Oil and Gas Continues to Crack

Long Houston-Based Hotels

Investors are demanding the greatest premium to own HY energy debt relative to the broader junk-bond market since December. pic.twitter.com/YQSnsMMD1y

— Lisa Abramowicz (@lisaabramowicz1) March 19, 2019

The bankruptcy waiting room is becoming standing room only for oil and gas companies despite oil resting near 2019 highs (even after a rough 2% decline on Friday). We’ve previously mentioned Jones Energy ($JONE), Sanchez Energy Corporation ($SN), Southcross Energy Partners LP ($SXEE), Vanguard Natural Resources, Alta Mesa Holdings LP ($AMR) and Chaparral Energy Inc. ($CHAP) in “⛽️Is Oil & Gas Distress Back?⛽️.” Based on earnings reports or other SEC filings this week, add Emerge Energy Services LP ($EMES), EP Energy Corporation ($EPE) and Approach Resources Inc. ($AREX) to the list.

Emerge Energy Services experienced some wild stock fluctuation this week after it filed a Form 12b-25 with the SEC indicating that was unable to timely file its FY 2018 Form 10K. Therein, the company stated that it has been distracted by negotiations with its revolving credit facility agent, PNC Bank NA, and second lien note purchase agreement agent, HPS Investment Partners LLC, on several forbearance agreements and amendments to the two agreements. Tee this baby up for a potential BK.

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Cracks in Malls Grow Deeper (Long Thanos, Short CMBS)

Retail Carnage Continues Unabated (R.I.P. Payless, Gymboree, Charlotte Russe & Shopko)

Talk of retail’s demise is so pervasive that the casual consumer may be immune to it at this point. Yeah, yeah, stores are closing and e-commerce is taking a greater share of the retail pie but what of it?

Well, it just keeps getting worse.

Consider 2019 alone. The Payless ShoeSource, Gymboree, Charlotte Russe, Shopko, and Samuels Jewelers* liquidations constitute thousands of stores evaporated from existence. It’s like Thanos came to Earth and snapped his fingers and — POOF! — a good portion of America’s sh*tty unnecessary retail dissipated into dust. Tack on bankruptcy-related closures for Things Remembered, Beauty Brands and Diesel Brands USA Inc. and you’re up to over 4,300 stores that have peaced out.

That, suffice it to say, would be horrific enough on its own. But “healthy” (read: non-bankrupt) retailers have only added to the #retailapocalypse. Newell Brands Inc. ($NWL)is closing 100 of its Yankee Candle locations to focus on “more profitable” distribution channels. Gap Inc. ($GPS) announced it is closing 230 of its more unprofitable locations and spinning Old Navy out into its own separate company — the good ol’ “good retail, bad retail” spinoff. Chico’s FAS Inc. ($CHS) is closing 250 stores. Stage Stores Inc. ($SSI) — which purchased once-bankruptcy Gordmans — is closing between 40-60 department stores. Kitchen Collection ($HBB) is closing 25-30 stores. E.L.F. Beauty ($ELF) is closing all 22 of its locations. Abercrombie & Fitch Co. ($ANF)? Yup, closing stores. Up to 40 of them. GNC Inc. ($GNC) intends to close hundreds more stores over the next three years. Foot Locker Inc. ($FL)? Despite a strong earnings report, it is closing a net 85 stores. J.C. Penney Inc. ($JCP)…well…it didn’t report strong earnings and, not-so-shockingly, it, too, is closing approximately 27 stores this year. Victoria’s Secret ($LB)? 53 stores. Signet Jewelers Ltd. ($SIG)? Mmmm hmmm…it’s been closing its Zales and Kay Jewelers stores for years and will continue to do so. As we noted on Sunday, The Children’s Place Inc. ($PLCE) also intends to close 40-45 stores this year. Build-A-Bear Workshop Inc. ($BBW) will close 30 stores over the next two years. Ascena Retail Group Inc. ($ASNA) recently reported and disclosed that it had closed 110 stores (2% of its MASSIVE footprint) in the last quarter. Even the creepy-a$$ dolls at American Girl aren’t moving off the shelves fast enough: Mattel Inc. ($MAT) indicated that it needs to rationalize its retail footprint. There’s nothing Wonder Woman — or even a nightmare-inducing American Girl version of Wonder Woman — can do to prevent all of this carnage.

As a cherry on top, EVEN FRIKKEN AMAZON INC. ($AMZN) IS CLOSING ALL 87 OF ITS POP-UP SHOPS! Alas, The Financial Times pinned the total store closure number for 2019 alone at 4,800 stores (and just wait until Pier 1 hits). Attached to that, of course, is job loss at a pretty solid clip:

All of this begs the question: if there are so many store closures, are the landlords feeling it?

In part, surprisingly, the number appears to be ‘no.’ Per the FT:

“Investors in mall debt have also shown little sign of worry. The so-called CMBX 6 index — which tracks the performance of securitised commercial property loans with a concentration in retail — is up 4.4 per cent for 2019.”

Yet, in pockets, the answer also appears to be increasingly ‘maybe?’

For example, take a look at CBL & Associates Properties Inc. ($CBL) — a REIT that has exposure to a number of the names delineated above.

On its February 8th earnings call, the company stated:

“We are pleased to deliver results in line with expectations set forth at the beginning of the year notwithstanding the challenges that materialized.”

Translation: “we are pleased to merely fall in line with rock bottom expectations given all of the challenges that materialized and could have made sh*t FAR FAR WORSE.”

The company reported a 4.4% net operating income decline for the quarter and a 6% same-center net operating income decline for the year. The company is performing triage and eliminating short-term pressure: it secured a new $1.185b ‘23 secured revolver and term loan with 16 banks as part of the syndicate (nothing like spreading the risk) to refinance out unsecured debt (encumbering the majority of its ‘A Mall’ properties and priming the rest of its capital structure in the process); it completed $100mm of gross dispositions plus another $160mm in “sales” of its Cary Towne Center and Acadiana Mall; it reduced its dividend (which, for investors in REITs, is a huge slap in the face); and it also engaged in “effective management of expenses” which means that they’re taking costs out of the business to make the bottom line look prettier.

Given the current state of affairs, triage should continue to remain a focus:

“Between the bankruptcy filings of Bon-Ton and Sears, we have more than 40 anchor closures.”

“…rent loss from anchor closures as well as rent reductions and store closures related to bankrupt or struggling shop tenants is having a significant near-term impact to our income stream.”

They went on further to say:

“Bankruptcy-related store closures impacted fourth quarter mall occupancy by approximately 70 basis points or 128,000 square feet. Occupancy for the first quarter will be impacted by a few recent bankruptcy filings. Gymboree announced liquidation of their namesake brand and Crazy 8 stores. We have approximately 45 locations with 106,000 square feet closing.”

Wait. It keeps going:

“We also have 13 Charlotte Russe stores that will close as part of their filing earlier this month, representing 82,000 square feet.”

Earlier this week, Things Remembered filed. We anticipate closing most of their 32 locations in our portfolio comprising approximately 39,000 square feet.”

And yet occupancy is rising. The quality of the occupancy, however — on an average rental basis — is on the decline. The company indicated that new and renewal leases averaged a rent decline of 9.1%. With respect to this, the company states:

As we've seen throughout the years, certain retailers with persistent sales declines have pressured renewal spreads. We had 17 Ascena deals and 2 deals with Express this quarter that contributed 550 basis points to the overall decline on renewal leases. We anticipate negative spreads in the near term but are optimistic that the positive sales trends in 2018 will lead to improved lease negotiations with this year.

Ahhhhh…more misplaced optimism in retail (callback to this bit about Leslie Wexner). As a counter-balance, however, there is some level of realism at play here: the company reserved $15mm for losses due to store closures and co-tenancy effects on company NOI. In the meantime, it is filling in empty space with amusement attractions (e.g., Dave & Buster’s Entertainment Inc. ($PLAY), movie theaters, Dick’s Sporting Goods Inc ($DKS) locations, restaurants, office space and hotels. Sh*t…given the amount of specialty movie theaters allegedly going into all of these emptying malls, America is going to need all of those additional gyms to work off that popcorn (and diabetes). Get ready for those future First Day Declarations that delineate that, per capita, America is over-gym’d and over-theatered. It’s coming: it stretches credulity that the solution to every emptying mall is Equinox and AMC Entertainment Holdings Inc. ($AMC). But we digress.

All of these factors — the average rent decline, the empty square footage, etc. — are especially relevant considering the company’s capital structure and could, ultimately, challenge compliance with debt covenants. Net debt-to-EBITDA was 7.3x compared with 6.7x at year-end 2017. Here is the capital structure and the respective market prices (as of March 19):

The new Senior secured term loan due ‘23:

The Senior unsecured notes due ‘23:

The notes due ‘24:

The notes due ‘26:

Additionally, the company is trying to promote how flexible it is with its ability to pay down debt and invest in redevelopment properties. Here is a snippet of the company presentation that displays the debt covenants on its revolver, term loan and other unsecured recourse debt:

What is the real value of the mall assets that are left unencumbered? Recently, the Company has been slowly impairing a number of its assets and many of the Company’s tier 2 and 3 malls have yet to be revalued. If appraisers lower the value of these assets that are really supposed to be supporting the debt, what then?

Life as an unsecured creditor....when a third of your collateral value comes from dying C malls, and you gaze longingly at the A malls inside the term loan lenders' fence. #YouveBeenPrimed $CBL pic.twitter.com/ENgGeTY4zK

— Donut Shorts (@DonutShorts) February 8, 2019

And that doesn’t even take into consideration the co-tenancy clauses. As anchor tenants fall like flies, you’ll potentially see a rush to the exits as retailers with four-wall sales that don’t justify rents (and rising wages) exercise their rights.

So, given all of above, does the market share management’s (misplaced) optimism?

J.P. Morgan’s Michael W. Mueller wrote in a February 7, 2019 equity research report:

"While commentary in the earnings release noted some sequential improvement in 4Q results, we still see it being a grind for the company over the near to intermediate term."

BTIG’s James Sullivan added on February 20, 2019:

"We see no near-term solution for the owners of more marginal “B” assets like CBL & Associates. Sales productivity for such portfolios has shown little growth over the last eight quarters in contrast to the better-positioned “A” portfolios."

"The recent re-financing provides CBL with some near-term liquidity but limits future access to the mortgage market as only a small number of readily “bankable” assets remain unencumbered."

“We expect the challenging conditions in the industry to continue to create pressure on the operating metrics of mall portfolios with average sales productivity of less than $400/foot. More anchor closures are likely and in-line tenants are also likely to manage their brick-and-mortar exposure aggressively and close marginal locations. We reiterate our Sell rating and $2 price target.”

“With overall flat sales productivity in the portfolio, there is limited evidence that a turnaround in performance is likely in the next 24 months. Instead, we expect continued declines in SSNOI with negative leasing spreads and lower operating cost recovery rates.”

“CBL’s new facility which totals $1.185B is secured and replaces a series of unsecured term loans and a line of credit. Collateral includes 20 assets, of which three are Tier 1 Malls, 14 are Tier 2 Malls, and three are Associated Centers. As a result, CBL now has a much smaller number of unencumbered malls.”

“There are no unencumbered Tier 1 Malls (Sales exceeding $375/foot). There are nine unencumbered Tier 2 Malls (sales $300 -$375/foot) and those malls averaged $337/foot in 2017. The 2018 data is not available yet, but sales/foot for Tier 2 assets in 2018 declined by an average $5/foot. So assuming the law of averages applies, the average productivity of the unencumbered Tier 2 assets is $332/foot. Malls with that level of productivity cannot be financed in the CMBS market per CBL management.”

“With limited access to financing using their unencumbered malls, CBL has to look to its available capacity on its new line of credit, $265m, and projected free cash flow after paying its dividends, we estimate, of $155m in 2019 and $135m in 2020. CBL is currently estimating an annual capital requirement of $75m - $125m to redevelop closed anchor boxes. The per box range is $7m - $10m which we believe is low compared to peers whose cost per unit is closer to $17m. So CBL faces dwindling capital sources at the same time that its portfolio is suffering significant quarterly drops in SSNOI.”

Apropos, the shorts are getting aggressive on the name:

Short Interest in CBL & Associates Properties, Inc. $CBL Increases By 6.8% https://t.co/SBsgSN7VU9

— Zolmax News (@ZolmaxNews) March 5, 2019

The historical stock chart is ugly AF:

Which brings us to commercial mortgage-backed securities (CMBS) — derivative instruments comprised of loans on commercial properties. Canyon Partners’ Co-Chairman and co-CEO Joshua Friedman is shorting the sh*t out of mall-focused CMBS (containing among many other things, CBL properties) via a well known CDS index: the Markit CMBX.BBB- (and lower Indices) — to the tune of approximately $1b (out of $25b AUM). This is the mall-equivalent of the big short, except for commercial real estate. 🤔🤔

Here is a CMBX primer for anyone who wants to nerd out to the extreme. Choice bit:

CMBX allows investors to short CMBS credit risk across a wide array of vintages and credit ratings. Shorting individual cash bonds is difficult and rarely done, with the exception of a few very liquid names. The market for cusip level CMBS CDS used to exist, but the liquidity proved very poor and it was quickly replaced by trading of the synthetic indices.

And here is some color on what Mr. Friedman said regarding his trade:

Wowzers. Just imagine what happens to retail — including the malls — when the noise gets even louder.

