🗞The NYT, New Media Models & Snowflake Subscribers🗞

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Take a look at these revenue numbers:

This, ladies and gentlemen, represents the most recently reported revenue from New York Times Co. ($NYT). It’s also evolution, illustrated.

We all know the story: in an age of heaps of free media and secular decline of print, media companies are (a) in the midst of a great pivot away from the ad-based business model and (b) as part of a hybrid model, leaning more heavily upon recurring-revenue-producing subscription (and other) products.

This pivot — and the reason for it — couldn’t be clearer from the reported Q2 ‘19 earnings. As you can see above, advertising revenue is flat, while subscription and “other” revenue is growing.

Generally speaking, the report was sound. The company added 131k net subscriptions; it also separately grew its separate subscription channels for “Cooking” and “Crossword,”* and launched a news series, “The Weekly,” on FX and Hulu (PETITION Note: we can’t help but question the long-term success of this series: who really wants to go to Hulu to watch a NYT news series? In the end, that didn’t work for Vice News on HBO. That said, this series apparently contributed to a 30% increase in “other” revenue in the quarter, so, who knows? Maybe we’re dead wrong). In total, subscriptions were up by 197k and the company now reports 3.8mm digital-only subscribers.

On the negative side, the company’s operating costs are increasing and, in turn, its operating profit is decreasing (down $4mm YOY) as it looks to grow its digital channels, properly analyze and manage its sales funnel, acquire additional journalist talent, etc. Some choice bits relating to subscriptions from the earnings call:

Total subscription revenues increased 4% in the quarter with digital-only subscription revenue growing 14% to $113 million. On the print subscription side, revenues were down 2.5% due to declines in the number of home delivery subscriptions and continued shift of subscribers moving to less frequent and therefore less expensive delivery packages as well as a decline in single copy sales. This decrease in print subscription revenues was partially offset by a home delivery price increase that was implemented early in the year.

Total daily circulation declined 8.5% in the quarter compared with prior year, while Sunday circulation declined 7.1%.

No surprises here. Digital is ⬆️, print is ⬇️, and even where there is print, the average revenue per user is shifting down in large part due to subscribers opting for ⬇️ delivery frequency. Interestingly, people are also buying fewer newspapers on the fly (“single copy sales”).

On the advertising side:

Total advertising revenue grew 1.3% compared with the prior year with digital advertising growing 14% and print declining by 8%. The increase in digital advertising revenue was largely driven by growth in direct sold advertising on our digital platforms, including advertising sold in our podcast and our creative services business. The print advertising result was mainly due to declines in the financial services, retail and media categories, partially offset by growth in technology.

The stock market did not act favorably — note the demarcation below:

Indeed, as of the time of this writing, the share price is down 20% from where it was on the date of the release.

There are some interesting takeaways here. First, podcasts continue to be a source of growth for many a media company — despite the lack of viable analytics across the podcasting space. Second, the second order effects of the decline in retail and media are notable. Third, the company’s purchase of Wirecutter is feeding its “other” revenue which implies — though it is not line-itemed — that affiliate-related revenue is a growing part of the business (long Amazon!).**

As for guidance, the company forecasted continued YOY subscription growth in the low-to-mid single digits, a decrease in ad revenue, and an increase in “other” revenue. Notably, “other” revenue also includes income from subletting office space, commercial printing, and licensing deals (i.e., when the NYT is referenced in a movie, etc.).

It will be interesting to see whether the NYT can continue to demonstrate subscriber growth in the midst of a hyper-polarized political environment. To point, a shift to subscribers is not without its dangers. Recently the NYT came under pressure both for (i) its 1619 Project about slavery and (ii) a headline describing President Trump’s reaction to the El Paso and Dayton shootings. Per The Wrap:

The New York Times saw an increase in subscription cancellations after a reader backlash over its lead headline on a story about a Donald Trump speech on Monday, a Times spokesperson told TheWrap.

The paper has “seen a higher volume of cancellations today than is typical,” the spokesperson said on Tuesday.

In an age of hyper-competition for the marginal dollar, this is a big problem. In a story about the dismal performance of the Los Angeles Times’ digital initiatives (net 13k subscriptions in the first six months of ‘19), Joshua Benton writes for Neiman Lab:

But once you get all those subscribers signed up, you’ve got to prove yourself worthy of their money, over and over again. Churn has always been an issue for newspapers, but it’s even more of one in a world of constant competition for subscription dollars. (“Hmm, Netflix raised their price — do I really use that L.A. Times subscription?”) Retention is critical to making reader revenue the bedrock of the new business model….

That’s what happens when you switch to a subscriber model. Investors care less about ad revenue and more about subscriber growth. Each individual subscriber matters. And retention really matters.

