a University of Michigan business school professor.

Ugh. Wake us up when its finally over. Even Karl eventually died.


PETITION provides analysis and commentary about restructuring and bankruptcy. We discuss disruption, from the vantage point of the disrupted. Get our Members’-only a$$-kicking newsletter by subscribing here.

🚴 Peloton = Gympocalypse? 🚴

The Rise of Peloton, Tonal, Mirror and Other DTC Home Fitness Products (Long Seclusion)

 Source: Mirror

Source: Mirror

Back in January we wrote a longform piece about the rise of Peloton. It’s worth revisiting. Subsequently, the at-home fitness space has only gotten more interesting with (i) Peloton’s soon-to-be-released treadmill and (ii) a couple more well-funded startups going after the gym crowd with high-priced at-home apparatuses that give one further incentive to just stay home, never talk to anyone and never do anything outside. Because that's just what we need in today's hyper-polarized environment: more people just scurrying off into their own corners and refusing to deal with and compromise with anyone or anything. And that apparently includes the use of gym equipment.

The New York TimesErin Griffith recently wrote that Tonal and Mirror, two new on-the-wall connected fitness platforms, are…

"…among the first start-ups to pounce on the success of Peloton, a stationary bike start-up that investors recently valued at $4 billion. Peloton blends the hardware of a bike with the software of a video streaming subscription and the content of spin classes. Its skyrocketing growth has made investors wary of missing the next big thing in fitness." 

The next big thing in fitness appears to be a flashy screen, a solid wifi connection, expensive hardware and streaming fitness instruction brought to you by a recurring revenue subscription model. 

Web Smith frames it another way

He writes:

Silicon Valley wants to redefine the fitness membership. Through the adoption of connected devices like the Peloton bike, there’s been an inflection point as consumers seem to be trickling away from the current model. No longer do you have to drive to a place to be in a community. As Americans become more health conscious and driven to maximize performance, the DTC equipment industry is a timely bet on the next generation of  fitness data-driven IoT (internet of things).

He continues:

Whereas the Fitbit-phase of wearables emphasized individual fitness, the next generation of connected devices seem to be incorporating community in ways that could emerge as a challenge to the status quo: community-driven fitness facilities.

And:

By building systems that allow community to be gained outside of physical retail outlets, these tools are aiming to become the new medium for instruction and training.  These internet-enabled equipment manufacturers aren’t just selling plastic and metal, they’re selling virtual community.

He finished by saying:

"...it could spell trouble for your gym. Spin franchises are already beginning to adjust to the threat of Peloton and as the threat of connected cycles continues to grow as also-has brands rise up in the wake of Peloton’s premium pricing."

That sound you may have just heard was the collective moan of mall owners who are increasingly dependent upon gyms to fill space:

Okay, okay, let's dial it down. Peloton has created a luxury brand experience that, it is argued, makes economic sense relative to the long-term economics of attending Flywheel or SoulCycle classes. We're not so sure that translates to other non-niche forms of fitness. Especially at the price-points these companies are touting. 

Apropos, some of the comments to the NYT piece are amusing:

Obviously, these machines are for a niche market where money is irrelevant and style is paramount. Best of luck to them, but I'll stick to the free version...my own body. 

So far the comments are 22-0 against. I wonder if the Tonal can automatically adjust that resistance.

Or, you know, you could just go outside, feel the sun and wind on your back, do some pushups and chinups to feel your own weight against the pull of the Earth, hear nature all around you, talk to a person (gasp!)... 

But then again it's so nice to stare at a screen all day long, so what do I know.

Look for these items in the free piles left curbside after garage sales in about 6 years. 

While we're not necessarily convinced that Tonal and Mirror are the future of fitness, it seems to us that gyms ought to start thinking "omnichannel" like retailers and figure out way to drive more value to customers both in and outside of the gym, during on and off hours. How is it, for instance, that Equinox doesn't have any streaming classes that you can do at home or in your office? 

Whatever happens, expect the area to get more heated as more and more money chases this burgeoning at-home community-based exercise market. Bloomberg already notes that “the treadmill wars are here.” And, Peloton, for instance, is now suing Flywheel for patent infringement. It knows that the at-home fitness opportunity is now. If it can slow down a rival (in advance of an IPO?), all the better.

We asked in January whether Peloton could thrive in a downturn. Now the question is broader: will any of these companies with high-priced hardware be able to survive a downturn?

🚗Will California Jumpstart Electric Vehicles?🚗

Electric Vehicles (Short Musk-Related Noise; Long Technology)

This is not a fangirl ode to Elon Musk. We’ll leave that to the Twittersphere. The trials and tribulations of everyone’s favorite Marvel-character-inspiring eccentric billionaire may be distracting from developments far bigger and far badder than Tesla’s ($TSLA) balance sheet: the advancement of electric vehicles.

Last week, California’s state legislature approved a bill that requires the state — subject to Governor Jerry Brown’s signature — to get 100% of its electricity from carbon-free sources by 2045. Yes, 2045 — 27 years from now. Sure, it might be hard for you to be impressed or to care. If PETITION is even still around by then it will likely be written by artificial intelligence bots. So, we get it.

Still, California ALREADY gets 29% of its electricity from zero-carbon wind, solar, biomass and geothermal energy — in part to dramatically reduce greenhouse gas emissions and in part, no doubt, to flick off the President of the United States. Indeed, greenhouse gas emission levels have decreased such that they now rival those of the 1990s.

Yet, emission levels related to transportation in California have barely moved. Nevertheless, consistent with what we wrote previously about advancements in the auto space, Nathanial Bullard notes that that appears primed to change. In a piece entitled “Electric Vehicles’ Day Will Come, and It Might Come Suddenly,” he wrote:

In the first half of the year, vehicles with a battery were more than 10 percent of new vehicle sales in California. The model mix includes hybrids like the Toyota Prius that have no electric charging plugs, as well as plug-in hybrids and pure electric cars with no combustion engine at all.

The data reveal three trends. The first is the steady erosion of hybrid market share, which is down from seven percent of new sales in 2013 to four percent in the first half of 2018. That’s noteworthy, and so is the fact that battery electric vehicles are now more popular than plug-in hybrids.

In 2017, the plug-in electric car market is now more than six percent of new car sales in California. It’s not a big number — but it will get bigger, and it’s worth asking, “how much bigger?”

Looking at Norway, Bullard posits that it can get substantially bigger. He notes that:

It took Norway about a decade to reach six percent electric vehicle sales but then only five years to go from 6 percent to 47 percent. 

Is 6% some sort of magical inflection point for electric vehicles? Debatable. Norway is super-progressive when it comes to the environment; it also offers extensive incentives to encourage EV adoption. But with a statewide push towards zero-carbon electricity, a push towards zero-emission electric cars may not be far behind. Californian car sales are pushing towards 2 million in 2018. And selection is about to improve: everyone from Audito BMW to Porsche are coming out with all-electric models in the next several years. Tremendous growth may not be too far off. The OEMs — Tesla’s competitors — are making sure of it.

*****

Speaking of technological advancement in auto (and auto distress), we find Andreesen Horowitz’s Benedict Evans’ musings on the topic to be thoughtful and thought-provoking. We previously wrote about him WAY back in January 2017 when he wrote about mobile eating the world. The piece is worth revisiting.

Last week, he released a new piece with questions right up our alley. He asked:

…what happens when ‘software eats the world’ in general, and when tech moves into new industries. How do we think about whether something is disruptive? If it is, who exactly gets disrupted? And does that disruption…mean one company wins in the new world? Which one?

He seems to conclude the following: not Tesla.

One narrative surrounding Tesla in the post-Solar City acquisition world is that it more than just a car company: it’s a battery play. Musk’s powerwall feeds this narrative. SolarCity, to some degree, feeds this narrative. But Evans begs to differ; he thinks the battery — as well as EV components, generally — will become commodities. Commodities that spawn victims along the way. He notes:

It’s probably useful here to compare batteries in particular with the capacitive multitouch screens in a smartphone. Apple was the first to popularise these screens, and arguably still implements them best, and these screens fundamentally changed how you made a phone, but the whole industry adopted them. There are better and worse versions, but everyone can buy these screens now, and making a multitouch phone by itself is not a competitive advantage.

