President Trump Kills More Guns (Long Unintended Consequences).

Callback to four previous PETITION pieces:

The first one — which was a tongue-in-cheek mock First Day Declaration we wrote in advance of Remington Outdoor Company’s chapter 11 bankruptcy — is, if we do say so ourselves, AN ABSOLUTE MUST READ. The same basic narrative could apply to the recent chapter 11 bankruptcy filing of Sportco Holdings Inc., a marketer and distributor of products and accessories for hunting, which filed for bankruptcy on Monday, June 10, 2019. Sportco’s customer base consists of 20k independent retailers covering all 50 states. But back to the “MUST READ.” There are some choice bits there:

Murica!! F*#& Yeah!! 

Remington (f/k/a Freedom Group) is "Freedom Built, American Made." Because nothing says freedom like blowing sh*t up. Cue Lynyrd Skynyrd's "Free Bird." Hell, we may even sing it in court now that Toys R Ushas made that a thing. 

Our company traces its current travails to 2007 when Cerberus Capital Management LP bought Remington for $370mm (cash + assumption of debt) and immediately "loaded" the North Carolina-based company with even more debt. As of today, the company has $950mm of said debt on its balance sheet, including a $150mm asset-backed loan due June '19, a $550mm term loan B due April '19, and 7.875% $250mm 3rd lien notes due '20. Suffice it to say, the capital structure is pretty "jammed." Nothing says America like guns...and leverage

Indeed, this is true of Sportco too. Sportco “sports” $23mm in prepetition ABL obligations and $249.8mm in the form of a term loan. Not too shabby on the debt side, you gun nuts!


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💰The United States Trustee (Long Perverse Incentives).💰

The Wall Street Journal reports that the UST fund is approximately 75% short of its funding goal for the year.* Currently, the fund gets fed by quarterly fees paid by bankrupt companies with over $1mm in operating expenses. As with all things bankruptcy, the new federal law mandating the fee increase has a number of holes in it. Consequently, various cases implicating the law are winding their way through the courts.


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Trickle-Down Healthcare Distress (Long Electronic Beds, Short Nana).

Nana’s Post-Acute Care, Powered by Private Equity.

There has been notable bankruptcy activity in the healthcare industry this year — from continuing care retirement communities to the acute care space. When end users capitulate and need to streamline operations and cut costs, who gets harmed farther down the chain? It’s a good question: after all, there’s always some trickle down effect.

Our internal search for answers to this question recently brought us to Charlotte-based Joerns Healthcare, a “premier supplier and service provider in post-acute care.” The company sells supportive care beds, transport systems, respiratory care solutions and more.

Now, all of that sounds well and good and even with operational and budgetary issues and rising healthcare costs, one could be forgiven for thinking that a business like this might be insulated to some degree — especially as baby boomers get older. Healthcare is not something people tend to skimp on. Yet, that simplistic thinking fails to take private equity into account. That’s right: your Nana’s post-acute care, powered by private equity.


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🏦How are the Investment Banks Doing? Part II.🏦

You didn’t think we’d just stop at Evercore and Greenhill, did you?

Moelis & Company ($MC) recently reported “disappointing” financial results reflecting a dramatic decline in M&A activity in Q1, which affected revenues significantly. Reported revenue was $138mm, down 37%. “This compares to the overall M&A market in which the number of global M&A completions greater than $100 million declined 18% during the same period. The decline in revenues was primarily driven by fewer transaction completions.” Restructuring activity “declined slightly.” MC guided towards softness in the first half of the year with a relatively stronger second half.

Some key takeaways:

  • Brexit and a number of shaky elections in Europe are having some effect on M&A activity in Europe.

  • Expected continued chill of cross-border M&A that involves China due to “underlying weariness” of “significant Chinese ownership of American companies.”

  • The melt down in late Q4 certainly affected M&A chatter in the C-suite as people are cautious about price volatility.

Asked what happens at MC if the M&A volume remains down, Moelis unabashedly indicated that costs would have to come out of the business, i.e., travel expense and headcount. That must’ve been a bit chilling for MC employees. Sheesh.


