More Retail Dominos Fall

Tax Credits Can't Save Failing Bon-Ton Stores

We're going to stay thematically on-point. If you missed us last week, we recommend that you go back and read our take on the Cenveo bankruptcy. In fact, we owe an apology to some of you: there were about 400 of you who did not get our a$$-kickingness at all due to an inexplicable Mailchimp screw-up. Mailchimp ≠ a$$-kicking (more on this soon). Anyway, here is a link to the entire newsletter.

A quick preface:

Protection of dying industry extends beyond federally-imposed #MAGA (see, e.g., coal, solar tariffs), and trickles down to local communities. Indeed, local-level legislators are looking at tax credits to prop up industry in the wake of, among other things, Appvion’s chapter 11 bankruptcy (and job cuts) and Kimberly-Clark’s reorganization (and mass job cuts). This is familiar: tax incentives to prop up industry aren’t extraordinary. Sheesh, just look at all the governors getting bent in the hope of drawing Jeff Bezos’ attention. The question is, though, how sound is the social contract? How many dying industries can we as taxpayers prop up all at once? We don’t have an answer. But keep reading.

******

Inside and outside of the startup context, people often ask stupid questions about companies. "How many employees does it have?” That’s a regular one. Or “How many locations?” Also common. “What’s revenue?” Irrelevant on its own. Uber makes a ton of revenue but is still bleeding cash. Netflix has gobs of revenue but is free cash flow negative. Cenveo, as we noted last week, had $1.59 billion of gross revenue in ’17. Now it’s in bankruptcy court. 

What if we told you about a particular business that had 23,000 employees and that those employees had an average tenure of 12 years? That had 256 locations. That owned 22 properties. That made $2.55 billion - yes, BILLION - in revenue in 2017. That would sound like a pretty damn successful company wouldn’t it? 

It’s not. 

We omitted some key data points: like the company’s capital structure and business vertical. 

Here’s the capital structure:

• a Tranche A revolving credit facility of up to $730mm
• a Tranche A-1 term facility of up to $150mm

The interest rate on the debt is a formula but, if we understand it correctly, it was no less than 9.5%. Funded debt as of Monday was $339mm under Tranche A (ex-interest), $150mm under Tranche A-1 (ex-interest of $3.9mm), and millions more in letters of credit.  

The company also has $350mm of 8% senior secured notes outstanding (Wells Fargo Bank NA) and due in 2021. Combined with the above debt, that’s a hefty interest expense. Oh, and the company is publicly-traded. Because this particular company is NOT successful - and with equity ranking in “absolutely priority” below debt - we reckon that there are a lot of Moms and Pops eating sh*t right now in their personal accounts. They won’t be the only ones.

The problem is that this company operates in an “increasingly challenging retail environment.” And, therefore, its story  - The Bon-Ton Stores story - is wildly unoriginal. In the company’s words, "Like many other department store and retail companies, the Debtors have been subjected to adverse trends in the retail industry, including consumers’ shift from shopping in brick-and-mortar stores to online retail channels. Bon-Ton, with a significant geographic operating footprint and operating presence, is dependent on store traffic, which has decreased as customers shift increasingly toward online retailers. In addition to competing against online retailers, Bon-Ton faces competition from other established department stores, such as J.C. Penney, Kohl’s and Macy’s.” It's like a zombie cage fight.

More specifically, it continues, "The department store segment of the U.S. retail industry is a highly competitive environment that has evolved significantly in response to new and evolving competitive retail formats, such as the increased prominence of mass merchandisers and increased competition among national chain retailers, specialty retailers and online retailers, as well as the expansion of the internet and, most significantly, the ubiquitous role that mobile technology and social media now play in the retail consumer shopping experience. The Debtors’ results and performance (and that of their competitors) has been significantly impacted by the aforementioned factors in the U.S. retail industry. Presently, numerous business and economic factors affect the retail industry, including the department store sector. These include underemployment and the low labor participation rate, fluctuating consumer confidence, consumer buying habits and slow growth in the U.S. economy and around the globe.” But, but…#MAGA?!?

Given these factors, the company has been engaged in a tug-of-war with its senior creditors for the better part of months. We’ll spare you the back-and-forth but suffice it to say, no concrete long-term plan that would’ve avoided bankruptcy came to pass. Only the retention of a liquidation agent to close 42 stores. And acquisition of a new $725mm credit facility to fund the cases while the company scrambles to find a buyer. Or liquidate.

Remember all of those shiny, positive numbers up above? Um, yeah. 

It gets worse. Though they were ultimately shot down - at least for now - in court yesterday (Feb 6), the bondholders argued “that the best and only available path for the Debtors to maximize value for their creditors in these freewill bankruptcy cases is to conduct an immediate orderly liquidation of the Debtors’ inventory and other assets. The Second Lien Noteholders made this determination after conducting their own due diligence, and following repeated missteps by the Debtors and their various boards and management teams, who proved themselves unwilling and/or unable to adapt to the fierce headwinds facing brick and mortar retailers and in particular, department stores”(emphasis in original). Savage.

Unwilling. Or unable. To adapt. Sadly, this seems to sum up a lot of distressed retailers these days. 

Even sadder, remember those long-tenured 23k employees we mentioned above? Per the company, “[Bon-Ton] has been part of its employees’ and customers’ lives in their communities for years.”

Probably not for much longer. At this point, no tax credits can change that. 

Cenveo Inc. = Poster Child for Disruption

Envelope Manufacturer Succumbs to Technology. And Debt.

As loyal PETITION readers know, our tagline is “Disruption, from the vantage point of the disrupted.” After its Chapter 11 bankruptcy last week, Cenveo Inc. may very well be the poster child for disruption.

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

And, yet, it sells a lot of product. In fiscal year ended December 31 2017, Cenveo generated gross revenue of $1.59 billion with EBITDA of $102.8mm. Those are real numbers. But so are those on the other half of the company’s balance sheet.

After years of acquisitions (16 between 2006 and 2013, representing a strategic shift from print-focus to envelope manufacturing), Cenveo has more than $1 billion of funded debt on its balance sheet and a corresponding $99.4mm in annual debt payment obligations (inclusive of cash and “principle” payments). That’s the problem with a lot of debt: eventually you’re going to have to pay it back. And the only way to do that is to have sustained and meaningful cashflows that are, hopefully, trending upwards rather than down. Therein lies the problem with Cenveo. As liquidity gets tight, a business may start getting a bit looser with payments, a bit less reliable. Savvy trade creditors sniff this from a mile away. With the company (very) publicly struggling under the weight of its balance sheet, vendors started hedging by contracting trade terms and de-risking; they start throwing off business to Cenveo’s competitors, further challenging Cenveo’s liquidity — to the tune of a net liquidity reduction of approximately $20mm. Initiate death spiral.

But, wait! There’s more. And it’s textbook disruption. Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo. More from the company,

“As society has become increasingly dependent on digital technology products such as laptops, smartphones, and tablet computers, spending on advertising and magazine circulation has eroded, resulting in an overall decline in the demand for paper products, and in-turn lowering reliance on certain of Cenveo’s print marketing business. In addition, there is generally a decline in supply of paper products in the industry, such that only a handful of paper mills control the majority of the paper supply. As a result, paper mills and other vendors that sell paper products have a large amount of leverage over their customers, including Cenveo. The overall decline in the paper industry combined with the diminished supply in paper products has led to overall decline in the industry, dramatically impacting Cenveo’s revenues.”

Consequently, the company has spent years trying to implement an operational restructuring (read: streamline operations and cut costs). The company adds,

“Faced with an industry in transformation, Cenveo, beginning in 2014, commenced a strategic review of a significant portion of its businesses and concluded that it needed to focus its portfolio on profitable segments that would be better-positioned to grow in the future and to divest non-core, unprofitable segments. To implement this strategy, between 2014 and 2017, Cenveo applied a number of broad-based cost savings and profitability initiatives, which included downsizing its workforce, reducing its geographic footprint, and divesting certain non-core business segments, which was designed to reduce costs, minimize the possible effect of decreased sales volume for underperforming product lines, and remain competitive.”

While the company notes that it currently employs nearly 5200 people in the US, it is clear that many people have lost their jobs. 100 people in Orchard Park, New York. 108 people in Exton, Pennsylvania. 112 people in the Twin Cities. 91 people in Portland, Oregon. You get the point. You should read theGlassdoor reviews for this company. The employees sound miserable. The comment board is riddled with critiques of management, allegations of squandering, tales of job cuts and no raises. Even sexual harassment. We can’t wait for the uproar over the inevitable Key Employee Incentive Plan.