It’s pretty clear that electric disrupts the internal combustion engine, and everything associated with it. It’s not just that you replace the internal combustion engine with electric motors and the fuel tank with batteries - rather, you remove the whole drive train and replace it with sometime with 5 to 10 times fewer moving or breakable parts. You rip the spine out of the car. This is very disruptive to anyone in the engine business - it disrupts machine tools, and many of the suppliers of these components to the OEMs. A lot of the supplier base will change. 

This is not the same as disrupting the OEMs themselves. If the OEMs can buy the components of an electric car as easily as anyone else, then the advantage in efficient scale manufacturing goes to the people who already have a lead in efficient scale manufacturing, since they’re doing essentially the same thing. In other words, it’s the same business, with some different suppliers, and electric per se looks a lot more like sustaining innovation. (emphasis added) 

Likewise, he highlights how Tesla’s (i) software, (ii) data aggregation and (iii) efforts with autonomous driving may be leading now but they may not be as disruptive, in the truest sense of the term, to competitor OEMs as some might believe. That is, many OEMs are making progress of their own in those areas. The lead is not that wide. Tesla’s moat is not vast. Read the piece: he raises some interesting points — too many to note here.

He concludes:

…the history of the tech industry is full of companies where having a lovely product, or being the first to see or build the future, were not enough. Indeed, the car industry is the same - a great, innovative car and a great car company are not the same thing. Tesla owners love their cars. I loved my Palm V, and my Nokia Lumia, and my father loved his Saab 9000. But being first isn’t enough and having a great product isn’t enough - you have to try to think about how this fits into all the broader systems. 

Indeed. Many companies — many of which seem wildly successful today — will falter as that system develops.

💣Diebold. Disrupted.💣

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

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

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📱Is Tech in Trouble? Part 2.📱

Short Hefty Seed Rounds

ICYMI, in “📱Is Tech in Trouble?📱,” we asked whether…well…tech was in trouble. We aren’t alone.

A few weeks ago Brad Feld of Foundry Group wrote the following in a piece entitled, “Early Stage VCs — Be Careful Out There”:

Yesterday, in one of the quarterly updates that we get, I saw the following paragraph.

“Historically, the $10 million valuation mark has been somewhat of a ceiling for seed stage startups. But so far this year, we’ve seen that a number of companies, often times with nothing more than a team and a Powerpoint presentation, have had great success raising capital north of that $10 million level. Furthermore, round sizes continue to tick up, with many seed rounds now in the $2.5 million to $4.0 million range.”

We are seeing this also and have been talking about it internally, so it prompted me to say something about it.

I view this is a significant negative indicator.

It has happened only one other time in my investing career – in 1999.

Man. There’s so much money out there looking for some action.

Read the piece. It’s short. He closes with this:

For anyone that remembers 2000-2003, this obviously ended badly. By 2002 investments at the seed level had evaporated (there were almost no seed financings happening). In 2003 the angels started to reappear (some of the best angel deals of all time were done between 2004 and 2007) and the super angel language started to be used around 2007.

All the experienced finance people I know talk regularly about cycles. If you believe in cycles, this one feels pretty predictable. Of course, there is an opportunity in every part of the cycle. But, be careful out there.

The kinds of companies he’s talking about aren’t in the same zone as those that we wrote about last week. These early stage companies are too early to have any of the characteristics (i.e., public equity, advanced IP, leases, exposed directors) that we noted might qualify a company to leap outside of the sphere of an assignment of benefit of creditors and into bankruptcy court. But still. This piece could just as easily slide into our “What to Make of the Credit Cycle” series.

To put a cherry on top, read this piece from Jason Calacanis. We typically think Mr. Calacanis is too high on his own sh*t but this cautionary letter to the founders he’s invested in is, in fact, instructive. We particularly liked his link to a Sequoia Capital presentation circa 2008. It’s a must read for anyone who wants a primer/refresher on what the hell happened back in the financial crisis and some insight into how investors thought about the time.

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The upshot: he instructs his founders to do everything they can to ensure 12-18 months of runway.

So, where are we in the credit cycle? The part where a number of folks are starting to exercise and advise a bit more caution.

#BustedTech's Secret: Assignment for the Benefit of Creditors

Long Private Markets as Public Markets

Screen Shot 2018-08-14 at 5.25.07 PM.png

⚡️🤓Nerd alert: we need to lay a little foundation in this one with some legal mumbo-jumbo. Consider yourself warned. Solid payoff though. Stick with it.🤓⚡️

Allow us to apologize in advance. It’s summer time and yet we’ve been nerding out more often than usual: on Sunday, we dove into net-debt short activism, for goodness sake! We know: you want to just sit on the beach and read about how Petsmart implicates John Wick. We get it. Bear with us, though, because there is a business development aspect to this bit that you may want to heed. So attention all restructuring professionals (and, peripherally, start-up founders and venture capitalists)!

Recently the Turnaround Management Association published this piece by Andrew De Camara of Sherwood Partners Inc, describing a process called an “assignment for the benefit of creditors” (aka “ABC”). It outlines in systematic fashion the pros and cons of an ABC, generally, and relative to a formal chapter 11 filing. When the bubble bursts in tech and venture capital, we fear a number of you will, sadly, become intimately familiar with the concept. But there’ll be formal bankruptcies as well. ABCs won’t cut it for a lot of these companies at this stage in the cycle.

Let’s take a step back. What is the concept? Per Mr. De Camara:

An ABC is a business liquidation device governed by state law that is available to an insolvent debtor. The ABC procedure has long existed in law and is sometimes addressed in state statutes. In an ABC, a company, referred to as the assignor, transfers all of its rights, title, and interest in its assets to an independent fiduciary known as the assignee, who liquidates the assets and distributes the net proceeds to the company’s creditors. The assignee in an ABC serves in a capacity analogous to a bankruptcy trustee in a Chapter 7 or a liquidating trustee in a Chapter 11.

He goes on to state some characteristics of an ABC:

  • Board and shareholder consent is typically required. “If a company is venture-backed, it may be required to seek specific consent from both preferred and common shareholders. It is possible to enter publicly traded companies into an ABC; however, the shareholder proxy process increases the difficulty of effectuating the ABC and results in a much longer pre-ABC planning process.”

  • There is no discharge in an ABC.

  • Key factors necessitating an ABC include (a) negative cash burn + no access to debt or equity financing, (b) lender wariness, (c) Board-level risk as a lack of liquidity threatens the ability to pay accrued payroll and taxes, and (d) diminished product viability.

And some benefits of an ABC:

  • ABC assignees have a wealth of experience conducting liquidation processes;

  • The assignee manages the sale/liquidation process — not the Board or company officers — which, as a practical matter, tends to insulate the assignee from any potential attack relating to the process or sale terms;

  • Lower admin costs;

  • Lower visibility to an ABC than a bankruptcy filing;

  • Secured creditors general support the process due to its time and cost efficiency, not to mention distribution of proceeds; and

  • Given all of the above, the process should result in higher distributions to general unsecured creditors than, say, a bankruptcy liquidation.

Asleep yet? 😴

Great. Sleep is important. Yes or no, stick with us.

ABCs also have limitations:

  • Secured creditor consent is needed for use of cash collateral.

  • Buyers cannot assume secured debt without the consent of the secured creditor nor is there any possibility for cramdown like there is in chapter 11.

  • There is, generally, no automatic stay. This bit is critical: “While the ABC transfers the assets out of the assignor and therefore post-ABC judgments may have no practical value or impact, litigation can continue against the assignor, and the assignee typically has neither the funding nor the economic motivation to defend the assignor against any litigation. In addition, hostile creditors may decide to shift their focus to other stakeholders (i.e., board members or officers in their capacity as guarantors or fiduciaries) if they believe there will likely be no return for them from the ABC estate.”

  • Assignees have no right to assign executory contracts, diminishing the potential value of market-favorable agreements.

  • No free-and-clear sale orders. Instead you get a “bill of sale.” Choice quote: “A bill of sale, particularly from an assignee who is a well-known and well-regarded fiduciary, is a very powerful document from the perspective of creditor protection, successor liability, etc., but it does not have the same force and effect as a free-and-clear sale order from a bankruptcy court.”