*****

But retention cannot come at a cost. A publication must establish values and live up to them. Take, for instance, this note we received from a reader recently:

“Your writings are done well, interesting, and humorous. However, take it from me and many of my colleagues, your anti-Trump insults are aggravating and misguided.  Some of us are considering unsubscribing because of it.”

He is referring to this piece, “Tariffs Tear into Tech+,” wherein we wrote about the recent escalation in trade hostility as follows:

We’re frankly not sure why this is controversial. All we did was insinuate that the man is intemperate (is that really even debatable?) and describe him in his own words.

President Trump’s policies — for better or for worse — have an impact on the economy. The delivery of those policies infuses volatility into the markets. It affects whether a company will commit to investing millions in coming months; it affects sales; it affects consumer spending which, in case you didn’t notice, is, for now, the only thing keeping GDP afloat. We’re going to write about that. And we’re going to do so in our usual voice. Just like we would if a democrat were in office: we’re equal opportunity snark.***

So, sure, Mr. Orange County, feel free to cancel your Membership if you think we’re misguided. That’s just what we all need: another highly educated person running for the hills because a few words didn’t comport with his sensibilities. Thanks for summing up this country’s current plight of discourse/discord in three sentences.

In conclusion, we won’t be bullied, subscription be damned.

*Impressively, the Cooking product has 250k subscribers and the Crosswords product has 500k subscribers.

**For those who don’t know, an affiliate fee is essentially a referral fee for sending traffic over to an affiliate partner that ultimately results in a transaction. So, for instance, if you go to Wirecutter.com to look up best back-to-school backpack and click on their #1 choice, a L.L. Bean ‘Quad Pack,’ and buy one, Wirecutter earns approximately 4% on that purchase.

***Case and point: we’ve previously asked, “Are Progressives Bankrupting Restaurants?

☎️Who Knew? People Don’t Use Landlines Anymore? (Short the Peso, Short US-denominated EM Debt).☎️

We’re all for a reprieve from retail and energy distress. Hallelujah.

Maxcom USA Telecom Inc. is a telecommunications provider deploying “smart-build” approaches to “last mile” connectivity (read: modems, handsets and set-up boxes) for enterprises, residential customers and governmental entities in Mexico — which is really just a fancy way of saying that it provides local and long-distance voice, data, high speed, dedicated internet access and VoIP tech, among other things, to customers.* It purports to be cutting edge and entrepreneurial, claiming “a history of being the first providers in Mexico to introduce new services,” including (a) the first broadband in 2005, (b) the first “triple-play” (cable, voice and broadband) in 2005, and (c) the first paid tv services over copper network using IP…in 2007. That’s where the “history” stops, however, which likely goes a long way — reminder, it’s currently the year 2019 — towards explaining why this f*cker couldn’t generate enough revenue to service its ~$103.4mm in debt.** Innovators!!

And speaking of that debt, it’s primarily the $103.4mm in “Old Notes” due in 2020 that precipitated this prepackaged bankruptcy filing (in the Southern District of New York).***

The Old Notes derive from a prior prepackaged bankruptcy — in 2013 (PETITION Note: not a “Two-Year Rule” violation) — and were exchanged for what were then outstanding 11% senior notes due in 2014. These Old Notes have a “step-up interest rate,” which means that, over time, the interest rate…uh…steps up…as in, increases upward/up-like. The rate currently stands at 8%. Unfortunately, the company doesn’t have revenue step-ups/upwardness/upseedayzee to offset the interest expense increase; rather, the company “…incurred losses of $4.9 million for the three months ended June 30, 2019, as compared to losses of $2.9 million for the three months ended June 30, 2018, and losses of $16 million for the year ended December 31, 2018, compared to losses of $.8 million for the year ended December 31, 2017….” Compounding matters are, among other things, the negative effects of decreased interest income and foreign currency exchange rates (the dollar is too damn strong!).**** The closure of the residential segment also, naturally, affected net revenue.


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💩There’s No End in Sight for Retail Pain (Long the “Playbook”)💩

Retail, retail, retail.

Brutal. Absolutely B.R.U.T.A.L.

Avenue Stores LLC, a speciality women’s plus-size retailer with approximately 2,000 employees across its NJ-based HQ* and 255 leased stores,** is the latest retailer to find its way into bankruptcy court. On Friday, August 16, Avenue Stores LLC filed for chapter 11 bankruptcy in the District of Delaware. Like Dressbarn, another plus-size apparel retailer that’s in the midst of going the way of the dodo, any future iteration of the Avenue “brand” will likely exist only on the interwebs: the company intends to shutter its brick-and-mortar footprint.