So what now? The company claims it’s ready for the e-commerce age and that it can make a ton of money on package labels. Provided that it can shed its debt. Accordingly, the company engaged the holders of its first and second lien debt and was able to secure a (shaky?) restructuring support agreement (RSA) and a commitment of $290mm in financing. The RSA exhibits the company’s intent to equitize the first lien holders’ debt. Notably, Brigade Capital Management — representing over 60% of the second lien debt and a meaningful percentage of first lien debt — isn’t on board with the RSA and noted in a filing that the bankruptcy may be “more contentious and protracted than indicated” by the company. Indeed, they are already agitating against the company and certain insiders alleging, among other things, that the Burton family has received approximately $80mm of disclosed compensation between 2005 and 2016 that ought to be investigated. And that the RSA seeks to enrich the insiders with a generous post-reorg equity grant of 12%. In other words, this could get ugly. Fast.

We should also note that the company will also need to address its underfunded pensions (approximately $97.3mm) and 18 active collective bargaining agreements. Funding contributions for 2018 are over $10mm. The pension plan(s) cover 5700 retirees and 734 active employees. And so while sophisticated funds duke it out over valuation and the corresponding value of their claims/recoveries, thousands of employees and retirees will be left in the lurch. Yikes.

As you can see, disruption is hard. Silicon Valley types love to talk about their big revolutionary products and how they’re going to change the world. That sexy stuff gets CEOs on magazine covers. Cameos in Iron Man movies. And more. The attorney from Kirkland & Ellis LLP representing Cenveo used an IPad in court. Symbolic.

But there is a dark underbelly to disruption too. As new technologies come online and habits change, long-standing businesses like Cenveo falter. People lose jobs — or struggle one day at a time to keep them. People lose pensions they’d planned to live on. Hopefully the professionals who make money managing these elements in-court don’t lose sight of these factors and work hard to optimize efficiency in the process. And hopefully the engineers and disrupters take note of what their “big revolution” may mean for others. Cenveo is a great reminder.

Busted Tech (Short Influencers, Data Scientists & Fraudulent Founders)

Congratulations to Beme for being an Inception-like failure within a failure. Little more than a year ago, the ubiquitous Casey Neistat (of "Bike Lanes" fame (video)) sold his company Beme to CNN for $25mm in what, to those who track these things, was very clearly an acqui-hire rather than a legit acquisition. Neistat and his team were meant to be a boost of steroids for CNN's burgeoning digital content plans. Instead, he's gone and Beme is officially toast. Perhaps the shortest acqui-hire of all time. 

But at least Beme wasn't a $100mm bust. So, there's that. In contrast, Primary Data, a California-based data virtualization startup crashed and burned this week after 4 years of hype, $80mm in venture capital, $20mm in venture debt, and (practically) zero minutes of actual product delivery. Apple's Steve Wozniak was the company's data scientist. Notable VCs include Litespeed Venture Partners and Accel Partners.

And then there is Loot Crate, a monthly subscription service that sends video games and other nerdy gear to customers. Per Reuters, the company is a cesspool of controversy: it is the defendant in a sexual harassment lawsuit; and it had three non-exec Board members resign in recent weeks (including the high profile Mark Suster of Upfront Ventures). Consequently, it has hired Dendera Advisory LLC, a merchant bank of sorts, to raise new funds. We guess that means that, after $18.5mm of venture capital funding and Suster running for the exits, VC is no longer an option. Meanwhile, Dendera is apparently no stranger to distressed situations; it advised Sports Direct International in its purchase of Eastern Mountain Sports and invested in Performance Sports Group. 

Getting us progressively closer - but not quite in - to bankruptcy court, is Outcome Health, a medical advertising company that deploys technology (read: uh, tv screens) to doctor's offices. The company has (apparently) avoided a chapter 11 filing after settling fraud allegations Goldman Sachs and Google Capital lobbed at the company's founders. Jones Day, Rothschild and FTI Consulting were all reportedly laying in wait for a potential bankruptcy filing. The company has several million dollars of debt. As part of the settlement, the defendants and others will infuse the company with additional liquidity.

And, finally, further busting the everybody-gets-rich-off-of-tech narrative, Practice Fusion, a medical records startup, has sold for $100mm to AllScripts Healthcare Solutions Inc. ($MDRX) at a mere fraction of the once-heralded $1.5b valuation the company reportedly enjoyed. While management - including a General Counsel making $2.2mm - are getting enriched, employees taxed on earlier exercised stock options are getting shafted hard. It's a rough story. Peter Thiel (of Gawker fame) and Kleiner Perkins Caufield & Byers were large investors. 

PETITION NOTE: Startups fail all of the time. We note it only because, eventually, interest rates will rise, the bubble will burst, venture capital money will dry up, and EVEN MORE startups and tech companies will go "bust." A number of these companies - unbeknownst to many who don't follow tech - actually have venture debt (like Primary Data above) and valuable IP. Stay tuned. And imagine how long this section will be when that all that happens.

Toys R Us is a Dumpster Fire

All Signs Point to the Big Box Retailer Being in Serious Trouble

This week AlixPartners LLC released its latest "Retail Viewpoint" and its "Monthly Retail and Economic Update." Both documents cover retail results from the ever-important holiday season. Alix says this in its preface:

"The year 2017 may have been one of apocalyptic headlines, but a lot of forecasts—including ours—still predicted that retailers would have a good holiday performance.

No one thought it would be this good.

According to advance and preliminary numbers from the US Census Bureau, retailers brought the noise this past holiday-shopping season. Core retail sales increased 6.3% over 2016's, blowing past the National Retail Federation's forecast—and ours too. Sales in November and December were absolutely explosive, accounting for 17.2% of annual sales, the largest percentage since 1999.

Every core retail sector performed significantly better than it did the rest of the year (figure 1). Not even public enemy number one—e-commerce pure plays—could stop other sectors from increasing 2.3% during the holiday season compared with the rest of 2017. There must have been a lot of happy little kids (and bigger kids) gathered 'round the tree, because the poster children of recession-era bankruptcies, electronics and sporting goods/hobby/book/music stores, had the largest increases of all: 7.4% and 4.7%, respectively."

While there may have been "a lot of happy little kids," we're guessing they were NOT "Toys R Us kids." 

Consider this week's Toys R US-related operational news: 

• The Washington Post reports that 182 stores will close, with CEO Dave Brandon acknowledging "operational missteps" during the holiday season. The article cites various issues including (i) confusion around the bankruptcy filing, (ii) fear of buying gifts that can't be returned, (iii) weak marketing, and (iv) ineffective email promotions. An analyst at BMO Capital Markets notes that holiday sales in North America were down more than 10%. On the bright side, Reuters reports that all 83 stores in Canada will remain open.
• Quartz notes that the company seeks permission to pay store closing bonuses to those employees who help the company wind down the aforementioned 182 stores (which, for the record, is roughly 20% of the US footprint). Notably, neither the company nor Quartz is estimating the sheer number of jobs these closings affect. But it will be a meaningful number. #MAGA!!
• Bloomberg reported that the company obtained court approval to pay landlords' fees and expenses related to the Chapter 11 case in exchange for additional time for the company to decide whether to assume or reject leases. Nerd alert: the bankruptcy code imposes a 210-day deadline for a company to decide a course of action vis-a-vis its non-residential real property leases. These promised payments were in exchange for an extension of that timeframe. 

And consider, further, this week's Toys R Us-related financial news:

• Per RetailDive, Toys R Us won't release holiday sales results. 
• Per Debtwire, Toys R Us circulated a limited holiday performance snapshot for its international enterprise. The report didn't include number after December 23. Yes, Christmas is on December 25. 

We wonder: why the reluctance to release numbers? Our suspected answer: they must be ugly AF. In the period of October 29 - November 25, the company reported a net deficit (disbursements > receipts) of approximately $53mm. Later this week, we should see the company's monthly filing for the period covering Christmas. We don't like to speculate, but we can only imagine that the deficit will be even greater; we suspect that the company is burning cash like nobody's business. And we're wondering whether a liquidation of the US side of the business is out of the question given all of the "missed opportunities." 

For now, what we KNOW is that - through no fault of its own - Alix' assessment is incomplete. The fine folks over there may want to amend their report after we hear more from Toys R Us in coming days. 

**********

By extension of the above - and now is as good a time as any to remind you that nothing we write should be construed as investment advice - we'd think it's also safe to assume that this Bloomberg piece about efforts by Hasbro Inc. ($HAS) and Mattel Inc. ($MAT) to innovate is, maybe, a wee bit too rosy. While, yes, they may be pivoting towards mobile and less dependence on brick-and-mortar, how many times have we heard that a transition is slower and harder than anticipated? That excuse is cited in virtually every retail "First Day Declaration" of the past two years. We don't have high hopes for Q4 reports (Mattel supposedly reports Q4 earnings on 2/1 followed by Hasbro on 2/7). Along those lines, Meisheng Cultural Co. may want to wait and see what happens to Jakks Pacific's ($JAKK) numbers before it overpays. 