The question right now is, given the robust nature of the capital markets these days, should you care about any of the above? Per Pitchbook:

This is a golden age for venture capital and the startup ecosystem, as illustrated by PitchBook's latest PitchBook NVCA-Venture Monitor. So far this year, $57.5 billion has been invested in US VC-backed companies. That's higher than in six of the past 10 full years and is on pace to surpass $100 billion in deal value for the first time since the dot-com bubble.

Fundraising continues at breakneck speed. Unicorns are no longer rare, and deal value in companies with a $1 billion valuation or more is headed for a new record. The size of VC rounds keeps swelling. Deep-pocketed private equity players are wading in.

Signs of success (or is it excess?) are everywhere you look. On the surface, delivering a resounding verdict that the Silicon Valley startup model not only works, it works well and should be emulated and celebrated.

But what if that's all wrong? What if this is another mere bubble and the VC industry is in fact storing up pain…?

That's the question posited by Martin Kenney and John Zysman—of the University of California, Davis, and the University of California, Berkeley, respectively—in a recent working paper titled "Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance?"

Instead of spending millions, or billions, in the pursuit of unicorns that could emulate the "winner-takes-all" technology platform near-monopolies of Apple and Facebook and the massive capital gains that resulted, VC investors and their LP backers could instead be buying a bunch of fat Cheshire cats. Bloated by overvaluation, and likely to disappear, leaving just a smile and big losses, since many software-focused tech startups have no tangible assets.

They then ask whether there’s more here than meets the eye. More from Pitchbook:

The problem is that this cycle has been marked by easy capital and a fetishization of the early-to-middle parts of the tech startup lifecycle. Lots of incubators and accelerators. "Shark Tank" on television. "Silicon Valley" on HBO. Never before has it been this easy and cheap to start or expand a venture.

Yet on the other end of the lifecycle, exit times have lengthened, as late-series deal sizes swell, reducing the impetus to IPO (in search of public market capital) or sell before growth capital runs out.

So, what’s the problem?

…in the view of Kenney and Zysman, the VC industry lacks discipline, seeking disruption and market share dominance without a clear path to profitability. You see, VC-fueled startups aren't held to the same standard as existing publicly traded competitors who must answer to investors worried about cash flows and operating earnings every three months. Or of past VC cycles where money was tighter, and thus, time to exit shorter.

We’ll come back to the public company standard in a second.

The interesting thing about the private markets becoming the new public markets (with funding galore) is that when the crazy frenzy around funding (PETITION NOTE: read the link) eventually stops, the markets will just be the markets. And all hell will break lose. The question then becomes whether a company has enough liquidity to stem the tide. What happens if it doesn’t?

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An ABC may very well be a viable alternative for dealing with the carnage. But with private markets staying in growth stages privately for longer, doesn’t that likely mean that there’s more viable intellectual property (e.g., software, data, customer lists)? That a company has a bigger and better San Francisco office (read: lease)? That directors have a longer time horizon advising the company (and, gulp, greater liability risk)? Maybe, even, that there’s venture debt on the balance sheet as an accompaniment to the last funding round (after all, Spotify famously had over $1b of venture debt on its balance sheet shortly before going public)?

All of which is to say that “the bigger they come, the harder they fall.” When the music stops — and, no, we will NOT be making any predictions there, but it WILL stop — sure, there will be a boatload of ABCs keeping (mostly West Coast) professionals busy. But there will also be a lot of tech-based bankruptcies of companies that have raised tens of millions of dollars. That have valuable intellectual property. That have a non-residential real property lease that it’ll want to assign in San Francisco’s heated real estate market. That have a potential buyer who wants the comfort of a “free and clear” judicial order. That have shareholders, directors and venture capital funds who will want once-controversial-and-now-very-commonplace third-party releases from potential litigation and a discharge.

Venture capitalists tend to like ABCs for private companies because, as noted above, they’re “lower visibility.” They like to move fast and break things. Until things actually break. Then they move fast to scrub the logos off their websites. What’s worse? Visibility or potential liability?

And then there are the public markets.

A month ago, we discussed Tintri Inc., a California-based flash and hybrid storage system provider, that recently filed for bankruptcy. Therein we cautioned against IPOs of companies with “massive burn rates.” We then went on to highlight the recent IPO of Domo Inc. ($DOMO) and noted it’s significant cash burn and dubious reasons for tapping the public markets, transferring risk to Moms and Pops in the process. The stock was trading at $19.89/share then. Here is where it stands now:

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In the same vein, on Monday, in response to Sunday’s Members’-only piece entitled “😴Mattress Firm's Nightmare😴,” one reader asked what impact a potential Mattress Firmbankruptcy filing could have on Purple Innovation, Inc. ($PRPL), the publicly-traded manufacturer and distributor of Purple bed-in-a-box product. Our response:

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And we forgot to mention rising shipping costs (which the company purports to have mitigated by figuring out…wait for it…how to fold its mattresses).*

And then yesterday, Bloomberg’s Shira Ovide (who is excellent by the way) reported that “Cash Wildfire Spreads Among Young Tech Companies.” She wrote:

It’s time to get real about the financial fragility of young technology companies. Far too many are living beyond their means, flirting with disaster and putting their investors at risk. 

Bloomberg Opinion examined 150 U.S. technology companies that had gone public since the beginning of 2010 and were still operating independently as of Aug. 10. About 37 percent had negative cash from operations in the prior 12 months, meaning their cash costs exceeded the cash their businesses had generated. 

A handful of the companies, including online auto dealer Carvana Co., the mattress e-commerce company Purple Innovation Inc. and health-care software firm NantHealth Inc., were on pace to burn through their cash in less than a year, based on their current pace of cash from operations and reserves in their most recent financial statements.

In addition to Purple Innovation, Ms. Ovide points out that the following companies might have less than 12 months of cash cushion: ShiftPixy Inc. ($PIXY), RumbleON Inc. ($RMBL), RMG Networks Holding Corp. ($RMGN), NantHealth Inc. ($NH), Carvana Co. ($CVNA), and LiveXLive Media Inc. ($LIVX).

She continued:

The big takeaway for me: Young technology companies in aggregate are becoming more brittle during one of the longest bull markets ever for U.S. stocks. This trend is not healthy. Companies that persistently take in less cash than they need to run their businesses risk losing control of their own destinies. They need continual supplies of fresh cash, which could hurt their investors, and the companies may be in a precarious position if they can’t access more capital in the event of deteriorating market or business conditions.

It’s not unusual for young companies, especially fast-growing tech firms, to burn cash as they grow. But the scope of the companies with negative cash from operations, and the persistence of some of those cash-burning companies for years, was a notable finding from the Bloomberg Opinion analysis.

Notable, indeed. There will be tech-based ABCs AND bankruptcies galore in the next cycle. Are you ready? Are you laying the foundation? Are you spending too much time skating to where the puck is rather than where it will be?


*We’ll take this opportunity to state what should be obvious: you should follow us on Twitter.

But, seriously, and more importantly, we know we tout the disruptive effects of the direct-to-consumer model. But make no mistake: we are WELL aware that a number of these upstarts are going to fail. Make no mistake about that.

The Media is Stuck Between a Rock and a Hard Place (Long Recurring Revenue)

Magazines Are Suffering From Declining Ad Revenue

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It’s no secret that traditional advertising is in decline. Now we have some numbers to put around it. Per the WWD:

The magazine industry puts on a brave face, but data doesn’t lie.

New analysis from the Association of Magazine Media, which unabashedly pushed the power of print magazines as an advertising vehicle, shows an industry still trying to find its place in an instantaneous world while advertising revenue continues to slip away.

Reported magazine ad spending by the 50 biggest advertisers last year fell to $6.1 billion from $6.5 billion in 2016, according to AMM’s annual report. So magazines lost at least $417.5 million in revenue last year, a difference of 6.4 percent, numbers AMM did not make readily available in its report, which was sponsored by magazine printer Freeport Press.

The report notes how top advertisers spent their marketing dollars. Pfizer Inc.Johnson & JohnsonLVMH Moet Hennessy Louis VuittonEstee Lauder Cos. Inc.KeringChanel, and Amazon were all WAY down, more than offsetting increases from the likes of Proctor & Gamble and L’Oreal. As just one example, Pfizer’s spend decreased by $85mm. That’s a whopping number.

With whopping ramifications. More from the WWD:

With so much money being lost in print advertising, which is largely being diverted to other avenues, like Facebook, Google and influencers, it’s no wonder magazines keep shutting.