What is Avenue? In addition to a select assortment of national brands, Avenue is a seller of (i) mostly “Avenue” private label apparel, (ii) intimates/swimwear and other wares under the “Loralette” brand and (iii) wide-width shoes under the “Cloudwalkers” brand. The company conducts e-commerce via “Avenue.com” and “Loralette.com.” All of this “IP” is the crux of the bankruptcy. More on this below. 

But, first, a digression: when we featured Versa Capital Management LP’s Gregory Segall in a Notice of Appearance segment back in April, we paid short shrift to the challenges of retail. We hadn’t had an investor make an NOA before and so we focused more broadly on the middle market and investing rather than Versa’s foray into retail and its ownership of Avenue Stores LLC. Nevertheless, with the benefit of 20/20 hindsight, we can now see some foreshadowing baked into Mr. Siegel’s answers — in particular, his focus on Avenue’s e-commerce business and the strategic downsizing of the brick-and-mortar footprint. Like many failed retail enterprises before it, the future — both near and long-term — of Avenue Stores is marked by these categorical distinctions. Store sales are approximately 64% of sales with e-commerce at approximately 36% (notably, he cited 33% at the time of the NOA). 

A brand founded in 1987, Avenue has had an up-and-down history. It was spun off out of Limited Brands Inc. and renamed in 1989; it IPO’d in 1992; it was then taken private in 2007. Shortly thereafter, it struggled and filed for bankruptcy in early 2012 and sold as a going-concern to an acquisition entity, Avenue Stores LLC (under a prior name), for “about $32 million.” The sale closed after all of two months in bankruptcy. The holding company that owns 100% of the membership interests in Avenue Stores LLC, the operating company, is 99%-owned by Versa Capital Management. 

Performance for the business has been bad, though the net loss isn’t off the charts like we’ve seen with other recent debtors in chapter 11 cases (or IPO candidates filing S-1s, for that matter). Indeed, the company had negative EBITDA of $886k for the first five months of 2019 on $75.3mm in sales. Nevertheless, the loss was enough for purposes of the debtors’ capital structure. The debtors are party to an asset-backed loan (“ABL”) memorialized by a credit agreement with PNC Bank NA, a lender that, lately, hasn’t been known for suffering fools. The loan is for $45mm with a $6mm first-in-last-out tranche and has a first lien on most of the debtors’ collateral. 

The thing about ABLs is that availability thereunder is subject to what’s called a “borrowing base.” A borrowing base determines how much availability there is out of the overall credit facility. Said another way, the debtors may not always have access to the full facility and therefore can’t just borrow $45mm willy-nilly; they have to comply with certain periodic tests. For instance, the value of the debtors’ inventory and receivables, among other things, must be at a certain level for availability to remain. If the value doesn’t hold up, the banks can close the spigot. If you’re a business with poor sales, slim margins, diminishing asset quality (i.e., apparel inventory), and high cash burn, you’re generally not in very good shape when it comes to these tests. With specs like those, your liquidity is probably already tight. A tightened borrowing base will merely exacerbate the problem.


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⛽️Oil & Gas Continues to Be a Free-for-All (Long Houston’s Restaurant Scene)⛽️

Speaking of borrowing bases and being f*cked, there’s also Alta Mesa Holdings LP(“AMH”), a Houston-based E&P company focused on the Anadarko stack. See, the funny thing about asset-backed loans is that when the asset quality deteriorates, a bank, to no one’s surprise, wants to reduce its credit exposure and borrower risk. This is why lenders bake in “redetermination rights” into their credit documents; they want the flexibility to ratchet down their commitment to a borrower should the borrower, say, sh*t the bed in a big big way. 

In case you haven’t been paying attention, oil and gas, as an industry, has been sh*tting the bed in a big BIG way. 

Hence, Alta Mesa’s SEC filing earlier this week that it received notice pursuant to its credit agreement, that the borrowing base has been reduced from $370mm to $200mm. YIKES. 

Let’s, for sh*ts and giggles, parse out the filing, shall we? 

“AMH’s combined borrowings and letters of credit outstanding exceed the new borrowing base by $162.4 million.” 

PETITION Note: Ruh roh. Just like that, the lenders have put the squeeze on AMH. AMH meet world of hurt. World of hurt, meet AMH.


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❓How’s Oil and Gas Doing. (Spoiler Alert: Not Well)❓

Callback to May 12’s “Fast Forward - Oil & Gas is SO 2019.” We wrote:

In March’s “Oil and Gas Continues to Crack (Long Houston-Based Hotels),” we wrote:

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.

And:

Here’s the bottom line: both amend-and-extended and formally restructured oil and gas companies were an option on oil prices. That option is out of the money for a number of these companies. The end result will be an uptick in Texas’ hotel reservations and bankruptcy fees. And soon.

