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This series just keeps getting better and better. You can go back and read parts 1-4 here.
This week the Wall Street Journal reported that “junk bonds are getting junkier.” Oh boy. You have to hand it to to the private equity bros: they have a real sense of the markets these days...
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In 🍟Casual Dining is a Hot Mess🍟, we wrote:
…don’t let the lull in restaurant activity fool you. As we’ve stated before, this is a space worth watching given intense competition and the rise of food delivery and meal kit services - both direct-to-consumer and in-grocery.
Looks like we spoke to soon about a lull. Earlier this week RMH Franchise Holdings Inc.filed for bankruptcy in the District of Delaware. If you’ve never heard of RMH Franchise Holdings Inc., have no fear. You haven’t. Nor had we. But it is...
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Aceto Corporation ($ACET) reported earnings last week and followed them up with a 10Qthis week. The company, in coordination with a new interim CFO from AlixPartners and advisors from PJT Partners and Lowenstein Sandler LLP, is seeking strategic alternatives. Meanwhile, the company was recently non-compliant with its maximum net leverage and minimum debt service coverage ratios under its credit facility and obtained a waiver for the quarter. There is no waiver for the next quarter and so June will be interesting — particularly given downward trends across the board in consolidated net sales, gross profit, gross margins, etc. Not to mention a rise in SG&A...
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In what could amount to a solid case study in #BustedTech and the up/down nature of entrepreneurship, Videology Inc., a Baltimore based software ad-tech company that generated $143.2 million in revenue in fiscal 2017 has filed for bankruptcy.
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Ok. Soooooo…this won’t shock anyone who has been paying attention. Apparently Moviepass — the company that lets subscribers see one movie a day for only $9.99 a month — is burning cash like nobody’s business. S.H.O.C.K.E.R. A first grade student can do THAT math.
Moviepass’ parent company Helios and Matheson Analytics Inc. ($HMNY) reported in an 8K filed this week that it burned $21.7 million per month from September 2017 through April 2018. The company now has $15.5 million in available cash with another $27.9 million in accounts receivable. Hang on: 15.5 + 27.9 (carry the four) = 43.4. Minus 21.7 and another 21.7 and….💥🔥💥🔥. Which prompted CNN to ask, “is the end near?” Here’s a choice quote...
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In “McKinsey Gets Thrown Under the Bus (Long Relationships with the WSJ),” we began,
Okay, this WSJ article is bananas. What are the chances that Jay Alix has a direct line in to Gerard Baker?
Given that the WSJ piece is now front in center in the “Complaint and Jury Demand” filed by Jay Alix in Alix v. McKinsey & Co. Inc., et al (page 4, paragraph 11), wethinks the chances are pretttttttty prettttttty high (we’re 100% speculating here so take this with the usual PETITION grain of salt). Crack open a beer, break out the popcorn, and kick back: there’s a lot to unpack here…
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By: Ted Gavin, Managing Director & Founding Partner of Gavin/Solmonese
In recent years, ABI Presidents have pursued lengthy agendas, including the ABI Chapter 11 Commission, launching an ethics task force, and creating the Consumer Bankruptcy Commission – all worthy projects deserving our respect. I have a tough act to follow as the incoming president.
Last month, I was pleased to announce the formation of the ABI Task Force on Veterans Affairs. Led by members and U.S. veterans John Ames, John Penn and Jack Williams, the group is comprised of individuals who are committed to changing veterans’ lives in a meaningful way. The Task Force will examine how the bankruptcy system treats veterans differently, and unfortunately— less favorably. Recommendations and corrective steps will be proposed to Congress or the Rules Committee in the coming year to improve bankruptcy outcomes for all veterans.
Consider what it’s like for vets to return home with any one of the many issues our brave warriors experience after serving their country. And then add to that the financial burden imposed by their service— a burden exacerbated by the cost of transitioning to civilian life; the medical fees associated with caring for injuries; transportation expense to healthcare professionals located at inconveniently-located VA hospitals; and lost income each time they have to see a VA doctor.
Then imagine as the crushing burden of medical or consumer debt mounts, you may be treated in an unfavorable way under the current Bankruptcy Code— especially if you’re a disabled vet.
When a civilian qualifies for and receives social security disability payments, those payments are based on their past income, and in the event of a bankruptcy filing, are not counted as income under the means test. When a disabled veteran files a bankruptcy petition, their disability payments are counted as income under the means test. The effect of this disparity is that someone on veteran disability has a lower likelihood of being able to avail themselves of the complete discharge offered by chapter 7 than a debtor who receives social security disability payments. This is but one of the ways in which the Code fails to work for veterans and service members.
I look at this problem, and I am reminded that ABI’s membership has shown, time and time again, that when its talents are utilized and focused, we can literally redefine our field. And I ask, what solutions to this problem might be unlocked by the brainpower of our members? I know that we haven’t done enough to change the things we can for veterans.
For an organization that many associate with corporate mega-bankruptcies, we’ve achieved quite a lot to improve outcomes for individuals whose lives are impacted by bankruptcies – either their own, their employer’s, or the companies they have built that have fallen on hard times. And now, we’re going to make bankruptcy function better for those who have served our country.
