iHeartMedia 👎, Spotify 👍?

Channeling Alanis Morissette: In the Same Week that Spotify Marches Towards Public Listing, iHeartMedia Marches Towards Bankruptcy

In anticipation of its inevitable direct listing, we’d previously written about Spotify’s effect on the music industry. We now have more information about Spotify itself as the company finally filed papers to go public - an event that could happen within the month. Interestingly, the offering won’t provide fresh capital to the company; it will merely allow existing shareholders to liquidate holdings (Tencent, exempted, as it remains subject to a lockup). Here’s a TL;DR summary:

And here’s a more robust summary with some significant numbers:

• Revenue: Up 39% to €4.1 billion ($4.9 billion) in ‘17, ~€3 billion in ‘16 and €1.9 billion in ‘15. Gross margins are up to 21% from 16% in 2014 - and this is, in large part, thanks to renegotiated contracts with the three biggest music labels. Instead of paying 88 cents on every dollar of revenue, the company now only pays 79 cents. Only.

• Free Cash Flow: €109 million ($133 million) in ‘17 compared to €73 million in ‘16.

• Profit: 0. Net loss of €1.2 billion in ‘17, €539 million in ‘16, and €230 in ‘15.

• Funding: $1b in equity funding from Sony Music (5.7% stake), TCV (5.4%), Tiger Global (6.9%) and Tencent (7.5%). Notably, Tencent’s holdings emanate out of a transaction that converted venture debt held by TPG and Dragoneer into equity - debt which was a ticking time bomb. Presumably, those two shops still hold some equity as Spotify reports that it has no debt outstanding.

• Subscribership. 159 million MAUs and 71 million premium (read: paid) subscribers as of year end - purportedly double that of Apple Music. Services 61 countries.

• Available Cash. €1.5 billion

• Valuation. Maybe $6 billion? Maybe $23.4 billion? Who the eff knows.

For the chart junkies among you, ReCode aggregates some Spotify-provided data. And this Pitchfork piece sums up the ramifications for music fans and speculates on various additional revenue streams for the company, including hardware (to level the playing field with Apple ($AAPL) and Amazon ($AMZN)…right, good luck with that), data sales, and an independent Netflix-inspired record label. After all, original content eliminates those 79 cent royalties.

Still, per Bloomberg,

Spotify for a long time was a great product and a terrible business. Now thanks to its friends and antagonists in the music industry, Spotify's business looks not-terrible enough to be a viable public company. 

Zing! While this assessment may be true on the financials, the aggregation of 71 million premium members and 159 million MAUs is impressive on its face - as is the subscription and ad-based revenue stemming therefrom. Imagine the disruptive potential! Those users had to come from somewhere. Those ad-dollars too.

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Enter iHeartMedia Inc. ($IHRT), owner of 850 radio stations and the legacy billboard business of Clear Channel Communications. In 2008, two private equity firms, Bain Capital and Thomas H. Lee Partners, closed a $24 billion leveraged buyout of iHeartMedia, saddling the company with $20 billion of debt. Now its capital structure is a morass of different holders with allocations of term loans, asset-backed loans, and notes. The company skipped interest payments on three of those tranches recently. While investors aren’t getting paid, management is: the CEO, COO and GC just secured key employee incentive bonuses. Ah, distress, we love you. All of which will assuredly amount to prolonged drama in bankruptcy court. Wait? bankruptcy court? You betcha. This week, The Wall Street Journal and every other media outlet on the planet reported that the company is (FINALLY) preparing for bankruptcy. And maybe just in time to lend some solid publicity to the DJ Khaled-hosted 2018 iHeartRadio Music Awards on March 11.

For those outside of the restructuring space, we’ll spare you the details of a situation that has been marinating for longer than we can remember and boil this situation down to its simplest form: there’s a f*ck ton of debt. There are term lenders who will end up owning the majority of the company; there are unsecured lenders alleging that they should be on equal footing with said term lenders who, if unsuccessful in that argument, will own a small sliver of equity in the reorganized post-bankruptcy company; and then there is Bain Capital and Thomas H. Lee Partners who are holding out to preserve some of their original equity. Toss in a strategic partner like billionaire John Malone’s Liberty Media ($BATRA) - owner of SiriusXM Holdings ($SIRI), the largest satellite radio provider - and things can get even more interesting. Lots of big institutions fighting over percentage points that equate to millions upon millions of dollars. Not trivial. Would classifying this tale as anything other than a private equity + debt story be disingenuous? Not entirely.