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💥Sungard Napalms the United States Trustee💥

New Chapter 11 Filing - Sungard Availability Services Capital Inc Part I

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Pennsylvania-based Sungard Availability Services Capital Inc. — a provider of “critical production and recovery services to global enterprise companies,” with $977mm of net revenue and $203mm of EBITDA in fiscal 2018 — filed a prepackaged chapter 11 plan in the Southern District of New York on Wednesday. And, if you blinked, you may have missed its residency in bankruptcy. Indeed, some lost their minds because Kirkland & Ellis LLP was able to shepherd the case in and out of bankruptcy in less than 24 hours — breaking the previous record only recently set in FullBeauty. Yes, people care about these things.*

The upshot of this expeditious bankruptcy case is that (a) the company shed nearly $900mm of debt from its balance sheet (reducing debt down to approximately $400-450mm) and (b) transferred 89% ownership to a variety of debt-for-equity swapping funds such as GSO Capital PartnersFS InvestmentsAngelo Gordon & Co., and Carlyle Group (who will also receive $300mm in senior secured term loan paper). Major equity holders — Bain Capital Integral Investors LLCBlackstone Capital Partners IV LPBlackstone GT Communications Partners LPKKR Millennium Fund LPProvidence Equity Partners V LPSilver Lake Partners II LPTPG Partners IV LP — had their equity wiped out (we had previously highlighted KKR’s investment here in “A Hot-Potato Plan of Reorganization. Short BDC Retail Exposure,” discussing the broader context of BDC lending).

This is what the capital structure looked like and will look like:

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That balance sheet is the driver behind the bankruptcy filing. Per the company:

This legacy capital structure was created based upon the Company’s historical operating model and performance and is unsustainable under current market conditions. When the capital structure was put in place, the Company benefited from a larger revenue base with substantially higher free cash flow. As business conditions evolved and the Company’s revenue declined, cash flow available to service debt and invest in products and services substantially declined. Consolidated net revenue declined by approximately 18% from approximately $1.2 billion in 2016 to approximately $977 million in 20188 while adjusted EBITDA margins remained within a range of approximately 20% to 22%. Negative net cash flow from 2016 to 2018 was approximately $80 million.

In other words, this is as clear-cut a balance sheet restructuring that you can get. Indeed, general unsecured claims are — as you might expect from a prepackaged plan of reorganization — riding through unimpaired. This consensual restructuring is clearly the right result. Getting it in and out of court so quickly is a bonus.


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🌋FuelCell Sucks Wind (Long Distressed Power)🌋

Fuel Cell Power Plant Manufacturer Struggles

Amazon is not too big to fail… In fact, I predict one day Amazon will fail,” Jeff Bezos said back in November. He makes a salient point: even once-uber-successful companies are subject to disruption and questions of sustainability over long periods of time. This is an industry-agnostic notion. 

We can debate the definition of “successful” but it seems fair to say a company that once had a market capitalization of $1.5b falls into that category. One such company that fits that bill, FuelCell Energy Inc. ($FCEL), is now a shell of its former self, teetering on the brink of chapter 11 bankruptcy. 

Connecticut-based FCEL designs, manufactures, installs, operates and services “ultra-clean” efficient and reliable stationary full cell power plants to an end market of commercial, industrial, government and utility customers. It’s mission is a worthy one: to deliver clean innovative power solutions, utilizing environmentally responsible fuel cells. There’s just one problem with all of that: it doesn’t make money. And it hasn’t since its fiscal year ended October 1997.

The company — not the first to experience distress in the power sector in recent times — is getting battered on all sides. Wind and solar have stolen a lot of the company’s mojo. Competitors such as the controversial Bloom Energy Corp. ($BE)have taken market share even while it, too, has seen its market cap shrink from over $4b to just over $1b. New order volume has been elusive. 

All of this shows in the company’s numbers. Revenues have declined from $190mm in 2013 to $90mm in 2018. LTM revenue is only ~$70mm. The company’s Quick Ratio and Current Ratio — both measures of the company’s ability to cover short-term financial obligations — are .6x and 1.3x respectively, versus industry comps of 1.1x and 1.5x. And, thanks to these numbers, capital sources may no longer be available.