Ted Gavin is a Certified Turnaround Professional and the managing partner of Gavin/Solmonese. In 2016, The Deal Pipeline ranked Ted the #1 Crisis Manager in the U.S. based upon the number of active engagements. He has over 20 years of experience working with distressed companies and their stakeholders in diverse industries, including retail, transportation, regulated and non-regulated manufacturing, pharmaceutical and healthcare, professional services, construction, and metal-forming. He has served in leadership roles in engineering, manufacturing, information technology, and regulatory affairs functions. Ted has extensive experience in strategic planning and process re-engineering, with hands-on management experience in nonprofit, for-profit, and public sector operations. Ted testifies frequently as an expert witness on matters such as ordinary course of business issues in preference litigation, as well as on fiduciary duties of management in distressed companies.
On Mary 15, 2017 - nearly exactly a year ago — rue21 Inc. became the latest in what was a string of specialty fashion retailers to file for bankruptcy; it sought to pursue both an operational and a financial restructuring. The company had 1179 brick-and-mortar locations in various strip centers, regional malls and outlet centers. It also had a capital structure that looked like this:
Much of the leverage emanated out of an Apax Partners LLP-sponsored take-private transaction in 2013. We recently discussed Apax Partners in the context of FullBeauty here, in our recent Members’-only briefing.
Without any real contest, it was clear that the term loan holders constituted the “fulcrum” security and would end up swapping said loans for equity in the reorganized company. And that is precisely what happened. The ABL was covered, the term lenders funded a roll-up DIP credit facility along with new money to finance the pendency of the cases and then converted that DIP into an exit facility. The post-emergence capital structure consists of:
$125 million ABL; and
$50 million term loan (plus accrued interest on the DIP term loan as of the effective date).
General unsecured claimants were provided an equity “kiss” on the petition date and then, after the Official Committee of Unsecured Creditors’ (“UCC”) formed, it extricated additional value in the form of, among other things, (i) a put option to sell its post-reorg equity to one of the reorganized debtors, and (ii) a waiver by the prepetition term lenders of their $200 million deficiency claim. While the UCC did try and go after third-party releases for Apax, Apax ultimately succeeded in obtaining the release pursuant to the bankruptcy court’s September 9 confirmation order on the basis that it…
“…agreed to (i) support the Plan, including by promptly facilitating and participating in prepetition Plan discussions that culminated in the Restructuring Support Agreement and the Plan, notwithstanding that their equity position would likely be eliminated thereunder; and (ii) participate in the financing of the DIP Term Loan Credit Facility.”
In other words, Apax bought its release for $2 million in DIP allocation.
All told, this was a solid deleveraging of roughly $700 million. Moreover, the company closed roughly 400 stores. The company was seemingly well-positioned to effectuate the rest of its proposed restructuring, including (i) revamping its e-commerce strategy, (ii) improving the in-store experience, and (iii) pursuing a long-term business plan under relatively new management in a highly competitive retail atmosphere.
“Seemingly” being the operative word. In January, The Wall Street Journal reported (paywall) that the retailer experienced lackluster sales and tightening trade terms. Then, in February, Reuters reported that the company “is seeking financing after lackluster holiday sales failed to generate the cash it had hoped for….” It noted, further, that the company had engaged Piper Jaffray Companies ($PJC) to raise the funds. Notably, there has been nothing new on this front since. No news is probably not good news when it comes to this situation. Start the sewing machines: a Scarlet 22 tag may be in order and a liquidation on the horizon.
In the meantime, if the company is looking for ways to preserve liquidity, it might want to consider a far less generous return policy:
With clothes like this and a customer like that, what could go wrong?
Back in “WeWork Invents a New Valuation Methodology,” we snarked about how WeWork pioneered an entirely new valuation technique. We noted,
"Indeed, to assess WeWork by conventional metrics is to miss the point, according to Mr. Neumann. WeWork isn’t really a real estate company. It’s a state of consciousness, he argues, a generation of interconnected emotionally intelligent entrepreneurs. And Mr. Neumann, with his combination of inspiration of chutzpah, wants to transform not just the way we work and live, but the very world we live in.”
A state of consciousness. A state of effing consciousness. Being a biglaw associate is also a state of consciousness but that doesn’t necessarily mind-port you to partner after 8 years, let alone 12.
We continued,
"Even Adam Neumann, a co-founder of WeWork and its CEO, admits that his company is overvalued, if you’re looking merely at desks leased or rents collected. ‘No one is investing in a co-working company worth $20 billion. That doesn’t exist.’ he told Forbes in 2017. ‘Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.'“
We’re sure bankers all across the world will be happy to add “energy and spirituality analysis” to the lineup of valuation methodologies like precedent transaction, comparable company and discounted cash flow analyses. What the bloody hell.
Then last Wednesday, in 💵WeWork Taps Cap Markets; People Lose Minds 💵, we briefly covered the proposed WeWork’s proposed $500 million high yield bond issuance. People went nuts because the offering memorandum finally shed some more light on the business. And it was a feeding frenzy. Little did we know, that was only Part II of this (unintentional) comedy.