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"It is telling when companies like Spotify hit the markets while more traditional players retrench. Like we've seen in retail, disruption is real and if you stand still and don't adapt, you'll be in trouble. It gets harder to compete when new entrants are delivering a great product at low cost." - Perry Mandarino, Head of Restructuring, B. Riley FBR.

Indeed, there is a disruption angle here too, of course. Private equity shops - though it may seem like it of late - don’t intentionally run companies into the ground. They hope that synergies and growth will allow a company to sustain its capital structure and position a company for a refinancing when debt matures. That all assumes, however, revenue to service the interest on the debt. On that point, back to Spotify’s F-1 filing:

When we launched our Service in 2008, music industry revenues had been in decline, with total global recorded music industry revenues falling from $23.8 billion in 1999 to $16.9 billion in 2008. Growth in piracy and digital distribution were disrupting the industry. People were listening to plenty of music, but the market needed a better way for artists to monetize their music and consumers needed a legal and simpler way to listen. We set out to reimagine the music industry and to provide a better way for both artists and consumers to benefit from the digital transformation of the music industry. Spotify was founded on the belief that music is universal and that streaming is a more robust and seamless access model that benefits both artists and music fans.

2008. The same year as the LBO. Guessing the private equity shops didn’t assume the rise of Spotify - and the $517 million of ad revenue it took in last year alone, up 40% from 2016 - into their models. Indeed, the millennial cohort - early adopters of streaming music - seem to be abandoning radio. From Nielsen:

Finally, Pop CHR is one of America’s largest formats. It ranks No. 1 nationwide in terms of total weekly listeners (69.8 million listeners aged 12+) and third in total audience share (7.6% for listeners 12+), behind only Country and News/Talk. In the PPM markets it leads all other formats in audience share among both Millennial listeners (18-to-34) and 25-54 year-olds. However, tune-in during the opening month of 2018 was the lowest on record for Pop CHR in PPM measurement, following the trends set in 2017, the lowest overall year for Pop CHR, particularly among Millennials. While CHR still has a substantial lead with Millennials (Country ranked second in January with 8.4%), it will be interesting to track the fortunes of Pop CHR as the year goes on, and music cycles and audience tastes continue to shift.

This is the hit radio audience share trend in pop contemporary:

And, consequently, radio ad revenues have essentially flattened. And if Spotify has its way, the “flattening” will veer downward:

With our Ad-Supported Service, we believe there is a large opportunity to grow Users and gain market share from traditional terrestrial radio. In the United States alone, traditional terrestrial radio is a $14 billion market, according to BIA/Kelsey. The total global radio advertising market is approximately $28 billion in revenue, according to Magna Global. With a more robust offering, more on-demand capabilities, and access to personalized playlists, we believe Spotify offers Users a significantly better alternative to linear broadcasting.

One company’s disruptive revenue-siphoning is another company’s bankruptcy. Now THAT’s “savage.”

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PETITION LLC is a digital media company focused on disruption from the vantage point of the disrupted. We publish an a$$-kicking weekly Member briefing on Sunday mornings and a non-Member "Freemium" briefing on Wednesday. You can subscribe HERE and follow us on Twitter HERE.

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. 

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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.

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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.

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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?

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.

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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.

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. 

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. 

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.

The (Hard) Business of Eating

Long VC Subsidies & Facebook's Copying Skills

Generally speaking, there are four categories in the dining space. First, there are the QSRs (quick service restaurants). Your run-of-the-mill fast food spots fall into this space. For the most part, these guys are doing okay: McDonald's ($MCD) and Wendy's ($WEN), for instance, have both seen great stock performance in the TTM. Second, there's the fast casual space. Competition here is fast and furious covering all manner of ethnicities and varieties. Chipotle ($CMG) and Panera Bread are probably the two best known representatives of this category. The former has gotten SMOKED and the latter got taken private. Generally speaking, there'll be some shakeout here, but the category as a whole has been holding its own. Third, there's the fine dining space. This is a tough space to play in but there are clear cut winners and losers (Le Cirque, see below): not a lot of chains fall in to this category. And, finally, there is the casual dining category. Here is where there's been a ton of shakeout. This past week, for instance, Ruby Tuesday Inc. ($RT) - the ubiquitous casual dining restaurant loosely associated with bad New Jersey strip malls - got bailed out...uh, taken private by NRD Capital at a fraction of its once $30/share price. (There was some assumed debt, too, to be fair). Moreover, Romano's Macaroni Grill filed for chapter 11 bankruptcy. In RMG's bankruptcy papers, the company's Chief Restructuring Officer said the following, "The Debtors’ operations and financial performance have been adversely affected by a number of economic factors, but perhaps most notably by an overall downturn for the casual dining industry. The preferences of such customers have shifted to cheaper, faster alternatives. On the other end of the spectrum, there is a trend among younger customers to spend their disposable income at non-chain “experience-driven” restaurants, even if slightly more expensive." No. Bueno. See below for a more in-depth (and slightly repetitive summary) of this particular bankruptcy filing. 