One last related note: Sphero, the Disney-backed ($DIS) maker of STEM toys like a robotic BB-8 that you can buy at...wait for it...TOYS R US, announced earlier this week that it was laying off 45 staff members globally "following a holiday season that failed to live up to expectations." Curious. Maybe it was too dependent upon a certain big box toy retailer? 

Long "Peloton and Chill"?

GoPro Inc. ($GPRO), as we previously noted, is the poster child for the “hardware is hard” narrative. Look at this chart:

It’s brutal. Of course, there are obvious exceptions to the narrative. Apple($AAPL), for instance. Take a look at this chart:

Apple’s hardware division feeds a services division of other software products that grew 34% in 2017 and generated $34b. That’s massive. And that’s what makes Apple so special: it crushes margins and revenue on its hardware and tags on services revenue for good measure. It’s obvious, then, why Apple is marching towards a $1 trillion market capitalization.

Elsewhere in hardware, Peloton made big waves recently at the Consumer Electronics Show after it unveiled its $3,995 Peloton Tread, a new connected treadmill. It’s the first new Peloton product to market after its wildly popular and “cultish” $1,995 exercise bike came out a few years ago.And, no, those figures are not typos.

It is ironic that Peloton is expanding its product line right at the same time that GoPro is shrinking. Just a short time ago, GoPro’s growth prospects were predicated upon it moving away from pure hardware and pivoting towards “content” fed by an ever-expanding line of EXTREME new cameras and even EXTREMER drones. Fast forward a little more than a year and the new cameras are official flops, the drones are toast, and its content is nowhere to be found. Hardware is hard, sure, but pivoting into new (hardware) product and (expensive) content is too.

Meanwhile, Peloton ALSO maintains that it is more than just a hardware company; it is a hardware, software, media (read: content), and logistics company rolled into one. And, it seems, its gadgets are only a piece of the pie; its service is equally if not more important. Still, the core product, to date, has been the exercise bike. It is the vehicle for home-based live-streamed fitness workouts that cuts out the chafe of schlepping to the studio, sweating like a beast, showering, changing amidst strangers, and then walking back out into the cold to commute home. For this luxury, people pay handsomely. The numbers bear this out.

The company reported $170mm in sales in 2016 and $400mm in sales in 2017. In additional to the lofty hardware cost, people pay $39/month for the monthly service — just a little over the cost of one SoulCycle class. This monthly recurring revenue helps to offset the company’s breakeven cost on the hardware. Indeed, hardware is hard. But it’s made easier with 600,000 reported subscribers, a 95% retention rate, and a 90+ “Net Promoter Score.”Meanwhile, Peloton has funded its R&D with $450mm of venture capital at a valuation of $1.25 billion — the latest Series E round arranged by JPMorgan ($JPM)(as they make PAINFULLY clear in this video) and participated in by NBCUniversal, Fidelity Investments, and Kleiner Perkins Caufield & Byers, among others. Some suspect an IPO is near. Others — like Tristan Walker — suspect a sale (to Nike?). After all, Peloton is causing people to cancel their gym memberships. And sparking Twitter debates. And none of this really even speaks to the revenue to be generated from a hardware-independent app, branded apparel, and data.

Right, the data. Peloton founders make a point of saying that they WANT you to work out. Think about the difference between that and a gym. A gym doesn’t give a rat’s a$$ whether you use that membership. They just want you to sign up; they know that once they have you, they’ve got you because that membership is sticky AF. In fact, the LESS you go, the better…? That’s less maintenance at the location. Fewer towels to wash. Longer-lasting Kiehl’s product. And so forth. In contrast, Peloton is the best guilt-inducing machine on the planet; it sits right in your living room. With a (relatively) low monthly nut, it just sits there encouraging you to hop on and give it a whirl. Each time that you do, Peloton captures your data. The data makes Peloton a lot like Netflix. It can produce content based on what its users are doing. It has health specs now on 600,000 users. Do most gyms have content geared towards AND health data on you?

Peloton can also make its instructors stars in a way that Netflix can provide Gaten Matarazzo the opportunity to be in literally every commercial on TV. Distribution. Teach a few classes at Equinox a week to 100 riders, in the aggregate, or put yourself on Peloton’s platform and broadcast to 600k. And get paid more to boot. As “celebrity” instructors flock to Peloton, won’t that just juice the network effects further and encourage EVEN MORE people to flock to its platform? And with the treadmill, 51k future NYC marathoners can now get marathon coaching too. So, add a huge running community to the mix.

The disruptive implications of Peloton’s incursion into your home are immense. Look at the way they market: get up and ride before the kids even need breakfast. Who needs to deal with a gym membership when you can do THAT? Note, also, how the Tread is being billed as more than just a treadmill. The video demonstrates people getting off the apparatus, on to the floor for some weights, and back on the Tread. After a while, Peloton will no doubt distribute streaming videos from star trainers without the need for you to even hop on a multi-thousand dollar machine.

---

A few weeks ago, Hollywood released its numbers and they were ugly. Revenues down. Attendance down. Netflix ($NFLX), meanwhile, reported numbers on Monday and, with its addition of millions of subscribers, blew everyone away (and ascended into the $100b market cap stratosphere). In summary, millions more people opted to watch content at home YOY while millions of people opted to view fewer movies in the theater YOY. Now take a look at this third chart:

Now, what happens if Peloton owns home fitness like Netflix owns home entertainment? How does Equinox/SoulCycle do? New York Sports Club? Private-equity owned 24 Hour Fitness? Consider this: Dwayne Johnson has 318k Instagram followers. Half of his posts are photos and videos of him working out. How hasn’t Peloton nailed down a partnership with him? If people will watch other people play videogames on Amazon’s Twitch, and people will stream instructed classes on Peloton, there’s no doubt that they’d watch and mimic the Rock working out. Or Hugh Jackman beefing up to become Wolverine. Or Tom Hardy becoming Bane. Or Gerard Butler jacking up for 300. How hasn’t this happened yet? The sky is the limit.

Others have noticed. Namely, SoulCycle. It filed its S-1 years ago but, for now at least, still remains private. That is indicative of something, isn’t it? But, it, too, is evolving — in this case with different style classes. As is Classpass, which recently introduced ClassPass Live, live-streaming classes for home bodies. And, finally, Fitbit ($FIT), which continues to try anything to remain relevant. It is launching its partnership with Xbox One, making it easier for users to work out at home with its Coach training service. Clearly a number of players have identified the home as the next frontier in fitness. But Peloton may just have a very solid head start.

But here’s the thing: as readers read on Sunday, Guggenheim predicts a recession in late ’19 or early ’20. What happens when that downturn ultimately occurs? When disposable income and consumer confidence both go down? Who gets beat up more — Peloton or, say, SoulCycle? What happens to Peloton and its expensive hardware then? Do people start cancelling their monthly subscriptions? Alternatively, do people quit SoulCycle and migrate towards Peloton on the (arguable) basis that it’s a stronger value for the money? Or is Peloton’s customer demographic — seemingly the 1% — immune to a downturn? What happens, though, if the venture capital dries up? The company has had a tremendous amount of success but is it just a product of a frothy time? These are all important questions.

For now, though, the wind seems to be at Peloton’s back. And more conventional fitness players ought to be concerned. Just like with entertainment and Netflix, the fitness home invasion is happening. And there’ll be winners and losers.

---

PETITION is a digital media company focused on disruption from the vantage point of the disrupted. We have a kick-a$$ weekly newsletter. You can subscribe HERE and follow us on Twitter HERE.

Is New York City F*cked? Part II.

We previously expressed our concern about the New York City Mayor Bill de Blasio's plan for tackling disruption. The gist was that the Mayor's budget fails to take into account the effect of Uber and Lyft on taxi medallion values. To add insult to injury, this American Council for Capital Formation report makes it sound like the City's pension funds are being managed in a way that would make even Bill Ackman look good. Choice quote: "The performance of the New York City Pension Funds over the past decade has not kept pace with what is needed to stay solvent over the long term. Unfortunately, even conservative estimates project unfunded liabilities to be in excess of $56 billion. It is therefore extremely concerning that managers are spending dwindling resources on investments that are socially or politically motivated, rather than based on performance." The report paints a pretty gnarly picture of how New York City Comptroller Scott Stringer has handled pensions, notwithstanding the funds' recent market-based improvement. Distressed investing fans will particularly love this bit: "For example, the New York City pension funds paid $2.1 million in fees to Perry Capital in fiscal 2016, and had $129 million invested in the firm when it shut down its flagship fund in September 2016 after losing money for three consecutive years. The cumulative return of the city’s pension funds’ investments in Perry Capital inception to date was -14 percent, as of September 2016." Riiiiiiiight. 

As we said before, color us concerned.

Is New York City F*cked?

Uber, Lyft, and Political Incompetence: Mayor de Blasio Needs to Get it Together

Maybe New York City Mayor Bill de Blasio ought to subscribe to PETITION. He clearly doesn’t grasp disruption. And other elected officials are calling him out on it.