Introducing “Community-adjusted EBITDA.” Per Barron’s:
As The Wall Street Journal reported, while revenue doubled last year, to $866 million, WeWork’s losses also doubled, to $933 million. But WeWork “earned $233 million, based on a metric the company dubbed “community adjusted Ebitda.” That consists of earnings before interest, taxes, depreciation, and amortization — a widely used measure of operating cash flow — but also excludes basic operating expenses, such as marketing, general and administrative, development, and design costs. That’s not in any accounting textbooks I’m aware of.
“I’ve never seen the phrase ‘community adjusted Ebitda’ in my life,” said Adam Cohen, founder of Covenant Review, a bond research company.
There’s a first time for everything, homie. Or as Bloomberg’s Matt Levine put it,
Well, sure, Mr. Covenant Review, but I bet you’ve never reviewed the covenants of a state of consciousness either.
Some more choice commentary:
Indeed, Moody’s was mildly schizophrenic (registration required) in its evaluation of the company’s new notes; it didn’t deign to even discuss WeWork’s accounting gymnastics as it assigned a B3 Corporate Family rating and a Caa1 rating to the notes.
Dealbreaker’s Thornton McEnery was far less measured. In lofty prose worthy of a Pulitzer, he led his piece entitled “WeWork’s First-Ever Bond Offering Is A Master Class in Financial Masturbation” with “[n]o company has its head farther up its own ass than WeWork.” We literally laughed out loud at that. But wait. There’s more,
That said, making up your own holistic, artisan, New Age Brooklyn accounting principle just to pretend that you’re hemorrhaging less money than you really are? Well, that’s actually super-ballsy and we’d almost respect it if WeWork wasn’t trying to write down Kombucha on tap and losses associated with ping pong ball replacements. It’s the height of Millennial hipster exceptionalism and it would truly make our skin crawl if, again, we didn’t respect the balls-out ego involved here.
Can you even say “balls-out” anymore? We thought #MeToo killed that. And ping pong? C’mon. That’s so 2014. It’s esporting Fortnite matches that are all the rage now, broheim. Anyways…
Then Bloomberg’s Matt Levine and Axios’ Dan Primack crashed the party by issuing a bit of defense. Levine’s is here — noting that the calculus is a bit different for bond investors. Primack spoiled some of the fun by clarifying what the new-fangled metric represents:
The metric includes all tenant fees, rent expense, staffing expense, facilities management expense, etc. for active WeWork buildings.
The exclusions are company-wide expenditures, which do not get pro rated. Much of that relates to growth efforts, although not all of it (executive salaries, for example).
One comp, and its not perfect, could be how Shake Shack reports "shack-level operating profit margins."
Bottom line: It's still kind of silly, but less silly than it at first appears. And obviously the ratings agencies and bond markets didn't seem put off.
Silly? Less silly? Whatevs.
Either way, the Twitterati largely neglected to take into account today’s dominant theme-among-themes: yield, baby, yield. Or said another way — per The Financial Times,
WeWork does have substantial backing, blue-chip customers and a good plan to increase profit-sharing leases. A high yield in its first bond, adding 150 basis points or so to the index average yield, would help, too. That could swell the offer above $500m. Even sober bond investors may not prove immune to the appeal of succulents and exposed brick.
Prescient. And bond investors did not prove immune. Nor sober.
Welcome to Part III. This is the part in the story where the record scratches, the jukebox stops, and everyone has an utterly perplexed look on their faces. Like, wait. WHAT? That’s right. Demand for this paper was so high, that it upsized from $500 million to $702 million. And just like that, poof! Adam Neumann looks into the camera, smirks, and then walks down the street like Kaiser-m*therf*ckin-Soze. He can tap the venture capital markets — stateside and abroad (in the case of Softbank) — and the debt market.
The Real Deal somewhat inexplicably stated,
WeWork sold $700 million in bonds Wednesday to investors wary of another startup with unstable cash flow entering the debt market.
Wary? How do you explain the upsized offering then? The only thing people should be wary of are other people who are shocked to see this happening. Again: YIELD. BABY. YIELD. And, to be clear, it was actually $702 million (at 7.785%). The notes are guaranteed by US subsidiaries that hold approximately 60% of the company’s assets at year end; “adjusted ebitda” was also used as the base for leverage requirements under the notes’ covenants. There’s hair all over this thing. The Financial Times took a deeper dive into lender protections as it…
wanted to get a general idea of the rights its bondholders might have if the bonds were sold under the terms laid out in the preliminary prospectus and then Millennials everywhere suddenly decided they would prefer to work from home.
Right, exactly. Or in a cafe where you can sit for hours for $3/day. Anyway, you can read that FT analysis here. Moreover, BloombergGadfly cautions about the rent duration mismatch here — a subject of particular note for restructuring professionals well-versed in section 365 of the bankruptcy code. Bloomberg notes,
WeWork acknowledges that its expenditures "will make it difficult for us to achieve profitability, and we cannot predict whether we will achieve profitability in the near term or at all." Risk is all part of the game for junk investors, and this one looks like it will be priced to go with a fat yield. But the more prudent will take that caveat seriously.