The company’s historical financial channels included sales of equity (including a NUMBER of preferred equity issuances), corporate and project level debt financing, and local or state government loans or grants. Here is a snapshot of the company’s debt sitch:

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In the light of this debt, $41.6mm of debt at the corporate level, and the company’s declining revenue predicament, the company is focused on liquidity. Per the company’s most recent 10K:

The Company’s future liquidity will be dependent on obtaining a combination of increased order and contract volumes, increased cash flows from the Company’s generation and service portfolios and cost reductions necessary to achieve profitable operations.

To grow its generation portfolio, the Company will invest in developing and building turn-key fuel cell projects which will be owned by the Company and classified as project assets on the balance sheet. This strategy requires liquidity and is expected to continue to have increasing liquidity requirements as project sizes increase.

Which, you might appreciate, creates a bit of a circularity problem. The company needs to spend more to make more which means cash flow in the near term is highly unlikely.

Consequently, the company just sh*tcanned 135 people to save approximately $11.5mm. To the extent those employees held stock, well:

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Bloomberg recently noted:

NRG, the largest independent U.S. power producer, has also been a key backer. It owned 1.4 million shares in the company, based on the latest holding data compiled by Bloomberg, and provided a $40 million revolving credit facility to help FuelCell build power plants. But that credit line may expire this year, and without another large investor willing to throw more money at the company's technology, FuelCell faces a grim future, [an analyst] said.

“Their only hope,” he said, “is to find someone who wants to finance this.”

We find it highly unlikely that any financing occurs outside of bankruptcy court. Notwithstanding a recently-announced new purchase power agreement with the City of San Bernardino Municipal Water Department, we suspect we’ll be seeing this thing in Delaware sometime soon. 

Casual Dining is a Hot Mess. Part VI. (Short Franchisees).

We’ve previously written about Kona Grill Inc. ($KONA) and Luby’s Inc. ($LUB) here. Indeed, we marked the former’s now-inevitable descent into bankruptcy as far back as April 2018. Subsequently, we’ve followed each quarter with interest only to witness the conflagration get bigger and bigger along the way. This sucker is certainly headed into bankruptcy.

Here is what’s new: Kona hired an Alvarez & Marsal Managing Director as its CEO — its fifth CEO in less than a year. It publicly indicated that it may have to file for bankruptcy. And Nasdaq delisted it. Stick a fork in it.

Likewise, we first highlighted Luby’s in July 2018. In a follow-up in January, we wrote:

And then there is Luby’s Inc. ($LUB)We featured the chain back in July, highlighting continued overall same store sales and total sales decreases. We did note, however, that the company has the advantage of owning a lot of its locations and that asset sales, therefore, could help buy the company time and assuage lender concerns. Real estate sales have, in fact, been a significant part of the company’s strategy. And so the lenders haven’t been its problem. Activist shareholders have been.

But that’s not entirely the full picture. We also noted that the company’s numbers “suck.” Which begs the question: now that another quarter has gone by, has anything changed?

On the performance side, not particularly.

Same store sales decreased 3.3%. Restaurant sales were down 12.1% (offset slightly by culinary contract services sales). Every single restaurant brand performed poorly: Luby’s Cafeterias were down 6.1%, Cheeseburger in Paradise (TERRIBLE name) down 76%, F*cked-ruckers…uh, Fuddruckers, was down 19%, and combo locations were down 7%. Basically this was an absolute bloodbath. Fuddruckers same-store sales were -5.3%. Analysts don’t even bother covering the stock. The company trades at $1.50/share at the time of this writing.

But things have changed a bit on the cost side. The company has closed 27 underperforming restaurants and sold $34.7mm in assets. It has also moved forward with its plans to refranchise many company-owned Fuddruckers, converting five units to franchisors who are clearly gluttons for punishment. The company has also engaged in food and operating cost cutting initiatives. Who is helping them out with this? Duh…the new CEO and Alvarez & Marsal’s “performance improvement” group

PETITION Note: we always find “PI” projects spearheaded by divisions out of large turnaround advisory firms to be interesting beasts. Imagine the conversations behind closed doors:

PI Managing Director: “Yeah, bro, we just took $0.2mm of SG&A out of the business and we believe there is more room to run there once we beat up the supply chain a bit, postpone repairs and maintenance, adjust employee hours, and make food cuts.

