New Chapter 11 Bankruptcy Filing - LSC Communications Inc.

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LSC Communications Inc.

April 13, 2020

Chicago-based LSC Communications Inc. ($LSC) and 21 affiliated debtors (the “debtors”), a provider of traditional and digital print products, print-related services and office products, filed for bankruptcy in the Southern District of New York. The company is the result of a 2016 spinoff from R.R. Donnelley & Sons and though it subsequently diversified its business into logistics, it still deals with old-school categories like print magazines, catalogs, books, directories, various other print-related services, and office products. In fact, it is one of the largest printers of books in the US. All of which is to say that the debtors were ripe for disruption.

Nothing about this ought to be surprising to people who have been paying attention to the retail and media landscape over the last decade. Nevertheless, it is painful to read:

Although the Company is a market leader in the printing and printing related services industries, the Company’s product and service offerings have been adversely impacted by a number of long-term economic trends. Digital migration has substantially impacted print production volume, in particular with respect to printed magazines as advertising spending continues to move away from print to electronic media. Catalogs have experienced volume reductions as retailers and direct marketers allocate more of their spending to online advertising and marketing campaigns and some traditional retailers and director marketers go out of business in the face of increased competition from online retailers. The Company saw an unprecedented drop in demand for magazines and catalogs in 2019, with the faster pace of decline in demand primarily due to the accelerating movement from printed platforms to digital platforms.

Thanks Facebook Inc. ($FB). Clearly all of the Restoration Hardware Inc. ($RH) catalogues in the world couldn’t offset the shift of advertising away from print media and soften this blow.

And then there’s this:

Demand for printed educational textbooks within the college market has been adversely impacted by electronic substitution and other trends such as textbook rental programs and free open source e-textbooks. The K-12 educational sector has seen an increased focus on e-textbooks and e-learning programs, but there has been inconsistent adoption of these new technologies across school systems. Consumer demand for e-books in trade and mass market has impacted overall print book volume, although e-book adoption rates have stabilized and industry-wide print book volume has been growing in recent years.

Apropos to the brief discussion above about Mary Meeker’s presentation, we’ve got news for these guys: these trends away from printed textbooks are going to gather steam post-COVID. And while we’re happy to see an uptick in physical book production, it’s unclear whether that is a short-term trend or a longer-term rebound. Someone is going to have to get comfortable betting on the latter. More on this in a moment.

As if the secular trends weren’t bad enough, the debtors’ attempt to consolidate with Quad/Graphics Inc. ($QUAD) (synergies!) in late 2018 met with resistance. The DOJ filed a civil antitrust lawsuit seeking to block the proposed merger and ultimately the parties agreed to terminate the merger. While LSC received a reverse termination fee that exceeded the amount of transaction costs, the proposed merger (i) hindered the debtors’ ability to make much-needed operational fixes (i.e., plant consolidation and footprint optimization), (ii) affected new business development efforts and strained existing customer relationships, and (iii) created uncertainty among the employee ranks that, in some respects, sparked attrition.

All of the above led to an internal restructuring. The debtors set their sights on nine plant closures and footprint reductions — primarily in magazines and catalog manufacturing; they also renegotiated a number of unprofitable customer contracts. Bear in mind: all of this was pre-COVID. Matters can only have gotten worse.

What does all of this look like from a financial perspective? The debtors filed their annual report in early March and the numbers don’t lie:

LSC Annual Report 3/2/20

LSC Annual Report 3/2/20

Net sales declined 13% and while there was a corresponding decline in the cost of sales, SG&A remained constant and restructuring costs ballooned.* The magazines/catalogues/logistics segment declined 7.3%. The book segment fell 3.6%. Office products were a rare bright spot up 8.1% (PETITION Note: this is a relatively small portion of the debtors’ business and we’ll see how that plays out going forward given that there may be a huge shift there).

Due to this piss poor operating performance, the debtors tripped their consolidated leverage ratio and minimum interest ratio covenants in their credit agreement. That’s right: you didn’t think this story would be complete without a significantly over-levered balance sheet, did you?

The company has $972mm of total funded indebtedness broken out among a revolver ($249mm + $50.8mm in outstanding letters of credit), a term loan ($221.9mm) and senior secured notes ($450mm at 8.75%). The term loan requires quarterly principal payments of $10.625mm. While the entire capital structure is secured by an “equal first-priority" ranking with respect to the collateral, the revolver has a “first-out” priority and is entitled first to any proceeds from the collateral while the term loan and the senior secured notes enjoy pari passu status. This is where the rubber meets the road: that’s a lot of parties to get to agree on a transaction.

Before it could agree to anything, however, the debtors needed time and therefore entered into a widely reported forbearance in early March. S&P Global Ratings promptly slapped a downgrade on the company saying that it believed a debt restructuring was likely within 90 days. What a genius call!! While all of this was happening, the debtors continued to deteriorate:

During its March discussions with creditors, the Debtors began to see a significant decrease in their available liquidity, driven in part by the long-term industry trends discussed above and made acute by the severe economic impact of the COVID-19 pandemic.

Which begs the question: what is the value of this business? Cleary nobody can agree on that: there is no restructuring support agreement here. Instead, there appears to be an arms-locked resignation that a parallel-path is needed to (i) nail down some DIP financing to shore up liquidity ($100mm at L+6.75%) and buy time, (ii) continue to discuss a balance sheet restructuring, AND (iii) simultaneously market test the business via a strategic marketing process. A lot of people will need to wait and see how this plays out, primarily pensioners owed over $50mm and various trade creditors including the bankruptcy-familiar RR Donnelley & Sons Co. ($RRD), Eastman Kodak Company ($KODK) and Verso Paper Holding LLC.

  • Jurisdiction: S.D. of New York (Judge Lane)

  • Capital Structure: $249mm funded RCF (plus $50.8mm LOCs), $221.9mm funded TL (Bank of America NA), $450mm ‘23 8.75% senior secured notes (Wells Fargo Bank NA)

  • Professionals:

    • Legal: Sullivan & Cromwell LLP (Andrew Dietderich, Brian Glueckstein, Alexa Kranzley, Christian Jensen) & Young Conaway Stargatt & Taylor LLP

    • Financial Advisor: AlixPartners LLP

    • Investment Banker: Evercore Group LLC

    • Claims Agent: Prime Clerk LLC (*click on the link above for free docket access)

  • Other Parties in Interest:

    • DIP Agent ($100mm): Bank of America NA

      • Legal: Moore & Van Allen PLLC (David Eades, Charles R. Rayburn III, Zachary Smith)

    • Ad Hoc Group of Term Lenders: Bardin Hill Investment Partners LP, Eaton Vance Management, HG Vora Capital Management, LLC, Marathon Asset Management, Shenkman Capital Management, Sound Point Capital Management LP, and Summit Partners Credit Advisors, L.P.

      • Legal: Arnold & Porter Kaye Scholer LLP (Michael Messersmith, Sarah Gryll, Lucas Barrett)

    • Ad Hoc Group of Secured Noteholders: Capital Research and Management Company, Manulife Investment Management, Atlas FRM LLC, TD Asset Management Inc.

      • Legal: Paul Weiss Rifkind Wharton & Garrison LLP (Andrew Rosenberg, Alice Eaton, Claudia Tobler)

    • Official Committee of Unsecured Creditors

      • Legal: Stroock & Stroock & Lavan LLP (Frank Merola, Brett Lawrence, Erez Gilad, Harold Olsen, Gabriel Sasson)