Investors must’ve REALLY wanted in on the action. Many didn’t take that caveat seriously. Something tells us Burton Malkiel will be adding an addendum to his “Greater Fool Theory” coverage in “A Random Walk Down Wall Street” and this will be the case study.
What explains the enthusiasm? As The Wall Street Journal notes, this isn’t a $20 billion decacorn-x2 for nothing:
The numbers offer some positive signs for WeWork. Its net construction costs per desk fell 22% in 2017 to $5,631. And its corporate business—as opposed to revenue from freelance and small companies—appears to be growing well, as rating agency Standard & Poor’s said in its analysis. The agency said it expects large corporations will occupy 50% of WeWork’s desks within two years, up from 25% today.
But then they flip right around and note,
There also are concerns for investors in WeWork’s growth trajectory. Its revenue per user fell 6.2% to $6,928 in 2017, while sales-and-marketing costs more than tripled to $139 million, representing 16% of revenue, up from 9.9% in 2016.
Taking on debt adds risk to a company whose business model hasn’t been tested in a downturn. Given that its members typically sign monthly or annual leases, a drop in demand during a recession would mean the rents it charges tenants would fall, while the payments it owes to landlords would stay constant.
Nevertheless, the market spoke. It gobbled up those bonds.
But then, in Part IV, the market spoke again, mere days later. As Bloomberg noted,
WeWork Cos.’s bonds extended their losses on Tuesday, as investors who were at first enthused to get a piece of the action have since been cashing in their chips.
The $702 million of speculative-grade bonds, which sold last week at par, fell for the fourth straight day on Tuesday to 95.75 cents on the dollar, according to Trace bond-price data. That’s a sharp contrast to the outsized orders the company saw when it marketed its debt in primary markets last week.
And then they kept falling.
Source: Bloomberg
Per Trace, the bonds last printed on Friday, May 4 at 94.9 — a pretty impressive decline on the week (h/t @donutshorts).
This sequence of events likely has bondholders screaming, “Yield, baby. YIELD!!!”
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PETITION is twice-weekly newsletter covering disruption from the vantage point of the disrupted. We meander sometimes to other areas. This piece was in today's Members'-only newsletter. You can check us out here and follow us on Twitter here.
In “Credit Default Swaps (Long Yield, Baby, Yield),” we discussed credit default swaps and the ongoing battle between hedge funds in the Hovnanian matter.* The Commodity Futures Trading Commission has finally weighed in. There were no minced words:
"The CDS market functions based on the premise that firms referenced in CDS contracts seek to avoid defaults, and as a result, the instruments are priced based on the financial health of the reference entity. However, recent arrangements appear to involve intentional, or ‘manufactured,’ credit events that could call that premise into question. In a public statement dated April 11, 2018, the International Swaps and Derivatives Association’s (ISDA) board of directors criticized manufactured credit events, writing that they ‘could negatively impact the efficiency, reliability, and fairness of the overall CDS market,’ and ISDA’s board indicated that it advised its staff ‘to consult with market participants and advise the Board on whether...amendments to the ISDA Credit Derivatives Definitions should be considered’ to address manufactured credit events.
"Manufactured credit events may constitute market manipulation and may severely damage the integrity of the CDS markets, including markets for CDS index products, and the financial industry’s use of CDS valuations to assess the health of CDS reference entities. This would affect entities that the CFTC is responsible for overseeing, including dealers, traders, trading platforms, clearing houses, and market participants who rely on CDS to hedge risk. Market participants and their advisors are advised that in instances of manufactured credit events, the Divisions will carefully consider all available actions to help ensure market integrity and combat manipulation or fraud involving CDS, in coordination with our regulatory counterparts, when appropriate.”
Better late than never we guess. You’d think they would have awakened to these issues after Codere, Radio Shack, and others. But, hey. Regulators. Enough said.
*****
Enough said, indeed. Query whether the The Commodity Futures Trading Commission will have more to say given the aforementioned “cherry on top” in the McClatchy transaction.
What is the cherry? Well this — per Bloomberg:
It seemed like a sure-fire bet: short the debt of a highly leveraged newspaper company that’s losing money. And for a while, it worked as investors piled up almost $500 million of wagers by buying credit-default swaps on the publisher, McClatchy Co.
That is until hedge fund Chatham Asset Management stacked the deck with a deal that’s threatening to make those swaps all but worthless.
The McClatchy situation is the latest trade that’s drawing jeers from critics who say the $11 trillion CDS market has devolved into a haven for manipulation.
Whoops.
At issue is the “newly established LLC” bit we noted above. As Bloomberg further explains,
Because the new debt would be shifted away from the parent and into the new unit, it’s fueling speculation that the Chatham deal will create what’s commonly known in the CDS world as an orphaned contract. In other words, anyone who bought insurance on a McClatchy default would effectively be paying insurance on an entity with no significant debt.
