🍾Happy Anniversary, Tower Records!!🍾

Tower Records Filed for Chapter 22 on August 20, 2006 (Long Disruption)

12 years ago today Tower Records Inc. filed for bankruptcy for the second time in 2.5 years, ending the company’s run in the United States (and most other places of the world).

The company first filed for bankruptcy in February 2004. The music retailer had approximately 90 stores and more than $110mm in debt that it owed to the likes of AIG Investment Group, Goldman Sachs & Co., JPMorgan Chase and…wait for it…Bear Stearns Securities Corp. The first bankruptcy was a short prepackaged bankruptcy that eliminated $80mm of debt in a debt-for-equity swap, leaving the company’s famous and eccentric owners with 15% of the company. The company attempted a sale process but had no takers. CIT Group provided the company with a $100mm DIP credit facility. O’Melveny & Myers LLP and Richards Layton & Finger PA represented the company (and both signatories to the petition actually still remain at those firms).

Interestingly, with some limited exception, the narrative explaining the company’s demise is not-all-too-different from what we see from retailers today. SFGate wrote at the time:

Tower's difficulties reflect those of the music industry during the past few years. Industry sales declined from $10.49 billion in 1999 to $8.93 billion in 2002, according to a report from the National Association of Recording Merchandisers, which attributed the swoon to digital downloading and copying. Retailers are also under pressure from online sales by firms such as Amazon.com, and from deep discounting by such rivals as Wal-Mart, and fierce competition from other chains like Borders and Barnes & Noble.

CBSNews added:

The filing is expected to help clear the way for selling the 93-store chain that suffered from rapid changes in the music business, especially the exploding popularity of downloading music for free from the Internet. Discounters such as Best Buy, Circuit City and Wal-Mart Stores also undercut Tower's prices and hurt the chain's earnings.

Those trends and a major slump in the music industry followed fast on the heels of the company's 1998 decision to expand using $110 million of borrowed money. The expansion drove Tower to a peak of more than $1 billion in annual revenue with nearly 200 stores in 21 states and numerous franchises internationally. But it has been rapidly downsizing since 2001.

A filing last April with the U.S. Securities and Exchange Commission revealed the retailer had lost money for 13 straight quarters.

Wait. Amazon ($AMZN)? Check. Deep discounting from the likes of Walmart ($WMT)? Check. Too much debt to fund an over-expansion? Check. Revenue declines on the basis of technological innovation? Check. We guess the more things change, the more they stay the same.

And stay the same they did. Even then. It took just 2.5 years for the company to wind its way back into bankruptcy court. And for all of the same reasons. Two months later, Great American Group, a firm that specializes in liquidations, emerged as the highest and best bidder in an auction for the company, winning with a bid of $134.5mm; it beat Trans World Entertainment Corporation ($TWMC), an entertainment media retail store operator that — shockingly — still exists. You may be familiar with it: it’s largest specialty retail brand is fye, which as of May 2018, still operated 253 stores. It is hanging by a thread, but it still exists — largely on the back of its etailz segment, which apparently thrives by doing omni-channel business with Amazon, Ebay, Jet.com/Walmart and Wish.

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Anyway, Trans World had hoped to continue operating at least some of the Tower locations; it lost the bidding by $500k. And, accordingly, Tower Records liquidated. While there is such a thing as Tower Records in Asia, the name is all but a distant memory today.

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

Long Private Markets as Public Markets

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

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

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

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

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

He goes on to state some characteristics of an ABC:

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

  • There is no discharge in an ABC.

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

And some benefits of an ABC:

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

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

  • Lower admin costs;

  • Lower visibility to an ABC than a bankruptcy filing;

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

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

Asleep yet? 😴

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

ABCs also have limitations:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

So, what’s the problem?

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

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

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

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

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

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

And then there are the public markets.

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

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

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

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

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

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

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

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

She continued:

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

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

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


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

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

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

Magazines Are Suffering From Declining Ad Revenue

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

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

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

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

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

With whopping ramifications. More from the WWD:

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

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

It continued:

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

Little wonder advertisers are looking elsewhere.

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

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

Or they’ll just share passwords. Per Digiday:

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

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

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

🍟Casual Dining is a Hot Mess. Part IV 🍟

Short Kona Grill ($KONA)

We’ve been all over the casual dining space so much that it’s time to just make this a recurring series. We’ve previously discussed casual dining here (Macro trends, Kona GrillP.F. Ghang China Bistro Inc.Ruby Tuesday and Bertucci’s), here (Applebee’s Neighborhood Grill & Bar) and here (Luby’s Inc. and Steak ‘n Shake).

To continue reading, you must be a PETITION Member. Join here

The Rise of Net-Debt Short Activism (Short Low Default Rates)

Aurelius Goes After Windstream Holdings Inc. 

🤓Another nerd alert: this is about to get technical.🤓

With default rates low, asset prices high, and a system awash with heaps of green, investors are under pressure by LPs and looking for ways to generate returns. They’ll manufacture them if needs be. These forces help explain the recent Hovnanian drama, the recent McClatchey drama and, well, basically anything involving credit default swaps (“CDS”) nowadays. To point, the fine lawyers at Wachtell Lipton Rosen & Katz (“WLRZ”) write:

The market for corporate debt does not immediately lend itself to the same kind of “activism” found in equity markets.  Bondholders, unlike shareholders, do not elect a company’s board or vote on major transactions.  Rather, their relationship with their borrower is governed primarily by contract.  Investors typically buy corporate debt in the hope that, without any action on their part, the company will meet its obligations, including payment in full at maturity.

In recent years, however, we have seen the rise of a new type of debt investor that defies this traditional model.