Just recently, Thomas DiNapoli, State Comptroller, released his “Review of the Financial Plan of the City of New York”. Buried within the document is a subtle rebuke of the de Blasio administration’s failure to acknowledge any semblance of reality. Here are some key highlights:

• The November (Financial) Plan covers a four-year financial plan from 2018–2021. That plan projects a budget gap of $7.1b, a number dismissed as “relatively small as a share of City fund revenues (averaging 3.5 percent).” The gap has tightened in large part due to pension fund over-performance. PETITION Note: Hmmm. Query how long that will last.
• NYC’s economy has expanded more than at any time since WWII. But job growth is slowing and may slow more given federal tax policies.
• The FY 2019 budget gap estimate was increased by $360mm to $4.4b because “tax receipts have fallen short of expectations.” “Despite the strength of the City’s economy, non-property tax collections have underperformed. For example, the City had assumed that business tax collections would increase by 9.1 percent in FY 2018, but collections declined instead by 8.9 percent during the first four months of the fiscal year (after declining for two consecutive years). Although the City lowered its forecast by $240 million in FY 2018, the out-year forecasts were left unchanged.” PETITION Note: read that last line again!
• The Plan anticipates $8.3b of federal funding in FY 2018, accounting for 10% of the City budget. PETITION Note: Right. We’ll see. There is obviously a real question whether the federal government may be counted on to fund the City at the same levels. And federal taxes and home ownership costs are obviously expected to increase for many City residents. “Changes in federal fiscal policies, however, constitute the greatest risk to the City since the Great Recession.”

And then our favorite bit:

• The City has 1650 taxi medallions to sell but has postponed sales since 2014 with the express acknowledgement that ride-sharing companies like Lyft and Uber are affecting medallion values. “The average sale price for a taxi medallion peaked at $1 million in calendar year 2014, but it was nearly cut in half by 2016. Weakness in market conditions has continued, with the average sale price declining in 2017 to $350,000 as of November 2017.” And, YET, the November Plan assumes the 1650 medallions will be sold at an average price of $728k.

Wait, what? Just last week, First Jersey Credit Union reportedly auctioned off six NYC taxi medallions for a high bid of $186k. And then on Tuesday January 16, five medallions were sold for a total of $875,000. Two additional medallions sold for $189k and $199k, respectively. To quote the previously linked Crain’s New York piece, “When a taxi medallion sold for $241,000 last March, the seemingly rock-bottom price made major news. It turns out, those were the good old days.” And then there is this, “One industry veteran said the auction prices are low, relatively speaking, because these are cash deals at a time when banks are not lending for medallion purchases.” Right, because the banks know that medallions make for crappy collateral and have zero desire to try and catch those falling knives. These are just the latest in a recent trend of distressed medallion sales — many of which have taken place in the bankruptcy courts. This stuff is public information. We’d think that Mayor de Blasio and his administration would be aware of it. Apparently not.

Here’s the problem: either through ignorance (it’s not like others haven’t noticed) or wishful thinking (that, what, Uber AND Lyft will FAIL?), the administration is budgeting on the basis of medallion sales that may never happen. And, even if they do, they are unlikely to fetch the value projected. Per DiNapoli, this error leaves an estimated $731mm shortfall in the budget. This is an astounding level of cluelessness. Even for a politician.

More importantly, if the de Blasio administration can’t see what is occurring right in front of them, how is it to be counted on to address bigger issues coming soon? Like autonomous cars, for instance? “‘Autonomous vehicles will have a significant and fundamental effect on cities and how they’re laid out’”. Color us concerned. If you live in New York, you should be too.

---

PETITION is a digital media company focused on disruption from the vantage point of the disrupted. We have a kick-a$$ weekly newsletter. You can subscribe HERE and follow us on Twitter HERE.

Elizabeth Warren vs. the Bankruptcy Bar

A Reminder That Disruption Takes on Many Forms

PETITION is, broadly speaking, a newsletter about disruption. As loyal readers have surely noticed, the predominant emphasis, to date, has been tech-based disruption. But, spoiler alert, there are other forms. Earlier this week, Senators Elizabeth Warren and John Cornyn proposed a bill that swiftly reminded a cohort of (mostly Delaware) legal professionals that legislation, if passed, can be an even more immediate, powerful and jarring form of disruption.

Let’s take a step back. Shortly before Christmas, the Commercial Law League of America (CLLA) indicated that the U.S. Senate should consider a new bankruptcy venue reform bill. The gist of the proposal is that a debtor should have to file for bankruptcy in its principal place of business (or where their principal executive offices reside) - as opposed to, as things currently stand, its state of incorporation (the "Inc Rule"), where an affiliate is located (the "Affiliate Rule"), or where a significant asset is located (the "Abracadabra Rule"). Notably, a large percentage of companies are incorporated in Delaware, a state with well-established and well-developed corporate laws and legal precedent. Consequently, thanks to the "Inc Rule," Delaware is typically the most sought after venue by debtors, perennially topping annual lists with the most bankruptcy filings. In other words, the state of Delaware is the biggest beneficiary of the status quo. 

Putting aside the Inc Rule for a moment, the “Affiliate Rule” and “Abracadabra Rule,” respectively, have provided debtor companies with wide and crafty latitude to file in jurisdictions other than that of their principal place of business. Again, typically Delaware (and then, to a lesser extent, New York). Have a non-operating subsidiary formed in Delaware? Venue, check on the "Affiliate Rule." Got a random (unoccupied) office you set up last week in a WeWork in Manhattan? POOF, venue! Check on the "Abracadabra Rule." Got a bank account set up (a week ago) with JPMorgan Chase Bank in New York? Venue, again check on the "Abracadabra Rule". It is, seemingly, THAT optional. All of this is like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, General Motors ($GM) should file for bankruptcy in New York rather than Michigan. Oh, wait. That actually happened. Take two: that’s like saying that despite the entire automobile industry being manufactured, headquartered and principally-based in Detroit, Chrysler should file for bankruptcy in New York rather than Michigan. Damn. That also happened. Ok, here’s a good one: that’d be like saying it’s okay for the Los Angeles Dodgers to file for bankruptcy in Delaware rather than California. Wait, SERIOUSLY!?!? WTF. Who is to blame for this outrage? 

We'll keep this simple, lest this become a treatise absolutely nobody will want to read: federalism. Bankruptcy law is federal but every state has their own courts, circuit courts, and legal precedent. Some states have bankruptcy courts that are historically more favorable to debtors (cough, Delaware...need that incorporation business) - which, speaking commercially and realistically - are de facto clients of the state. Currently, debtors typically choose the venue so if you want to drive debtors to your courthouse steps, favorable corporate and debtor-favorable bankruptcy case precedent goes a long way towards filling court calendars. Not to mention hotels. In this regard, the bankruptcy court isn't all too dissimilar from a large tech company. Go fast and furious to market, aggregate a ton of users (here: debtors), acquire talent (read: judges), and build a database full of information (read: precedent) to then use against everyone else who tries to compete with you. That aggregation is the moat, the competitive advantage. Say, "we're the most sophisticated due to our talent, data, and predictability" and win. Boom. Dial up the Hotel Du Pont please!  

As a consequence of federalism, one jurisdiction's "makewhole provision" enriching bondholders is another jurisdiction's "no recovery for you" enraging bondholders. One jurisdiction's "restructuring support agreement" is another jurisdiction's "meaningless bound-to-be-blownup-worthless-piece-of-paper." That's the beauty of venue selection, currently. The system allows debtors to choose based on that precedent. Ask any of your biglaw buddies about "venue analysis" and watch their eyes roll into the back of their heads. That is, if you're even still reading this. They've all had to do it. It's a big part of the filing calculus. And everyone knows it. 

Enter Senators Warren and Cornyn. They're saying, "No way, Jose. This sh*t needs to stop." Okay, they didn't say that, exactly, but Senator Warren did say this, "Workers, creditors, and consumers lose when corporations manipulate the system to file for bankruptcy wherever they please. I’m glad to work with Senator Cornyn to prevent big companies from cherry-picking courts that they think will rule in their favor and to crack down on this corporate abuse of our nation’s bankruptcy laws.” The argument goes that the bill “'will strengthen the integrity of the bankruptcy system and build public confidence' by availing companies, small businesses, retirees, creditors and consumers of their home court." Ruh roh. 

A few years ago, a heavy hitter lineup of restructuring professionals were asked by The Wall Street Journal what they thought about this venue debate. The general upshot was "nothing to see here." With apologies for the paywall attached to the following links, you'll get the general idea. See, e.g., "the myth of forum shopping." See, also, "venue reform is a solution in search of a problem."; 
“allowing fiduciaries to exercise their business judgment about what filing location might maximize enterprise value or reduce execution risk or both.”; “If it ain’t broke, don’t fix it.”; "the current status quo of wide venue choice – should win out.”; “It’s not clear that these rules are problematic, so don’t apply a fix with its own set of unintended consequences.”; “The truth is that venue provisions are very appropriate and do not need to be adjusted”; "Letting debtors choose as they can now is 'good business sense.'"; and "current venue requirements 'strike a fair balance.'” In summary, you've got Senators Warren and Cornyn up against a LARGE subset of the bankruptcy bar. And those aren't all Delaware practitioners. That's a cross-section of the entire bar - with some financial advisors and investment bankers thrown in for good measure. Pop us some popcorn.