Which, naturally, begs the question: who is on the other side of the contract? Well, Chatham, of course. Because CDS! There’s no measure of how America has become great again like one fund ripping off other funds. Take a look at this chart:
More from Bloomberg,
Leading up to the deal, Chatham had been selling swaps insuring against a default by McClatchy. So if the transaction were to be completed, it would be getting paid CDS premiums to guarantee against a default that could never technically happen.
“The whole market is losing credibility when you have events like this where you try to trigger the CDS or create orphaning situations,” XAIA’s Felsenheimer said.
Joshua Friedman from Canyon Partners appears to agree that these trades “go beyond the bounds” (video). And, so, people are losing their minds (query whether these same people led to the upsized WeWork debt financing). As always, Matt Levine puts this whole event in perspective,
The thing is, if you bet against McClatchy’s credit by buying CDS on it, you were betting not only that it would have problems with cash flow or whatever, but also that no white knight would come along to keep it afloat until after your CDS expired. A realistic credit analysis asks not only about the company’s own paying capacity but also about its external sources of financing. If you buy five-year CDS on a company, you are betting that it will default on its debt within five years. If the next day a deep-pocketed shareholder (Chatham owns 19.8 percent of McClatchy) refinances all of the company’s debt into a seven-year zero-coupon bond—or a seven-year PIK-toggle bond, or whatever, some form of debt that it cannot default on during the life of the CDS—then you have lost your bet. But you weren’t cheated out of your bet or anything. You just bet that the credit would implode, and then it didn’t.
He’s right. And in the absence of regulators paying more attention to CDS work-arounds, this will be just one more needle in a stack of perceived-manipulated-needles.
*Yesterday, Hovnanian upheld its end of the bargain with GSO by skipping its interest payment.
The McClatchy Company ($MNI) may not be well known to you on its face but if you’ve ever read the Miami Herald, The Kansas City Star, The Sacramento Bee, The Charlotte Observer, The (Raleigh) News and Observer, The (Fort-Worth) Star-Telegram, The (Durham NC) Herald-Sun or one of 24 other media companies, you’ve read one of its properties. It is a provider of digital and print news and advertising services. And it reported Q1 earnings last week.
The earnings — as you might imagine for a company with a large print-media division — were far from gangbusters and are highly cyclical in nature. Take a look at this chart:
The company missed estimates on both EPS and revenue. Total revenues were down 10.1% YOY. Total advertising revenues were down 16.7% YOY. Direct marketing advertising revenues declined 21.9% YOY. On the flip side, the company experienced growth in its digital initiatives, including increases in digital-only subscribers and average total unique visitors to online properties. The company also partnered with Subscribe with Google to push further improvements in the digital business. But, all in, this is a company that it is facing a massive wave of disruption coming at it from all angles.
First, its capital structure. The company’s leverage ratio stands at 4.42x as of the end of Q1 on the basis of its existing cap stack. Currently, it has about $30 million of outstanding letters of credit issued against its $65 million revolving credit facility (Bank of America). As of 12/31/17, the company had $344.6 million of 9% ‘22 senior secured first lien notes outstanding on top of (a) as of 4/27/18, $82.1 million of 7.15% ‘27 debentures and (b) $274 million of 6.875% ‘29 indentures.
But, not for long. Enter Chatham Asset Management. The fund — which may or may not be fresh off of a shiny new $1b private equity vehicle for debt-related investments — is taking out a large chunk of the capital structure. The company filed an 8k on April 26th, indicating that there is a term sheet pursuant to which a newly established LLC will issue $250 million of 7.372 % ‘30 Tranche A Term Loan paper and $168.5 million 6.875% ‘31 of Tranche B Term Loan paper, the proceeds of which will be used to take out the long-dated debentures (except $8.3 million) and a portion of the senior secured notes. The structure isn’t yet determined but the interest expense is expected to increase incrementally. There is a makewhole as well, as you might expect, and we’re guessing it will have some fairly iron clad verbiage. In other words, this reeks of loan-to-own — with a cherry on top (see #2 below). Perhaps Chatham will eventually roll up the properties with American Media Inc., parent to The National Enquirer, which Chatham owns 80% of and, per The Wall Street Journal, appears to be having issues of its own.
Some notable bits in the company’s earnings call:
A. Tariffs. Tariffs on newsprint may have an effect on traditional print media companies. Note the following comments:
One more word on the print newspaper world. We are often asked on these calls about the impact of newsprint prices on our operating model. As the print side of our business has declined so has our operating sensitivity to fluctuations in newsprint supply and pricing, now less than 4% of our operating expense, down from 20% at the peak of print newspaper revenues more than a decade ago.
Nonetheless, policies such as the newsprint tariffs announced by the administration earlier this year are unhelpful we believe, both to free market and to public policy. We oppose them and we have made our position clear to the administration. We say this as an equity owner of one of the few remaining U.S. domestic newsprint producers. So one might assume we would be on the other side of this issue, but we are not. Public policy that makes these input prices more costly at a time of great stress in this industry harms our local communities and is against the public interest.
Interesting. The company is guiding towards higher print costs, including increases in pricing coming from Canadian mills. #MAGA!!