*Samuels Jewelers filed chapter 11 last year but announced liquidation this year after failing to secure a buyer for its assets.

The Sporting Goods Space Takes it in the Groin ($DKS)

Short Bricks, D*cks and Mortar

In “The Fallacy of "There Must be One" Theory,” we questioned whether Dick’s Sporting Goods Inc. ($DKS) has a reason to exist. The stock was trading at $34.92/share at that point and has largely been on the slow-roll rise ever since, reaching as high as $39.38/share in late February. It reported earnings on Tuesday and, suffice it to say, it ain’t pushing $40 anymore:

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🍿Sears = The Gift That Just Keeps Oooooon Giving🍿

The Sears estate and Eddie Lampert are at it again

Oh, Sears. We just can’t quit you.

On Sunday in “Sears is Such a Drama Queen (Long Contract Interpretation Issues),” we discussed how — SHOCKER!! — there are already problems brewing between Transform Holdco (ESL’s buyer entity) and the debtors’ estate (the seller). Transform Holdco delineated a laundry list of beefs it had with the estate and filed a motion seeking mediation — a thoughtful strategy given that White Plains already foreshadowed how it might come out on any APA interpretation issues. Knowing full well that we were only getting one side of the story — and Eddie Lampert being Eddie Lampert — we hedged a bit:

Given all of the evidence pointing towards administrative insolvency to begin with, any obstreperousness on the part of the sellers (if true, as alleged) is wildly counter-productive: again, the estate is more likely than not administratively insolvent!! It would seem, then, that mediation would be a no brainer (though we reserve judgment for when the sellers respond — which we’re sure will be an entertaining dig at how much they think Lampert is retrading on certain parts of the deal…time to ramp up those PR machines again!!).

Now was that an easy call or was that an easy call?

On Monday night, the debtors responded with a motion to enforce the APA (and the automatic stay) and compel turnover of estate property — the main crux of which is the debtors allegation that Transform Holdco is in breach “by refusing to deliver $57.5 million that are the property of the Debtors….” They allege:

The Buyer’s request for mediation is nothing more than an attempt to delay turning Estate property over to the Debtors by conflating unrelated post-closing disputes (to which the Debtors have fully responded) with the Buyer’s refusal to deliver $57.5 million that plainly belongs to the Debtors per the APA, despite the Debtors’ repeated demands.

And jab:

…the Buyer is well aware of the extent to which the Debtors have limited resources to engage in protracted litigation. The $57.5 million in funds improperly retained by the Buyer are critical to maintaining administrative solvency and the Buyer is jeopardizing the Debtors’ ability to timely file a chapter 11 plan by withholding these funds. Rather than simply turn over the Estate assets, or seek guidance from this Court (which is intimately familiar with the APA and its terms), the Buyer instead conflates its obligation to turn over Estate property with a litany of unsubstantiated claims of misrepresentations and breaches by the Debtors, and requests a mediation that would, at best, delay resolution of any of these issues by more than a month.

And jab, cross:

…if there is a dispute, the Debtors would prefer to keep these issues front and center with this Court, which is most familiar with the APA and the issues facing the Debtors and their Estates, as well as the dynamics currently affecting the Estates. The Motion to Mediate should be seen for what it is: the Buyer’s transparent attempt to delay the transfer of Estate assets to gain leverage in its ongoing effort to sidestep the liabilities which Buyer assumed under the APA, including the $166 million in assumed accounts payable that this Court previously indicated the Buyer would be very unlikely to avoid.

There it is: the ever-controversial $166mm in assumed accounts payable. Can someone please pass the butter for our popcorn?

Is there any wonder that the estate would like to keep any and all disputes in White Plains? The judge’s fingerprints are all over this deal; he’s incentivized to make sure that it proceeds without dispute, that a plan of reorganization gets filed, and that creditors get some sort of shot at a recovery — a shot that diminishes each day given the magnitude of fees that are accumulating in this case. Case and point:

Whoa boy: another Sears whopper.

Akin's fees in November...repeat, NOVEMBER...BEFORE discovery and the multi-day sale haring were nearly $5.1mm. The final numbers for this case are going to be in the stratosphere. pic.twitter.com/l9JSz7V0Zg

— 💥PETITION💥 (@petition) March 12, 2019

Still, we can’t help but to question certain of the Debtors’ decisions here. This bit was…imprudent…maybe?:

Prior to the time of Closing, the Buyer advised that it had not done the work necessary to implement its own cash management system or to set up its own bank accounts. Meghji Decl. at ¶ 6. As a concession to the Buyer—in order to alleviate the risk to Closing and in an effort to help facilitate a seamless transition of the going-concern business in the interests of, among others, the Debtors’ employees and key stakeholders—the Debtors agreed to give the Buyer possession and control of the Debtors’ cash management system, including its bank accounts as of the Closing Date. Id. ¶ 7.

What is that old cliche about possession and the law? And that one about the road to hell being paved with good intentions? How is it that ESL hadn’t done the work necessary to set up bank accounts? HE HAD TEN FRIKKEN YEARS.

Anyway, to be fair to the debtors, they thought they had contracted around the issue, putting into place a protocol for the repayment of pre-closing-accrued funds that landed in the cash management account post-closing. Nevertheless, apparently ESL and their financial advisors, E&Y, be like:

And so money is apparently due and owing on both sides and the debtors want their money and ESL wants clarification on certain liabilities and trust has apparently broken down in the process. ESL — knowing that Judge Drain will be none-too-pleased — wants a mediator and all the while cash registers are ringing and the estate becomes more and more administratively insolvent.

Like we said on Sunday, “Like…does ANYTHING ever go easy for Sears?”

Disruption Milks Milk Producers (Long…Oats?)

Dean Foods Co. Dips into Distressed Territory

Dean Foods Co. ($DF), the largest US supplier of milk and dairy to retailers with over 50 brands, announced this week that, in light of “a significant amount of change happening in the marketplace” and a “dynamic retail environment,” that it would pursue strategic alternatives (read: a sale, a take-private transaction, asset sales, a JV, or a merger). The company’s stock plunged nearly 12% on the announcement before rebounding slightly later in the week.* It is down 90% since its peak in 2007.

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💥Windstream Blown Into Bankruptcy💥

Windstream Files for Bankruptcy (Long Litigation-Induced Bankruptcy)

Takata. PG&E. Imerys. Windstream. The litigation-induced bankruptcies are flooding the bankruptcy courts. What’s to come? Our prediction: opioid-related filings. $PCG $WIN

— 💥PETITION💥 (@petition) February 25, 2019

Well, that sure escalated quickly.

Days after being on the wrong-side of a ruling by Judge Jesse Furman in the United States District Court for the Southern District of New York in U.S. Bank National Association v. Windstream Services, Inc. v. Aurelius Capital Master, Ltd., Case No. 17-cv-7857 (JMF), Arkansas-based Windstream Holdings Inc. ($WIN) — a provider of (i) network communications and technology solutions for businesses and (ii) broadband, entertainment and security solutions to retail consumers and small businesses in small rural areas across 18 states — filed for bankruptcy in the Southern District of New York (along with 204 affiliates). The upshot of Judge Furman’s decision is that, as of the petition date, the debtors are on the hook for approximately $5.6b in funded debt obligations. And they are f*cking pissed about it. Likewise, a number of investors (Blackrock, Vanguard), hedge funds (Elliott Management Corporation, Brigade Capital Management LP, PointState Capital LP, BlueMountain Capital Management LLC), retirees (California Public Employees’ Retirement System) and counterparites (AT&T…yikes…a $49.5mm unsecured claim) are likely also a wee bit miffed this week. But remember: “💥Aurelius is NOT Litigious, Y'all💥” and “The Rise of Net-Debt Short Activism (Short Low Default Rates).” MAN THIS IS SAVAGE.

In the press release announcing the debtors’ bankruptcy filing, CEO Tony Thomas said:

“The Company believes that Aurelius engaged in predatory market manipulation to advance its own financial position through credit default swaps at the expense of many thousands of shareholders, lenders, employees, customers, vendors and business partners. Windstream stands by its decision to defend itself and try to block Aurelius’ tactics in court. The time is well-past for regulators to carefully examine the ramifications of an unregulated credit default swap marketplace.

“Windstream did not arrive in Chapter 11 due to operational failures and currently does not anticipate the need to restructure material operations,” Thomas said. “While it is unfortunate that Aurelius engaged in these tactics to advance its returns at the expense of Windstream, we look forward to working through the financial restructuring process to secure a sustainable capital structure so we can maintain our strong operational performance and continue serving our customers for many years to come.”

Eeesh. Here’s a live shot of Mr. Thomas after getting board authorization for the bankruptcy filing:

In turn, here’s a live shot of Aurelius’ Capital Management LLP’s Mark Brodsky:

(Yes, we thought that Mike Tyson was an apt choice here given how hard this punch landed). Aurelius absolutely loves this sh*t.

For those of you who are new to this sh*tshow, here is a link to Judge Furman’s decision. If you don’t feel like reading 55 pages of boring legalese, here is a summary by Weil Gotshal & Manges LLP. Therein, Weil succinctly recounts (i) the 2015 transaction wherein Windstream created a new holdco to enter into a sale-leaseback transaction with a spunoff real estate investment trust, Uniti Group Inc. ($UNIT), and (ii) the 2017 transaction wherein WIN obtained post facto consent from a majority of noteholders to waive the resultant (alleged) default in exchange for money money money and new notes. To these events, Aurelius was like:

And Judge Furman concurred; he ruled that the 2015 transaction was a prohibited sale-leaseback transaction under WIN’s indenture and invalidated the 2017 consent solicitation, awarding Aurelius $310.5mm plus interest. As justification, the Judge basically concluded that (i) the new holdco was just a legal shell/pretense, (ii) the subsidiaries who previously owned the assets continued to use those assets, (iii) the subsidiaries exercised effective control over the assets, (iv) the subsidiaries were effectively paying rent under the lease by way of dividending payments up through the new shell holdco, and (v) WIN had admitted to nine state regulators that the transferor entities would get the benefit of the leaseback. In other words, for all intents and purposes, the new holdco’s name was on the transaction but no legal abracadabra was going to fool anyone into thinking that the original transferring subsidiaries weren’t the real parties under the lease.

Yet, suffice it to say, this result was not at all what WIN expected. Here was WIN’s statement relating to the decision. And here is Aurelius laughing and pointing at WIN as it responded to WIN’s statement. They wrote:

We take no pleasure in Windstream's resulting financial predicament.  Windstream could easily have averted it – first by not playing fast and loose with its noteholders in 2015, hoping nobody would hold the company to account, and second by settling.  Instead, Windstream wasted an exorbitant amount – more than would have been needed to settle with us at the time – on an ineffective exchange offer and then on litigation. 

In our view, a management and a board with an extreme and unwarranted assessment of Windstream's legal case chose to bet the company.  The company lost.

They take no pleasure, huh? We find that a bit hard to believe. Why? This is a live shot of Aurelius writing its response:

Check out the rest:

According to its statement last Friday, Windstream now intends to appeal.  This is welcome news for our fund, as it will require Windstream to post a surety bond exceeding $300 million.  That surety bond will pay in full the notes our fund owns when Windstream loses the appeal.  We are happy to take the surety company's credit over Windstream's.

To noteholders who chose to play the company's game even after it had broken its promise, we wish you luck with your exchange notes.  Between their dubious status and their OID risk in bankruptcy, we suspect you will need it.

🔥💥🔥💥

Dubious status? What dubious status? Per Weil:

While the court held that the notes issued under the Indenture—i.e. any notes outstanding prior to the exchange offers—are accelerated, it specifically declined to hold that the New Notes issued in the 2017 exchange are invalid, giving rise to confusion over their status. (See Op. at 51). Because the Court held that the Third Supplemental Indenture containing the waiver of default was invalid, it follows that all holders of the 2023 Notes at the time of the exchange—not just Aurelius—should be entitled to a judgment. At least some of this confusion could have been obviated by a finding that all holders of the New Notes are to be restored to their status quo ante as it existed prior to the exchange offers. While this ruling would also raise complex issues, it would better accord with the operation of the Indenture.

Right. That probably would have made more sense. Insert some litigation here. And Weil doesn’t otherwise comment one way or another as to whether the Judge took liberties by extending his review outside the four corners of the legal document. They simply state:

The Court’s reliance on Windstream’s admissions is a reminder for counsel to consider not just whether a proposed transaction fits within the literal terms of the debt documents, but also whether it is: (1) consistent with the company’s public statements; (2) supported by the contemporaneous factual record; and (3) whether the economic substance of the transaction is consistent with its characterization.

But Professor Stephen Lubben did. He writes:

The court readily concedes that the plain language of the indenture does not cover the transaction on its face. Rather the court repeatedly argues that the “economic realities” of the transaction bring it within the terms of the indenture.

In essence, the court has granted Aurelius covenant protection that it (and its predecessors) were not savvy enough to negotiate in the first place. That’s the kind of interpretive stretch that law professors expect to see with sympathetic plaintiffs – the classic “widowers and orphans.” But Aurelius?

As the author of a law school corporate finance text, I’ve read my share of these sorts of opinions. I often tell my students that the one constant theme running through the bulk of corporate finance jurisprudence is that “if you want protection, you’d better contract for it.”

The Windstream opinion represents a clear departure from that trend. Instead, the theme seems to be, “I know what you really meant.”

Meh. We could get an ID with a picture of Chris Hemsworth next to it but that doesn’t make us Chris Hemsworth. You get what we’re saying?

