The Great Escape

"The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds." - John Maynard Keynes, The General Theory of Employment, Interest and Money (13 December 1935).

This past week, Michael Batnick, from Ritholtz Asset Management deployed a version of this quote to make a point about investing; he provided a nice callback to Blockbuster and an equity analyst's repeated bad calls vis-a-vis Netflix (which popped this week after impressive subscription growth - despite negative free cash flow (-$600mm+) and an increasingly levered balance sheet). TL;DR: don't be too wed to your ideas. 

This applies to the actual businesses that investors pour money into too. In today's rapidly transforming environment, businesses must now, more than ever, pivot, and innovate. They can't be too wed to legacy ideas. Recognizing that is the first step. It then becomes a question of execution in the face of constraints.  

Enter Avaya Inc., a privately-held provider of contact center, "legacy" unified communications and networking products and services with 176 global entities, $940mm of adjusted EBITDA, 200,000 customers and 9700 employees. To Avaya's credit, the company pivoted in 2009 away from its historical hardware-based operating model - recognizing the shift towards software-based and cloud-oriented services solutions. It undertook a massive reinvention, adapting its revenue model and streamlining operating performance in a manner that cut $700mm in costs since 2014. To some degree, the company's private equity overlords - TPG Capital and Silver Lake Partners - deserve some credit, too, for working with management and reconciling the need to pivot. After all, they had a $8.2 billion LBO to rationalize. 

But sometimes the constraints are insurmountable. Avaya has $6 billion of debt on its balance sheet; it has $440mm of annual interest expense along with an additional $180mm nut for annual pension and OPEB obligations. And it faces stiff competition from the likes of Microsoft, Cisco, and others, necessitating another ~$400mm in expenditures to fund R&D and other investments. It's been bleeding cash, losing over $505mm in the fourth quarter and over $750mm in fiscal '16.

And so the company is now a bankruptcy filer. Notably, the papers accompanying the filing have zero specificity about the company's go-forward business plan. Its one small victory is a robust DIP financing commitment and milestones intended to achieve a rapid turn in bankruptcy court. But then what? 

We rarely see big freefall bankruptcy cases anymore. Clearly there seems to be disagreement among the various constituencies about how best to proceed with this business in the face of competition and technological headwinds. That said, the company was able to secure $425mm of its proposed DIP facility at the "First Day" hearing on Friday. So there's that. 

"Software is eating the world," we noted last week (per Marc Andreesen). We'll see very soon whether Avaya gets swallowed along with TPG and Silver Lake's investment. Yes, they pivoted. But was it too little too late?

Thoughts? Opinions? Let us know at petition@petition11.com. 

Odd ad to place in the WSJ on the day after bankruptcy.

Are Progressives Bankrupting Restaurants?

According to the CEO of Garden Fresh Restaurant Intermediate Holdings (GFRIH), they are.  

This past week, John Morberg filed an affidavit in support of the chapter 11 bankruptcy filing of GFRIH, the holding company to restaurant brands Souplantation and Fresh Tomatoes. This family of restaurants includes 123 locations, 17 central kitchens and 2 distribution centers. All in, the company has 5500 employees, the majority of which work in the restaurants located in California, Texas and Florida.  

In addition to having approximately $135mm of funded debt, the company experienced increasing cash flow pressure which, according to Morberg, triggered the bankruptcy. Chief among the causes for this pressure was "declining sales consistent with the declines experienced in the entire restaurant industry." Morberg, here, is clearly referencing a string of recent restaurant bankruptcies including Cosi, Fox & Hound, Logan's Roadhouse, Don Pablo's, Zio Restaurants, Buffetts, and Champps. Cheap gasoline was supposed to translate into bigger consumer spending. Not so for these restaurants, apparently. 

Still, Morberg's explanation for the bankruptcy went a step farther. He noted that cash flow pressures also came from increased workers' compensation costs, annual rent increases, minimum wage increases in the markets they serve, and higher health benefit costs -- a damning assessment of popular progressive initiatives making the rounds this campaign season. And certainly not a minor statement to make in a sworn declaration.  

It's unlikely that this is the last restaurant bankruptcy in the near term. Will the next one also delineate progressive policies as a root cause? It seems likely.

Discounted Crackly-Crust Flatbread...

"All Sorrows Are Less With Bread" - Miguel de Cervantes Saavedra

If crackly-crust flatbread and Squagels (yes, this exists...and it is what it sounds like) are on your Christmas wish-list this year, you may be in luck: the once high-flying Cosi Inc. could be yours via bankruptcy sale.

For those familiar with Cosi In NYC, the downfall of the fast casual chain is particularly surprising. Once upon a time, blockbusting lunch lines for Cosi were a regular occurrence. As they waited, people jostled for access to the excess baked crackly-crust bread the bakers regularly dispensed. In certain locations, the competition for the excess was so fierce that the bakers resorted to placing the pieces in a small metal bowl on the counter - the fast casual equivalent of a home owner lazily putting a basket of Halloween candy on the doorstep for trick-or-treaters. Never mind hygiene: 126,292 other people put their hands into that bowl between the hours of 12 and 2. Yech.  

Here are the stats:

• 107 stores in 3 countries (but most in the US).
• 1555 employees (many of whom will now be losing their jobs)
• $7.5mm of (gulp, maybe) secured debt (which will position the lenders to own the business)
• $3mm in net losses in Q2 '16 (hence why we're talking about bankruptcy in the first place).

The court filings contain a choice quote: "The deteriorating sales are at least partially due to macro-economic issues as the restaurant industry as a whole and the fast casual sector in particular are experiencing decreasing sales trends." So much to unpack here. First, what happened to the notion that the "gasoline windfall" would lead to greater consumer spending? Second, aren't millennials spending more on food and experiences than on physical goods? Third, how does this purported trend affect the likes of Panera Bread, Chipotle, and a whole host of other fast casual upstarts? Sadly, the filings don't substantiate this statement. Curious.  

Winners:

• the original founders who blew out after the I.P.O. (yes, this thing is publicly-traded).

Losers:

• the senior secured lenders - they'll either get pennies on the dollar or 78 rubber-chicken-serving fast casual locations facing (unsubstantiated) headwinds; and
• the former CEO - the (public) filings go out of their way to note that he failed miserably to acknowledge the decline in the business and effectively turn it around (ouch). 
• employees - many are losing there jobs with little to no advanced notice.  
• shareholders - unlikely to see any recovery for their position.  

Thoughts, comments or questions? Note the comment section below.