We also wrote:

Legacy Reserves Inc. ($LGCY) is yet another E&P company that looks like it may be destined for the bankruptcy bin. The company announced this week that it is evaluating strategic alternatives. It subsequently filed its 10-K which included going concern language and, significantly, confirmation that the company’s lenders had agreed to extend the company’s maturity under its credit agreement from April 1 to May 31, 2019. This is like a good movie needing a bit more production time prior to theatric release: usually, the movie ultimately it gets released. Likewise, this will ultimately end up in bankruptcy court.

Let’s take stock of the bankruptcy bodybag count since then:

  • Jones Energy ✅;

  • Southcross Energy Partners LP ✅;

  • Vanguard Natural Resources ✅;

  • Sanchez Energy Corporation ✅;

  • Emerge Energy Services LP ✅;

  • Legacy Reserves ✅.

Meanwhile, EP Energy Corporation ($EPEG) reportedly just missed its $40mm interest payment due under the indenture governing its 8.000% 1.5 Lien Notes due 2025 (due on August 15, 2019). Of course, there’s also been a number of private oil-and-gas companies 


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⚡️Update: Interlogic Outsourcing Inc.⚡️

We wrote about this bankruptcy filing on August 11. We noted the highly competitive landscape confronting outsourced payroll, benefits and human resources services companies. Because the bankruptcy filing wasn’t complete at the time of publication, however, we didn’t have the opportunity to add that the company descended into bankruptcy primarily because its sole owner (fraudulently?) mismanaged the company and misappropriated approximately $90mm. Uh oh.

The result? A free fall into bankruptcy one month after an independent director took over management of the business, a CRO came on board (Huron) and an expedited sale process commenced. This world being the savage world it is, competitors started picking off company clients and so the value of this company appears to be dissipating before our eyes with each passing day. The company has a $7.8mm DIP commitment in place from pre-petition lender, KeyBank NA.


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💩Yes, Let’s Get Right to It: Retail Blows. The End.💩

 

You have to respect the brevity deployed by Lolli and Pops Inc., the sweets retailer that filed for bankruptcy in the District of Delaware on Monday. In a shockingly-yet-refreshingly terse 8-page first day declaration, the company and its affiliated debtors’ CRO justified the bankruptcy filing by saying, in effect, the following: retail blows. The funny thing is that the document could have been even shorter. We’ll give it a shot:


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📦Nerds Lament: Subscription Box Company Goes BK📦

We’re old enough to remember when subscription boxes were all the rage. The e-commerce trend became so explosive that the Washington Post estimated in 2014 that there were anywhere between 400 and 600 different subscription box services out there. We reckon that — given the the arguably-successful-because-it-got-to-an-IPO-but-then-atrocious-public-foray by Blue Apron Inc. ($APRN) — the number today is on the lower end of the range (if not even lower) as many businesses failed to prove out the business model and manage shipping expense.

And so it was only a matter of time before one of them declared bankruptcy.

Earlier this morning, Loot Crate Inc., a Los Angeles-based subscription service which provides monthly boxes of geek- and gaming-related merchandise (“Comic-con in a box,” including toys, clothing, books and comics tied to big pop culture and geek franchises) filed for bankruptcy in the District of Delaware.* According to a press release, the company intends to use the chapter 11 process to effectuate a 363 sale of substantially all of its assets to a newly-formed buyer, Loot Crate Acquisition LLC. The company secured a $10mm DIP credit facility to fund the cases from Money Chest LLC, an investor in the business. The company started in 2012.

Speaking of investors in the business, this one got a $18.5mm round of venture financingfrom the likes of Upfront VenturesSterling.VC (the venture arm of Sterling Equities, the owner of the New York Mets), and Downey Ventures, the venture arm of none other than Iron Man himself, Robert Downey Jr. At one point, this investment appeared to be a smashing success: the company reportedly had over 600k subscribers and more than $100mm in annualized revenue. It delivered to 35 countries. Inc Magazine ranked it #1 on its “Fastest Growing Private Companies” listDeloitte had it listed first in its 2016 Technology Fast 500 Winners list. Loot Crate must have had one kicka$$ PR person!

But life comes at you fast.

By 2018, the wheels were already coming off. Mark Suster, a well-known and prolific VC from Upfront Ventures, stepped off the board along with two other directors. The company hired Dendera Advisory LLC, a boutique merchant bank, for a capital raise.** As we pointed out in early ‘18, apparently nobody was willing to put a new equity check into this thing, despite all of the accolades. Of course, allegations of sexual harassment don’t exactly help. Ultimately, the company had no choice but to go the debt route: in August 2018, it secured $23mm in new financing from Atalaya Capital Management LP. Per the company announcement:

This financing, led by Atalaya Capital Management LP ("Atalaya") and supported by several new investors (including longstanding commercial partners, NECA and Bioworld Merchandising), will enable Loot Crate to bolster its existing subscription lines and improve the overall customer experience, while also enabling new product launches, growth in new product lines and the establishment of new distribution channels.