Anyway, Lubben also reiterates a prior alarm that credit default swaps are having a deleterious effect on the market. He writes:

Long ago I warned that the growth the of the CDS (credit default swap) market represented a threat to traditional understandings of how workouts and restructurings are supposed to happen. The recent Windstream decision from the SDNY shows that these basic issues are still around, notwithstanding an intervening financial crisis and resulting regulatory reform.

Bloomberg’s Matt Levine adds:

“…the universal assumption is that Aurelius has also bought a lot of credit-default swaps that will pay out if Windstream defaults on its debt: By pushing Windstream into default, Aurelius will make a profit on its CDS, even if it loses money on the bonds. And, look, in general, I am all for CDS creativity, but here even I find it distasteful. “We, along with others in the market, found Windstream’s arguments that Aurelius pursued this litigation in bad faith and in order to ensure a payout on its CDS to be compelling,” wrote analysts at CreditSights.”

The Financial Times writes:

“The judge just missed . . . the big picture”, said one hedge fund set to lose money from the ruling, noting Aurelius’ position in credit derivatives. “This decision opens a Pandora’s Box and is going to encourage a lot of aggressive behaviour”.

Ugly fights between creditors and companies over clauses in dense legal agreements are nothing new. But Aurelius’s win has companies suddenly wondering what enterprising hedge fund is now combing through their past wheeling-and-dealing, looking for an obscure technical violation that could result in a ransom payment. Debt investors have recently targeted Sprint/T-Mobile and Safeway over similar covenant technicalities.

Matt Levine rightly continues:

“Windstream’s accusation of market manipulation is nonsense,” says Aurelius, and that is completely correct as far as it goes. As far as Windstream is concerned, all that Aurelius did was read its bond documents, assert its rights under those documents, go to court to argue its position, and win in court. None of those things could be market manipulation. If Aurelius also bet in the CDS market that it would be correct, well, (1) that doesn’t sound like manipulation to me and (2) Windstream wasn’t selling CDS so the integrity of the CDS market isn’t its problem.

But of course the overall result is very much Windstream’s problem: Windstream is bankrupt now because Aurelius came after it, and it’s hard to imagine Aurelius coming after it if Aurelius hadn’t bought a lot of CDS on Windstream first. (Windstream’s other bondholders were very willing to forgive Windstream’s covenant violation, tried to help it fend off Aurelius, and are now facing huge losses due to Aurelius’s activism.) It is not hard to sympathize with Windstream’s view that something is wrong with the CDS market, if this is the result.

Sure, but, like, maybe don’t hate the player, hate the game??

Putting aside the CDS aspect, the (one) comment to Mr. Lubben’s piece is indignant and raises valid points. Sisi Clementine (cute name) writes:

WIN opco spun out the assets, and then holdco leased them back. What did holdco do with those assets? Well, they allowed opco to use the assets freely. Hmm, okay, but then how did holdco pay rent? Well, opco pays a dividend to holdco in the exact rent amount and then holdco pays it to the spinoff. I see. So do holdco and opco share the property? No, holdco has no separate address, employees or business, so the property is for the exclusive use of opco. Umm, does this smell funny to anyone else?

In fact, it does! The judge! In his ruling, he cite a body of case law on leases that shows that a person who makes regular fixed payments in exchange for the exclusive use of a space is the holder of a lease, regardless of whether a paper contract exists. Personally, I find this conclusion to be on firmer legal ground than Windstream's version of events, which is essentially that the lease goes to holdco and then disappears inside the company in an opaque cloud of trust.

Of course, the Judge did not rely exclusively on this reasoning for his judgment. He added two further, independent reasons why the opco was party to the lease. The first is that Windstream, as a regulated telecom carrier, required approval from state regulators for the transaction. When regulators expressed concern, WIN formally told them it was a sale-leaseback transaction to reassure them. The judge then estopped WIN from changing its story in court. The second independent reason is that WIN opco signed 120 subleases on the space. You cannot sublease without a lease, therefore opco must have had a lease in order so sign those contracts.

What Prof Lubben has not told you, is that the court's habit of siding with businesses in matters of likely covenant breaches is only about a decade old. Market participants have found it troubling that businesses are given the benefit of the doubt as long as they have some legal explanation, no matter how tenuous. Management has grown increasingly brazen over the last few years, often with the backing of their private equity sponsors. The fact that it has taken an opportunist like Aurelius to right this wrong is proof that there are no heroes here. But maybe one day the legal establishment will wake up and end this plainly predatory behavior. (emphasis added)

Apologies, Clementine, but Aurelius may have achieved the impossible with all of this:

Aurelius, of all funds, may actually live long enough to see itself become the hero. In contrast to Levine, Clementine is saying that WIN is the predator, NOT Aurelius! And Clementine isn’t alone:

It's good to see courts starting to push back on these types of deals. Hopefully it's a start of a trend; most courts have been willing to defer to form over substance when the issuer has an argument that they did not violate a debt covenant. (7/7)

— Jared Ellias (@jared_ellias) February 16, 2019

Levine adds:

You can choose to view Aurelius not as an interloper messing up a perfectly amicable situation between a company and its bondholders, but rather a vindicator of the rights of bondholders against an overbearing issuer. The story might be that, in 2015, Windstream flagrantly violated the terms of its bonds and dared its bondholders to do something about it, and those bondholders were too meek or confused to defend themselves. They were simple long-only credit investors, they don’t have the time or inclination to sue, their positions weren’t concentrated enough to make it worthwhile, they weren’t expert document-readers, or whatever: They were mugged by Windstream and had no practical way to stand up for themselves. But eventually they (well, some of them) sold their bonds to Aurelius, and Aurelius stood up for bondholders’ rights. And now other bond issuers will think twice before trying to steamroll their bondholders in the future, knowing that Aurelius may be lurking to call them on it.

As for Windstream placing the blame at Aurelius’ feet? Aurelius had something to say about that too. Per Barron’s:

“Windstream’s accusation of market manipulation is nonsense,” says an Aurelius spokesperson. “Rather than whining about us and Judge Furman, Windstream’s management and board should engage in much-needed introspection. They alone caused the company to enter into a terrible sale-leaseback and prejudice its bondholders by breaking its promises to them.”

Things really ARE getting weird in distress these days. Just imagine what will happen when we finally tip into an actual distressed cycle…? Will less boredom lead to less “manufactured” action??

So, where do things stand now? The bankruptcy court held the first day hearing yesterday and generally the debtors got all requested relief approved (including access to $400mm in interim funding — out of a committed $1b — under the DIP credit facility). This will obviously address the immediate liquidity crunch the company faced upon the post-judicial-decision acceleration of its debt.

If you're looking for a brief explanation of the immediate reason why $WIN filed for chapter 11 bankruptcy today, there's the liquidity issue: pic.twitter.com/XCIKIC0GZo

— 💥PETITION💥 (@petition) February 26, 2019

So now all focus turns to Uniti Group Inc. which, itself, isn’t exactly unscathed by all of this.

Source: Yahoo Finance.

Per Bloomberg:

Uniti’s future is clouded because the company gets more than two-thirds of its revenue from its former parent, with a master lease giving Windstream the exclusive right to use the Uniti’s telecommunications network. That lease could be in jeopardy because of its sizable expense to Windstream -- more than $650 million a year -- and bankruptcy proceedings often lead to revision or rejection of existing contracts.

Windstream relies on Uniti to serve its customers, and it’s also Uniti’s biggest customer, making a complete cutoff of their relationship less likely. 

So, yeah. There’s that. There are also those — notably, the ad hoc group of second lien noteholders — who may agitate for the debtor to go after Aurelius for its “manufactured default.”

The equitable subordination claim against Aurelius for CDS self-interest will be interesting to watch. https://t.co/ZjOHJd7iNH

— Jared Ellias (@jared_ellias) February 25, 2019

Not for everyone (if it happens…we’re dubious). In fact, we’re pretty sure none of WIN, its debt and equity investors, or its other interested parties find this “interesting” at all.

We (STILL) Have a Feasibility Problem (Long the “Two-Year Rule”)

Payless ShoeSource Files for Chapter 11. Again.

Man. That aged poorly AF.

That’s one + two + three…yup, three total “success” claims and that’s just the heading, subheading and intro paragraph. EEESH. This has turned into the bankruptcy equivalent of Oberyn Martell taking a victory lap in the fighting pits of King’s Landing.

And, sadly, it almost gets as cringeworthy:

Of course, we obviously know now that the Payless story is about as ugly as Oberyn’s fate.

Payless is back in bankruptcy court — a mere 18 months after its initial filing — adorning the dreaded Scarlet 22. It will liquidate its North American operations, shutter over 2000 stores, and terminate nearly 20k employees. All that will remain will be its joint venture interests in Latin America and its franchise business — a telltale sign that (a) the brick-and-mortar operation is an utter sh*tshow and (b) the only hope remaining is clipping royalty and franchise fee coupons on the back of the company’s supposed “brand.” And so we come back to this:

8. Success? Really?

New rule: before any pro can declare a (retail) restructuring a success, they have to wait 24 months. If there hasn't been a chapter 22 in that time, they have our permission to use the word. See, eg., Payless https://t.co/KAFGAPPZva

— 💥PETITION💥 (@petition) December 31, 2018

That’s right. We have ourselves another TWO YEAR RULE VIOLATION!!

Okay. We admit it. This is all a little unfair. We definitely wrote last week’s piece entitled, “💥We (Still) Have a Feasibility Problem💥,” knowing full-well — thanks to the dogged reporting of Reuters and other outlets — that a Payless Holdings LLC chapter 22 loomed around the corner to drive home our point. Much like Gymboree and DiTech before it, this chapter 22 is the culmination of an abject failure of epic proportions: indeed, nearly everything Mr. Jones stated in the press release reflected above proved to be 100% wrong.

Let’s start, given a dearth of new financial information, with the most obvious factor here as to why this company has round-tripped into bankruptcy — destroying tons of value and irreversibly hurting retail suppliers en masse along the way. In the company’s financial projections attached to its 2017 disclosure statement, the company projected fiscal year 2018 EBITDA of $119.1mm (PETITION NOTE: we’d be remiss if we didn’t highlight the enduring optimism of debtor management teams who consistently offer up, and get highly-paid investment bankers to go along with, ridiculous projections that ALWAYS hockey stick up-and-to-the-right. Frankly, you could strip out the names and, in a compare and contrast exercise, see virtually no directional difference between the projected revenues of Payless and the actual revenues of Lyft. Seriously. It’s like management teams think that they’re at the helm of a high growth startup rather than a dying legacy brick-and-mortar retailer with sh*tty shoes at not-even-discounted-for-sh*ttiness prices.

you're paying up for the brand, is it not obvious?

— Barbarian Capital (@BarbarianCap) February 19, 2019

On what realistic basis on this earth did they think that suddenly — POOF! — same store sales would be nearly 10%.

Re: Payless, is this right? Did someone actually think the company would drive a 9.9% increase in same-store sales post-bankruptcy??! Where do we get what they're smoking?https://t.co/yGHeJ9KWS4 pic.twitter.com/45APRNUBlS

— 💥PETITION💥 (@petition) February 12, 2019

Seriously. Give us whatever they’re smoking out in Topeka Kansas: sh*t must be lit. Literally.

So what did EBITDA actually come in at? Depending on which paragraph you read in the company’s First Day Declaration filed in support of the chapter 22 petition: negative $63mm or negative $66mm (it differs on different pages). For the mathematically challenged, that’s an ~$182mm delta. 🙈💩 “Outstanding leadership team,” huh? The numbers sure beg to differ.

This miss is SO large that it really begs the question: what the bloody hell transpired here? What is this dire performance attributable to? In its 2017 filing the company noted the following as major factors leading to its bankruptcy:

Since early 2015, the Debtors have experienced a top-line sales decline driven primarily by (a) a set of significant and detrimental non-recurring events, (b) foreign exchange rate volatility, and (c) challenging retail market conditions. These pressures led to the Debtors’ inability to both service their prepetition secured indebtedness and remain current with their trade obligations.

The company continued:

Specifically, a confluence of events in 2015 lowered Payless’ EBITDA by 34 percent—a level from which it has not fully recovered. In early 2015, the Debtors meaningfully over purchased inventory due to antiquated systems and processes (that have since undergone significant enhancement). Then, in February 2015, West Coast port strikes delayed the arrival of the Debtors’ products by several months, causing a major inventory flow disruption just before the important Easter selling period, leading to diminished sales. When delayed inventory arrived after that important selling period, the Debtors were saddled with a significant oversupply of spring seasonal inventory after the relevant seasonal peak, and were forced to sell merchandise at steep markdowns, which depressed margins and drained liquidity. Customers filled their closets with these deeply discounted products, which served to reduce demand; the reset of customer price expectations away from unsustainably high markdowns further depressed traffic in late 2015 and 2016. In total, millions of pairs of shoes were sold below cost in order to realign inventory and product mix. (emphasis added)

You’d think that, given these events, supply chain management would be at the top of the reorganized company’s list of things to fix. Curiously, in its latest First Day Declaration, the company says this about why it’s back in BK:

Upon emergence from the Prior Cases, the Debtors sought to capitalize on the deleveraging of their balance sheet with additional cost-reduction measures, including reviewing marketing expenses, downsizing their corporate office, reevaluating the budget for every department, and reducing their capital expenditures plan. Notwithstanding these measures, the Debtors have continued to experience a top-line sales decline driven primarily by inventory flow disruption during the 2017 holiday season, same store sales declines resulting in excess inventory, and challenging retail market conditions. (emphasis added).