Now, we've been highlighting venue shenanigans since our inception. Not because it's wrong to leverage a favorable venue with uber-favorable precedent if you have that option; rather, because it has gotten so FRIKKEN OBVIOUS. Clearly an industry with $1750/hour billing rates isn't known for its subtlety. Want a third-party release to shield the private equity bros? St. Louis here we come! Have the opportunity to take advantage of a "rocket docket" and get those billable rates rubber stamped? Godspeed. Want to issue a "Standing Order" to divert bankruptcy traffic (back) into your court? May the Force be with you. 

That last bit is particularly notable. Venue gaming got so blatant that even the courts got in to the game. That "Standing Order" is as patent an acknowledgement of venue manipulation as anything we've seen of late. Why did this happen? Take a look at the case trends. After a few early (small) oil and gas exploration and production companies (E&P) filed in Texas and things, uh, didn't go particularly well for professionals, a deluge of E&P debtors mysteriously started popping up in Delaware. That's basic cause and effect. The subsequent cascading secondary effect was the "Standing Order" which, in response, guaranteed professionals that they'd get one of two judges and that, effectively, the Texas courts were open for business. Once that Order came out, debtor traffic curiously reverted back to Texas. E&P management teams and creditors could be heard in their home jurisdiction. Local firms could become "local counsel." Delaware counsel's loss was Texas counsels' gain. (If only the same could be said for lead counsel). Naturally, then, both the Texas Bankruptcy Bar Association and Texas Hotel & Lodging Association back the proposed bill: it basically fortifies the Standing Order. Also, guess where Senator Cornyn is from? Alexa, please cancel that Hotel Dupont reservation. 

We're not taking a position in this debate. We have no skin in that game. But we can't help but to chuckle at the timing. Ironically, it seems that more and more debtors are filing near their principal place of business rather than Delaware anyway (cough, third party releases!). See, e.g., Toys R Us, rue21, Payless Shoesource. And so this has the potential to reinforce a recent trend and compound the issues that have already surfaced for Delaware professionals. 

This is nerdy sh*t. But it’s still big deal disruption. Just disproportionately for the Delaware bar and the city of Wilmington. It’s so big that even iHeartRadio released a podcast discussing it. Without irony. Dramatic disruption AND comedy. 

Who knew bankruptcy could be so entertaining?

The Quill decision (Short Wayfair)

You'll recall that, in September, we wrote about the disparity that exists in e-commerce taxation. In summary, e-commerce players have been able to avoid state taxation because of a lack of "physical presence." As we pointed out, Amazon ($AMZN) benefitted from this for years - at least until it decided that it wanted to conquer the "last mile." Did this help spark the #retailapocalypse? You betcha. But South Dakotans - all 3 of them - don't like to be effed with and so they're back in South Dakota v. Wayfair for a second bite at the apple in the Supreme Court. You legal bro-dorks may want to dust off your Commerce Clause know-how. This hyperbolic piece describes what's at stake, arguing that the SC's previous Quill decision ought to be fixed to accommodate technology and disruption. The briefers write, "Four negative effects of the physical presence requirement merit emphasis. First, the physical presence rule poses a much more serious threat to the fiscal stability of state and local governments than the Quill Court could have anticipated. Second, the rule results in economically inefficient consumption choices to an extent that the Quill Court could not have foreseen. Third, the physical presence rule distorts firms’ decisions about production, distribution, and corporate structure in ways that perversely discourage businesses from expanding across state lines. Fourth and finally, the physical presence rule likely raises the aggregate cost to consumers and businesses of complying with state sales and use tax laws." No wonder Overstock ($OSTK), which is also implicated, is shifting from e-commerce to bitcoin. 

Entertainment 3.0 (Short Hollywood, Long Subsidized Data Plays & Will Smith?)

More Data = More Crap Like "Bright" 

We've addressed algorithmic-based books and music, we might as well triple-down with movies. It's well known by now that Netflix ($NFLX) and Amazon ($AMZN) are using their respective data sets to develop new original projects. This circumvents the otherwise costly endeavor of licensing deals for outside content which, naturally, is fragmented in such a way that is costly to Netlfix/Amazon and frictionful in certain respects for the end user. Why is some content available internationally while other content is not? Why is certain content downloadable but other isn't? All of that has to do with "rights" for licensable content. 

This is precisely why we get "Bright," the new Will Smith vehicle that "feels like it was produced by an algorithm to fit in as many genres as possible (crime, fantasy, cops, etc.)." Netflix has said that 11mm people watched the movie in the first three days of release. At an average movie price of $8.90/ticket, that's the equivalent of nearly $98mm in revenue in three days. A sequel has been green-lit. This movie was an experiment dripping with data-based motivation and it seems to have worked. What does this portend for Hollywood?

Oh, Hollywood. This week we also learned that moviegoing has fallen to its lowest rate in a generation: theater admissions fell nearly 6% in 2017.  Choice quote, “'The industry should be concerned if the metric falls again in 2018,' said Geetha Ranganathan, a Bloomberg Intelligence analyst. 'Especially with a stronger film slate for this year, fewer moviegoers would be a warning sign that the industry may be in secular decline.'” Ruh Roh. 

And so should we really be surprised that there's a company out there now attempting to exploit data relating to Hollywood-produced theatrically-released movies? Enter Moviepass, a subscription-based business that lets movie-goers go to an unlimited amount of movies per month for only $9.95/month (subject to a one movie in 24 hours restriction). The movie theaters are like, "What the hell?" but consumers are like, "Sign me up!" 1 million of them. The movie theaters are like, "That's our data!" and Moviepass is like, "We don't care, go fly a kite home-slice." 

This Tren Griffin piece does a deep dive into the Moviepass business and leaves much to unpack. The piece is long but it provides some real insights into the movie theater business and the numbers are bleak. For theaters. For Moviepass. For basically everyone other than the moviegoers who ought to enjoy the Moviepass-subsidized movie-going while it lasts. And that probably includes malls - many of which are betting their futures on moviegoers seeking the moviegoing "experience." 

All of which would explain the recent waive of consolidation. In the past month alone, Cineworld Group Plc agreed to buy #2 U.S. movie chain Regal Entertainment Group for $3.6 billion. And Walt Disney Co. ($DIS) awaits approval of its proposed $52.4b acquisition of 21st Century Fox Inc., including the company’s movie studio. Content is king right now. It helps drive more data for more content. Yes, this is becoming very circular. 

And so back to Will Smith. Rumor has it that the actor famously performed a data-based analysis to determine how he could best catapult himself to stardom. Then came Independence Day. And Men in Black. Those movies weren't luck: they were strategy. Which is to say that if streamers are all about data, and Hollywood is (now) all about data, and actors are all about data, consumers probably ought to get used to movies like Bright. 

Is Spotify Ultimately the Death of Music?

Spotify Made Liam Gallagher Make His Own Coffee. That's Bad. 

Source: Pexels.com

It’s 2018 and that means that, unless side-tracked by $1.6b litigation, Spotify’s “direct listing” is imminent, marking the company’s latest foray screwing over (read: disrupting) professionals who endeavor to make money. No, we don’t have much sympathy for the bankers who will lose out on rich underwriting fees. If anything, the blown IPOs for Snapchat ($SNAP) and Blue Apron ($APRN) kinda made the direct listing alternative a fait accompli. Now the market will be watching with great interest to see how the stock does without the various IPO-related safeguards in place. 

The real professionals on the short end of Spotify's stick, however, aren’t the bankers but may just be the artists themselves. Recall this video from Liam Gallagher. Recall this chart highlighting the juxtaposition between digital and physical sales. But that's not all, there's this piece: it stands for the proposition that Spotify really ought to go f*ck itself. Indeed, "To understand the danger Spotify poses to the music industry—and to music itself—you first have to dig beneath the “user experience” and examine its algorithmic schemes. Spotify’s front page “Browse” screen presents a classic illusion of choice, a stream of genre and mood playlists, charts, new releases, and now podcasts and video. It all appears limitless, a function of the platform’s infinite supply, but in reality it is tightly controlled by Spotify’s staff and dictated by the interests of major labels, brands, and other cash-rich businesses who have gamed the system." To point, Spotify has perfected "the automation of selling out. Only it subtracts the part where artists get paid." There is so much to this piece. 