Unfortunately, the restaurant world received some other (slightly under-the-radar) bad news this past week: UberEATS, Uber's food delivery service, reportedly generated 10% of the company's total global bookings in Q2 - which, extrapolated, equates to $3b in gross sales for the year. That's a lot of food delivery to a lot of people sitting at home doing the "Netflix-and-chill" thing instead of the eat-microwaved-mozzarella-sticks-at-the-local-Ruby-Tuesday-thing. Of course, this is attributable to Softbank and other venture capitalists who are subsidizing this money-losing endeavor: UberEATS is unprofitable in 75% of the cities it services. On the other hand, do you know what IS profitable? Facebook ($FB). Yeah, Facebook is profitable. And Facebook is going after this space too; it released its plans to get into the online food ordering business earlier this week. And many suspect that this may be a precursor to a foray into food delivery as well. Why? Perhaps Mark Zuckerberg saw Cowen's prediction that US food delivery would grow 79% in the next several years. Delivery or not, anything that helps make online food ordering easier and more mainstream is an obvious headwind to the casual dining spots. Given that this area is already troubled and many casual dining spots have already fallen victim to bankruptcy, there don't seem to be many indications of a near-term reversal of fortune. Headwinds for the casual dining space correlate to tailwinds for restructuring professionals. Sick? Yeah. Sad? Sure. But true. 

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.

How the Supreme Court Helped Amazon

THE LAW IS ALWAYS ONE STEP BEHIND

Since 2008 Walmart ($WMT) has paid 46x more in income tax than Amazon ($AMZN). That is a crazy stat and the link (source: Axios) is worth a read. But there's more to the Amazon tax story than that: it seems that the United States Supreme Court has contributed to the rise of Amazon and the rise of the "Amazon Effect." 

Here's the condensed version:

• In 1992, the Supreme Court ruled in favor of a mail-order vendor over the state of North Dakota in a dispute over the collection of sales taxes. The case was Quill Corp. v. North Dakota. Why? Taxing the vendor would "unduly burden interstate commerce." The Court ruled that taxation would only apply to retailers with a "physical presence" in states. 
• There's a ton of discussion about the "last mile" now - a reflection of just how much retail continues to evolve - but this ruling impacted corporate decisions in a big way for a long time: why locate a warehouse in the same state as the lion-share of customers and suffer a higher tax burden? 
• Amazon avoided having any fulfillment center in California FOR 17 YEARS to avoid sales taxes. Overstock ($OSTK) and Wayfair ($W) STILL limit their distribution centers for this reason. (Now Amazon collects in all 50 states.)
• The decision looks headed for re-evaluation. In what looks like a purposeful strategy to test the precedent, South Dakota lawmakers passed a law requiring businesses to collect state sales taxes on sales of goods over $100k - even if those businesses have no presence in SD. South Dakota's highest court held that the law violates Quill. 
• So what's next? Looks like the lawyers are primed to petition for certiorari to the Supreme Court with the hope of a reversal of Quill. A reversal could help take some cash off of corporate balance sheets (see chart below) and fill state coffers. This could help counter-balance state budget ills, including underfunded pensions (see below). On the flip side, it may stifle e-commerce startup growth which, in a stroke of irony, may actually benefit Amazon further. Don't hate the player, hate the game...or something.

Where is the Restructuring Work?

Strong Voices in Finance Are Raising the Alarm

We have some very exciting things planned for the Fall that we cannot wait to share with you. Until then, we'll be channeling our inner John Oliver and spending the rest of the summer researching and recharging. Oh, and structuring our imminent ICO in a way that (i) circumvents the SEC's recent decision noting that ICOs are securities offerings and (ii) gives all current PETITION subscribers a first look at participation. Don't know what we're talking about? For a crash course, read this, this, and this. The ICO stuff is BANANAS and, yes, we're TOTALLY KIDDING about doing one. We are not kidding, however, about our planned Summer break. We'll be back in September with the a$$-kicking curated weekly commentary you've come to know and love. In the meantime, please regularly check out our website petition11.com, our LinkedIn account, and our Twitter feed (@petition) for new content throughout August. 