Like, seriously? WTF. And it actually gets more ludicrous. In fact, the inventory story barely changed at all: the company might as well have cut and pasted from the Payless1 disclosure statement:

The Debtors also faced an oversupply of inventory in the fall of 2018 leading into the winter of 2019. As a result, the Debtors were forced to sell merchandise at steep markdowns, which depressed margins and drained liquidity. Customers filled their closets with these deeply discounted products, which served to reduce customer demand for new product. In total, millions of pairs of shoes were sold at below market prices in order to realign inventory and product mix. (emphasis added)

As if that wasn’t enough, the company also noted:

The delayed production caused a major inventory flow disruption during the 2017 Holiday season and a computer systems breakdown in the summer of 2018 significantly affected the back to school season, leading to diminished sales and same store sales declines.

Sheesh. Did the dog also eat the real strategy? Bloomberg writes:

The repeat bankruptcies are a sign the original restructuring may have been rushed through too quickly or didn’t do enough to solve the retailers’ industry-wide and company-specific problems.

And this quote, clearly, is dead on:

“One of the easiest ways to waste time and money in Chapter 11 is to use the process only to effect a change in ownership but not to take the time and protections afforded by the bankruptcy process to fix underlying operations,” Ted Gavin, a turnaround consultant and the president of the American Bankruptcy Institute, told Bloomberg Law. 

This begs the question: what did the original bankruptcy ACTUALLY accomplish? Apparently, it accomplished this pretty looking chart:

And not a whole lot more.*

The company also failed to achieve another key strategic initiative upon which its post-bankruptcy business plan was based: investment in its stores and the deployment of omni-channel capabilities that, ironically, would make the company less dependent upon its massive brick-and-mortar footprint. Per the company:

…the Debtors’ liquidity constraints prevented the Debtors from investing in their store portfolio to open, relocate, or remodel targeted stores to keep up with competitors.

And:

Moreover, Payless was unable to fulfill its plan for omni-channel development and implementation, i.e., the integration of physical store presence with online digital presence to create a seamless, fully integrated shopping experience for customers. As of the Petition Date, the completion of this unified customer experience has been limited to approximately two hundred stores. Without a robust omni-channel offering, Payless has been unable to keep up with the shift in customer demand and preference for online shopping versus the traditional brick-and-mortar environment.

In other words “success” really means “still too much effing debt.” This would almost be funny if it didn’t tragically end with the termination of thousands of jobs of people who, clearly, mistakenly put their faith in a management team so entirely in over their heads. Literally nothing was executed according to plan. Nothing.

Seven months after emerging from bankruptcy the company was already in front of its lenders with its hand out seeking more liquidity. Which…it got. In March 2018, the company secured an additional $25mm commitment under the first-in-last-out portion of its asset-backed credit facility. What’s crazy about this is that, never mind the employees, the supplier community got totally duped again here. In the first case, the debtors extended their suppliers by ONE HUNDRED DAYS only for them, absent critical vendor status, to get nearly bupkis** as general unsecured claimants. Here, the debtors again extended their suppliers by as much as 80 days: the top list of creditors is littered with manufacturers based in Hong Kong and mainland China. Who needs Donald Trump when we have Payless declaring a trade war on China twice-over? (PETITION NOTE: we know this is easier said than done, but if you’re a supplier to a retailer in today’s retail environment, you need to get your sh*t together! Pick up a newspaper for goodness sake: how is it that the entire distressed community knows that a 22 is coming and yet you’re extending credit for 80-100 days? It’s honestly mind-boggling. The company cites over 50k total creditors (inclusive of employees) and $225mm of unsecured debt. That’s a lot of folks getting torched.)

Some other notes about this case:

Liquidators. Much like with Things Remembered and Charlotte Russe, they mysteriously have bandwidth again such that they no longer need to JV up as a foursome as they did in Gymboree. Instead, we’re back to the slightly-less-anti-competitive twosome of Great American Group LLC ($RILY) and Tiger Capital Group.

Kirkland & Ellis. There’s something strangely ironic here about the fact that the firm went from representing the company in the chapter 11 to representing its liquidators in the 22. Seriously. You can’t make this sh*t up.

Independent Directors. Here we go again. Remember: the Payless 11 led us to Nine West Holdings which led us to Sears Holding Corp. ($SHLD). We have documented that whole string of disasters here. In the first case, Golden Gate Capital and Blum Capital got away with two separate dividend recaps totaling millions of dollars in exchange for a piddling $20mm settlement. Moreover, to incrementally increase the pot for general unsecured creditors, senior lenders had to waive their deficiency claims that would have otherwise diluted the unsecured pool and made recoveries even more insubstantial. So, here we are again. Two new independent directors have been appointed to the board and they will investigate whether controlling shareholder Alden Capital Management pillaged this company in a similar way that it has reportedly and allegedly pillaged newspapers across the country.***

If you're in media and you've been looking for Alden Global Capital to take a hit on...something...anything...given their handling of newspapers across the nation, look no further than their equity holdings in Payless. Their 66.5% stake is now worth 🍩🍩. pic.twitter.com/WlmJjK2yRx

— 💥PETITION💥 (@petition) February 19, 2019

Fees. If you want to quantify the magnitude of this travesty, note that the first Payless chapter 11 earned the following professionals the following approximate amounts:

• Kirkland & Ellis LLP = $4.995mm

• Armstrong Teasdale LLP = $495k

• Guggenheim Securities LLC = $6.825mm

• Alvarez & Marsal = $1.9mm

• Munger Tolles = $898k

• Pachulski Stang Ziehl & Jones LLP (as lead counsel to the UCC) = $2.5mm

• Province Inc. = $2.6mm

• Michel-Shaked Group = $560mm

Now THAT was money well spent.****

---

*Via three separate store closing motions, the company shuttered 686 stores. The second store closing motion proposed 408 store closures but was later revised downward to only 216.

**Unsecured creditors received their pro rata share of two recovery pools in the aggregate amount of $32.3mm, $20mm of which came from the company’s private equity sponsors as settlement of claims stemming from two pre-petition dividend recapitalization transactions. In exchange, the private equity firms received releases from potential liability (without having to admit any wrongdoing).

***Alden Global Capital is no stranger to controversy over its media holdings. In the same week it finds itself in bankruptcy court for Payless, Alden found itself in the news for its reported desire to buy Gannett. This has drawn the attention of New York Senator Chuck Schumer who expressed concerns over Alden’s “strategy of acquiring newspapers, cutting staff, and then selling off the real estate assets of newsrooms and printing presses at a profit.” 

***This is but a snapshot. There were several other professionals in the mix including, significantly, the real estate advisors who also made millions of dollars.

💥Sears: An Anticlimactic Sale💥

Sears Sales Process “Ends” With a Thud (Long Strong PR).

Over the last several weeks we received various emails inquiring as to why we hadn’t — given our previous fulsome coverage of Sears Holding Corporation’s ($SHLDQ) bankruptcy — done a deep dive into the Official Committee of Unsecured Creditors’ lengthy objection to the company’s proposed sale to Eddie Lampert. In most cases, we curtly answered, “it’s not worth our time.” Suffice it to say, we were right. As a legal and practical matter, it seemed obvious since the auction which direction the sale hearing was going to go. Mr. Lampert “won” the auction over the bid of Abacus Group, a liquidator, and literally within hours the UCC’s objection to the sale hit the docket. Among other things, the UCC alleged that the creditors were better off with liquidation, that Mr. Lampert’s business plan lacked credibility, and that, in some respects, the whole auction process was a joke.

It was all for nothing. After three days of hearings, Judge Drain approved the debtors’ proposed sale to Mr. Lampert, overruling the vehement objections of the UCC; he applied, as expected, the "business judgment" rule and approved a sale pursuant to an asset purchase agreement that, in exchange for a total of approximately $5.2b of (a hodge-podge of) consideration, means that Sears will continue as a going concern business under Mr. Lampert's continued management. Approximately 425 stores will remain. For at least the short-term. And 45k jobs have been preserved. At least in the short-term. The court officially entered the 83-page sale order onto the docket midday on Friday, February 8.

Some takeaways from the hearing:

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👜Retail May Get Marie Kondo'd👜

👠Marie Kondo is Coming to a First Day Declaration Near You (Long Thrift Shopping)👠

2019 has already been a rough year for retail. Beauty Brands LLC, a Kansas City-based brick-and-mortar retailer with 58 stores in 12 states filed for chapter 11 bankruptcy in the first week of January. Then, last week, both Shopko (367 stores) and Gymboree (~900 stores) filed for chapter 11 bankruptcy — the former hoping to avoid a full liquidation and the latter giving up hope and heading straight into liquidation (it blew its first chance in bankruptcy). And, of course, there’s still Charlotte Russe, Things Remembered, Payless and others to keep an eye on.

All of this has everyone on high alert. Take this piece from The Wall Street Journal. Pertaining to J.C. Penney ($JCP) and Sears Holding Corporation ($SHLDQ), the WSJ notes:

J.C. Penney Co.’s sales are falling, its stores are stuck in malls and the turnaround strategy keeps changing. Now, three months after the embattled retailer hired a new chief executive, a handful of senior positions remain vacant.

The series of events is prompting analysts and other industry experts to question whether Penney can avoid the fate of fellow department-store operator Sears Holdings Corp., which filed for bankruptcy and barely staved off liquidation.

The Plano, Texas-based chain was once the go-to apparel retailer for middle-class families. It and Sears had once dominated American retailing but lost their customers, first to discounters like Walmart , then to fast-fashion retailers and off-price chains like T.J. Maxx. The shift to online shopping hastened their decline.

First, the Sears Holding Corporation ($SHLDQ) drama continues as the company heads towards a contested sale hearing in the beginning of February. To say that it “staved off liquidation” is, at this juncture, factually incorrect. While the company’s prospects have improved along with Mr. Lampert’s purchase offer, it is not a certainty that the company will be able to avoid liquidation. At least not until the Official Committee of Unsecured Creditors’ objection is overruled and the bankruptcy court judge blesses the Lampert deal. The sale hearing is slated for February 4.

Second, we were relieved to FINALLY see an article about retail that didn’t pin the blame solely at the feet of Amazon Inc. ($AMZN). As we’ve been arguing since our inception, the narrative is far more nuanced than just the “Amazon Effect.” To point, Vitaliy Katsenelson recently wrote in Barron’s:

Retail stocks have been annihilated recently, even though retail sales finished 2018 strong. The fundamentals of the retail business look horrible: Sales are stagnating, and profitability is getting worse with every passing quarter.

Jeff Bezos and Amazon.com get most of the blame, but this is only part of the story. Today, online sales represent only 8.5% of total retail sales. Amazon, at about $100 billion in sales, accounts only for 1.6% of total U.S. retail sales, which at the end of 2018 were around $6 trillion. In truth, the confluence of a half-dozen unrelated developments is responsible for weak retail sales.

He goes on to cite a shift in consumer spending to more expensive phones, more expensive phone bills, more expensive student loan bills and more expensive health care costs as contributors to retail’s general malaise (PETITION Note: yes, it appears that lots of things are getting more expensive. Don’t tell the FED.). More money spent there means less discretionary income for the likes of J.C. Penney. Likewise, he highlights the change in consumer habits. He writes:

We may not care about clothes as much as we may have 10 or 20 years ago. After all, our high-tech billionaires wear hoodies and flip-flops to work. Lack of fashion sense did not hinder their success, so why should the rest of us care about the dress code?

And:

Consumer habits have slowly changed, including the advent of rental clothes from companies like Rent the Runway and LeTote.

We’ve previously written extensively about the rental and resale wave. We wrote:

Indeed, per ThredUp, a second-hand apparel website, the resale market is on pace to reach $41 billion by 2022 and 49% of that is in apparel. Moreover, resale is growing 24x more than overall apparel retail. “[O]ne in three women shopped secondhand last year.” 40% of 18-24 year olds shopped retail in 2017. Those stats are bananas. This comment is illustrative of the transformation taking hold today,

“The modern consumer now has a choice between shopping traditional retail or trying new, innovative business models. New apparel experiences and brands are emerging at record rates to replace old ones. Rental, subscription, resale, direct-to-consumer, and more. The closet of the future is going to look very different from the closet of today. When you get that perfectly curated assortment from Stitch Fix, or subscribe to Rent the Runway’s everyday service, or find that killer handbag on thredUP you never could have afforded new, you start realizing how much your preferences and behavior is changing.”

Lots of good charts here to bolster the point.

That wave just got a significant shot of steroids.

Earlier this month Netflix Inc. ($NFLX) debuted “Tidying Up with Marie Kondo,” a show that springs off of Ms. Kondo’s hit 2014 book, “The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organizing.” The news since is not too encouraging for retailers.

Per NPR, “Thrift Stores Say They’re Swamped With Donations After ‘Tidying Up with Marie Kondo’” (audio and audio transcript). Indeed, thrift stores like Goodwill are seeing an uptick in donations across the country (and Canada). The Wall Street Journal published a full feature predicated upon “throw a lot of sh*t out.”