B. Cost Controls. This company has all of the makings of a company in triage. Operating expenses were down 8.4%. The company outsourced printing operations. It entered into a sale leaseback transaction, pursuant to which $13 million of proceeds is being offered to the company’s senior secured noteholders in a tender offer at par. It sold off some intellectual property (CareerBuilder LLC). All of this is meant to buy the company time to effectuate its digital transformation.
C. Ad Spend. This should come as a surprise to nobody that follows the world of restructuring but the trickle-down effect of battered grocery and retail is notable here. This is the company’s statement about the higher-than-expected ad spend decline:
I mean retail results were disappointing. Obviously, that’s something that we’ve been seeing for some time now. Total retail revenues finished a bit better actually in Q1 and Q4, but that was driven entirely by digital growth. Revenue from preprints delivered with the newspaper actually got worse. And as Elaine said, our direct marketing circulars delivered to non-subscribers also softened. So our retail customers are facing some tough citing and it continues to have an impact on our print products. And some of those advertisers obviously in direct marketing are the same as the ones that are in the print newspaper, and their troubles affect both.
In retail print revenue, our largest declines were coming from the food and drug department store category, and we’ve seen that strand for a while. Preprints took a steeper decline in Q1. And then we’ve seen in previous quarters down about 38% over last year. Again though due to continued losses from the major department stores like Macy's, Sears, Stein Mart, Penne and stores no longer in business that were rolling over from last year like hhgregg and Toys "R" Us, or at least going in bankruptcy, Toys "R" Us is still struggling.
And so in preprints or about 12% of total advertising revenues, so when that gets hit that’s of percentage, it takes the whole category down. So mostly I think a story on the retail side, Avi, and continuing pressure on the print part of that business.
The company continued,
We sometimes talk about the importance of our role in local communities and with our neighbors, and these are the places we live where our employees are residents all across the country. The impact on local retail across the country has been, as you know, very widespread. This is an earnings call about a news and information company. So it’s the wrong place to talk about those underlying trends. But I would say we’re super aware of them. We obviously bare the impact from an advertising perspective, which also having a big impact on our communities. And that’s something that we’re extremely aware of as in many cases the leading local news and information company in those communities.
We appreciated the reminder. Jokes abound about the #retailapocalypse. For many local communities, the far-reaching effects of such are no laughing matter.
Okay, this WSJ article is bananas. What are the chances that Jay Alix has a direct line in to Gerard Baker? Choice passage,
A Wall Street Journal analysis of disclosure filings in all 13 chapter 11 cases in which McKinsey’s restructuring unit, called McKinsey RTS, has participated shows the company routinely discloses far fewer names and descriptions of connections than other advisers.
It continues,
McKinsey initially identified by name a total of 59 connections to participating debtors, creditors, lawyers and accountants in those cases. The roughly 45 other bankruptcy professionals involved in those cases, including law firms, accounting firms and restructuring advisers, reported more than 15,000 named connections in total. On average, McKinsey reported five such relationships per case compared with the other firms’ disclosures of 171 connections each.
Typically conflicts disclosures don’t figure as high drama warranting a major newspaper’s #longform front-page coverage.
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As concerns grow about Iranian and Venezuelan production levels, oil and gas is now hovering around $67-68, and there are headlines like this: “Is Big Oil Back?” You’d think, therefore, there’d be a bit less talk about distressed oil and gas companies. After all, distressed oil and gas is so 2015.
Think again. This past week Houston-based Erin Energy Corporation ($ERN) filed for bankruptcy; it is a Sub-Saharan Africa-focused exploration and production company. Meanwhile, we’ve all heard about Rex Energy’s imminent restructuring, but now there are fissures appearing at Austin-based Jones Energy ($JONE) as well.
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In parts one (Legal), two (Investment Bankers - Members’ only) and three (Financial Advisors - Members’ only) of our ‘18 “Preliminary Review,” we noted that Q1 was dominated by Kirkland & Ellis LLP, Weil Gotshal & Manges LLP, Evercore, PJT Partners, and Alvarez & Marsal North America LLC. As we looked at the statistics, however, it has become abundantly clear that the success shared by those firms in gobbling up large company-side cases is nothing compared to another industry player that, we’ve come to realize, is the epitome of company-side domination. Introducing Prime Clerk LLC.
Now this is an impressive case roster: Cenveo Inc., iHeartMedia Inc., Fieldwood Energy LLC, Claire’s Stores Inc., Southeastern Grocers, FirstEnergy Solutions. And that is just in Q1. Last year the firm was involved in Toys R Us Inc., Takata Inc., Puerto Rico, Seadrill Ltd.,Avaya Inc., The Gymboree Corporation and Payless Holdings LLC to name just a small sampling. With the exception of Puerto Rico and First Energy, Weil or Kirkland is at the helm for every single one of the above cases. In other words, as much as Kirkland and Weil have dominated debtor market share, Prime Clerk has dominated Kirkland and Weil. And that is apparently not just a Q1 phenomenon. Already in Q2, Kirkland and Prime Clerk have been working together on EV Energy and Nine West Holding. We’re too time-constrained to dig back into 2017 or before, but something tells us that we’d start seeing a longer-dated pattern here. No wonder The Carlyle Group sank its claws into this case administrator: it is a practical monopoly of a duopoly.