And then there is this piece - from a musician - which really puts things in perspective, as far as second order effects go. One choice quote (among many in this must read piece), “As a dad seeing my kids fall for an indistinguishable blob of well-coiffed brandoid bands and Disney graduates, I’m not at all shocked that amid their many fast-germinating aesthetic and creative ambitions, my own offspring have never seriously taken it into their heads to pick up an instrument or start a band. The craft of music has entirely succumbed to its marketed spectacle.” 

Against this backdrop, the distressed state of Gibson Brands Inc. and Guitar Center Inc.makes more sense. Here is Gibson Brands:

Given these disturbing downward trends, it's no wonder that Jefferies is working with the company to address the company's balance sheet and that Alvarez & Marsal LLC is helping streamline costs on the operational side. Indeed, last quarter the company negotiated some amendments (EBITDA, for one) with its lender, GSO, and even more recently negotiated, per reports, an extension of time to report financials to GSO. We can't wait to get our hands on those.

Guitar Center Inc., meanwhile, reported pre-holiday YOY increases in top and bottom line numbers, including a 1.3% increase in same store sales. Which surprised basically everyone. They have yet to release holiday numbers. They did, however, get a nice downgrade leading into Christmas. And there are debt exchanges to come in '18 for the company to manage an over-levered balance sheet unsustained by recent revenues.

Remember, Spotify did all of this with the help of $1b in venture debt (and NYC taxpayer subsidies, but we digress). Which, unless something has changed, is a ticking timebomb getting more expensive with each quarter the company fails to go public. 

Lest anyone fail to appreciate the growth trajectory of Spotify, there's the chart below to put it in perspective. 

One last note here. A few weeks ago Josh Brown wrote a piece entitled, "Just own the damn robots." If you haven't read it, we recommend that you do. The upshot of it is that the massive stock moves of the FANG stocks and other tech stocks are rooted in people's fear of being automated out of relevance. 

In that vein, maybe Spotify's imminent listing is the BEST thing that could possibly happen to creatives. Get a significant part of the company out of Daniel Ek's hands, out of the hands of the venture debt holders (assuming they have an equity kicker), and the venture capitalists. Get it in the hands of the artists themselves. Perhaps that way they can have SOME manner of control over their own commoditization. 

Entertainment (Short Book Stores, Long Myopic Groupthink & Algorithms)

Barnes & Noble May Follow Book World into Obsolescence

Book store sales are down 39% from a decade ago. Why? Well, avid PETITION readers know we love to discount the "Amazon Effect," generally, as most failed retail is more complicated and nuanced than that. Just ask the private equity bros. But books: that's a different story. Amazon ($AMZN) owns that sh*t. And so Book World, the nation's fourth largest physical book seller, is liquidating. And Barnes & Noble Inc. ($BKS) is slowly unraveling before our eyes. The book retailer reported holidays sales for the 9-week period ending 12/30/17 and MAN O' MAN were they crappy. Total sales were down 6.4%. At least they nailed e-commerce, right? Wrong. Online sales declined 4.5%. Comp store sales declined too, "primarily due to lower traffic." The book business declined 4.5%. And the stock collapsed 14+%. Ouch. Luckily there's some in-demand non-controversial political book out there that people are literally lining up to purchase. You know, that little one about @realdonaldtrump. Hopefully they can capitalize on that. 

Ironically, of course, Amazon has launched 15 physical book stores and they're a sight to behold. We checked in on one for the first time over the holidays and several things struck us. One, the footprint of the place was dramatically smaller than the typical, say, BKS, with reduced inventory to match. Two, the signage/placards emphasized the online reviews in lieu of prices. Third, most of the displays emphasized best sellers and wish list selections. You know, that old data play. There isn't much discovery there. Just a small selection of "popular" books force fed to the populace so that everyone can come to the very same conclusions from the very same books. Awesome.

Takeaways: Jamie Clarke, Live Out There

An Entrepreneur Seeks to Turn the Tables on Disruption

Source: Live Out There

Sometimes the disrupted need to become the disrupter.

If anyone can rebound from disruption, dust himself off, and get back on his feet ready for battle, we suppose it’s a man who has summited Mount Everest. Twice. And plans to again - wearing gear he designed and manufactured himself. Enter adventurer and serial entrepreneur, Jamie Clarke, the founder and CEO of a new direct-to-consumer (DTC) outdoor-wear brand, Live Out There.

Source: Live Out There

Several weeks ago Jamie received a deluge of press coverage after the launch of Live Out There (LOT). Most of the coverage – here (Fast Company), here (GearJunkie), and here (WWD), for example - was thematically similar, touting LOT’s (i) proposed radically-transparent production, (ii) get-people-off-their-phones-and-off-their-asses-into-the-outdoors mission, and (iii) DTC-powered lower price point. We’ll come back to all of that. There’s more to this story. To Jamie’s story. That is, Jamie, for better or for worse, is a manifestation of the retail apocalypse. His experience encapsulates many of the themes pervasive in retail today.

For 14 years prior to launching LOT, Jamie owned and operated the Out There Adventure Center, an 8000 square-foot brick-and-mortar retail location in downtown Calgary. The business featured apparel and equipment for the outdoor set; it was also an early attempt at the current retail-fad-of-the-moment: experiential retail. The Center had a warehouse in back with a theater space, a travel agent kiosk and hosted events; his business sought to engender community before “community” became a trite buzzword shamelessly used by everyone. Including us. 

All of this, however, simply wasn't enough to counteract today’s vicious retail reality. We discussed the notion of community, the #retailapocalypse, retail survival and more with Jamie. What follows are the highlights, edited for length and clarity. 

---------------------------------

PETITION: What’s interesting…is the experiential aspect of what you were trying to do. That’s the big deal right now and now everyone’s talking about experiential retail….

Jamie: We were in part, perhaps, ahead of our time or maybe that’s a convenient excuse to cover up that we didn’t execute property. I think maybe it’s a combination of both. That said, hosting events and having a travel agent among other things was a powerful way to really challenge the notion of retail. You’re not just here to buy things, you’re here to gain access to experiences.

PETITION: Give us some specifics…that contributed to the downfall of this brick and mortar location.

Jamie: We had big competitors who could negotiate with suppliers deeper discounts on their volume purchases which meant they could go on sale and still maintain margin. So we were constantly under margin pressure because the bigger players had better margin. Two, the transformation of late which ultimately began pounding the nails into our brick and mortar coffin was that our suppliers became competitors. Great companies that I admire and with whom we had worked for years wanted to go direct to consumer.

Here, Jamie is referring to the Arcterx, Northface and Icebreakers of the world.

PETITION: Did they offer experiential retail?

Jamie: Not to the degree that we were striving but they merchandize their stores beautifully. They were doing retail well in that old sense of retail. They looked nice. They were well lit. All the rest.

PETITION: Did you have e-commerce at all?

Jamie: We launched e-commerce seven years ago. So we were in our eighth year. As a small operator we had a hard time scaling that experience.

PETITION: Did you also have the burden of an onerous lease that you could no longer justify from a revenue perspective?

Jamie: Have you suck in behind the scenes to read my lease agreement? Yes. The number one item that made our business untenable was that you had that market pressure. There are lots of levers as entrepreneurs. You know you can manage expense. You can shift promotion. You can change the way you staff the floor. You can even change the way you buy. But every month you run this monstrous nut for a chunk of rent. Its unavoidable and it ultimately rose as a percentage of revenue. And it was untenable for us.

And so Jamie shut the doors on June 9, 2017.

Jamie: I tell you it was heartbreaking. It was definitely devastating financially. Personally.

PETITION: Is there anyone in that space now?

Jamie: Empty. I think they’re going to struggle to fill it. The landlord wants a big national with a good covenant. You’re going to have another big brand go in there and the little guy is gone.

PETITION: So you closed the brick and mortar and you got rid of those partners. You're embracing your brand as your core competency. Now you're going direct to consumer. Talk to us about the decision making process on going DTC.

Jamie: The whole partner-slash-competitor issue escalated and that’s when we had to do a monstrous pivot and really challenge the industry and make that shift from being the disrupted to the disruptor. Do we want to continue being the victim? Do we want to continue being part of the problem here which is markup and middlemen or do we want to shift our business? Do we have the courage to be part of the solution even though doing that is filled with so much unknown? And it's entirely a shift in retail and we came to that conclusion in part by desperation because we had no other choice.

We've always known that outdoor is beyond reach for many many many people. We could see it when things go on sale how quickly our revenue would jump when we put a discount. And not just hungry people looking for deals. It was because a lot of people just couldn't afford it. And couple that with our investigation we began to realize that elevated price was the issue. For instance, a down hooded jacket on the market for $329. When we began to dig in there we found that those jackets are being built for say $80. What? An $80 jacket being sold for $329? What's going on here? And that's when we realized...we are the problem. We’re the middle. We're the retailer in the middle and that jacket gets sold to us for $150. We mark it up by $150 and then sell it for $329.