Of course, all of this decluttering is an opportunity. Anna Silman writes in The Cut:

Well, congrats to all the people who have committed to the KonMari life and ridded themselves of the burden of their unwanted possessions, and who now have to waste 15 minutes a day folding their underwear into tiny rectangles. But also, good for us! Imagine how many bad choices people are liable to make in a feverish post New Year’s Kondo-inspired purge? Mistakes will be made. Purgers are going to see that lavish fur cape they never wore and deem it impractical; come Game of Thrones finale cosplay time, they’re going to rue their hastiness. Conscientious closet cleaners will dispose of the low-rise jeans they haven’t worn since the mid-aughts, but the joke’s on them, because low-rise jeans are coming back, bitches!

So, my fellow anti-Kondoers, if you’re in a post-holiday shopping mood, get thee to thy nearest second-hand clothing store Beacon’s (or Goodwill, or Buffalo Exchange, or Crossroads, or the internet) and get started on building your 2019 wardrobe. And if you arrive at your nearest resale outlet and see a long line, don’t worry: Those people are there to sell. Those aren’t your people. Forget them. Focus on the racks — those sweet, newly stocked, overflowing racks, where so much joy awaits.

It’s just like the old adage: One woman’s trash is another woman’s treasure, especially because most of it was never trash to begin with.

Likewise, Lia Beck writes in Bustle, “…get out there and find some things that spark joy for you.”

And reseller The RealReal is signaling that resale is so big that it’s ready to IPO. Talk about opportunistic. No better time to do this than during Kondo-mania. The company has raised $115mm in venture capital from Perella Weinberg Partners, Sandbridge Capital and Great Hill Partners, most recently at a $745mm valuation.

None of this is a positive for the likes of J.C. Penney. They need consumers to consume and clutter. Not declutter. Not go resale shopping. We can’t wait to see who is first to mention Marie Kondo as a headwind in a quarterly earnings report. Similarly, we wonder how long until we see a Marie Kondo mention in a chapter 11 “First Day Declaration.” 🤔

Peak Direct-to-Consumer (Long Sharks to Jump)

We’ve been discussing direct-to-consumer (“DTC”) digitally-native-vertical-brands (“DNVBs”) since our inception because we thought it was important to give restructuring professionals a more well-rounded narrative about what is transpiring in retail today. We hope that at least some of you have been paying attention and have baked the overall trend into your talking points: let your more-neanderthalic peers/competitors lazily repeat “the Amazon Effect” at every turn. You know what’s up.

And so, of course, there’s now a DTC DNVB for basically everything. Like, literally. Have erectile disfunction? There’s a DTC DNVB for that (at least two, actually). Want organic feminine products? There’s a DTC DNVB for that. Glasses? We all know that one. Mattresses? Damn straight Mattress Firm knows those. You name it and there’s probably a DTC DNVB for it.

And so now, of course, there are at least two DTC DNVB paint brands out there competing for your hard-earned dollars. That’s right: paint. They’re called Clare ($2mm of seed funding back in September) and Backdrop.

Interestingly, their stories sound remarkably similar. From Clare’s website:

Paint has the power to completely transform a space and that’s exciting. But the first step — paint shopping — is universally known as a headache. Anyone who’s shopped for paint knows the process can be confusing, overwhelming, and downright painful. We believe shopping for paint should be a joy, not a hassle, so we took on an archaic industry to reinvent the entire experience. We’ve created a better way, an expertly curated color palette, the highest quality paint, no-mess, no-fuss color sampling, and the best painting supplies all delivered to your door. Plus, guidance to get you going and keep you inspired along the way.

And, this, from Backdrop’s website:

Welcome to Backdrop. Where we believe choosing your new backdrop should be easy and painting should fun. Let's be honest, painting today is pretty painful. From multiple trips to the hardware store to tiny crappy color cards; from messy sampling to expensive supplies—the paint industry is deeply outdated. Backdrop is here to change that—we're making more than just paint. We're transforming the whole process of painting. We've done the hard work so you don’t have to—from curating the perfect color palette to sourcing the highest quality supplies. We’ve got you covered with everything you need and nothing you don’t to get your job done right . . . whatever “right” looks like to you. After all, we think you’re the expert at choosing your life’s backdrop.

We get it: paint shopping is “painful.” We get it: there are too many colors and the sweet spot, apparently, is 50-55 options. We get that a $45-$49 price point is where it’s at. And we get that paint cans are annoying to open and have terrible design. But, really? Is this the future of paint shopping? Can an upstart paint company really scale based on brand identity built on newly designed paint cans with fancy fonts and disrupt the long-standing incumbents in the space?

Look, the effect on big consumer products companies by the likes of Dollar Shave Club, Glossier and others is real. But they’re also recurring categories: men need replacement blades and women run out of makeup. And so is this one of those bits where we argue that The Sherwin-Williams Company ($SHW) is effed and that another brick-and-mortar retailer is heading to the bankruptcy bin? No. It’s not. It’s one of those bits where we say the brand-based DTC DNVB trend is really starting to jump the shark. This is beginning to remind us of the Uber-for-X craze that led to…well, what, exactly? A lot of #BustedTech.

*****

Speaking of DTC DNVBs apparently the paradox of choice is very real because in addition to having too many paint colors to choose from for your newborn’s room, there are also too many stroller options. And apparently millennials get flustered when researching the various products. So, enter…wait for it…a new DTC DNVB stroller company named Colugo.

Per Fast Company:

As Iobst began to explore the stroller market, he discovered some problems. First, the industry had evolved in the age of the big box store, so brands were used to selling products through retailers like Buy Buy Baby and Target (and increasingly Amazon), which inevitably meant that customers were paying middleman markups of about 40%. And many stroller brands offer many models, all with slightly different features and price points, which added a layer of complexity to an already unpleasant shopping experience. One stroller might have more shock-absorbing wheels, while another might have a bigger basket underneath. “Expecting parents are already trying to process so much new information,” says Iobst. “Now they have to compare tiny features in a product that is entirely new to them.”

Oy. We love how entrepreneurs “paint” their customers like complete f*cking idiots.

But…but…maybe Iobst is, gulp, on to something…?

Colugo offers a lighter simpler newly-designed collapsable stroller with a baked-in rain cover and customizable features. It has a 100-day trial period and a $285 price point. It actually sounds like a pretty strong product and, to put the cherry on top, Iobst is deploying the playbook of fellow Wharton byproduct, Warby Parker, by talking about “community” and “brand.”

These concepts are also starting to jump the shark. Then again, have you ever visited a Mommy Facebook group? If ever the word “community” might actually apply…. 🤔🤔

And so short Babies “R” Us.

Oh. Wait. No need.

💰All Hail Private Equity💰

Private Equity Rules the Roost (Long Following the Money)

So, like, private equity is apparently a big deal. Who knew?

Readers of PETITION are very familiar with the growing influence, and impact of, private equity. We wouldn’t have juicy dramatic bankruptcies like Toys R Us, Nine West and others to write about without leveraged buyouts, excessive leverage, management fees, and dividend recapitalizations. Private equity is big M&A business. Private equity is also big bankruptcy business. And it just gets bigger and bigger. On both fronts.

The American Lawyer recently wrote:

Private equity is pushing past its pre-recession heights and it is not expected to slow down. Mergermarket states that the value of private equity deals struck in the first half of 2018 set a record. PricewaterhouseCoopers expects that the assets under management in the private equity industry will more than double from $4.7 trillion in 2016 to $10.2 trillion in 2025.

With twice as much dry powder to spend on deals, private equity firms will play a large role in determining the financial winners and losers of the Am Law 100 over the next five-plus years. It amounts to a power shift from traditional Wall Street banking clients and their preferred, so-called white-shoe firms to those other outfits that advise hard-charging private equity leaders.

Indeed, PE deal flow through the first half of the year was up 2% compared to 1H 2017:

In August, the American Investment Council noted that there was $353 billion of dry powder leading into 2018. No wonder mega-deals like Refinitiv and Envision Healthcare are getting done. But, more to the point, big private equity is leading to big biglaw business, big league. Say that five times fast.

The American Lawyer continues:

It is hard to find law firm managing partners who don’t acknowledge the attraction of private equity clients. Their deals act as a lure, catching work for a variety of practice groups: tax, M&A, finance and employee benefits. And lawyers often end up handling legal work for the very companies they help private equity holders buy. Then, of course, there is always the sale of that business. A single private equity deal for one of the big buyout firms can generate fees ranging from $1 million to $10 million, sources say.

“It’s kind of like there’s a perfect storm taking all those things into consideration that makes private equity a big driver in the success of many firms, and an aspirational growth priority in many more firms,” says Kent Zimmermann, who does law firm strategy consulting at The Zeughauser Group.

Judging by league tables that track deals (somewhat imperfectly, as they are self-reported by firms), Kirkland has a leading position in the practice. According to Mergermarket, the firm handled 1,184 private equity deals from 2013 through this June. Latham is closest with 609. Ropes & Gray handled 323, while Simpson Thacher signed up 319.

Hey! What about “catching work” for the restructuring practice groups? Why is restructuring always the red-headed step child? Plenty of restructuring work has been thrown off by large private equity clients. And Kirkland has dominated there, too.

Which would also help explain Kirkland’s tremendous growth in New York. Per Crain’s New York Business:

In just three years, Kirkland & Ellis has grown massively. The company, ranked 12th on the 2015 Crain's list of New York's largest law firms, has increased its local lawyer count by 61% to climb into the No. 4 spot.

Much of that growth has come in its corporate and securities practice, where Kirkland's attorney count has nearly doubled in three years. The 110-year-old firm's expansion in this area is by design, said Peter Zeughauser, who chairs the Zeughauser Group legal consultancy.

"There aren't many firms like Kirkland that are so focused on strategy," Zeughauser said. "Their strategy is three-pronged: private equity, complex litigation and restructuring. New York is the heart of these industries, and Kirkland has built a lot of momentum by having everyone row in the same direction. They've been able to substantially outperform the market in terms of revenue and profit."

Kirkland's revenue grew by 19.4% last year, according to The American Lawyer, a particularly remarkable increase, given that it was previously $2.7 billion. Zeughauser has heard that a growth rate exceeding 25% is in the cards for this year. The firm declined to comment on whether that prediction will hold, but any further expansion beyond the $3 billion threshold will put Kirkland's performance beyond the reach of most competitors.

Zeughauser, the consultant featured in both articles, thinks all of this Kirkland success is going to lead to law firm consolidation. Kirkland has been pulling top PE lawyers away from other firms. To keep up, he says, other firms will need to join forces — especially if they want to retain and/or draw top PE talent at salaries comparable to Kirkland. We’re getting PTSD flashbacks to the Dewey Leboeuf collapse.

As for restructuring? This growth applies there too — regardless of whether these outlets want to acknowledge it. Word is that 40+ first year associates started in Kirkland’s bankruptcy group recently. That’s a lot of mouths to feed. Fortunately, PE portfolio companies don’t appear to stop going bankrupt anytime soon. Kirkland’s bankruptcy market share, therefore, isn’t going anywhere. Except, maybe,…up.

That is a scary proposition for the competition. And those who don’t feast at Kirkland’s table — whether that means financial advisors or…gulp…judges.

*****

Apropos, on Monday, Massachusetts-based Rocket Software, “a global technology provider and leader in developing and delivering enterprise modernization and optimization solutions,” announced a transaction pursuant to which Bain Capital Private Equity is acquiring a majority stake in the company at a valuation of $2b.

Dechert LLP represented Rocket Software in the deal. Who had the private equity buyer? Well, Kirkland & Ellis, of course.

We can’t wait to see what the terms of the debt on the transaction look like.

*****

Speaking of Nine West, Kirkland & Ellis and power dynamics, we’d be remiss if we didn’t point out that a potential fight in the Nine West case has legs. Back in May, in “⚡️’Independent’ Directors Under Attack⚡️,” we noted that the Nine West official committee of unsecured creditors’ was pursuing efforts to potentially pierce the independent director narrative (a la Payless Shoesource) and go after the debtor’s private equity sponsor. We wrote:

In other words, Akin Gump is pushing back against the company’s and the directors’ proposed subjugation of its committee responsibility. They are pushing back on directors’ poor and drawn-out management of the process; they are underscoring an inherent conflict; they are highlighting how directors know how their bread is buttered. Put simply: it is awfully hard for a director to call out a private equity shop or a law firm when he/she is dependent on both for the next board seat. For the next paycheck.

Query whether Akin continues to push hard on this. (The hearing on the DIP was adjourned.)

The industry would stand to benefit if they did.

Well, on Monday, counsel to the Nine West committee, Akin Gump Strauss Hauer & Feld LLP, filed a motion under seal (Docket 717) seeking standing to prosecute certain claims on behalf of the Nine West estate arising out of the leveraged buyout of Jones Inc. and related transactions by Sycamore Partners Management L.P. This motion is the culmination of a multi-month process of discovery, including a review of 108,000 documents. Accompanying the motion was a 42-page declaration (Docket 719) from an Akin partner which was redacted and therefore shows f*ck-all and really irritates the hell out of us. As we always say, bankruptcy is an inherently transparent process…except when it isn’t. Which is often. Creditors of the estate, therefore, are victims of an information dislocation here as they cannot weigh the strength of the committee’s arguments in real time. Lovely.

What do we know? We know that — if Akin’s $1.72mm(!!) fee application for the month of August (Docket 705) is any indication — the committee’s opposition will cost the estate. Clearly, it will be getting paid for its efforts here. Indeed, THREE restructuring partners…yes, THREE, billed a considerable amount of time to the case in August (good summer guys?), each at a rate of over $1k/hour (nevermind litigation partners, etc.). Who knew that a task like “Review and revise chart re: debt holdings” could take so much time?🤔

That’s a $10k chart. That chart better be AI-powered and hurl stats and figures at the Judge in augmented reality to justify the fees it took to put together (it’s a good thing it’s redacted, we suppose).