In "What to Make of the Credit Cycle (Part 4)," we wrote:
The point is: some opportunistic folk sure seem to think that there’s another cycle coming. And they’re putting their money where their mouth is, thinking that there will be money to be made in the (seemingly saturated) case administration business. Time will tell.
In the meantime, those who can leverage robust M&A activity will. But let’s take a step back…
Do you remember THAT scene in the “Wolf of Wall Street?” The one where Leo and Matty-C pound their chests in the most bro-ey of bro-ey banker moments…? We’re pretty sure this is what the bankers over at Moelis & Company ($MO) were doing before, after and as they were announcing earnings on Monday.
Take this quote for instance:
Analyst: “Ken, I still get plenty of investors that mispronounce the name of your firm, so I guess we’re still working on it.”
Ken Moelis: “There is no mispronunciation, there’s only a wrong phone number. If they get the phone number right….”
Kind of hard to argue with that. Who gives a crap how your name is pronounced if the phone is ringing, the rates are increasing and the dollars are coming in? Marlo Stanfield’s “My name is my name” proclamation in the final season of The Wire clearly doesn’t apply to Ken Moelis. Have to admire that.
So, right after we gave Evercore ($EVR)(which reports earnings today) and PJT Partners($PJT) props in our Q1 review of bankers (to be fair: covering company-side only), Moelisdropped these numbers:
We achieved $219 million of revenues in the first quarter, up 27% over the prior year. This represented our highest quarter of revenues on record. Our performance compares favorably to the overall M&A market in which the number of global M&A completions greater than $100 million declined 14% during the same period. Our growth was primarily attributable to very strong M&A activity in the quarter. We're participating across industries and deal sizes, and we are also earning higher average fees per transaction. In addition, restructuring activity continue to be a solid contributor.
The fee part of this is interesting. Achieving pricing power in this environment is a big accomplishment. Query whether that relates more to M&A and less so to restructuring given the relative dearth of bankruptcy deal flow. Regardless, here’s what the stock did on Tuesday, a day the S&P 500 otherwise declined 1.34% and the Dow was down 424 points:
Source: Yahoo! Finance
When asked about restructuring, specifically, this is what Mr. Moelis had to say:
Well, never expect things to only get better, but it's been - look, it's been a low default environment for a long time. And I think some of the peers and competitors have kind of - who were edging into restructuring might have edged out a bit; we're not. We think we have the leading restructuring group on the Street. They've been together for years and years and years, and now the way we integrate them, the amount of spread we can get using the 120 on these to really make sure that they are talking to companies that are having issues. And those issues could be opportunities, too. It's almost - it crosses over with liability management. It might stay to be a 1% or 2% default rate for a while []. You can never tell. But there's a large amount of paper out there. So even at 1% or 2%, you can stay busy if you have a market-leading restructuring group which we do. Look, it could get worse. I guess nobody could default, but I think between 1% and 0% defaults and 1% and 5% defaults, I would doubt we hit 5% before we hit 0%. So, I'm happy we held the team together, we've added to it, we've integrated it, it continues to be a solid part of our business, and I think it has a lot more upside than downside.
Ok, so this must be a misstatement. He must have meant that he doubts that we reach 0% rather than 5%. And so: A. Lot. More. Upside. In late 2019? Early 2020? Who has edged out? Will others between now and then? The analysts didn’t ask those questions.
We’ve spent a considerable amount of space discussing what to make of the credit cycle. Our intent is to give professionals a well-rounded view of what to expect now that we’re in year 8/9 of a bull market. You can read Parts one (Members’ only), two, and three (Members’ only), respectively.
Interestingly, certain investors have become impatient and apparently thrown in the towel. Is late 2019 or early 2020 too far afield to continue pretending to deploy a distressed investing strategy? Or are LPs anxious and pulling funds from underperforming or underinvested hedge funds? Is the opportunity set too small - crap retail and specialized oil and gas - for players to be active? Are asset values too high? Are high yield bonds priced too high? All valid questions (feel free to write in and let us know what we’re missing: petition@petition11.com).
In any event, The Wall Street Journal highlights:
A number of distressed-debt hedge funds are abandoning traditional loan-to-own strategies after years of low interest rates resulted in meager returns for investors. Some are even investing in equities.
PETITION Note: funny, last we checked an index fund doesn’t charge 2 and 20.
The WSJ continues,
BlueMountain Capital Management LLC and Arrowgrass Capital Partners LLP are some of the bigger funds that have shifted away from this niche-investing strategy. And lots of smaller funds have closed shop.
A number of smaller distressed-debt investors have closed down, including Panning Capital Management, Reef Road Capital and Hutchin Hill Capital.
PETITION Note: the WSJ failed to include TCW Group’s distressed asset fund. What? Too soon?
We should note, however, that there are several other platforms that are raising (or have raised) money for new distressed and/or special situations, e.g., GSO and Knighthead Capital Management.