Restructuring Managing Director: “Food cuts, huh?

PI Managing Director: “Yeah, we DEFINITELY wouldn’t recommend you eat there.

Restructuring Managing Director: “Got it. So, uh, this is obviously a bit delicate but, uh, here’s the real question: how can you guys continue to take SOME costs out of the business and look like heroes…without…uh…improving performance…you know…TOO MUCH?

Boisterous bro-tastic laughs, winks and secret handshakes ensue.

Now, sure, sure, that’s cynical AF and not at all fair here: we’re not at all saying that anyone is doing anything untoward here. Yet, we wouldn’t be surprised, however, if conversations such as these happen though. Just saying.


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Fast Forward: Boy Scouts of America & More Potentially Coming to a Bankruptcy Court Near You

Boy Scouts of America. As talk of bankruptcy ramps up, so do the number of potential claimants. According to the Texas Standard:

“Recently, over 200 people have come forward with new sexual abuse allegations against the Boy Scouts of America. The Irving, Texas-based organization is one of the largest youth groups in the country, and has already dealt with numerous charges of abuse over the years. One expert estimates some 7,800 hundred individuals allegedly abused more than 12,000 children.”

😬😡


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Disruption, Illustrated. Fuse LLC Files for Bankruptcy. (Long Netflix).

California-based Fuse LLC, a multicultural media company composed principally of the cable networks Fuse and FM, filed a prepackaged chapter 11 along with 8 affiliated debtors in the District of Delaware to effectuate a swap of $242mm of outstanding secured debt for (a) $45mm in term loans (accruing at a STRONG 12% interest and maturing in five years), (b) new membership interests in the reorganized company and (c) interests in a litigation trust. General unsecured creditors will recover nothing despite being owed approximately $10mm to $25mm.

The company is well known to millions of US homes: approximately 61mm homes get Fuse, an independent cable network that targets young multicultural Americans and Latinos. FM’s music-centric content reached approximately 40.5mm homes “at its peak.” The company has three principal revenue streams: (a) affiliate fees; (b) advertising; and (c) sponsored events; it generated $114.7mm in net revenue for the fiscal year ended 12/31/18 and “had projected affiliate fees of approximately $495 million through 2020.

Why is it in bankruptcy? In a word, disruptionDisruption of content suppliers (here, Fuse) and content distributors (the traditional pay-tv companies). Compounding the rapid changes in the media marketplace is the company’s over-levered balance sheet, an albatross that hindered the company’s ability to innovate in an age of “peak TV” characterized by endless original and innovative content.


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Bankruptcy, Transparency and the White Knight: McKinsey (Short Logic)

Another week, another chapter in the Jay Alix and McKinsey drama. And, seriously, folks, this sh*t is fiercer than a White Walker facing off against some dragons so hold on to your seats.

On Tuesday, Law360 reported:

Restructuring consultant Jay Alix again urged a New York bankruptcy court on Tuesday to let him investigate McKinsey & Co. over alleged conflicts of interest in the SunEdison Inc. Chapter 11 case, just days after McKinsey revealed that it paid $17.5 million to SunEdison’s estate to resolve nearly identical claims.

Tuesday’s motion comes as U.S. Bankruptcy Judge Stuart M. Bernstein is considering whether to take additional action in the SunEdison case, or let the $17.5 million settlement end matters as far as McKinsey is concerned.

And on Wednesday:

Alix’s filing in the SunEdison case comes as a Texas bankruptcy court rejected his pleas to dig further into McKinsey in the case of the Westmoreland Coal Company, which emerged from bankruptcy last month and is another McKinsey client.

The conflict of interest claims Alix raised in that case forced McKinsey to disgorge $5 million in fees in a settlement with Westmoreland’s estate, but on Wednesday U.S. Bankruptcy Judge David R. Jones shot down Alix’s request for an “emergency order” that would allow him to conduct further discovery.