Speaking of fees it takes to put something together, this is ludicrous:

The debtor has to pay committee counsel $100k for it to put together an application to get paid? For heaven’s sake. Even committee members should be up in arms about that.

And people wonder why clients are reluctant to file for bankruptcy.

*****

Speaking of independent directors, one other note…on the fallacy of the “independent” director in bankruptcy. Yesterday, October 9, Sears Holdings Corporation ($SHLD)announced that it had appointed a new independent director to its board. To us, this raised two obvious questions: how many boards can one human being reasonably sit on and add real value? At what point does a director run into the law of diminishing returns? Last we checked, it’s impossible to scale a single person.

But we may have been off the mark. One PETITION reader emailed us and asked:

The question you want to be asking is "what sham transaction that probably benefits insiders is the independent director being appointed to bless" or "what sham transaction that benefitted insiders is the independent director being appointed to "investigate" and find nothing untoward with?"

Those are good questions. Something tells us we’re about to find out. And soon.

Something also tells us that its no coincidence that the rise of the “independent fiduciary” directly correlates to the rise of fees in bankruptcy.

Tell us we’re wrong: petition@petition11.com.

💈KentuckyWired is KentuckyFried💈

Project Finance Needs Finance to Work (Long Ambition; Short Government).

The funny thing about “project finance” is that, well, as the phrase might suggest, the project needs money. And sound execution. Pretty basic sh*t, really. So what happens when the project doesn’t? 🤔

In the case of KentuckyWired, it starts contingency planning.

KentuckyWired is an ambitious $327mm public-private partnership with Macquarie Capital…

TO CONTINUE READING, YOU MUST BE A PETITION MEMBER. BECOME ONE HERE.

☠️R.I.P. Sears (Finally)?☠️

Sears, Malls & Shorting the "End of the #Retailapocalypse" Narrative (Short Karl).

It’s official: the media apparently cares more about Sears Holding Corp. ($SHLD) than consumers do. Sure, it’s a public company and so “investors” may also care but, no offense, if you’re still holding SHLD stock than you probably shouldn’t be investing in anything other than passive index funds. If anything at all (not investment advice).

Anyway, the internet is replete with commentary about what went wrong, what the bigbox retailer did and didn’t do right, what plans may not have ever existed, what could have happened and what’s going to happen (video). It didn’t build an online brand OR invest in stores! It was mismanaged! Choice bit:

Ted Nelson, CEO and strategy director at Mechanica, agreed that financial management played a big role. He believes the story of Sears and its downfall isn’t a brand story at all. “[It’s one of] financial engineering and hedge-fund manager hubris gone awry,” he said. “There are a lot of places that brand [and collection of owned brands] could have evolved to. But that would have required a savvy, cross-functional and empowered leadership team, which isn’t what Sears got.”

Oh my! It’s such a shame that Sears may liquidate!

Meetings with lenders only lasted one hour!

Maybe it will get itself a DIP credit facility and last through Christmas! Either way, it is likely to immediately shutter up to 150 locations! This is all such a shame! Look at what it used to be!

From Bloomberg:

“The handwriting has been on the wall for years,” said Allen Adamson, co-founder of Metaforce, a marketing consultancy. “It’s been like watching an accident. You can’t look away, but you know it’s coming.”

Right. We’re over it. We honestly could not care less about Sears at this point. Bankruptcy professionals will make money and this thing finally…FINALLY…may get the burial it deserves. Like we previously said, “This thing is like ‘Karl’ in Die Hard.” Even Karl did, eventually, die.

That all said, we do care about how Sears’ demise affects malls.

First, a bit about malls generally…

On October 7, Axios’ Felix Salmon wrote “Retailpocalypse Not,” and highlighted a Q2 2018 retail report from CBRE, concluding “The death of shopping malls is exaggerated: They are currently 94% occupied, according to CBRE.” Yet, he missed key parts of CBRE’s report:

And mall rents are on the decline:

Other reports substantiate these trends. Per RetailDive:

It's still not a pretty picture on the ground, however. Second quarter mall rents fell 4.6% from the first quarter and 7.1% year over year, hit by major store closures from Toys R Us, Sears and J.C. Penney, according to a trend report from commercial real estate firm JLL. Mall vacancy rates hit 4% during the period, JLL said. The retail sector suffered its worst quarter in nine years with net absorption of negative 3.8 million square feet, which pushed the regional mall vacancy rate up by 0.2% to 8.6% as the average mall rent increased 0.3%, according to another report from commercial real estate firm Reis emailed to Retail Dive.

And things have gotten worse since then. On October 3, four days before the Axios piece, The Wall Street Journal reported on Q3 numbers:

Mall vacancy rates rose to 9.1% in the third quarter, their highest level in seven years. Many of the older shopping centers that lack trendy retailers, lively restaurants, or other forms of popular entertainment continue to lose tenants, or even close down.

But many lower-end malls are still struggling to benefit from the economic revival, especially in some of the more economically depressed areas in Pennsylvania, Ohio and Michigan. They suffer from a glut of shopping centers but not enough consumers.

The average rent for malls fell 0.3% to $43.25 a square foot in the third quarter, down from $43.36 in the second quarter, according to data from real-estate research firm Reis Inc. The last time rents slid on a quarter-over-quarter basis was in 2011.

What sparked the vacancy jump? Bankrupted Bon-Ton Stores closing and, gulp, Sears closures too. Which, obviously, could get a hell of a lot worse. Indeed, Cowen and Company recently concluded that “we are only in the ‘early innings’ of mass store closures.” As noted in Business Insider:

"Retail square footage per capita in the United States has been widely sourced and cited as being far above most developed countries — more than double Australia and over four times that of the United Kingdom," Cowen analysts wrote in a 50-page report on the state of the retail industry. The data "suggests that the sector remains in the early innings of reduction in unproductive physical retail."

On point, one category that had largely remained (relatively) unscathed in the last 2 years of retail carnage is the home goods space. But, now, companies like Pier 1 Imports Inc. ($PIR) and Bed Bath & Beyond Inc. ($BBBY) appear to be in horrific shape. Bloomberg’s Sarah Halzack writes:

Two major companies in this category, Bed Bath & Beyond Inc. and Pier 1 Imports Inc., are mired in problems that look increasingly unsolvable. Bed Bath & Beyond saw its shares tumble 21 percent on Thursday after it reported declining comparable sales for the ninth time in 10 quarters. And Pier 1’s stock fell nearly 20 percent in a single day last week after it saw an even ghastlier plunge in same-store sales and discontinued its full-year guidance.

The struggles of those two retailers ought to compound problems in the overall retail environment. Pier 1 has 1000 stores. Bed Bath & Beyond has 1024 stores.

Still, not all malls are created equal.

Barron’s writes:

Sears’ poor performance has long been an issue for owners, but landlords are split between those that are probably cheering the possibility of reclaiming its locations for more profitable tenants and those that see its potential bankruptcy as a negative tipping point.

Wells Fargo’s Jeffrey Donnelly compiled a list of REIT exposure to Sears, ranking various REITs by how much revenue exposure there is to Sears.

Seritage Growth Properties (SRG) is at the top of the list, with 167 properties, or 72% of its space and 43% percent of its revenue. Urban Edge (UE) has four properties for 3.5% of space and 4.2% of revenue. Next comes Washington Prime Group (WPG) with 42 locations, or 9.8% of space and 0.9% of revenue, followed by CBL & Associates(CBL) with 40 properties, a negligible amount of its space and 0.8% of revenue. Brixmor (BRX) has 11 locations for 1.4% of its space and 0.6% of revenue, Kimco (KIM) has 14 locations, 1.9% of its space and 0.6% of revenue. Simon Property Group (SPG) is at the bottom of the list with 59 locations, 5.3% of its space, and 0.3% of revenue.

Among the companies he covers, he says, CBL & Associates is the most at risk because the “low productivity and demographics of its mall portfolio could make re-leasing challenging and extended vacancies could trigger co-tenancy.” By contrast, Macerich (MAC) is the best positioned, Donnelly argues, due to its “negligible exposure and industry-leading productivity of [its] portfolio.”

Here (video) is Starwood Capital Group ($STWD) CEO Barry Sternlicht opining on the demise of Sears. He says about Sears filing:

“Probably a net positive. So, in our malls that we own…the income that comes near the Sears store is 3% of the mall’s income. Nobody wants to be in front of the Sears because there’s nobody in the Sears. So, we take it back and make it an apartment building or a Dave & Busters or a Kidzania or…a theater…so honestly its good for the owners to get on with this…and we’ll see what happens with Penney’s too….”

In “Sears Exit Would Leave Big Holes in Malls. Some Landlords Welcome That,” The Wall Street Journal noted:

Mall owners with trendy retailers, lively restaurants and other forms of popular entertainment have continued to prosper. Many of these landlords would welcome Sears’ departure, mall owners and analysts said. The department store’s exit would allow them to take over a big-box space and lease it to a more profitable tenant.

In malls where leases were signed decades ago, Sears rents could be as low as $4 a square foot. New tenants in the same space could bring as much as six times that amount.

J.C. Penney ($JCP) and Best Buy ($BBBY) are other theoretical beneficiaries (though that would STILL require people to go to malls).

Who is not benefiting? Apparently those hedge funds that famously shorted malls.

Looks like Sears won’t be the last loser playing in the mall space.

💤Sears 💤

Eddie Lampert, ESL & Shenanigans

BREAKING NEWS: SHORT SEARS HOLDING CORP.

We’re old enough to remember when Sears Holding Corp. ($SHLD) was last rumored to file for bankruptcy. In 2017. 2016. 2015. 2014. 2013. 2012. 2011. And 2010 (the last year it turned a profit). This thing is like “Karl” in Die Hard.

Or this lady:

It just won’t die.

So this week’s reports that Sears’ CEO Eddie Lampert “Urges Immediate Action to Stave Off Bankruptcy” were met with, shall we say, a collective yawn. Lampert has been performing financial sleight-of-hand for years, all the while the five-year SHLD stock chart looks like this:

This is what the Twitterati had to say about this: [ ].

Yes, that blank space is intentional. We’ve never seen Twitter so quiet. Grandma was like, “Sears? Sears? I last shopped in Sears when I was prom shopping…in 1956.” Mom was like, “I once bought you a Barbie at Sears…in 1989.” Some millennial somewhere was probably like, “Sears? What’s a Sears, brah?”

Just kidding: nobody is talking about Sears. That would imply mindshare. 🔥

Lack of mindshare notwithstanding, the company, despite a wave of closures over the years (including 46 unprofitable stores slated for closure in November ‘18), consists of 820 stores (including KMart). As of 2017, the company had 140,000 employees. Thats Toys R Usx 4.5. The company also has approximately $5.5 billion of debt, $1.1 billion of pension and post-retirement benefits, declining revenues, negative (yet improving) same store sales percentages, negative gross margin, and increasing net losses.

Source: SHLD Q2 Earnings Release Presentation, September 13, 2018

It also had $941mm of cash available as of the end of Q2 2018.

On Sunday, Lampert filed a Schedule 13D with the SEC outlining his proposal to save Sears in advance of a $134 debt payment due on October 15. High level, the proposal was…

“…to the Board requesting Holdings to consider liability management transactions, real estate transactions and asset sales intended to extend near-term debt maturities, reduce long-term debt, eliminate associated cash interest obligations and obtain additional liquidity.”

The proposed liability management transactions…provide for exchange offers to eligible holders of second lien debt…and eligible holders of unsecured debt…. These potential exchange offers together could save Holdings approximately $33 million per year in cash interest and eliminate approximately $1.1 billion in debt.

More specifically, the proposal calls for, among other options, ‘19 and ‘20 second lien debtholders and ‘19 unsecured noteholders to swap into zero-coupon mandatorily convertible secured debt (no yield, baby?)(read the 13D link above for more detail). It also calls for the sale of $3.25 billion worth of real estate and assets, including Sears Home Services and Kenmore.

After all of this time, why now? Per Bloomberg:

Lampert and ESL acted after watching other retailers including Toys “R” Us Inc. and Bon-Ton Stores Inc. wind up in liquidation, according to people with knowledge of the plan. The aim is to get something done out of court to preserve value for shareholders, since they don’t usually fare well in bankruptcy proceedings, said the people, who weren’t authorized to comment publicly and asked not to be identified.

There’s something strangely poetic about Lampert and ESL using the ghosts of Toys R Us and BonTon past to coerce creditors into an exchange transaction now.

Anyway, Twitter may have been quiet, but naysayers abound.

From Bloomberg:

“It seems the next natural iteration of all the financial engineering the company has been engaging in over the last few years,” Bloomberg Intelligence analyst Noel Hebert said. “For non-bank creditors not named Eddie Lampert, there is a bit of prisoner’s dilemma -- maybe something more tomorrow, or the near certainty of very little today.”

“This is simply storing up trouble for the future,” according to a note from Neil Saunders, managing director of research firm GlobalData Retail. “Sears is focusing on financial maneuvers and missing the wider point that sales remain on a downward trajectory,” he wrote. “Even in a strong consumer economy, customers are still drifting away to other brands and retailers.”

From the Washington Post:

“Eddie Lampert is seeking permission from himself to keep Sears on life-support while he continues to drain every last remaining drop of blood from its corpse,” said Mark Cohen, director of retail studies at Columbia Business School and the former chief executive of Sears Canada. “The operation is a failure, and there is no plan to turn that around."