But before we ride off to the Lake, a few thoughts (and a longer PETITION than usual)...

There has been a marked drop-off in meaningful bankruptcy filings the last several weeks and people are gettin' antsy. Where is the next wave going to come from? A few weeks ago, Bloomberg noted that there was a dearth of restructuring deal flow and a lot of (restructuring) mouths to feed. Bloomberg also reported that, given where bond prices/yields are, bank traders are so bored that they're filling their days by Tindering and video-gaming like bosses rather than...uh...trading. (You're not going to want to thumb-wrestle millennials.) These trends haven't stopped the likes of Ankura Consulting from announcing - seemingly on a daily basis - a new Managing Director or Senior Managing Director hire (misplaced optimism? Or a leading indicator?). No surprise, then, that financial advisors and bankers are whipping themselves into a frenzy in an attempt to complement Paul Weiss as advisors to a potential ad hoc group in Guitar Center Inc. (yes, people do buy guitars online on Amazon and, yes, $1.1b of debt is a lot given declining trends in guitar playing). Even the media is getting desperate: now the Financial Times is pontificating on the "short retail" trade (firewall; good charts within) that others have been discussing for a year or so. The internet is impacting shopping malls (firewall)? YOU DON"T SAY! Commercial mortgage delinquencies are rising (firewall)? NO WAY! We've gotten to the point that in addition to having nothing to do, no one actually has anything original to say. 

That is, almost no one. After all, there is always Howard Marks of Oaktree Capital Management, who, once again, demonstrates how much fun he must be at parties. Damn this was good. Looooong, but good. And you have to read it. Boiled down to its simplest form he's asking this very poignant question: what the f&*K is going on? Why? Well, because:
(i) we now see some of the highest equity valuations in history;
(ii) the VIX index is at an all-time low;
(iii) the trajectory of can't-lose stocks is staggering, see, e.g., FAANG (though, granted, Amazon ($AMZN) and Alphabet ($GOOGL) both got taken down a notch this week);
(iv) more than $1 trillion has moved into value-agnostic investing;
(v) we're seeing the lowest yields in history on low-rated bonds/loans (and cov lite is rampant again);
(vi) we're seeing even lower yields on emerging market debt;
(vii) there's gangbusters PE fundraising (PETITION NOTE: we'd add purchase price multiple expansion and, albeit on a much smaller scale, gangbusters VC fundraising);
(viii) there is the rise of the biggest fund of all time raised for levered tech investing (Softbank); and
(ix) bringing this full circle to where we started above, there are now "billions in digital currencies whose value has multiplied dramatically" - even taking into account a small pullback.

Maybe we really should consider an ICO after all. 

And then there's also Professor Scott Galloway. He, admittedly, looks at "softer metrics" and highlights various signals that show "we're about to get rocked" in this piece, a sample of which follows (read the whole thing: it's worth it...also the links): 

We don't think he's kidding, by the way. Anyway, we here at PETITION would add a few other considerations:

1. The Phillips Curve. Current macro trends countervail conventional thinking about the relationship between unemployment and inflation/wages (when former down, the latter should be up...it's not);
2. The FED. Nobody, and we mean NOBODY, knows what will happen once the FED earnestly begins cleansing its balance sheet and raising rates; 
3. (Potentially) Fraudulent Nonsense Always Happens Near the Top. SeeHampton Creek. See Theranos. See Exxon ($XOM). See Caterpillar ($CAT). See Martin Shkreli. And note worries about Non-GAAP earnings;
4. Auto loans. Delinquencies are on the rise; and
5. Student loans. Delinquencies are on the rise.

We're not even going to mention the dumpster fire that is Washington DC these days (random aside: is anyone actually watching House of Cards or is reality enough?). 

And, finally, not to steal anyone's thunder but one avid biglaw reader added that a telltale sign of an imminent downturn is the rise of biglaw associate salaries. Haha. At least there are wage increases SOMEWHERE.

All of the above notwithstanding, even Marks cautions against calling an imminent downturn admitting, upfront and often, how he has been premature in the past. That said, nobody saw oil going from $110 to $30 as quickly as it did either. So he's right to be highlighting these issues now. At a minimum, it ought to give investors a lot of pause. And, perversely, this all ought to give restructuring professionals a little bit of hope for what may lay ahead for '18 and '19. 

Have a fun and safe rest of Summer, everyone. Don't miss us too much.