It's not working. It's failing the customer.  Failing people who are sitting on the couch not getting outside doing stuff. That's when we found the courage to say we know gear. We can make our own. We'll go direct to consumer. We'll take that markup out of the antiquated distribution model. And here's the kind of radical transparency that we're challenging industry with. We need to put more money into the materials so that the environment is protected. So that working conditions are improved. We need more money in the manufacturing process. Not negotiating with those manufacturers or the mill to grind them on price. We need to actually put more money into the making of those jackets so that people are paid well. So the air conditioning gets turned on. So the maternity leave is instated. All the things that are reasonable working conditions to improve manufacturing. We need to be more transparent, need to share what's going on. And that was the disruption piece. This may not work. We may go down in a barrel or ball of flames but we're going to go down swinging. This is what needs to be done.

We're proposing to pay more money for manufacturing of our product than our competitors. And in part that is a scale issue. They're just making tens of thousands of jackets and we're making hundreds. So through that alone we're paying more. Plus I'm trying to ensure that we put the best material in our product. The savings that we have on our price point is purely on the distribution side not on the manufacturing side. I got to make stuff equal to or better than the most in the market primarily because I get to use and I want to make sure it works.

PETITION: Who are your models for DTC?

Jamie: Everlane is a company in the states that is DTC and transparent. They're in the fashion industry. But we have marveled at what they were doing and the courage it took to do it and felt that that was something that we should do. There’s a company in the States called Kuju. They make high altitude hunting apparel. Clearly Contacts.

PETITION: What’s your reaction to the fact that Everlane just opened up brick and mortar store in New York City?

Jamie: For me our long-term vision will be to return to where we were 15 years ago: to create a physical space that is an experience of the brand.

PETITION: So, basically you’re going to go that direct to consumer digitally native vertical brand route like others have recently. Everlane is a great example. Away would be another good example. Warby Parker. Get the community. Get the brand recognition. Get the following. Build the brand, And then reengage in the brick and mortar for purposes of scaling further. That is that a fair synopsis of what you're thinking?

Jamie: Yes, yes exactly. I want to do what we couldn’t do originally. I want to do a smarter more efficient store, not in the old school way. We won’t carry inventory in the back. It would be more about the experience, more about a meeting place. Smaller stores. Strategically placed. And not just ‘ol New York’s a great place and need to show up there because it’s good PR.’ Use data and information. Where are our customers? Where does it make sense? It might make sense for us to be in Boulder more than downtown New York. It might make sense for us to be in Chicago or Kingston Ontario.

PETITION: Well it also sound like there’s also an aspirational element here. Our readership may be in conference rooms 15-18 hours a day. Aside from saying its a better product, you're saying 'this is attached to me. If it's good enough for me it's definitely good enough for you.' 

Jamie: Yes. It sounds ego-maniacal and I’m always concerned about that. But as a consumer I want to identify with the people of a company. The soul of the company. Not a spokesperson because those can be hired. I will never abandon that personal and intimate connection to what we make, why we make it, and how we make it, and for whom. And I believe that matters.

PETITION: Why haven't you gone the blog/Wirecutter route to review gear and used your mountaineering expertise to drive affiliate revenue?

Jamie. It’s on the list for sure, but we’re a small team scaling up slowly. Between outside workouts and time with family we are slammed 7 days per week right now. 

PETITION: Considering your experience as the disrupted, what advice would you have for other entrepreneurs in the consumer products space?

Jamie. Be clear on your unique offering. If you’re not offering different value—you’re dead. 

PETITION: Why not crowdfund LOT gear leveraging your own personal story to get pre-orders and drive demand?

Jamie. That’s in the works for an upcoming piece of gear.

PETITION: We've seen a tremendous amount of distress in retail obviously. But even more specific than that is the sporting goods segment of retail. Sports Authority. Eastern Outfitters. Ski Chalet. Bob's Stores. Michigan Sporting Goods. Gander Mountain. There have been a number of these retailers who have gone bankrupt and or liquidated maybe some of them have managed to maintain a little bit of a footprint here and there or maybe they maintain some sort of e-commerce business post-bankruptcy but a number of them have just disappeared. What's your thought on that state of affairs?

Jamie: Well there is a there is a retail revolution afoot and with the revolution comes blood and pain and death and those are some of the victims. My brick and mortar store was one of them. And that's not just the outdoor industry, that's retail as a whole. There's a transformation afoot. But the adventurer in me which beats the same heart as the entrepreneur believe those who can endure this storm will come out stronger and smarter and better and ultimately the customer will benefit. It's long overdue; it needed to happen. It needs to change. There is the digitization of the industry afoot for certain and retail has been slow to catch up. But that time is here and there will be pain. And so be it. That's where the growth comes.

You know to be lazy is to say 'oh well you know Amazon is destroying retail.' There's a lot more going on. A lot of very interesting story lines. And lots of opportunity....

Automotive (Short the B2B Business Model)

More Signs of Upcoming Auto-Related Distress

Assuming Uber Technologies Inc. can survive its latest self-imposed issues, e.g., an unreported data breach, increased regulatory scrutiny, skittish investors in Softbank and Benchmark Capital, etc.,, it appears to be positioning itself and the automobile industry towards a brand new business model. This week Uber announced its (non-binding) agreement to purchase 24k sport utility vehicles from Volvo Cars to seed a fleet of autonomous cars. Deployment date: 2019. Yes, 2019. Anyway, in addition to the obvious and previously discussed implications for labor, this move might have bigger ramifications: a forced pivot of the automotive business model in the direction of the airline model.

What do we mean by that? Assuming a great many things (including Uber's ability to successfully deploy its sensors and software with Volvo's hardware, regulatory hurdles, etc.), this could be another blow to the model of individual car ownership, the B2C formula deployed by the OEMs for years. Hyperbole? Maybe, but if people stop buying cars (and borrow money to do so), auto companies will see significant revenue effects. And they'd have to sell more to fleet operators, i.e., Uber, Lyft, etc., much like Boeing ($BA) and Airbus ($AIR) sell to Delta ($DAL), United Airlines ($UA), etc. This could mean fewer cars on the road, all told. Which, as we've previously discussed here and here, could lead to increased pain in the auto supply chain. 

Elsewhere in auto, the Faraday Future dumpster fire is turning into a full-fledged conflagration and looks like a ripe candidate to be voluntaried into bankruptcy.

And, finally, we noted back in February that 3D-printing could have a big impact on a number of industries. Now, apparently, 3D printing is projected to have a spike in activity in 2018. Businesses sourcing it most? Manufacturing, telecom, defense, and, of course, auto. To point, Divergent 3D just raised $65mm Series B financing round to build its car frame business. Curious.

Is Digital Media in Trouble?

Don't Sleep on Digital Media "Distress"

Last week we announced that we'll be rolling out our Founding Member subscription program in early '18. The response was overwhelmingly positive with many of you reaching out and essentially saying "what took you so long." That warmed our heart: thank you! We look forward to educating and entertaining you well into the future. The timing fortuitously dovetails into a general narrative about the state of digital media today. 

For instance, is it fair to characterize Mashable as a distressed asset sale? Well, the company - once valued at $250mm - is reportedly being sold to Ziff Davis, the digital media arm of J2 Global Inc., for just $50mm. So, what happened? New capital for media companies has dried up (unless, apparently, you're Axios) amidst weakness in the ad-based business model. With Google ($GOOGL) and Facebook ($FB) dominating ads to the point where even Twitter ($TWTR) and Snapchat ($SNAP) are having trouble competing, digital media brands are feeling the heat. Bloomberg highlights that at least a half dozen online media companies - from Defy Media (Screen Junkies, Made Man, Smosh) to Uproxx Media (BroBible) - are also considering sales to bigger platforms. Indeed, in an apparent attempt to de-risk, Univision is ALREADY reportedly trying to offload a stake in the Gawker sites it recently bought out of bankruptcy.

Which is not to say that bigger platforms are killing it too: the Wall Street Journal reported earlier this week that both Buzzfeed and Vice will miss internal revenue targets this year. Oath, which is Yahoo and AOL, binned 560 people this week. Of course, those in the distressed space know that one's pain is another's gain. To point, Bloomberg quotes Bryan Goldberg, founder of Bustle, saying "Small and more challenged digital media companies have been hit hard. This is a time for companies with cash flow and capital to start acquiring the more challenged digital assets." That sounds like the mindset of a distressed investor: the buyside and sellside TMT (telecom/media/technology) bankers must be licking their chops. Back to restructuring, these sorts of mandates may be decent consolation prizes for those professionals not lucky enough to be involved with the imminent bankruptcies of (MUCH larger and obviously different) media companies like Cumulus Media ($CMLS) and iHeartMedia Inc. ($IHRT), both of which are coming close to bankruptcy (footnote: click the iHeartMedia link and tell us that that headline isn't dangerous in the age of 280-characters!). For instance, Mode Media is an example of a digital media property that failed last year despite at one time having a "unicorn" valuation (based on $250mm in funding), a near IPO, and tens of thousands of users. It sold for "an undisclosed sum" (read: for parts) in an assignment for the benefit of creditors. Scout Media Inc. filed for bankruptcy in December of last year and sold in bankruptcy to an affiliate of CBS Corporation for approximately $9.5mm. Not big deals, obviously, but there are assets to be gained there. And fees to be made. 