A total of 50 magazines with at least a quarterly publication frequency closed last year, despite 134 titles being launched, leaving the number of magazines last year at 7,176. The number of magazines has been a bit up and down over the last decade, but on the whole, down, as there are 207 fewer than in 2008.

It continued:

Overall, there are very few major magazine brands managing to pull strong through the digital shift. Of the 114 magazine brands tracked by AMM, 56 titles, or 50 percent, have a total audience in decline year-to-date. Print and digital editions are faring even worse, with 74 titles, or 64 percent of magazines, seeing audience on the decline.

Little wonder advertisers are looking elsewhere.

Apropos, a heads up for PETITION readers: you can give the media business a whirl if you masochistically desire. On August 27, the chapter 7 trustee in the case of Interview Inc., the once-famous magazine owned by Peter Brant, is conducting an auction for the sale of the media property. If bankrupted magazines aren’t your jam, there are plenty of other options available — including, most recently, New York Magazine.

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Given the decline in advertising, media companies are re-evaluating their business models and many are toggling over to subscriptions. Subscriptions are the “it” thing now. And that obviously includes PETITION (though, to be accurate, we were never dependent on ads). In fact, we now subscribe to so many different resources that our costs are going up meaningfully from month to month. That’s the truth. At a certain point, consumers may get subscription fatigue.

Or they’ll just share passwords. Per Digiday:

Subscriptions are a great way to draw a steady stream of revenue from readers — unless readers share their login credentials with everyone they know.

As publishers try to grow subscription businesses, they have to figure out how to handle password-sharing, a phenomenon that subscription services like Netflix and Spotify have wrestled with for years.

Netflix and Spotify can absorb this danger. But smaller media outlets either struggling to survive or looking to grow don’t have that luxury. Every time someone shares media that lives off of the subscription model, he/she is effectively siphoning off revenue from them and pushing them one step closer to insolvency. Sadly, only a very select few of you will make fees in that scenario. The rest of you will lose out on quality content you’ve come to love and enjoy. Now wouldn’t that be a shame?

😴Mattress Firm's Nightmare😴

Mattress Firm May File for Bankruptcy (Long Cardboard Box Manufacturers)

 Source: PETITION LLC

Source: PETITION LLC

⚡️Nerd alert: we need to lay a little foundation here.⚡️

For the uninitiated, a First Day Declaration (“FDD”) typically accompanies a chapter 11 petition when a debtor-company files for bankruptcy. The FDD is the first opportunity for a representative of a chapter 11 debtor to sell a particular narrative to the Bankruptcy Judge and other parties in interest; it sets the tone for the company’s “first day hearing,” which is the first formal appearance the company makes in bankruptcy court (typically within 24-48 hours after filing for chapter 11). The FDD is a descriptive document that often spells out the what, why and when of a company’s demise. Nearly all FDDs follow the same format: they (i) provide some color about the declarant, (ii) describe the history and nature of a business, (iii) delineate the capital structure, (iv) outline the events leading to bankruptcy, (iv) articulate the hopes for the bankruptcy case, and (v) summarize the relief sought on the first day. Lawyers often request that the FDD be admitted into the record at the first day hearing (subject to cross examination of the declarant).

Frustratingly, lawyers also often seem compelled to regurgitate the FDD once at the podium at the hearing. This is typically the role of the senior most partner on the matter, i.e., the person who — as it relates to certain firms — probably knows the least about the company, why it’s in bankruptcy and how the hell its going to grind its way out of it. We’re not entirely sure why they feel the need to do this: the judge has presumably read the papers. Perhaps they feel it’s necessary to repeat the narrative to set the tone for the case and establish credibility (more important in controversial cases than in uncontested hearings); perhaps they just like hearing themselves speak; or — the most likely justification — perhaps they bill by the hour and need to justify their (a) existence, (b) exorbitantly high billing rate and/or (c) first billing on the case caption. Maybe it’s all of the above. In any event, this custom is exactly the opposite of what lawyers are taught in law school: be concise and to the point.

We often like to imagine what the FDD would look like in certain situations. Long time PETITION readers may recall our mock FDD for Remington Outdoor Company. Well, we’re at it again. This time for Mattress Firm Holding Corp. Hopefully this will spare the estate some expenses.

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💰Goldman Sachs Has its Cake and Eats it Too💰

Short GNC Holdings Inc. Long Care/of. 

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We’ve written extensively hereherehere and here about GNC Holdings Inc. ($GNC) and the challenges that the company faces. We won’t revisit all of that here other than to note that GNC was, upon information and belief, preparing for a bankruptcy filing prior to it amending and extending its term loan, entering into a new ABL, and obtaining $275mm of asset-backed FILO term loans. We quipped that this was the quintessential “kick-the-can-down-the-road” transaction. Goldman Sachs ($GS) advised the company on the entire capital structure fix. Suffice it to say, then, that Goldman Sachs is intimately familiar with the GNC business.

Which, naturally, makes the fact that Goldman Sachs Investment Partners (a division of Goldman Sachs Asset Management) served as the lead investor in vitamin startup Care/of’s Series B financing all the more interesting.

Now, of course, we know Goldman is a big shop. They’re probably talking to WeWorkabout how to design their spaces to balance the sheer volume of “Chinese walls” with the need for an aesthetic that appeals to the millennial mindset. And, surely, Goldman Sachs’ capital advisory arm is entirely different and separate from Goldman’s asset management and venture arm.

But still.

Earlier this week Care/of, a direct-to-consumer wellness brand that specializes in monthly subscriptions of personalized vitamins and supplements, announced the new round of $29mm. In addition to Goldman, investors included Goodwater Capital, Juxtapose, RRE Ventures and Tusk Ventures. Former President of GNC, Beth Kaplan, also invested and will be joining the Board. 🤔

Bloomberg notes:

Care/of, a startup selling vitamins and herbal supplements online, raised funds from investors including Goldman Sachs Group Inc.’s venture arm that value the company at $156 million, within striking distance of publicly traded retail chains that are among the industry’s leaders.

The startup’s $156 million valuation isn’t far from Vitamin Shoppe Inc., with 3,860 employees and a market capitalization of about $203.5 million, or GNC Holdings Inc., which has a market value of $254.2 million with 6,400 employees. Care/of has about 100 workers, Chief Executive Officer Craig Elbert said.

“Consumers are increasingly shifting spend online and so I think large retail footprints have the potential to be a liability,” Elbert said in an interview. “There’s a lot of growth ahead of us and lot of reasons why this should be an e-commerce business.”

This is so Goldman-y. Collect an advisory fee to extend the life of the dominant brick-and-mortar retailer with one hand while investing in a nimble direct-to-consumer upstart that will chip away on that very same retailer on the other hand. Even before the former requires capital markets advice from a Goldman-type in a few years — which, it undoubtedly will — it may be on the lookout for an M&A banker. Perhaps to sell itself. Perhaps to buy a start-up and build a moat against Amazon. How convenient that Goldman will have familiarity with both businesses. We’d say that maybe there’d be a conflict somewhere in there but, well…do those really even exist anymore??

🛋There's Disruption Afoot in the Furniture Space🛋

Add Furniture to the List of Disrupted Categories (Home Heritage Group Inc. Filed for Bankruptcy)

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“New Chapter 11 Filing!” Or is it technically a Chapter 22? 🤔

We know what you’re thinking. You’re thinking “this filed a few days ago and I’ve already read all about it.” You may have read something about it, but not like this. Bear with us…

Home Heritage Group Inc. (“HHG”) is a North Carolina-based designer and manufacturer of home furnishings; it sells product via (i) retail stores, (ii) interior design partners, (iii) multi-line/independent retailers, and (iv) mass merchant stores.” In addition, the company has an international wholesale business.

Why do we mention Chapter 22? For the uninitiated, Chapter 22 in bankruptcy doesn’t actually exist. It is a somewhat snarky term to describe companies that have round-tripped back into chapter 11 after a previous stint in bankruptcy court. That, to some degree, is the case here.