Shortly thereafter, it began selling its boxes on Amazon Inc. ($AMZN). When a DTC e-commerce business suddenly starts relying on Amazon for distribution and relinquishes control of the customer relationship, one has to start to wonder. 🤔

And, so, now it is basically being sold for parts. Per the company announcement:

"During the sale process we will have the financial resources to purchase the goods and services necessary to fulfill our Looters' needs and continue the high-quality service and support they have come to expect from the Loot Crate team," Mr. Davis said.

That’s a pretty curious statement considering the Better Business Bureau opened an investigation into the company back in late 2018. Per the BBB website:

According to BBB files, consumers allege not receiving the purchases they paid for. Furthermore consumers allege not being able to get a response with the details of their orders or refunds. On September 4, 2018 the BBB contacted the company in regards to our concerns about the amount and pattern of complaints we have received. On October 30, 2018 the company responded stating "Loot Crate implemented a Shipping Status page to resolve any issues with delays here: http://loot.cr/shippingstatus[.]

In fact, go on Twitter and you’ll see a lot of recent complaints:

High quality service, huh? Riiiiiiight. These angry customers are likely to learn the definition of “unsecured creditor.”

Good luck getting those refunds, folks. The purchase price obviously won’t clear the $23mm in debt which means that general unsecured creditors (i.e., customers, among other groups) and equity investors will be wiped out.***

Sadly, this is another tale about a once-high-flying startup that apparently got too close to the sun. And, unfortunately, a number of people will lose their jobs as a result.

Market froth has helped a number of these companies survive. When things do eventually turn, we will, unfortunately, see a lot more companies that once featured prominently in rankings and magazine covers fall by the wayside.

*We previously wrote about Loot Crate here, back in February 2018.

**Dendera, while not a well-known firm in restructuring circles, has been making its presence known in recent chapter 11 filings; it apparently had a role in Eastern Mountain Sports and Energy XXI.

***The full details of the bankruptcy filing aren’t out yet but this seems like a pretty obvious result.

⚡️Here a Sale. There a Sale. Everywhere a Sale Sale! (Long Bankruptcy Code Section 363)⚡️

In a nutshell, bankruptcy code section 363 allows a debtor to sell assets free and clear of liens and encumbrances.

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In other words, a company can sell itself and the buyer can leave a bunch of bad sh*t behind. It’s a powerful tool and helps the buyer avoid any sort of “fraudulent conveyance” liability down the road. We’re seeing a proliferation of 363-based bankruptcy cases. In the last week, for instance, Barneys New York Inc., iPic-Gold Class Entertainment LLC, and Perkins & Marie Callender’s LLC all filed with the intent of pursuing sales (PETITION Note: see, also, Jack Cooper Ventures Inc. below).


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⛽️Halcon Resources Poised to be the Next Oil & Gas Chapter 22 (Long Kerosene)⛽️

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Nearly three years after its last prepackaged plan of reorganization wiped $1.8 billion of debt off of the company’s balance sheet, onshore E&P company, Halcon Resources Corporation ($HKRS), is once again on the bankruptcy courthouse steps with another prepackaged bankruptcy. This company is burning debt like a baaaaaaaaaaaawse.

In the prior bankruptcy, the company eliminated $1b of 13% ‘22 senior secured third lien notes, $316mm of 9.75% ‘20 senior notes, $297mm of 8.875% ‘21 senior notes, $37mm of 9.25% ‘22 senior notes, and $290mm of 8% ‘20 senior convertible notes. The majority of the equity in the reorganized entity went to the third lien noteholders, with other equity going to unsecured holders (15.5%), convertible noteholders (4%) and common stockholders (4%). That equity holds very little value today. The stock traded publicly up until July 23, 2019, when the Nasdaq delisted the company’s shares ($HR) and the stock began trading on OTC pink sheets under the $HKRS symbol.

Meanwhile, here’s what the company’s current debt sitch looked like this as of the most recent 10-Q:


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📽A $5.7mm “Human Error” (Short Bankruptcy Projections)📽

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Never try to cover sh*t up in corporate America. That is f*ck up #1 and a sure-fire way to get yourself pink-slipped. When you screw up in corporate America — and you WILL screw up in corporate America — the right approach is to squelch the temptation to sweep that f*ckup under the rug and, instead, fess up to the mistake with a solution in hand. That last part is key: accepting responsibility isn’t enough. “Responsibility” in corporate America includes having a fix for the issue.