Indeed, Mr. Alix sought an “emergency motion” for entry of an order compelling McKinsey to disclose all of the investments of its affiliate MIO Partners Inc. Mr. Alix wrote:

The time to move forward on Mar-Bow’s objection and determine whether McKinsey is qualified to serve as a professional in this matter is long overdue. It is notable that McKinsey has never denied the MIO’s holdings in the Debtors’ estates or in interested parties. Accordingly, this emergency motion seeks prompt and highly discrete relief: an order compelling McKinsey to (a) identify all equity or debt investments held or managed by it or any of its affiliates (including MIO) in any Debtor, or in any party in interest, competitor, customer, or supplier; and (b) disclose information sufficient to allow the Court to evaluate the amount and nature of those investments.

The judge — perhaps a bit miffed that his docket had been completely overrun by motion practice relating to the Alix/McKinsey dispute…you know, rather than issues specific to the actual Westmoreland Coal Company matter — summarily dismissed the motion. In an order issued on Wednesday April 10, 2019, he wrote:

At best, the motion represents a self-created emergency with no underlying substance. At worst, the motion constitutes an improper collateral attack on the Court’s prior order at Docket No. 1427 for an illegitimate purpose. Counsel are advised that they are responsible for the words and allegations contained in pleadings on which their names appear. Candor and professionalism must never be sacrificed in the name of overzealous advocacy.

ZING!

Of course, we find this language to be a wee bit hypocritical coming from a Judge who has skewered professionals of all types — lawyers, service providers, whomever — from his perch on the Bench. As just one example, recall this classy bit from an August 4, 2016 hearing in the matter of Sherwin Alumina Company LLC (that related to the Noranda Aluminum matter too):

You are on my radar screen. The financial transaction that ought to be being discussed a first-year business student can see. I’m not the smartest guy in the world, and I see it. I have been reading pleadings. And I cannot express the degree of disappointment that I have in the professionals that have been running these cases. If this case is going to fail, if the Noranda cases are going to fail, then so be it. But that’s going to create a block of time, and I’m going to use all of my education, all of my training, all of my experience in deciding where to lay the blame for this failure. That’s not a threat; it’s a promise. And if anyone wants to test my resolve, I encourage them to do it. Anyone doubts my commitment? Noranda’s local counsel spent a lot of years with me. They know exactly how I can be. You all are a talented group of people. I find it offensive that egos have gotten in the way. If we really want to try and have a contest as to who’s got the biggest set, I promise you I will win that battle.

“That’s not a threat; it’s a promise.” Really?

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🥑#BustedTech: Munchery Filed for Bankruptcy.🥑

Short VC-Backed Hyper-Growth

We've previously discussed the process of an assignment for the benefit of creditors and posited that, as the private markets increasingly become the public markets, (later stage) "startups" will be more likely to file for chapter 11 than go the ABC route. Our conclusion was based primarily on three factors: (a) a number of these startups would have highly-developed and potentially valuable intellectual property and data, (b) more venture-backed companies have "venture debt" than the market generally recognizes, and (iii) parties involved, whether that's the lenders or the VCs, would want releases with respect to any failure and subsequent chapter 11 bankruptcy filing. Given continuing low — and as of this week, lower — yields and a system awash in capital looking for alternative sources of yield (read: venture capital), there's been a dearth of high profile startup failures of late. And, so, technically, we've been wrong. 

Yet, on February 28th, Munchery Inc. filed for bankruptcy in the Northern District of California (we previously noted the failure here and again here in a broader discussion of what we dubbed, “The Toys R Us Effect”). Munchery was a once-high-flying "tech" company founded in 2011 with the intent of providing freshly prepared meals to consumers. It made and fulfilled orders placed on its own app and also had a meal kit subcription business where customers received weekly kits with recipes and ingredients. Its greatest creation, however, might be its shockingly self-aware first day declaration — a piece of work that functions as a crash course for entrepreneurs on the evolution and subsequent trials and tribulations of a failing startup. 

Interestingly, the meal kit business wasn't part of the original business model. This represented the quintessential startup pivot: originally, the company's model was predicated upon co-cooking (another trend we've previously discussed) where professional chefs would leverage Munchery's kitchens (and, presumably, larger scale) to sell their products directly through Munchery's website and mobile apps. Of late, the co-cooking concept — despite some recent notable failures — has continued to gain traction. Apparently, former Uber CEO, Travis Kalanick, is very active in this space (see CloudKitchens). 