From the Wall Street Journal:

“Given Lampert’s shuffling of Sears assets in ways some creditors suspect was more to his benefit than theirs, there is a chance they will hesitate to let him reorganize unless it is under the watchful eye of a bankruptcy judge,” said Erik Gordon, a University of Michigan business school professor.

Ugh. Wake us up when its finally over. Even Karl eventually died.

---

PETITION provides analysis and commentary about restructuring and bankruptcy. We discuss disruption, from the vantage point of the disrupted. Get our Members’-only a$$-kicking newsletter by subscribing here.

What to Make of the Credit Cycle. Part 14.1. (Long Div Recaps; Long Blackstone; Short Refinitiv)

On Sunday in “What to Make of the Credit Cycle. Part 14. (Long Blackstone; Short Refinitiv),” we provided our colorful take on the fervent (and 2x over-subscribed) demand for the $13.5 billion Thomson Reuters’ Refinitiv loan and bond issuance. Our take was framed from the perspective of the high yield trader and was meant to provide some insight into the machinations that occur behind the scenes at a high yield fund. But what does this deal mean for private equity firms and leveraged buyouts?

Spoiler alert: all good things.

Reuters wrote:

The rousing results are likely to boost secondary pricing and will intensify pressure on primary pricing and other terms and conditions, after investors won a reprieve in the summer from aggressive transactions amid a surge in supply.

The SMi100, an index that tracks the 100 most widely held loans, stands at 98.73, the highest point since February. About 42% of US loans are now trading above par, according to LPC data. Average US high-yield bonds, meanwhile, have rallied sharply over the past couple of weeks to Treasuries plus 325bp, or just 3bp off post-crisis lows, according to ICE BAML data. (emphasis added)

Private equity firms likely smell blood in the water. More from Reuters:

The successes could also herald a more aggressive underwriting era as private equity firms squeeze arranging banks harder, which could open the door to another round of opportunistic repricings, refinancings and dividend recapitalizations that allow sponsors to take advantage of weak documentation.

“The next stuff behind the scenes is going to be punchy,” the global debt head said.

Ah, dividend recapitalizations. We miss those.

Reuters continued:

While the results are undeniably good for private equity firms, they may not be good for investors who are increasingly nervous about aggressive deals as an economic downturn draws closer at the end of an unusually long economic cycle.

With Refinitiv, Akzo and Envision, technical factors – primarily huge demand and a small visible pipeline of deals – overwhelmed any specific credit concerns and fears about aggressive documentation that allow sponsors to extract dividends quickly or make transformative asset sales and acquisitions without investors’ consent.

The three jumbo loans, each of which are capital-stretching, represent half of the forward calendar, which is already looking thinner. Worries about future supply encouraged investors to join the big, liquid deals in droves, particularly as new money carve-outs have previously proved to be particularly profitable.

All of this continues to worry financial regulators who are watching the fervor play out. The Bank of International Settlements recently warned that, per Bloomberg:

…likely distress among indebted borrowers may spread into the wider economy as central banks raise interest rates. It’s not just the total debt, but the fact that investors seem less and less concerned about protecting themselves against losses, the BIS said.

Yes, indeed. The return of covenant-lite debt has been well documented.

And the borrower-favorable market has been well documented.

“When there’s tons of liquidity, lenders don’t value covenants and they’re willing to lend at very high leverage values,” said Douglas Diamond, a finance professor at the University of Chicago Booth School of Business. “If you get a negative shock after that, you’ve now got a very vulnerable sector. The crisis won’t happen tomorrow but the vulnerability is there.”

The BIS report identified other concerns, including the prospect of fire sales by loan funds if ratings downgrades push some of their investments into junk. Diamond said there’s potential for such leveraged mutual funds to cause havoc.

“The borrowing that they do is usually from a bank,” he said in an interview. “They buy a loan from a bank, they borrow money from the bank to buy the loan from the bank -- not necessarily the same bank. So the risk would ultimately get back to bank balance sheets.”

But high yield mutual funds aren’t the only vehicles driving this meshugas. Don’t forget about CLOs, which, as we discussed in “💥The CLO Market is Going Bananas💥,” are in full-on volume mode. Relating to factors driving demand for borrower-friendly paper, Alexandra Scaggs wrote in Barron’s:

Another is the robust demand for floating-rate debt such as leveraged loans to protect against Federal Reserve rate increases. Funds investing in loans have seen $14.4 billion of inflows this year, according to EPFR, following on $16 billion of inflows in 2017 and $11 billion in 2016. It is not clear the scramble for floating-rate securities will stop any time soon, as the Fed is expected to raise rates four times in the next 12 months, according to Bloomberg data. The demand for loans has also been fueled by the rise of the market for collateralized loan obligations, securitized products that hold pools of loans as collateral and pay their investors the interest collected from those loans in order of tranche quality.

For the uninitiated, here is an excellent recently published primer from S&P Global Ratings on how CLOs function. Pour yourself a cup of coffee and give it a perusal. It’s worth it. CLO dynamics will definitely play into the next cycle.

*****

In a separate segment on Sunday, we snarked about over-the-transom strategic-alternatives pitch deck” and banker boredom. Distressed and high yield investors are, no doubt, equally if not more bored. Aside from Q1, 2018 has been a barren wasteland for restructuring and bankruptcy professionals looking for things to do. Long bitching come bonus time.

But all of this flippant high yield activity has to come home to roost at some point. The question, as always, remains “when?”

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PETITION provides analysis and commentary about restructuring and bankruptcy. We discuss disruption, from the vantage point of the disrupted. Get our Members’-only a$$-kicking newsletter by subscribing here.

Oil & Gas is Back Baby

Long the West Texas’ Permian Basin; Short Anadarko

If you’re Steve Rogers, Encino Man, or were otherwise frozen somehow from 2014 through 2017 and missed the oil and gas downturn, Bethany McLean’s “Saudi America” will give you a nice high-level overview of American oil policy and fracking. It discusses Aubrey McClendon, the Obama-era change oil export policy, President Trump’s notion of energy independence, the rise of the West Texas’ Permian basin and more. She writes:

“What people still fail to understand is that the most cyclical number we have is the theoretical break-even,” one oil man says. “There will be stories about how the $40 break-even became the $70 break-even, and people will say ‘Who lied to me?’”

And so it is that the most important factor in the comeback of shale is the same thing that started the boom in the first place: The availability of capital. “It came back because Wall Street was there,” says longtime short-seller Jim Chanos. In 2017, U.S. frackers raised $60 billion in debt, up almost 30 percent since 2016, according to Dealogic.

Wall Street’s willingness to fund money-losing shale operators is, in turn, a reflection of ultra-low interest rates. That poses a twofold risk to shale companies. In his paper for Columbia’s Center of Global Energy Policy, Amir Azar noted that if interest rates rose, it would wipe out a significant portion of the improvement in break-even costs.

But low interest rates haven’t just meant lower borrowing costs for debt-laden companies. The lack of return elsewhere also let pension funds, which need to be able to pay retirees, to invest massive amounts of money with hedge funds that invest in high yield debt, like that of energy firms, and with private equity firms — which, in turn, shoveled money into shale companies, because in a world devoid of growth, shale at least was growing. Which explains why Lambert, portfolio manager of Nassau Re, says “Pension funds were enablers of the U.S. energy revolution.”

Ah, yield baby yield.

A lot of the U.S. energy revolution and recovery from ‘14-’17 is coming from the West Texas’ Permian basin. McLean writes:

In 2010, the Permian Basin was producing just shy of 1 million barrels a day. In 2017, that had more than doubled to over 2.5 million barrels a day. By August, output from the Permian alone exceeded that of 8 of the 13 members of OPEC, according to Bloomberg. The International Energy Agency predicts that output will hit more than 4 million barrels a day within a few years. Production from the Permian is the primary driver behind skyrocketing estimates of how much oil the U.S. will produce.

Apropos, Bloomberg noted this week:

To get a toehold in the prolific Permian Basin, private equity is increasingly betting on a relatively obscure, and potentially risky, part of the pipeline industry.

Operations in the Permian that gather oil and gas, and process fuel into propane and other liquids, have drawn almost $14 billion in investment since the start of 2017, with $9.2 billion of that coming from private companies, according to Matthew Phillips, an analyst at Guggenheim Securities LLC.

Specifically, Bloomberg is referring to midstream companies manufacturing gathering and processing pipeline assets that transport oil and gas across states. Producers commit to pay for space in the pipes over a period of years. Restructuring professionals are very familiar with these gathering contracts: they were the subject of many a dispute during the recent downturn.

…investors in gathering pipes and processing plants are forced to lean on long-term projections, since their projects depend on continuous output over time from the same area.

“Any time there’s massive supply growth, there is some risk-seeking behavior,” said Jeff Jorgensen, portfolio manager and director of research at Brookfield Asset Management Inc.’s Public Securities Group. There’s a tendency by some to “invest in production profiles that are, let’s just say, hilariously aggressive in their assumptions” for the future, he said.

It’s easy to see where that aggressiveness is coming from. Researcher IHS Markit predicts output in the Permian Basin will double by 2023 to reach 5.4 million barrels a day. That’s more than every OPEC country except Saudi Arabia. By 2035, it could hit 6.3 million barrels, according to Wood Mackenzie.

Bloomberg continues:

…with the surge of private equity money giving way to smaller players that may be taking on added debt to pay for pricey projects, the risk increases dramatically.

“There’s definitely some sloppiness in the gathering and processing space,” she said. “The cash flow isn’t going to be what they expected, so we could see some of the smaller players financially weaken, and that may lead to consolidation.”

With oil prices on the rise, however, the risk may seem worth taking. Memories are short. And confidence in break-even costs must be through the roof. Regardless of whether President Trump is happy with oil prices where they are.

The bottom line is that in this oil and gas recovery, there are clear winners and losers. The Permian is a big winner. This explains the recent S-1 filing of Riley Exploration — Permian LLC ($REPX)(owned by Yorktown Partners LLC, Bluescape Energy Partners LLC and Boomer Petroleum LLC), which has 65k+ net acres in the Permian as of June 30, 2018. Look at that name: they’re clearly sending a message that screams “pureplay Permian exploration and development company.” It’s like companies putting “.com” in their name during the dot.com bubble and “blockchain” in their name in the more recent crypto bubble. Smart move.

The Bakken in North Dakota appears to be back too. Per Bloomberg:

North Dakota’s oil production surged to a new record in July, putting the mid-western state on par with OPEC member Venezuela.

Home to the Bakken shale play, North Dakota pumped 1.27 million barrels a day in July, according to state figures released Friday. That’s roughly the same output as Venezuela during the month. The South American nation, whose oil industry has collapsed amid a prolonged financial crisis, saw production fall further in August to 1.24 million barrels a day -- about half the level seen in early 2016, according to data from OPEC secondary sources.

Where are the losers? Look at the Anadarko/Woodford area (read: West Oklahoma). In quite the juxtaposition to Riley Exploration, this week Tapstone Energy, a Blackstone-backed oil and gas exploration and production company withdrew its proposed $400mm IPO. Those closely watching Gastar Exploration Inc. ($GSTC) will find it located there too. The stock was delisted, trades over-the-counter at $0.06/share. The bankruptcy clock is ticking.

Like we said. Winners and losers.

More Shenanigans in Retail: Neiman Marcus Edition

Retail Schmetail (Long Shenanigans; Long Litigation-Based Investment)

Just when retail was starting to get boring, Neiman Marcus stepped up this week to provide some real entertainment for bond investors. Thanks Neiman Marcus!

First, lending an additional boost the now-popular narrative that the "#retailapocalypse story is over, the luxury department store retailer reported earnings on September 18 that reflected (i) a 2.3% increase in quarterly revenue YOY, (ii) a dramatically reduced Q4 net loss on a YOY basis, and (iii) an increase in adjusted EBITDA. For fiscal year 2018, it reported total revenues of $4.9 billion, a 4.9% increase YOY. Free cash flow was $122.6mm vs. negative $57.7mm last year. Online revenues were up 12.5% for the quarter and accounted for 35% of the overall business.

And that last bit is where the rubber meets the road. At the tail end of its press release, Neiman slipped in this doozy like a slickster:

Subsequent to the end of the fourth quarter, the Company effected an organizational change as a result of which the entities through which the Company operates the MyTheresa business now sit directly under Neiman Marcus Group, Inc., the Company’s ultimate parent entity. These entities were unrestricted, non-guarantor subsidiaries under the Company’s debt instruments. As a result of this change, going forward the financial results of the MyTheresa entities will no longer be included in the Company’s publicly reported financial statements. The change is not expected to meaningfully affect operations for Neiman Marcus or MyTheresa.

Indeed, the company’s term loan and bonds — part of its $4.7 billion debt stack — did trade down but it wasn’t due to misplaced optimism. Rather, it was more likely attributable to the fact that the company, in a Petsmart-PTSD-inducing maneuver, just significantly weakened the bondholder collateral package.

Per the Wall Street Journal:

Before the transfer of MyTheresa to the parent company, Neiman Marcus Group Inc., there was some anticipation that the retailer would use the MyTheresa shares to entice bondholders to swap their debt for bonds with a longer maturity.

“Some bondholders may have incorrectly assumed that the company would embark on a distressed debt exchange involving MyTheresa shares as collateral,” said Steven Ruggiero, an analyst at Pressprich & Co.