A bit over a week ago, in the Z Gallerie LLC bankruptcy matter, the professionals kinda sorta followed this protocol.

In a statement filed with the bankruptcy court (Docket 464), the company described how it achieved the Herculean feat of selling Z Gallerie’s abysmal business (for ~$20mm) and confirming a plan of confirmation three-months-to-the-day from the petition date.* The company emphasized that it was incentivized to move the cases rapidly to (a) avoid a liquidation trigger under its DIP credit facility, (b) preserve value for the company’s prospective buyer by avoiding a long, drawn-out in-court proceeding that would surely have the effect of leaking value in today’s complex dog-eat-dog retail environment, and (c) “ensure[] that those who provide actual, necessary benefits to the company during its distress are paid in full.” To do this, however, the company had to do a wee bit of forecasting; it had to estimate its administrative claims to ensure that the company would have enough cash at sale closing to satisfy those claims.

The company performed this analysis and, ultimately, the company’s interim CEO declared to the bankruptcy court that, indeed, it, would have enough cash to satisfy priority and administrative claims under the plan (including DIP claims, professional fee claims, and other administrative and priority claims). But, as it turns out — and as PETITION readers know ALL TO WELL from our ongoing review of feasibility projections — forecasts are subject to, from time to time, “significant errors and omissions.” Or, put another way, “human error.” Or put another way, these mathematicians missed their numbers by $5.7mm. Or put ANOTHER way, this case puts the PETITION “Two-Year Rule” in an entirely new light. It’s one thing to realize that your projections are off within two years; it’s an entirely different story to realize you’re off within two months! 😬

So, what happened?

Up until roughly a week ago, the estate had been administered by a “Wind-Down Trust” that had been spearheaded by the company’s CFO. That CFO, however, was apparently too busy auditioning for a new job — uh, serving as DirectBuy’s main “transition” point of contact — to properly administer the trust. In a statement (Docket 465) in which the interim CEO acknowledged that he’s “ultimately responsible” for the estate, he simultaneously goes to great lengths to establish a record of ineptitude on the part of the company’s CFO. He failed to reconcile accounts, he failed to accurately predict invoices from the company’s delivery companies, etc. etc.** This is what the delta looks like:

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💰How are the Investment Banks Doing?(Long Increasing Fees?)💰

Evercore Inc. ($EVR) reported earnings this week and, well, inflation exists somewhere. The company increased adjusted revenue by 18% YOY to $535.8mm. Net income increased by nearly $18mm. The bank reported a decline in the number and dollar volume of its deals but…BUT…numbers nevertheless improved thanks to a strong move in investment banking advisory fees (up 22% YOY). With 81 earned fees of $1mm or more compared to 85 last year, the company appears to be adding clients and raising fees. Because the bank doesn’t delineate restructuring revenues separate and apart from other advisory services, it’s unclear to what degree restructuring is adding or detracting from performance — from either a deal volume or fee perspective. 

Houlihan Lokey ($HLI) also reported earnings; it notched a 14% revenue increase YOY ($250mm) and a 44% net income increase. Financial restructuring revenues increased 57%! Surprisingly, however, the bank noted that “[r]evenue increased primarily as a result of an increase in the number of closed transactions, partially offset by a reduction in the average transaction fee.” Curious. 


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💥Higher Interest Rates Eff Mortgage Originator (Long FED Fear of POTUS). New Chapter 11 Filing - Stearns Holdings LLC💥

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Hallelujah! Something is going on out in the world aside from the #retailapocalypse and distressed oil and gas. Here, Blackstone Capital Partners-owned Stearns Holdings LLCand six affiliated debtors (the “debtors”) have filed for bankruptcy in the Southern District of New York because of…drumroll please…rising interest rates. That’s right: the FED has claimed a victim. Stephen Moore and Judy Shelton must be smirking their faces off.

The debtors are a private mortgage company in the business of originating residential mortgages; it is the 20th largest mortgage lender in the US, operating in 50 states. The debtors generate revenue by producing mortgages and then selling them to government-sponsored enterprises such as Ginnie MaeFannie Mae and Freddie Mac. To originate loans, the debtors require a lot of debt; they also require favorable interest rates. Favorable interest rates = lower cost of residential home purchases = increased market demand and sales activity for homes = higher rate or origination.

Except, there’s been an itsy bitsy teeny weeny problem. Interest rates have been going up. Per the debtors:

The mortgage origination business is significantly impacted by interest rate trends. In mid-2016, the 10-year Treasury was 1.60%. Following the U.S. presidential election, it rose to a range of 2.30% to 2.45% and maintained that range throughout 2017. The 10-year Treasury rate increased to over 3.0% for most of 2018. The rise in rates during this time period reduced the overall size of the mortgage market, increasing competition and significantly reducing market revenues.