At the time, "food delivery was in its early stages." But local restaurant delivery has exploded ever since: Grub HubSeamlessDoor DashPostmatesCaviar, and Uber Eats are all over this space now. Similarly, in the meal kit space, Blue Apron inc. ($APRN)PlatedHello Fresh and SunBasket are just four of seemingly gazillions of meal kit services that time-compressed workaholics or parents can order to save time. 

As you can probably imagine, any company worth anything — especially after nearly a decade of operation and tens of millions of venture funding — will have some interesting proprietary technology. Here's the company's description of its tech (apologies in advance for length but it marks the crux of the bankruptcy filing): 

"The team’s early focus was to develop a proprietary technology platform to operate and optimize the entire process of making and delivering fresh food to customers. The technology developed and deployed by the company included: a front-end ecommerce platform, which allowed the company to post items daily and consumers to select, purchase and pay for meals through the company’s website and native apps; the production enterprise resource management (“ERP”) system, which enabled the company to develop and launch new recipes, manage the supply chain for fresh ingredients and supplies, produce the meals through batch cooking, and plate individual meals; the logistics and last-mile platform, which enabled the company to accurately and quickly pack-and-pack individual items and assemble orders using modified hand scanners, distribute orders via a hub-and-spoke system where refrigerated trucks would transport orders to specific zones and hand-off the orders to the assigned drivers; and, a driver app that assisted in managing and routing orders to arrive in the windows specified by customers. All of this was managed through a set of proprietary tracking and administrative tools used by the teams to monitor and mitigate operational issues—and connected to a customer relationship management platform. The team later developed algorithms to optimize the various aspects of the service to scale operations, increase efficiency, and improve the quality of the service. In addition, the company developed over three thousand meal recipes, including descriptions, nutritional information, and photographs. Over the life of the business, the company invested significantly in its technology capabilities, believing that the company’s ability to efficiently scale its operations leveraging technology would be a competitive advantage in the food delivery market."

All of that tech obviously required capital to develop. The company raised $120.7mm in three preferred equity financing rounds between 2013 and 2015. Investors included Menlo VenturesSherpa Capital, and E-Ventures. The company also had $11.8mm in venture debt ($8.4mm Comerica Bank and $3.4mm from TriplePoint Venture Growth BDC Corp.). 

The bankruptcy filing illustrates what happens when investors (the board) lose faith in founders and insist upon rejiggering the business to be operationally focused. First, they bring in a new operator and relegate the founders to other positions. With new management as cover, they then cut costs. Here, the new CEO's "first action" was to RIF 30 people from company HQ. Founders generally don't like to lose control and then see friends blown out, and so here, both founders resigned shortly after the RIF. This, in turn, gives the investors more latitude to bring in skilled operators which is precisely what they did.

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Oil and Gas Continues to Crack

Long Houston-Based Hotels

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)

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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 ShoeSourceGymboreeCharlotte 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 RememberedBeauty 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 SundayThe 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.

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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:

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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.

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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):

CBL Cap Stack.png

The new Senior secured term loan due ‘23:

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The Senior unsecured notes due ‘23:

CBL Unsecured Notes.png

The notes due ‘24:

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The notes due ‘26:

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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:

CBL Balance Sheet.png

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?

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:

The historical stock chart is ugly AF:

CBL Stock.png

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:

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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.

🍿Sears = The Gift That Just Keeps Oooooon Giving🍿

The Sears estate and Eddie Lampert are at it again

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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:

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?

💥Windstream Blown Into Bankruptcy💥

Windstream Files for Bankruptcy (Long Litigation-Induced Bankruptcy)

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 (BlackrockVanguard), hedge funds (Elliott Management CorporationBrigade Capital Management LPPointState Capital LPBlueMountain 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:

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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:

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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:

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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:

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.

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

Source: Yahoo Finance.

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.”

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.

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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.

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And, sadly, it almost gets as cringeworthy:

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

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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:

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.

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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.

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

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:

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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.***

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).

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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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💰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 UsNine 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.

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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.

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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?🤔

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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:

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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.

☠️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, AxiosFelix 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:

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And mall rents are on the decline:

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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.

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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.

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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.