Right. We sure have. Boredom sure is powerful inspiration. Anyway, WLRZ dubs these investors the “net-short debt activist” investor.

The net-short debt activist investor has a particular modus operandi. First, the investor sniffs around the credit markets trolling for transactions that arguably run afoul of debt document covenants (we pity whomever has this job). Once the investor identifies a potential covenant violation, it scoops up the debt (the “long” position”) while contemporaneously putting on a short position by way of CDS (which collects upon a default). The key, however, is that the latter is a larger position than the former, making the investor “net short.” Relying on its earlier diligence, the investor then publicly declares a covenant default and, if it holds a large enough position (25%+ of the issuance), can serve a formal default notice to boot. The public nature of all of this is critical: the investor knows that the default and/or notice will move markets. And that’s the point: after all, the investor is net short.

In the case of a formal notice, all of this also puts the target in an unenviable position. It now needs to go to court to obtain a ruling that no default has occurred. Absent that, the company is in a world of hurt. WLRK writes:

Unless and until that ruling is obtained, the company faces the risk not only that the activist will be able to accelerate the debt it holds, but also that other financial debt will be subject to cross defaults and that other counterparties of the company — such as other lenders, trade creditors, or potential strategic partners — may hesitate to conduct business with the company until the cloud is lifted.  

Savage. Coercive. Vicious. Long low default rate environments!

In the case of Little Rock Arkansas-based Windstream Holdings Inc. ($WIN), a provider of voice and data network communications services, all of this is especially relevant.

To continue reading, you must be a PETITION Member. Join here

😴Mattress Firm's Nightmare😴

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

 Source: PETITION LLC

Source: PETITION LLC

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

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

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

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

To continue reading, you must be a PETITION Member. Join here

💰Goldman Sachs Has its Cake and Eats it Too💰

Short GNC Holdings Inc. Long Care/of. 

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

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

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

But still.

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

Bloomberg notes:

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

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

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

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

🛋There's Disruption Afoot in the Furniture Space🛋

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

RetailDive notes:

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

Accordingly, GartnerL2 cautions that:

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

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

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

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

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

⚡️Is PG&E in Trouble?⚡️

PG&E Reported Earnings (Long Climate Change)

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

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

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Home Security is a Tough Business

Short Ascent Capital Group

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Tough is one word for it.

Saturated is another.

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

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

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

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

Especially for Monitronics.

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

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

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

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

And here we thought people were shunning the cable companies?

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

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

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

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

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

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

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

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

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

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

Moody’s noted:

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

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

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

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

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This company is looking a bit insecure.

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

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

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

As we said, “saturated.”

McKinsey Keeps Getting Burned (Long Newspaper Relationships)

We’ve previously covered the pending lawsuit by Jay Alix against McKinsey here. It’s next level and totally worth refreshing your recollection. You’ll recall the sequence of events: first, a Wall Street Journal article highlighted McKinsey’s failure to disclose potential conflicts in a variety of restructuring engagements and then Jay Alix immediately launched his lawsuit alleging racketeering, bribery, etc. Curious timing, as we said at the time. We wrote:

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).

Well, for McKinsey, the hits just keep on coming.

Subsequent to the above, the Wall Street Journal reported that a McKinsey retirement fund held investments that hinged on the result of some of the very bankruptcy cases that McKinsey RTS worked on. WHOOPS.

This week, Representative Andy Biggs of Arizona asked the director of the U.S. Trustee Program, a Justice Department unit, for clarity on the requirements governing how bankruptcy professionals comply with the Bankruptcy Code’s “disinterestedness” standard. Per The Wall Street Journal, Representative Biggs is “concerned that undisclosed conflicts at McKinsey & Co.’s restructuring unit may be compromising the nation’s bankruptcy system.” With all due respect to Mr. Biggs, there are greater dangers to the integrity of the bankruptcy system than the disclosure of McKinsey’s client list. Like some of the points made here (conflicts, generally). And here (independent directors). Or here (professionals’ fees). Or here (venue shenanigans and judges “playing ball”). This wouldn’t be the first time that a Congressman exhibited a negligible understanding of an issue. But we digress.

Anyway, like clockwork, Jay Alix pounced. This week, as (also) reported in The Wall Street Journal (which seems conveniently all over this drama), Mr. Alix filed papers in the U.S. Bankruptcy Court in Richmond Virginia asking the bankruptcy judge to consider reopening the bankruptcy case of Alpha Natural Resources, a case that confirmed eons ago. Per the WSJ:

The revelation that McKinsey had a financial interest in the outcome of Alpha’s bankruptcy warrants reopening the case and revisiting whether the firm failed to properly disclose potential conflicts of interest, according to Mr. Alix.

First, HAHAHAHAHA. Right, ok. We’re sure the judge will reopen the case on this basis.

Second, the article is entitled “Disclosure Advocate Seeks to Reopen Coal Miner’s Bankruptcy.” Therein, the WSJ deadpans:

Mr. Alix has been relentless in his battle with McKinsey. He is currently pursuing litigation against the firm in several courts, hiring some of the country’s top lawyers and ethics experts to help him take on the consulting giant.

Mr. Alix has denied McKinsey’s accusation that he is seeking a competitive advantage for AlixPartners, the prominent restructuring firm he retired from in 2006 but retains a minority ownership stake in.

Right. Of course he isn’t looking to take out a competitor (that once poached his employees) and/or juice his equity. Promise.

He’s a mere “disclosure advocate.”

New York City CRE (Long the Changing Retail Landscape)

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

Yesterday, Bloomberg noted the following:

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

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

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

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

Some brokers expressed disappointment with the tenant selection.

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

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

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

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

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

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

What? Too soon?