WAAAAAAAY back in November 2013, KPS Capital Partners LP formed the newly bankrupt HHG entity to acquire a brand portfolio and related assets out of the bankruptcy estate of Furniture Brands International Inc. (“FBI”). FBI had been, in the early 2000s, a very successful purveyor of various furniture brands — to the tune of $2b in annual sales. But in the 12 months prior to the acquisition, the company’s sales were down to $940mm and, more importantly, its EBITDA was negative $58mm. At the time of filing, it had $142mm in total funded debt outstanding, $200mm in unfunded pension obligations and another $100mm in general trade obligations.

Given this debt, a decline in sales at the time was devastating. The company noted in its court filings on September 9, 2013 (Docket #16):

As a manufacturer and retail of home furnishings, Furniture Brands’ operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Economic conditions deteriorated significantly in the United States and worldwide in recent years as part of a global financial crisis. Although the general economy has begun to recover, sales of residential furniture remain depressed due to wavering consumer confidence and several, ongoing global economic factors that have negatively impacted consumers’ discretionary spending. These ongoing factors include lower home values, prolonged foreclosure activity throughout the country, a weak market for home sales, continued high levels of unemployment, and reduced access to consumer credit. These conditions have resulted in a decline in Furniture Brands’ sales, earnings and liquidity.

Sales have continued to be depressed as a result of a sluggish recovery in the U.S. economy, continuing high unemployment, depressed housing prices, tight consumer lending practices, the reluctance of some households to use available credit for big ticket purchases including furniture, and continuing volatility in the retail market.

PETITION Note: My, how things have changed. Just reflect on that synopsis of the economy a mere five years ago. The company also noted that:

…some of the Company’s larger brands have lost some of their market share primarily due to competition from suppliers who are able to produce similar products at lower costs. The residential furniture industry is highly competitive and fragmented. Furniture Brands competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own store-branded products.

All of these factors stormed together to constrain the company’s liquidity and force a chapter 11 filing and eventual sale. KPS purchased several of the FBI brands for $280mm (subject to working capital adjustments), including Thomasville, Broyhill, Lane, Drexel Heritage, Henredon, Pearson, Hickory Chair, Lane Venture, and Maitland-Smith. In other words: brands that your grandfather would know and you would shrug at the mere mention of. Well, some of you anyway.

Fast forward five years and the successor entity HHG has $280mm of debt and…you guessed it…severe liquidity constraints. In its first day filing papers, HHG notes that the previous bankruptcy continues to have lasting effects on its business; it highlights:

Following years of sales declines, many furniture retailers had lost faith in the ability of the Company to produce, deliver, and service its products, and the bankruptcy led many of them to shift their purchases to a variety of competitors or even further utilize their own private label offerings.

This is what people still nostalgically refer to as “bankruptcy stigma.” Indeed, it still exists. The company continued:

In addition, the Company’s operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Although economic conditions have been steadily improving in recent years, the Debtors have struggled to adjust to certain shifts in consumer lifestyles, which include: (i) lower home-ownership levels and more people renting; (ii) more apartment living and single-person households; (iii) older consumers that want to age in place; and (iv) cash-strapped millennials that are slow in forming households relative to prior generations.

Haha! The poor millennials. Apparently an entire generation is “cash-strapped” and prefers to sleep in a tent under their WeWork desks. Blame the avocado toast and turmeric lattes. But, wait, there’s more:

Consumer browsing and buying practices are rapidly shifting as well toward greater use of social media, internet- and app-based catalogs and e-commerce platforms, and the Company has been unable to develop a substantial sales base for its brands through this key growth channel.

Furthermore, the residential furniture industry is highly competitive and fragmented. The Company competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own private label products. This competitive landscape has proved challenging for some of the Company’s larger brands as well-capitalized competitors continue to gain market share at the expense of the Debtors. (emphasis added)

PETITION Note: My, how things have remained the same. Sound familiar? Have to hand it to the professionals here: why reinvent the wheel when you can just crib from the prior filing? We guess being a repeat customer in bankruptcy has its benefits!! Chapter 22!!!

<p>Meanwhile a short digression relevant to those last two quoted paragraphs. According to Statistaworldwide online furniture and homewares sales are expected to be close to $190 billion. Take a look at this chart:

RetailDive notes:

E-commerce furniture sales have emerged as a major growth area, rising 18% in 2015, second only to grocery, according to research from Barclays.

Accordingly, GartnerL2 cautions that:

…home brands now have an outsized onus to produce best-in-class product pages for the influx of online shoppers. However, many brands have failed to deliver and aren’t keeping pace with industry disruptors.

Sounds like HHG has, admittedly, fallen into this category.

GartnerL2 highlights the disparate user experiences offered by Williams-Sonoma-owned West Elm and Chicago-based DTC disruptor Interior Define, which was founded in 2013 and has raised $27mm in funding (most recently a Series B in March). The latter offers extensive imagery, a visual guide and an augmented reality mobile app. All of these things appeal to the more-tech-savvy (non-cash-strapped??) millennial buyer.

And that is precisely the demographic that La-Z-Boy Incorporated ($LZB) is going after with its purchase of Joybird, a California-based direct-to-consumer e-commerce retailer and manufacturer of upholstered furniture. Founded in 2014, its $55mm in reported revenue last year took a chunk out of, well, someone. Other players in that space include Burrow ($19.2mm in total funding; most recent Series A in March from New Enterprise Associates) and, of course, Amazon’s in-house furniture brandsRivet and Stone & Beam. <p><end>

All of these factors resulted in continual YOY declines in sales and a liquidity squeeze. Now, therefore, the company is in bankruptcy to effectuate a sale — or sales — of its brands to prospective bidders. It has one purchaser in line for the “Luxury Group” and, according to the court filing, appears close to an agreement with a stalking horse buyer of the Broyhill and Thomasville & Co. properties. In the meantime, the company has a commitment from prepetition lender PNC Bank NA for a $98mm DIP, of which $25mm Judge Gross granted on an interim basis.

⚡️Is PG&E in Trouble?⚡️

PG&E Reported Earnings (Long Climate Change)

Long time PETITION readers know that our general theme is “disruption, from the vantage point of the disrupted.” Disruption can come in various forms. In many cases it comes from technological innovation. The dreaded “Amazon Effect” that everyone is so tired of hearing about falls into this category. But as we’ve said time and time again, mobile e-commerce is a big part of that story and that would never have been made possible — and perhaps brick-and-mortar would still be intact — if it weren’t for the Apple Iphone ($AAPL), for Shopify ($SHOP), and for Instagram ($FB), among many other disrupters. Today’s innovations are leading indicators for tomorrow’s bankruptcies.

Disruption — and, no, we don’t always use this term in the Clayton Christensen sense — can come in other forms. There can be regulatory and/or legislative disruption, political disruption, environmental disruption, etc. In the case of PG&E — short for Pacific Gas and Electric Company — it may be all of the above.

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Home Security is a Tough Business

Short Ascent Capital Group

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Tough is one word for it.

Saturated is another.

There are countless players in the home security and monitoring space including (i) recently-IPO’d ADT Inc. (owned by Apollo Asset Management),* (ii) Vivint Inc., (iii) Guardian Protection Services, (iv) Vector Security Inc., (v) Comcast Corporation, and (vi) SimpliSafe Inc. And there is also the identity-confused schizophrenic Monitronics International Inc., formerly known as MONI Smart Security and now known as Brinks Home Security, which is a wholly-owned subsidiary of publicly-traded holding company Ascent Capital Group ($ASCMA)(did you get all of that?). Nearly all of these companies compete in the market for “alarm monitoring agreements” (AMAs) — contracts pursuant to which these companies provide home monitoring services in exchange for predictable recurring revenue. Predictable in a manner of speaking: with this much competition, the industry is getting a wee bit…less…predictable…?

Ascent Capital Group noted in its most recent 10-K:

Competition in the security alarm industry is based primarily on reputation for quality of service, market visibility, services offered, price and the ability to identify and obtain customer accounts. Competition for customers has also increased in recent years with the emergence of DIY home security providers and other technology companies expanding into the security alarm industry. We believe we compete effectively with other national, regional and local alarm monitoring companies, including cable and telecommunications companies, due to our reputation for reliable monitoring, customer and technical services, the quality of our services, and our relatively lower cost structure. We believe the dynamics of the security alarm industry favor larger alarm monitoring companies, such as MONI, with a nationwide focus that have greater resources and benefit from economies of scale in technology, advertising and other expenditures. (emphasis added).