Said another way: mortgage rates are pegged off the 10-year treasury rate and rising rates chilled the housing market. With buyers running for the hills, originators can’t pump supply. Hence, diminished revenues. And diminished revenues are particularly problematic when you have high-interest debt with an impending maturity.

This is where the business model really comes into play. Here’s a diagram illustrating how this all works:


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⚡️Update: Trickle-Down Healthcare Distress (Long Electronic Beds, Short Nana). Part I.⚡️

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We scoured far and wide to see whether there might be some businesses that would get hammered by the uptick in healthcare distress we’ve all witnessed of late. In early June, we took a bit of a stab in the dark (Members’-only access):

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.

Among other things, we noted how the Joerns’ term loan maturing May 2020 “was among one of the worst performing loans in the month of May — quoted in the low 70s, down approximately 15% since April.” We insinuated that a bankruptcy filing may not be too far away.

We didn’t expect it to be in court a mere six weeks later.

On Monday, Joerns WoundCo Holdings Inc. and 13 affiliated entities filed a prepackaged bankruptcy in the District of Delaware. Among other reasons provided to explain its capitulation into bankruptcy court is “post acute sector disruption.” Now that’s music to our ears.

⚡️Update: FuelCell Energy Inc.⚡️

In May’s “🌋FuelCell Sucks Wind (Long Distressed Power)🌋,” we closed by saying:

“…we suspect we’ll be seeing this thing in Delaware sometime soon.”

The day of reckoning appears to have been stalled a bit.

FuelCell Energy Inc. ($FCEL) recently filed its Form 10-Q with the SEC. Across the board, the numbers were dogsh*t. This company is pretty darn good at losing money, apparently. Year-over-year revenues are WAY down and operating losses are mounting. The company retained Huron Consulting Group as CRO, paying them upwards of $1025/hour and an (elective) success fee:


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🛋Restoration Hardware B.R.I.N.G.S. IT (Long Shade)🛋

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There was so much that happened last week that we didn’t get a chance to report on RH’s stellar earnings report. We often report on sh*tty retail and so we’d be remiss not to highlight it: after all, RH crushed the home furnishing space this past quarter and fiscal year. It had record revenue, solid margins and strong go-forward guidance — despite headwinds such as tariffs (the costs of which the retailer unabashedly states will be passed on to the consumer). There were a number of interesting bits in the company’s earnings release.

In the midst of delineating successful initiatives, the company highlights:

Moving from a promotional to a membership model, elevating our brand and streamlining our business while developing a more intimate relationship with our customers.

That’s right. RH has one of the more shameful membership models out there: become a member and instantly benefit from meaningfully discounted prices. Then, forget that you became a member after your furnishing needs are satiated and continue to pay annual recurring membership fees to the retailer anyway. This annual membership isn’t like a media subscription or golf club dues: the chances of you purchasing furniture from RH every year are probably pretty low. As are the chances of you remembering to cancel your membership. Which, clearly, RH is banking on. One retailer’s promotion is another retailer’s flipped-upside-down membership model.

Second:

Opening architecturally inspiring and immersive physical experiences that render our products and services more unique and valuable, while doubling our retail revenues and earnings in every market.


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💥Mary Meeker’s “State-of-the-Internet” Slide Presentation💥

Another year, another banner “State-of-the-Internet” presentation from Mary Meeker. There are some bits that we thought would be of particular interest to the restructuring community.

  • For all we hear about Amazon and e-commerce destroying retail, e-commerce growth is slowing. It constitutes 15% of retail versus 14% a year ago.

  • There is a stark shift in time spent on various forms of media and, by extension, the use of ad budgets. This chart ought to frighten the sh*t out of print and radio content producers. Time spent on print and radio is down BIG. Even more disconcerting for print? All of the other mediums appear to have reached an equilibrium between time spent and ad spend but print, however, still enjoys a disproportionate amount of ad dollars. Said another way, print media outlets may still have some pain heading their way.

We’ve made recent mention of rising customer acquisition costs and how that might derail many retailers’ business plans. To reduce CAC, many streaming services (e.g., Zoom, Spotify) use free tiers at the top of their funnel to get potential customers in the door and familiar with their products and then focus primarily on making those potential customers happy instead of otherwise deploying effort to market wholesale (PETITION Note: similarly, this is what we do). That said, CACs are indeed increasing. Ms. Meeker has a chart for this:


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💩Coal Country is Busy. Noooo…not Mining. Filing. For Bankruptcy (Short #MAGA!)💩

Pour one out for the fine folks of eastern Kentucky and western Virginia. They can’t seem to catch a break.