In response, (some) digital media brands are looking more and more to subscribers and less and less to advertisers in an effort to survive. Longreads' "Member Drive," for example, drummed up $140,760 which, crucially, it'll use to pay writers for quality long-form content. Ben Thompson has turned Stratechery into a money-making subscription-only service; he told readers that they're funding his curiosity and their education. Indeed, his piece this past week on Stitch Fix ($SFIX) may have, in fact, impacted sentiment on the company's S-1 and, in turn, the company's IPO price. These are only two of many examples but, suffice it to say, the "Subscription Economy" is on the rise. 

Which is all to say that our path is clear. And we look forward to having you along for the ride. Please tell your friends and colleagues to subscribe TODAY: existing subscribers will get a preferential rate.

The US Postal Service Could Use Bankruptcy

The Mail-Carrier is a Financial Hot Mess

We here at PETITION use an e-newsletter as our primary source of direct communication with our readers. Non-subscribers can see some, but not all, of the same content on our website on a delayed basis. And of course we tweet on occasion too (follow us here). Once upon a time, however, this kind of messaging depended upon physical marketing mail. 

Not so much anymore. The U.S. Postal Service recently reportedly a deluge of negative numbers. In the nine months ended 6/30, first-class mail volume fell 4.1% YOY and marking mail volume declined 1.8%. Per the Wall Street Journal, "[T]he Postal Service's financial situation has continued to deteriorate. It has been hurt by the decline in first-class mail, its largest and most profitable business, as more communications shift online."  No. Sh*t. Sherlock. 

The situation is bad: the USPS has severely strained liquidity. The USPS reported a net loss of $2.1b for the fiscal third quarter, a nearly 25% loss YOY. It hasn't made payments to its retiree fund for five years (which basically means that retirees are financing operations) - skipping a $6.9b payment at the end of September. Retirees are owed $40b in total. Now the USPS seeks to increase the price of stamps and various shipping rates. But the Postal Regulatory Commission needs to approve such measures; it currently has a vacant Board of Governors that President Trumphasn't bothered to fill. Hard to think about the USPS during the middle of your latest golf round, we guess. #MAGA! 

Naturally, human capital costs are a big part of the problem. Decrease the high cost of employment - whether due to pensions, workers comp, wages, etc. - and this business may be more sustainable. This seems to be a pervasive theme for human capital businesses. This is why Uber, for instance, is so aggressively pursuing autonomous vehicles; it suffers from the same issue. 

And so what is the USPS looking into now to help promote economic efficiencies and curtail costs? Self-driving mail trucks, of course! A USPS-issued report notes that a semiautonomous prototype is in development now with a December delivery date (PETITION query: where the hell did the money come from?). As Wired reports, the idea is to have more efficient driving and fewer accidents, all the while allowing postal workers to perform other tasks in-truck rather than focusing on the driving 100% of the time. That way, no jobs are lost! Riiiiiiiiiiight. From Wired, "The report's authors insist they're not looking to dump human workers, and that AVs can help by trimming other costs. The agency paid about $67 million in repair and tort costs associated with vehicle crashes last year. It also shelled out $570 million for diesel fuel. If the robots perform as promised, making driving much safer and more efficient, those costs could plummet. If the USPS sticks with this plan, the jobs of the nation's 310,000 mail carriers could change, for better or worse. Once the vehicles do all the driving, the humans will be left with the sorting and the intricacies of the delivery process. Unless, of course, a robot can figure out how to do those too. And whatever the report says about protecting jobs, it's clear that the best way to cut down on employee health care costs is to cut down on employees."  Our sentiments exactly. 

Someone needs to reorganize this dumpster fire. And fast. But can the USPS even file for bankruptcy? We'll leave others to the analysis: here, Weil Gotshal & Manges LLP's Charles Persons (written four years ago and we're STILL talking about this). If only we had a President who appreciated the benefits of bankruptcy AND had a same-party-Congress to do his bidding. Hmmm.

Amazon's Disruptive Force...

...Is Industry & Asset-Class Agnostic

Scott Galloway likes to say that Amazon simply needs to make a simple product announcement and the market capitalization of an entire sector - of dozens of companies - can take a collective multi-billion dollar hit. On a seemingly weekly basis, his point plays out. Upon the announcement of the Whole Foods transaction, all of the major grocers got trounced. Upon news of Amazon building out its delivery infrastructure, United Parcel Service Inc. ($UPS) and FedEx Corporation ($FDX) got hammered. Upon news that Amazon was getting into meal kits, Blue Apron's ($APRN) stock plummeted. This week it was the pharma companies that got battered on the news that Amazon has been approved for wholesale pharmacy licenses in at least 12 states. It was a bloodbath. CVS Health ($CVS) ⬇️ . Walgreens Boots Alliance ($NAS) ⬇️ . Cardinal Health ($CAH) ⬇️ . Amerisource Bergen ($ABC) ⬇️ . Boom. (PETITION NOTE: obviously impervious - for now - are the ad duopolists, Alphabet Inc. ($GOOGL) and Facebook Inc. ($FB), both of which, despite news that Amazon did $1.12b in ad revenue this quarter, had massive bumps on Friday).* Luckily there isn't an ETF tracking doorman and home security services because if there were, that, too, would be down this week. 

What Galloway has never noted - to our knowledge, anyway - is the effect that Amazon's announcements have on the leveraged loan and bond markets. Remember that Sycamore Partners' purchase of Staples from earlier this year? You know...that measly $6.9b leveraged buyout? Yeah, well, that buyout was financed on the back of $1b of 8.5% unsecured notes (issued at par) and a $2.9b term loan.Ah...leverage. Anyway, investors who expected that the value of that paper would remain at par for longer than, say, 2 months, received an unpleasant surprise this week when Amazon announced its "Business Prime Shipping" segment. According to LCD News, the term loan and the notes traded down "sharply" on the news - each dropping several points. Looks like the "Amazon Effect" is biting investors in a variety of asset classes.

One last point: this is awesome. Maybe the future of malls really is inversely correlated to the future of (livable) warehouses. 

*Nevermind that Amazon's operating income declined 40% due to a 35% rise in operating expenses. Why, you ask, are operating expenses up? How else could Amazon be poised to have half of e-commerce sales this year?
 

Recent Feedback - The (Hard) Business of Eating

"Excellent narrative on the restaurant industry in Sunday’s Petition. Btw, I really love the snarky tone of the writing – it’s awesome!" - Managing Director, Financial Advisor. 

PETITION Response: Thank you! We love receiving feedback like this; we noted that QSRs were generally doing fine while fast casual was looking a bit shaky and casual dining was looking like total dogsh*t. Insert Restaurant Brands International Inc. ($QSR), owner of Burger King (comps up 3.6%), Tim Hortons (up 0.3%), and Popeyes (down 1.8%). It reported an earnings beat on higher revenues (and then stock traded down). Meanwhile, Chipotle Inc.($CMG) - bloodbath. No queso for you. Meanwhile, if you feel like trusting Uber with even MORE of your data, maybe THIS new credit card (which promotes 4% off UberEATS) is for you. With news that Aldi's move into the US is compressing grocery prices even further, the casual dining space looks primed for a lot more hurt. 

10/31/17 Updated: Not to belabor the point, but this story by The New York Times helps drive home the issue currently in the restaurant space. There are currently 620,000 eating establishments in the United States. 620,000. That is bananas. 

Too many restaurants? Too many brands? You think? It's a shame that so many folks are sinking their livelihoods into these businesses. We expect the chart to the right to show continued downward trends given recent reports of the likes of McDonalds ($MCD) and Shake Shack ($SHAK) automating.

Uber's Carnage: the Rise of Distressed Taxis

New York City Taxi Medallions Selling at Significant Discounts

Uber's Carnage (Distressed Taxis). As taxi medallion owners continue to struggle, Evgeny Friedman's bankrupt taxi companies are establishing "market value" for the New York City taxi medallion - and it's at the low end of a recently established spectrum. The New York Times writes, "In August alone, 12 of the 21 medallion sales were part of foreclosures; the prices of all the sales ranged from $150,000 to $450,000 per medallion." Friedman's medallions sold last week to a hedge fund for $186k/each for a block of 46. As context, medallions were once worth as much as $1.3mm. Considering that there are approximately 13.8k taxis in New York City today, one observer noted that it would take Uber (or Lyft), approximately $2.6b to simply buy out the entirety of the City's fleet at that valuation - a cost of a small percentage of Uber's supposedly sizable market cap. So there you have it: "disruption," quantified.