Like #Tech, Corporate Restructuring Has a Gender Imbalance

Unless you've been hiding under a rock, you've probably noticed the controversy that embroiled Silicon Valley over the July 4th weekend. In a nutshell, some super brave and bada$$ women came forward and accused a variety of high-powered men of sexual harassment and improper behavior. First, The Information reported (firewall) a story backed by the accounts of six women recounting the behavior of Justin Caldbeck of Binary Capital. He soon stepped down (as did his two partners, thus thwarting the close of BC's second fund). Then The New York Times published a piece implicating Chris Sacca (of Shark Tank fame) and Dave McClure of the venture capital firm, 500 Startups. The former had already given up on investing (and Shark Tank); the latter first stepped down as CEO of the firm, then, in a matter of days, stepped down as General Partner as well. Silicon Valley's gender imbalance has been in the spotlight for some time now. Now we're learning more and more why that imbalance exists in the first place. 

Before we get ahead of ourselves, we'll be upfront here: what we're about to say is in no way meant to imply that sexual harassment and inappropriate behavior runs rampant in the restructuring community. But, let's be honest: there is a wild gender imbalance in firm partnership ranks, conference room negotiations, and bankruptcy courts. The industry's most lucrative and prolific restructuring law firm has exactly one woman partner. One of the industry's top restructuring advisory IBs has exactly zero women partners and, yet, that didn't stop the leader of that group from being honored by Her Justice, an organization that provides legal services to NYC women in need. And those are just two examples. Suffice it to say, there are many.

Now there are exceptions to the general rule: AlixPartners LLC, for one, and Greenberg Traurig LLP, for another (see below), in that they are led (or co-led as the case may be) by women. Weil Gotshal & Manges LLP, as another example, includes a number of women partners on its roster. But there should be more. Industry-wide. And charity honorees should be the women who have risen through the ranks - despite the odds - AND cultivated other women to follow in their footsteps. Overall, the industry can do much much better.

Want to tell us we're morons? Or praise us? Cool, either way: email us. 

Platforms

The retail disruption plot thickens.

Facebook doesn't break out numbers for Instagram, but there are increasing signs that it is becoming a beast for driving retail sales. Yep, Instagram. 

As we foreshadowed last week, we find the continued evolution of digital platform-based retail interesting. This week, Bloomberg highlighted how Instagram is "kill[ing] the retail store," noting how more and more entrepreneurs rely on the platform to sell their wares. Brick-and-mortar is merely a complementary channel, used mainly to create brand awareness and otherwise create an aura of scarcity and, well, "cool." Choice quote: "We make sure that our products are sold out quickly through retailers...[w]e create rarity, and then - boom! - we have waves of clientele coming to our website directly, no middleman necessary." No. Middleman. Necessary. Explains a lot, doesn't it?

It is a bit ironic, though. Because the middleman is increasingly the digital platform rather than the brick-and-mortar retailer. And Instagram will eventually figure out a way to monetize the fact that it maximizes "discovery."

In the same vein, other retailers are increasingly using WhatsApp (Net-a-Porter) and iMessage (Coach) as sales channels, highlighting that "conversational commerce" drives higher volume. Indeed, other brands like Patagonia, Everlane and Coach are abandoning their own (expensive-to-maintain relative to value added) native apps, opting to explore further the potential of leveraging the aforementioned platforms as well as others, like Facebook Messenger and WeChat. Which is to say that these platforms are becoming more and more meaningful in the overall retail story and it is not just Amazon eating the world - a somewhat lazy and partially inaccurate narrative too often relied upon by restructuring professionals.

Busted Tech

Speaking of tech, Quixey, a "pioneer" of deep mobile search, announced in an epically hubristic blog post that it is shutting down and exploring strategic options (read: IP sale in bankruptcy, most likely). It has $31mm of venture debt and $134mm of venture capital from the likes of Alibaba and Softbank scattered on the cap table. On the topic of venture debt, choice quote from Fred Wilson taken from here: "I have lived [the venture debt] story several times in my career and we are seeing this play out again in the market." Sure sounds like it. We've surveyed a number of restructuring professionals and there seems to be very little attention given to busted tech. Well, maybe other than from us. Why? No debt, we're told. Really? No debt? See, e.g., Violin Memory, Answers.com, Aspect Software. And, now also, some Soundcloud news - a company we have previously identified as a potential bankruptcy candidate. The company appears to have secured an additional $70mm of venture debt (additive to the $30mm previously raised from Tennenbaum Capital Partners) from the likes of Ares Capital, among others. Something tells us that Houlihan Lokey isn't in the business of making nonsensical and useless acquisitions. Interested in this subject? Email us.