Make no mistake: ASCMA is purposefully highlighting its monitoring expertise, size and scale. And that is because the market for AMAs is getting increasingly challenged by a number of home security providers. And many of them are of the do-it-yourself (“DIY”) variety. For instance, home owners can get home security devices from Arlo by Netgear.** Or Canary. Or Honeywell ($HON). Or Google (Nest)($GOOG). Amazon Inc. ($AMZN) recently bought Ring Doorbell for $1 billion and that, too, has a home security system. Gadget stores are replete with options for DIY home security systems. Do people even need professional installation and/or monitoring anymore? With property crimes on a nationwide decline, is a self-monitoring system viable enough? Why bother when you can just get alerts to the phone in your pocket or the watch on your wrist? These are the big questions.

Especially for Monitronics.

Monitronics primarily sells its home security and monitoring services through a network of authorized dealers. While it also deploys certain direct-to-consumer initiatives under its DIY-focused subsidiary, LiveWatch Security LLC, the company’s real action is from the recurring fees baked into AMAs. Unfortunately:

In recent years, MONI's acquisition of new customer accounts through its dealer sales channel has declined due to the attrition of large dealers, efforts to acquire new accounts from dealers at lower purchase prices, consumer buying behaviors, including trends of buying security products through online sources and increased competition from telecommunications and cable companies in the market. MONI is increasingly reliant on its internal sales channel and strategic relationships with third parties, such as Nest, to counter-balance this declining account generation through its dealer sales channel. If MONI is unable to generate sufficient accounts through its internal sales channel and strategic relationships to replace declining new accounts through dealers, MONI's business, financial condition and results of operations could be materially and adversely affected. (emphasis added)

Was that a borderline “Amazon Effect” reference mixed in there? 🤔 Wait. There’s more:

As of December 31, 2017, MONI was one of the largest alarm monitoring companies in the U.S. when measured by the total number of subscribers under contract. MONI faces competition from other alarm monitoring companies, including companies that have more capital and that may offer higher prices and more favorable terms to dealers for alarm monitoring contracts or charge lower prices to customers for monitoring services. MONI also faces competition from a significant number of small regional competitors that concentrate their capital and other resources in targeting local markets and forming new marketing channels that may displace the existing alarm system dealer channels for acquiring alarm monitoring contracts. Further, MONI is facing increasing competition from telecommunications, cable and technology companies who are expanding into alarm monitoring services and bundling their existing offerings with monitored security services. The existing access to and relationship with subscribers that these companies have could give them a substantial advantage over MONI, especially if they are able to offer subscribers a lower price by bundling these services. Any of these forms of competition could reduce the acquisition opportunities available to MONI, thus slowing its rate of growth, or requiring it to increase the price paid for subscriber accounts, thus reducing its return on investment and negatively impacting its revenues and results of operations.

And here we thought people were shunning the cable companies?

Anyway, can Monitronics circumvent these issues with a superior product? By investing in new technology to ward off the onslaught of newcomers? More from the 10-K:

…the availability of any new features developed for use in MONI's industry (whether developed by MONI or otherwise) can have a significant impact on a subscriber’s initial decision to choose MONI's or its competitor’s products and a subscriber's decision to renew with MONI or switch to one of its competitors. To the extent its competitors have greater capital and other resources to dedicate to responding to technological innovation over time, the products and services offered by MONI may become less attractive to current or future subscribers thereby reducing demand for such products and services and increasing attrition over time. Those competitors that benefit from more capital being available to them may be at a particular advantage to MONI in this respect. If MONI is unable to adapt in response to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect its business by increasing its rate of subscriber attrition. MONI also faces potential competition from improvements in self-monitoring systems, which enable current or future subscribers to monitor their home environments without third-party involvement, which could further increase attrition rates over time and hinder the acquisition of new alarm monitoring contracts. (emphasis added)

Luckily this isn’t an issue because Monitronics currently has the best most technologically-advanced home security offering on the market. Oh. Hmmm. Wait. We spoke to soon…

Here is Wirecutter reviewing “The Best Home Security System.” And suffice it to say, the Monitronics’ product is not the winner. In fact, Wirecutter knocks the “Brinks Home Complete with Video” system on cost.

Here is PCmag reviewing “The Best Smart Home Security Systems of 2018” and the LiveWatch Plug & Protect IQ 2.0 is buried down the list with a 3.5 star rating (out of 5).

And here is Reviews.com’s list of “The Best DIY Home Security” and neither LiveWatch nor Brinks are listed. 😜

To offset all of these current challenges, the company luckily has unconstrained liquidity and a clean balance sheet to invest in marketing to dealers and upgrading its technology for the future. Oh. Hmmm. Wait. We spoke to soon. Again. 😜

Late last week, Moody’s Investors Service Inc. downgraded Monitronics International Inc.to Caa2 from B3; it also downgraded (i) the company’s $1.1 billion senior secured first-lien L+5.50% term loan due 2020 to Caa1 from B2 and (ii) its 9.125% $585 million senior unsecured notes to Caa3 from Caa2. To complete the capital structure picture, the company also has approximately $68.5 million outstanding on a $295 million L+4% credit facility “super priority” revolver due 2021. So, to make sure you grasp the magnitude here: 1 + 2 + 3 = $1.8 billion of debt. Yup, you read that right. There’s a lot of interest expense attached to that. Oh, and per ASCMA’s last 10-K:

The maturity date for both the term loan and the revolving credit facility under the Credit Facility are subject to a springing maturity 181 days prior to the scheduled maturity date of the Senior Notes. Accordingly, if MONI is unable to refinance the Senior Notes by October 3, 2019, both the term loan and the revolving credit facility would become due and payable.

Hmmm. 🤔 Siri, set an alarm for April 2019‼️💥

Moody’s noted:

The downgrade of Monitronics' CFR and facility ratings reflects strains on the company's liquidity and capital structure caused by impending maturities, as well as its continued lackluster operating performance.

The liquidity rating downgrade to SGL-4 reflects the approaching debt maturities. Moody's views Monitronics' liquidity as operationally adequate, but weak in terms of imminent, likely accelerating debt maturities. As a result of the company's continued lackluster performance, Moody's expects Monitronics to generate barely breakeven free cash flow this year. The (unrated) $295 million, super-priority revolving credit facility is large and has, as of early July 2018, a time of seasonally heavy revolver borrowing, roughly $80 million drawn. Reliance on the revolver also creates liquidity risk because the revolver expiration will spring to October 2019 if the notes are not refinanced. While cash on hand continues to be modest ($30 million at March 31st), Monitronics' parent company, Ascent Capital Group, Inc.("Ascent"), has nearly $110 million of cash, which may be viewed as providing additional implied support. Still, Monitronics' combined sources of liquidity are weak relative to the quantum of debt coming due in the next few years. Reliance on the revolver for operational initiatives and to fund purchases of new subscriber contracts from dealers will also prevent meaningful deleveraging over the next year. Weak operational metrics also continue to shrink the cushion it has relative to covenant limits, and the risk of a covenant violation over the next 12-15 months is elevated.

Ergo, the capital structure is rumored to be advisored up with (a) Houlihan Lokey and Stroock & Stroock & Lavan working with an ad hoc group of unsecured holders and (b) Jones Day and Evercore working with the term lenders. Latham & Watkins LLP reportedly represents the company. Anchorage Capital may be a bit of a wild card here as they allegedly hold a meaningful position in the term loan and the unsecured bonds.

All of this drama has taken its toll on ASCMA’s stock:

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This company is looking a bit insecure.

* ADT IPO’d earlier this year championing its revenue-generation. In its S-1 filing it noted, “In the nine months ended September 30, 2017 and the year ended December 31, 2016, we had total revenues of $3,210 million and $2,950 million, respectively, and net losses of $296 million and $537 million, respectively.” Um, okay. This looks like a textbook Apollo dump. And the market seems to be responding. Here is the range-bound stock performance post-IPO:

Hard to blame Apollo for getting out while the gettin’ is good.

** As we were researching and writing this piece, Arlo Technologies filed its S-1 for a planned $194mm IPO. The firm posted $6.6 million in income on $370.7 million in revenue for 2017.

As we said, “saturated.”

New York City CRE (Long the Changing Retail Landscape)

Is anything available in New York City for less than $5? Some of you are about to find out.