It appears so.

James Goldstein, a retail analyst at CreditSights, noted that proceeds from any sale could now go directly to the investment companies that control the Neiman parent company, with bondholders likely having no claim. The parent company is owned by Ares Management LP and the Canada Pension Plan Investment Board.

“MyTheresa was already in an unrestricted subsidiary, but the way it’s structured now proceeds of any sale of MyTheresa goes straight to sponsors’ pockets without having to deal with the bondholders,” Mr. Goldstein said.

For now, this is a (potential) win for pensioners and a loss for hedge funds holding the debt. And one such hedge fund was, shall we say, a wee bit nonplussed. On Friday September 21, Marble Ridge Capital LP sent a letter to the company’s board of directors (and subsequently issued a very public press release about said letter) stating:

"…what these transactions appear to be is an attempt to move the MyTheresa business beyond the reach of existing creditors sitting between the sponsors' equity and the valuable MyTheresa assets. Most troubling, we understand that Ares and CPPIB usurped this massive benefit and took the MyTheresa business for no consideration."

"Marble Ridge has reason to believe that the Company was insolvent at the time of the Transactions or was rendered insolvent thereby. The Company is the issuer and/or guarantor of at least $4.7 billion of indebtedness. Based on LTM EBITDA of $478.2 million, the Company's indebtedness prior to the Transactions implies nearly a 10x leverage multiple (far in excess of any of its peers). Moreover, a dividend or other form of a spinoff by an insolvent guarantor to its equity sponsors, for no consideration, has all the hallmarks of an intentional or constructive fraudulent transfer (or illegal dividend) and raises serious questions of breaches of duties of care and loyalty, with exposure for Ares and CPPIB, as controlling shareholders, and for the Company's board. As noted above, Marble Ridge also has concerns that the Transactions do not comply with the Indentures."

The Wall Street Journal had previously reported that:

Neiman Marcus hired Lazard Ltd. and Kirkland & Ellis last year for advice on how to restructure its debt.

Looks like they deployed some of that advice.

What to Make of the Credit Cycle. Part 14. Refinitiv Edition.

Long Blackstone. Short Market Timing.

🎶 Sing it with us now: “Yield, baby, yield.” 🎼

Let’s pretend for a second that you’re a trader “sitting on the desk” of a fund with a high yield mandate. Limited partners have given your Portfolio Manager millions upon millions (if not billions) of dollars to get access to — and active management of — high yield debt. They expect your PM and the team to deploy that capital. That’s what you said you’d do when you were out pounding the pavement fundraising. They don’t want to pay you whatever your management fee is for you to simply be sitting in cash, waiting on the sidelines counting your “dry powder.” So when a big issuance goes out to market, you’ve got to make your move. The pressure is on.

The first order of business it to simply make sure that you even get in the room. You’d better be on your game. There’s a lot of appetite for yield these days, so you better be working those phones, dialing up that “left lead” clown you suffered beers with a few weeks back with the hope of getting an opportunity to put in an allocation. You’re dialing and dialing and hoping that he doesn’t remember that your PM passed on — much to your chagrin — the last 4 or 5 looks that clown — let’s call him Krusty — gave you. Fingers crossed.

Your PM is pacing behind you. It’s creeping you out. Angst fills the room. The desk lawyer is running around screaming bloody hell about some covenants or something. Maybe it was a lack thereof. You’re not sure. You don’t care, damn it. Those LPs want that money deployed so you’re damn well gonna deploy it. Forget about covenants. Forget about risk. That lawyer can pound sand. Literally nobody cares. Because you and your team are super savvy. Surely you’ll be able to dump these turds of loans and bonds before the market speaks and the debt trades down. Or before all liquidity dries up. Either way, you’ll get out. You’re sure of it. Market timing is your jam.

You finally get through. Krusty says “what’s your number?” You turn to your PM and without much time to really crunch numbers — after all, the yield, the potential discount, the Euro piece vs. the US piece all keep changing — he shrugs and throws out a hefty number. And then does the Sam Cassell dance. You smile. There’s momentarily silence on the other end. Finally, Krusty says he’ll call you back; he seems wildly unimpressed. Your PM shrinks.

You know this same scene is playing out on trading desks all over Wall Street time and time again when there’s a juicy new issuance.

And so does Blackstone. So does Refinitiv.

This week the high yield universe worked itself into a tizzy as Refinitiv priced and issued $13.5 billion of debt to finance Blackstone’s multi-billion dollar ~55% takeover of Thomson Reuters’ Financial & Risk division. Why is this a big deal? Well, in part, because its a big deal. And the lack of (high yield) supply has led to pent up demand. Pent up demand can lead to some interesting compromises.

On September 8, the International Financing Review wrote:

The debt package is divided into US$8bn of loans and US$5.5bn of high-yield bonds. Those debts, combined with separate payment-in-kind notes (with a 14.5% coupon), will result in annual interest payments of US$880m at current price talk. A separate US$750m revolving credit facility will also need servicing.

“The banks had no choice but to price it attractively and it’ll be interesting to see how it goes,” a loan investor in London said. (emphasis added).

Furthermore,

The deal is being marketed with leverage of 4.25 times secured and 5.25 times unsecured, based on adjusted Ebitda of US$2.5bn, which includes US$650m of cost savings from the business’s reported Ebitda of US$1.9bn.

Wait. Take a step back. Cost savings? What cost savings? Blackstone is claiming that they can take $650mm out of the business thereby driving the leverage ratio down. That’s quite a gamble for investors to take. Particularly combined with loose interpretations of EBITDA and considerable add-backs.

The International Financing Review quoted some investors:

A portfolio manager in London said that he had calculated that leverage for the deal is “nearer six and seven times”.

“It’s very late cycle. I don’t really like it when you see a deal with this order of magnitude of projected cost savings as you really don’t know if and when they will be realised,” he said.

“It will be a bit of a test for the market given the size of the deal. But Blackstone and its partners have a good reputation and deep pockets.”

Moody’s and Fitch put leverage between 6.1x and 7.6x.

Covenant Review was nonplussed about the bond protections. It wrote:

“The notes are being marketed with extremely defective sponsor-style covenants riddled with flaws and loopholes that reflect the worst excesses of covenant erosion over the last two years.”

Tell us how you really feel.

Reuters channeled the ghosts of TXU:

The return of big buyouts to the leveraged finance market has rekindled memories of the 2006 and 2007 bad old days of risky underwriting and excessive debt.

So, in the end, how DID the issuance go?

The Wall Street Journal wrote:

One of the largest-ever sales of speculative-grade debt was completed with ease on Tuesday, a sign of the favorable environment for U.S. borrowers at a time of robust economic growth and strong demand from investors.

The $13.5 billion sale—which a Blackstone Group LP-led investor group is using to acquire a 55% stake in a Thomson Reuters Corp. data business called Refinitiv—comprised $9.25 billion of loans and $4.25 billion of secured and unsecured bonds, with different pieces denominated in U.S. dollars and euros.

Including a $750 million revolving credit line, the bond-and-loan deal amounted to the ninth-largest leveraged financing on record in the U.S. and Europe, and was the fourth-largest since the financial crisis, according to LCD, a unit of S&P Global Market Intelligence.

Said another way, demand was so high for the issuance that — aside from upsizing the loan component by $1.25 billion (with a corresponding bond decrease) and a reduction of future permitted debt incurrence — the company was able to offer bond investors LOWER interest rates at par, despite the fact that both Moody’s and S&P Global Ratings rated the issuance near the bottom of the ratings spectrum. Read: thanks to fervent demand, the banks were able to price a wee bit less aggressively than originally planned. That includes the loans: the company was also able to decrease the original guided discount (“OID”) for investors.

Per Bloomberg, orders…

“…total[ed] double the $13.5 billion of bonds and loans it needed to raise. The scale of the response was spurred on by a ravenous bid from collateralized loan obligations and other investors amid fears that there may be fewer new deals going into the fourth quarter."

🎶 One more time: “Yield, baby, yield.” 🎼

So here you had a 2x over-subscription despite some troubling characteristics:

High leverage wasn’t the only way Refinitiv has tested investors. Under the proposed terms of its bonds, the company could pay dividends to its owners even if it came under severe financial distress, a provision that the research firm Covenant Review described as “wildly off market.”

Back to International Financing Review quoting a high yield investor:

“It got to the point where the only thing I liked about the (Refinitiv) deal was the yield. And I’ve learned after 25 years in this business, that’s not enough.”

Among his concerns were business challenges that the Refinitiv business has already faced from competitors like Bloomberg and FactSet. But Blackstone’s ambitious cost-savings target also made him leery.

“When you look at the investment thesis of the sponsor, it’s very much about achieving cost synergies,” said the investor.

“The synergies they forecast are based on their story that they know how to do this better as sponsors than the corporate parent.”

Reasonable minds can debate the merits and reality of sponsor-driven cost “synergies.” But let’s be honest. Nobody is investing in this capital structure because they are whole-hearted endorsers of the Blackstone-promulgated cost-reduction narrative.

“Among the rationales for investors is confidence in the economy - it’s looking good right now, it’s looking good next year, and the belief that they can sell before the quality of the debt deteriorates,” Christina Padgett, a senior vice-president at Moody’s, told IFR.

In other words, market timing is their jam.

🚴 Peloton = Gympocalypse? 🚴

The Rise of Peloton, Tonal, Mirror and Other DTC Home Fitness Products (Long Seclusion)

Source: Mirror

Back in January we wrote a longform piece about the rise of Peloton. It’s worth revisiting. Subsequently, the at-home fitness space has only gotten more interesting with (i) Peloton’s soon-to-be-released treadmill and (ii) a couple more well-funded startups going after the gym crowd with high-priced at-home apparatuses that give one further incentive to just stay home, never talk to anyone and never do anything outside. Because that's just what we need in today's hyper-polarized environment: more people just scurrying off into their own corners and refusing to deal with and compromise with anyone or anything. And that apparently includes the use of gym equipment.

The New York Times' Erin Griffith recently wrote that Tonal and Mirror, two new on-the-wall connected fitness platforms, are…

"…among the first start-ups to pounce on the success of Peloton, a stationary bike start-up that investors recently valued at $4 billion. Peloton blends the hardware of a bike with the software of a video streaming subscription and the content of spin classes. Its skyrocketing growth has made investors wary of missing the next big thing in fitness." 

The next big thing in fitness appears to be a flashy screen, a solid wifi connection, expensive hardware and streaming fitness instruction brought to you by a recurring revenue subscription model. 

Web Smith frames it another way. 

He writes:

Silicon Valley wants to redefine the fitness membership. Through the adoption of connected devices like the Peloton bike, there’s been an inflection point as consumers seem to be trickling away from the current model. No longer do you have to drive to a place to be in a community. As Americans become more health conscious and driven to maximize performance, the DTC equipment industry is a timely bet on the next generation of  fitness data-driven IoT (internet of things).

He continues:

Whereas the Fitbit-phase of wearables emphasized individual fitness, the next generation of connected devices seem to be incorporating community in ways that could emerge as a challenge to the status quo: community-driven fitness facilities.

And:

By building systems that allow community to be gained outside of physical retail outlets, these tools are aiming to become the new medium for instruction and training.  These internet-enabled equipment manufacturers aren’t just selling plastic and metal, they’re selling virtual community.

He finished by saying:

"...it could spell trouble for your gym. Spin franchises are already beginning to adjust to the threat of Peloton and as the threat of connected cycles continues to grow as also-has brands rise up in the wake of Peloton’s premium pricing."

That sound you may have just heard was the collective moan of mall owners who are increasingly dependent upon gyms to fill space:

Okay, okay, let's dial it down. Peloton has created a luxury brand experience that, it is argued, makes economic sense relative to the long-term economics of attending Flywheel or SoulCycle classes. We're not so sure that translates to other non-niche forms of fitness. Especially at the price-points these companies are touting. 

Apropos, some of the comments to the NYT piece are amusing:

Obviously, these machines are for a niche market where money is irrelevant and style is paramount. Best of luck to them, but I'll stick to the free version...my own body. 

So far the comments are 22-0 against. I wonder if the Tonal can automatically adjust that resistance.

Or, you know, you could just go outside, feel the sun and wind on your back, do some pushups and chinups to feel your own weight against the pull of the Earth, hear nature all around you, talk to a person (gasp!)... 

But then again it's so nice to stare at a screen all day long, so what do I know.

Look for these items in the free piles left curbside after garage sales in about 6 years. 

While we're not necessarily convinced that Tonal and Mirror are the future of fitness, it seems to us that gyms ought to start thinking "omnichannel" like retailers and figure out way to drive more value to customers both in and outside of the gym, during on and off hours. How is it, for instance, that Equinox doesn't have any streaming classes that you can do at home or in your office? 

Whatever happens, expect the area to get more heated as more and more money chases this burgeoning at-home community-based exercise market. Bloomberg already notes that “the treadmill wars are here.” And, Peloton, for instance, is now suing Flywheel for patent infringement. It knows that the at-home fitness opportunity is now. If it can slow down a rival (in advance of an IPO?), all the better.

We asked in January whether Peloton could thrive in a downturn. Now the question is broader: will any of these companies with high-priced hardware be able to survive a downturn?

Initiate the Deluge of Lehman Retrospectives (Short History). Part II. What to Make of the Credit Cycle. Part 13.

Are you tired of all of the Lehman #failureporn yet? If not, you’re in luck. We’ve curated some favorites for you.

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