Still is the WSJ-reported capitulation a leading indicator of increased distressed activity to come? Owl Creek Asset Management LP seems to think so. The WSJ writes,
Owl Creek founder Jeffrey Altman, however, believes that if funds are shutting down and moving away from classic loan-to-own strategies then a big wave of restructuring is around the corner. “If anything, value players leaving credit makes me feel more confident that the extended run-up credit markets have been enjoying may finally be ending,” Mr. Altman said.
One’s loss is another’s opportunity.
*****
Speaking of leading indicators(?) and opportunity, clearly there are some entrepreneurial (or masochistic?) investors who are prepping for increased distressed activity. In December, The Carlyle Group ($CG), via its Carlyle Strategic Partners IV L.P. fund, announced a strategic investment in Prime Clerk LLC, a claims and noticing administrator based in New York (more on Prime Clerk below). Terms were not disclosed — though sources tell us that the terms were rich. Paul Weiss Rifkind & Wharton LLP served as legal counsel and Centerview Partners as the investment banker on the transaction.
On April 19th, Omni Management Group announced that existing management had teamed up with Marc Beillinson and affiliates of the Beilinson Advisory Group (Mark Murphy and Rick Kapko) to purchase Omni Management Group from Rust Consulting. Terms were not disclosed here either. We can’t imagine the terms here were as robust as those above given the market share differential.
The point is: some opportunistic folk sure seem to think that there’s another cycle coming. And they’re putting their money where their mouth is, thinking that there will be money to be made in the (seemingly saturated) case administration business. Time will tell.
In 2018 Q1 Preliminary Review (Long Duopolies = Long Kirkland & Weil), we noted the ongoing duopolistic slugfest between Weil Gotshal & Manges LLP and Kirkland & Ellis LLP with respect to company-side mandates. We subsequently noted in 2018 Q1 Preliminary Review (Part 2: Investment Banking) the following,
But then the question becomes, who benefits from this duopoly? In Q1 anyway, it appears that it was Evercore ($EVR) and PJT Partners ($PJT). The former was involved in three of the four Weil cases noted above; the latter in two of the four Kirkland & Ellis cases (as well as two other big Q1 deals, Bon-Ton Stores and Ascent Resources Marcellus Holdings LLC). Notably, Moelis & Co. ($MO) and Lazard Ltd. ($LAZ) were also company-side banker in 3 deals each in Q1. Read: relationships matter and it pays to be at the top of the duopolists’ list.
In the financial advisory world, no firm has worked those relationships for company-side mandates better than...to read this rest of this a$$-kicking commentary, you must be a Member.
In “The Latest and Greatest on Guitar Center,” we cast some shade on the guitar retailer’s amend-and-extend transaction. We wrote,
On Monday, Guitar Center — with the help of bankers UBS and Houlihan Lokey and the consent of Ares — launched an exchange offer and consent solicitation related to its unsecured notes. The offer is to swap the existing $325 million 9.625% notes for $325 million of 5% cash/8% PIK notes due 2022 (along with with some warrants). Per the company’s press release, $299 million worth of holders have already agreed (92% of the issuance). This swap would save the company $13,812,500 a year in interest expense AND have the effect of pushing out the maturity for three years. Gotta love the capital markets these days.
In tandem, the company is proposing to offer $635 million of new 9.5% senior secured notes due 2021. The use of proceeds of these new notes would be to redeem the $615 million 6.5% senior secured notes due 2019. With this piece of the transaction, the company will be taking on an additional $20.35 million of annual interest expense.
Finally, the company will also refinance the $375 million ABL, extending the maturity out by 5 years.
So, if you made it this far, here’s the upshot: if these transactions are successful, the company will have availed itself of a few years to turn itself around by pushing out its debt maturities. But, it will have eliminated ZERO INTEREST EXPENSE in the aggregate. Said another way: this is a band-aid, not a solution.
All of which means that the company needs to hope and pray some rock God hits the scene and reinvigorates the market for guitars in the next two years. We’ll take the under.
As it turns out, the company ultimately downsized the amount of 5% cash/8% PIK notes due 2022 from $325 million to $318 million which will, naturally, have the affect of...to read this rest of this a$$-kicking commentary, you must be a Member...
On Wednesday, we concluded the “DO. NOT. MESS. WITH. DAISY. CHAPTER 2 (Short Pet Retailers 2.0) 🔫🔫” about Petsmart Inc., with the following statement:
“With 1600 stores, the company isn’t light with its footprint and same store sales and pricing power are on the decline. Still, the company’s liquidity profile remains relatively intact and its services businesses apparently still drive foot traffic. Which is not to say that the situation doesn’t continue to bear watching — particularly if Chewy.com’s customer-acquisition-costs continue to skyrocket, overall brick-and-mortar trends continue to move downward, and the likes of Target ($T), Walmart ($WMT) and Amazon ($AMZN) continue to siphon off market share. A failure to stem the decline could add more stress to the situation.”
Well, guess what: industry trends are continuing to decline. Last week Petco Holdings announced dogsh*t earnings (oh man, we’ve been waiting all week for that…SO GOOD) and, suffice it to say, its (and Petsmart’s) bonds made fresh lows on the news.
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