Yesterday, Bloomberg noted the following:

Retail rents are tumbling in Manhattan, especially in the toniest neighborhoods.

In the area around the Plaza Hotel on Fifth Avenue, home to the borough’s priciest retail real estate, rents fell 13.5 percent in the second quarter from the previous three months, the largest decline among the 16 neighborhoods tracked by brokerage CBRE Group Inc. The drop was due in part to a single space that had its price cut from $3,500 a square foot to $2,500, CBRE said in a report Tuesday.

Tenants have the upper hand in New York as landlords contend with a record number of empty storefronts. Across Manhattan, 143 retail slots have sat vacant for the past year, and rents have been reduced on more than half of those spaces, CBRE said. Property owners are increasingly willing to negotiate flexible terms in an effort to get tenants to commit to leases, according to the report.

Apparently a number of commercial real estate brokers didn’t get the memo. Brokers reportedly lashed out last week upon news that General Growth Properties ($GGP) leased out a large space to Five Below, a discount consumer products chain, at 530 Fifth Avenue. Per Commercial Observer:

Some brokers expressed disappointment with the tenant selection.

“It’s not a Fifth Avenue-type tenant. Everyone is pissed,” one broker said of the deal because of the nature of the tenant on a prized part of Fifth Avenue. He added: “There goes the neighborhood.” A more suitable location, the broker said, would have been south of 42nd Street.

“Not sure this was the tenant surrounding landlords with available space were hoping for,” said Jeffrey Roseman, a vice chairman at Newmark Knight Frank Retail, who was not involved in the deal.

Wait. What? Currently, there’s literally a JPMorgan Chase Bank, a Walgreens and a Kaffe 1668 right there there. Who among that lot can rightfully object?

What these brokers don’t appear to grasp is that the brick-and-mortar landscape has dramatically changed. There aren’t very many tenant options for landlords — at least not for 10,800 square foot spaces (which is what this is). And there’s no benefit to any of the other retailers in the vicinity of the space for it to remain vacant. Apropos, as noted in Commercial Observer, one broker appears to get it:

“Five Below is the updated variety store or five-and-dime store of our day—something for everyone,” said Faith Hope Consolo, the chairman of the retail leasing and sales division at Douglas Elliman. “As for the character or image of the street, that is not really affected or important. The key is that a big space was absorbed and this type of tenant will generate traffic.”

Our thoughts exactly. Those adhering to a New York City of yesteryear clearly haven’t noticed the influx of coffee shops, pharmacies and banks on every corner. Who else would take such a large space? Toys R Us?

What? Too soon?

🍟Casual Dining Continues to = a Hot Mess🍟

Luby's & Steak N Shake Look Stressed (Short Soggy Mac N’ Cheese)

We’ve previously covered this topic in “🍟Casual Dining is a Hot Mess🍟” and “More Pain in Casual Dining (Short Soggy Mozzarella Sticks).” Recall that, back in April, Bertucci’s Holdings Inc. filed for bankruptcy and said the following in its First Day Declaration:

"With the rise in popularity of quick-casual restaurants and oversaturation of the restaurant industry as a whole, Bertucci’s – and the casual family dining sector in general – has been affected by a prolonged negative operating trend in an ever increasing competitive price environment. Consumers have more options than ever for spending discretionary income, and their preferences continue to shift towards cheaper, faster alternatives. Since 2011, Bertucci’s has experienced a year-over-year decline in sales and revenue."

Unfortunately for those in the space, those themes persist.

On Monday, Luby’s Inc. ($LUB) — the owner and operator of 160 restaurants (86 Luby’s Cafeteria, 67 Fuddruckers and 7 Cheeseburger in Paradise) reported Q3 earnings and they were totally on trend. While the company reported positive same-store sales at Luby’s Cafeteria — its largest brand — the company’s financial results nevertheless cratered on account of increased costs (in food, labor and operating expense) without a corresponding acceleration in sales (via either increased prices or guest traffic). The company’s overall same store sales decreased 0.9%, its total sales decreased 3.1%.

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The company noted:

“…the current competitive restaurant environment is making it difficult for our brand and the mature brands of many others to gain significant traction. We've been faced with the environment for quite some time, which has been a large drag on our financial results and our company valuation.

The challenge of rising costs, flattish-to-down sales, and a sustained debt balance are restricting the company's overall financial performance.”

Like many other chains, therefore, Luby’s is rationalizing its store count. The company previously committed to shedding at least 14 of its owned locations to the tune of an estimated $25mm in proceeds; it is accelerating its efforts in an attempt to generate an additional $20mm in proceeds. The use of proceeds is to pay down the company’s $44.2mm of debt. The company also announced that it hired Cowen ($COWN) to assist it with a potential restructuring of its Wells Fargo-agented ($WFC) credit facility. That hire was a requirement to a July 12-dated financial covenant default waiver (expiration August 10) provided by the company’s lenders.

This company does have one advantage over several distressed competitors: it owns a lot of its locations (in addition to its franchise business; a separate licensee operates an additional 36 Fuddruckers locations). The question therefore becomes whether the company’s lenders will provide the company with enough latitude (via continued waivers or otherwise) to sell enough locations to generate proceeds to pay down or “reduce [its] outstanding debt to near zero.” If patience wears thin or buyers balk at purchasing locations that later may become subject to a fraudulent conveyance attack, this may be yet another casual dining chain to find itself in bankruptcy. The stock, which has been range-bound for about a year, trades as follows:

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*****

Likewise, Steak ‘n Shake is also beginning to look stressed — at least as far as its senior secured term loan goes. The casual dining restaurant company has somewhere between 580 and 616 locations, approximately 2/3 of which are company-owned. According to Reorg Researchit also has a group of lenders who are agitating given (i) under-budget revenues, (ii) liquidity concerns, and (iii) lower loan trading levels. Per Reorg:

The lenders’ move to organize comes as Steak ‘n Shake has shifted its focus from company-owned locations to franchise opportunities in the face of declining revenue, same-store sales and customer traffic as well as increased costs. A wholly owned subsidiary of Biglari Holdings, Steak ‘n Shake is a casual restaurant chain primarily located primarily in the Midwest and South United States; the chain is known for its steak burgers and milkshakes. Biglari says that unlike company-operated locations, franchises have “continued to progress profitably.” “Franchising is a business that not only produces cash instead of consuming it, but concomitantly reduces operating risk,” the 2017 chairman’s letter says.

Even so, 415 of the total 616 Steak ‘n Shake locations are company-operated and creditors are pushing the company to bring in operational advisors, sources say. The company’s $220 million term loan due in 2019, which according to the Biglari 10-Q had $185.3 million outstanding as of March 31, has dipped to the 86/88 context, according to a trading desk. The term loan, which matures March 19, 2021, is secured by first-priority security interests in substantially all the assets of Steak ‘n Shake, although is not guaranteed by Biglari Holdings.

The company has been struggling for years. Per Restaurant Business:

Same-store sales fell 0.4% in 2016 and another 1.8% in 2017. Traffic last year fell 4.4%.

The decline in traffic wiped out the chain’s profits. Operating earnings per location declined from $83,300 in 2016 to just $1,000 in 2017.

Part of the issue may be the company’s geography-agnostic “consistent pricing strategy” which keeps prices static across the board — regardless of whether a location is in a higher cost region. This strategy has franchisees in an uproar which, obviously, could curtail efforts to switch from an owner-owned model to a franchisee model. Indeed, a franchisee is suing. Per Restaurant Business:

For franchisees that operate 173 of the 585 U.S. locations and have to pay for royalties on top of other costs, the traffic declines risk sending many locations into financial losses. In addition, rising minimum wages in many markets, along with competition for labor, could put further pressure on that profitability.

Steaks of Virginia, the franchisee that filed the lawsuit last week, claimed it was losing money at all nine of its locations.

Curious. Apparently the company’s reliance on higher traffic to generate profits didn’t come to fruition. Insert lawsuit here. Insert lender agitation here. Insert questionable business model shift here.

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.

Auto Distress (Short Short Memories)

With interest rates rising and fears of an imminent recession gaining increasing traction (see below), many remain concerned about the subprime auto lending market. The professionals at Davis & Gilbert LLP note:

Total auto loan debt increased to $1.23 trillion in Q1 2018, up from $1.17 trillion versus a year ago, and accounted for 9.3% of the $13.21 trillion in national household debt – remaining greater than credit card debt, but less than student loan and mortgage debt, according to Federal Reserve Bank of New York data.

While subprime originations have...

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Footwear Brands Reap Heaps of VC Investment (Short B&M Footwear Retailers)

Back in March, in “Nine West & the Brand-Based DTC Megatrend,” we noted the following:

The Walking CompanyPayless ShoesourceAerosoles. The bankruptcy court dockets have been replete with third-party sellers of footwear with bursting brick-and-mortar footprints, high leverage, scant consumer data, old stodgy reputations and, realistically speaking, limited brand value. Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect “not a hell of a whole lot”.

Shortly thereafter, Nine West did file for bankruptcy but we were a little off on the rest. That is, unless $340mm constitutes “not a hell of a whole lot.” That amount, landed on after a competitive bidding process, resulted in a greater-than-expected value to Nine West’s estate. Remember: the company filed for bankruptcy with a stalking horse bidder offering “approximately $200 million (inclusive of the above-stated $123 million allocation to IP, subject to adjustment).” This is where bankruptcy functions as a bit of alternative reality: $340 million is a good result for a company with $1.6 billion of debt, exclusive of any and all trade debt — particularly when the opening bid is meaningfully lower. For a more fulsome refresher on Nine West’s bankruptcy filing, go here.

Subsequent to Nine West’s filing, the tombstones for footwear retailers continued to pile up. For instance, in mid-May, The Rockport Company LLC filed for bankruptcy with a telling narrative. We highlighted:

The company notes, "[o]ver the last several years the Debtors have faced a highly promotional and competitive retail environment, underscored by a shift in customer preference for online shopping." And it notes further, "[t]he unfavorable performance of the Acquired Stores in the current retail environment has made it difficult for the Debtors to maintain sufficient liquidity and to operate their business outside of Chapter 11." PETITION NOTE: This is like a broken record, already.

We continued:

In light of this, armed with a $20 million new-money DIP credit facility (exclusive of rollup amounts) extended by its prepetition ABL lenders, the company has filed for bankruptcy to consummate a stalking horse-backed asset purchase agreement with CB Marathon Opco, LLC an affiliate of Charlesbank Equity Fund IX, Limited Partnership for the sale of the company's assets - OTHER THAN its North American assets — for, among other things, $150 million in cash. The buyer has a 25-day option to continue considering whether to purchase the North American assets but the company does "not expect there to be any significant interest in the North American Retail Assets." Read: the stores. The company, therefore, also filed a "store closing motion" so that it can expeditiously move to shutter its brick-and-mortar footprint at the expiration of the option. Ah, retail. 

And, ah, footwear. Check out this lineup:

And so we asked:

Given all of that, would you want Rockport’s brick-and-mortar business?

Answer: no. Apparently nobody did. And, in fact, nobody — other than the stalking horse, CB Marathon Opco, LLC — wanted any part of Rockport’s business.

On July 6, the company filed a notice that it cancelled its proposed auction. There were no qualified bidders, it noted, thereby making CB Marathon Opco, LLC the winning bidder by default. And given that the stalking horse agreement excluded the U.S. brick-and-mortar assets, those assets are now officially kaput. A hearing at which the bankruptcy court will bless the sale is scheduled for July 16. Aside from some additional administrative matters in the case, that hearing will mark a wretched ending for a company founded in the early 1970s.

*****

Juxtapose that doom and gloom with this Techcrunch piece about the rise of venture capital in footwear:

Over the past year-and-a-half, investors have tied up roughly $170 million in an assortment of shoe-related startups, according to an analysis of Crunchbase data. The vast majority is going to sellers and designers of footwear that people might actually want to walk in.

Top funding recipients are a varied bunch, including everything from used sneaker marketplaces to high-end designers to toddler play shoes. Startups are also experimenting with little-used materials, turning used plastic bottles, merino wool and other substances into chic wearables.

The piece continues:

It should be noted that recent footwear funding activity comes on the heels of some positive developments for the shoe industry.

Positive developments huh? “Some” must be the operative word given the preface above. There’s more:

First, this is a huge and growing industry. One recent report pegged the global footwear market at $246 billion in 2017, with annual growth rates of around 4.5 percent.

Second, public markets are strong. Shares of the world’s most valuable footwear company — Nike — have climbed more than 50 percent over the past nine months to reach a market cap of nearly $130 billion. Stocks of several smaller rivals, including Adidas, have also performed well.

Third, men are spending more on footwear. Though they’ve long been stereotyped as the gender with more restrained shoe-buying habits, men are putting more money into footwear and could be on track to close the spending gap.

And:

…one other bullish sneaker trend footwear analysts point to is the changing buying habits of women. Driven perhaps by a desire to walk more than a few blocks without being in pain, we’re buying fewer high heels and more sneakers.

The piece goes on to list a lineup of well-funded footwear companies. In marketplaces, GOAT and StockX. In streetwear, Stadium Goods. For children, Super Heroic. For comfort, AllbirdsRothy’s, and Birdies. And the article neglected to mention KoioGreats, and M. Gemi, to name a few. If you feel as if these names are unfamiliar because you didn’t see them at a brick-and-mortar footwear retailer in your last trip to the mall, well…yeahThat ought to explain a lot.

Interestingly, before unironically asking (and not entirely answering) whether any of these companies actually make money, the article also highlights Tamara Mellon,“a two-year-old brand that has raised more than $40 million to scale up a shoe design portfolio that runs the gamut from flats to spike heels.” Indeed, the company recently raised a $24mm Series B round* to grow its Italian-made pureplay e-commerce direct-to-consumer brand. In reality, though, Tamara Mellon is only technically two years old. It was around before 2016. In a different iteration. That iteration filed for bankruptcy.

In early 2016, Tamara Mellon Brand LLC filed for bankruptcy because of a liquidity crisis. And it couldn’t sufficiently raise capital outside of a chapter 11 filing to ensure its survival. After filing for bankruptcy, the company took on a $2mm debtor-in-possession credit facility from Ms. Mellon and, after combatting an equityholder-led “recharacterization”** challenge (paywall), swapped its term loan debt into equity. Winning prepetition equityholders like Ms. Mellon and venture capital firm New Enterprise Associates (NEA) came out with 16 and 31.1 percent of the equity, respectively. In turn, NEA capitalized the company to the tune of approximately $12mm.

Which highlights the obvious: not all of these companies will ultimately have renowned founders who merit second chances. A number of these high-flying e-commerce upstarts will fail; some of them will file for bankruptcy. The question is: as the funding rounds pour in from venture capitalists looking for the next big exit, how many other brands and shoe retailers will they push into bankruptcy first?

*****

*In October 2017, we wrote the following in “Sophia Amoruso's Nasty Gal Failure = Trite Lessons (Short Puffery)”:

We love how entrepreneurs are all about "move fast and break things" and "don't be afraid to fail" but then when they do, and do so badly, there is barely anything that really provides an in-depth post-mortem…Take, for instance, this piece of puffy garbage about Sophia Amoruso, which purports to inform readers about what Ms. Amoruso learned from Nasty Gal's rapid decline into bankruptcy. Instead it provides some evergreen inspirational advice that applies to virtually...well...everything and anything. TOTALLY USELESS.  

Apropos, the above-cited Fast Company piece is lip service Exhibit B. The piece notes:

Tamara Mellon cofounded Jimmy Choo with, well, Jimmy himself back in 1996. But in 2016, she decided to launch her own eponymous luxury shoe brand. It wasn’t easy, though: When she tried to go to high-end factories in Italy, she discovered that many refused to work with her, citing non-compete clauses with the Jimmy Choo brand.

But through persistence, she prevailed, and found factories that made shoes for other luxury brands.

We gather that what happened earlier in 2016 wasn’t relevant to the PR piece. Curious: is “persistence” a new euphemism for “bankruptcy”?

**If we understand what happened here correctly, other existing equityholders tried to recharacterize Ms. Mellon’s term loan holding as equity, effectively squashing her priority secured claim and demoting that claim to equal to or less than the equityholders’ claims. If successful, Ms. Mellon would not have been able to swap her debt for equity. Moreover, the other equityholders would have had a greater chance of a recovery on their claims. They failed, presumably recovering bupkis.