Earlier this week, Cambrian Holding Company Inc. (and its affiliate debtors) joined a long line of coal producers/processors (e.g., Cloud Peak EnergyWestmoreland CoalMission Coal) who have recently filed for bankruptcy. The company employees approximately 660 people, none of whom are members of a labor union (in contrast to bigger, more controversial, coal filings, i.e., Westmoreland) and most of whom must be fretting over their futures. They must really be getting tired of all of the post-election “winning” that’s going on in coal country.

The company’s problems appear to start in 2015, at the time the company acquired TECO Coal LLC and assumed $40mm of workers’ compensation and black lung liabilities that TECO had previously self-insured. The company sought to leverage its broader scale to increase production but it failed to raise the working capital it needed to live up to its obligations and sustain production at levels necessary to service the company’s balance sheet. Post-acquisition, the company doubled revenues, but it couldn’t sustain that progress and nevertheless recorded net losses from 2015 through 2018. In turn, the company triggered financial covenant and other defaults under its ABL Revolver and Term Loan.

In other words, the company has been in a state of emergency ever since the acquisition. Almost immediately, the company “undertook various efforts to return to a positive cashflow,” which, as you might expect, meant idling or closing certain mining operations, stretching the usable life of equipment, and laying off employees.* Its efforts proved fruitless. Per the company:

Notwithstanding these efforts, the Debtors have been unable to overcome the pressures placed on their profit margins from steadily declining coal prices (along with burdensome regulations and the accompanying decline in demand for coal), all of which have contributed to the Debtors’ substantial negative cashflow and inability to consummate a value-enhancing transaction.

So, what now? The company, with assistance from Jefferies LLC, will attempt to find a buyer willing to catch a falling knife: the plan is to “commence an expeditious sale and marketing process” of the company’s assets (call us crazy, but shouldn’t it be the other way around?). To fund this process, the company has a DIP commitment from affiliates of pre-petition lenders for $15mm.**

*Interestingly, it was in March 2016 when Hilary Clinton infamously stated, “Because we're going to put a lot of coal miners and coal companies out of business.” At the time, Cambrian was already struggling, laying off people in an attempt to generate positive cashflow. That message really must’ve struck a chord down in coal country. WHOOPS.

**The Term Lenders swiftly objected to the terms of the DIP and the use of cash collateral.

⛽️Even the Permian Isn’t Infallible (Long Heaps of Oil & Gas Distress)⛽️

 

Even at 95 years old, you can’t get one past Charlie Munger. #Legend.

The Permian Basin in West Texas is where it’s at in the world of oil and gas exploration and production. Per Wikipedia:

As of 2018, the Permian Basin has produced more than 33 billion barrels of oil, along with 118 trillion cubic feet of natural gas. This production accounts for 20% of US crude oil production and 7% of US dry natural gas production. While the production was thought to have peaked in the early 1970s, new technologies for oil extraction, such as hydraulic fracturing and horizontal drilling have increased production dramatically. Estimates from the Energy Information Administration have predicted that proven reserves in the Permian Basin still hold 5 billion barrels of oil and approximately 19 trillion cubic feet of natural gas.

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And it may be even more prolific than originally thought. Norwegian research firm Rystad Energy recently issued a report indicating that Permian projected output was already above 4.5mm barrels a day in May with volumes exceeding 5mm barrels in June. This staggering level of production is pushing total U.S. oil production to approximately 12.5mm barrels per day in May. That means the Permian now accounts for 36% of US crude oil production — a significant increase over 2018. Normalized across 365 days, that would be a 1.64 billion barrel run rate. This is despite (a) rigs coming offline in the Permian and (b) natural gas flaring and venting reaching all-time highs in Q1 ‘19 due to a lack of pipelines. Come again? That’s right. The Permian is producing in quantities larger than pipelines can accommodate. Per Reuters:

Producers burned or vented 661 million cubic feet per day (mmcfd) in the Permian Basin of West Texas and eastern New Mexico, the field that has driven the U.S. to record oil production, according to a new report from Rystad Energy.

The Permian’s first-quarter flaring and venting level more than doubles the production of the U.S. Gulf of Mexico’s most productive gas facility, Royal Dutch Shell’s Mars-Ursa complex, which produces about 260 to 270 mmcfd of gas.

The Permian isn’t alone in this, however. The Bakken shale field in North Dakota is also flaring at a high level. More from Reuters:

Together, the two oil fields on a yearly basis are burning and venting more than the gas demand in countries that include Hungary, Israel, Azerbaijan, Colombia and Romania, according to the report.

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All of which brings us to Legacy Reserves Inc. ($LGCY). Despite the midstream challenges, one could be forgiven for thinking that any operators engaged in E&P in the Permian might be insulated from commodity price declines and other macro headwinds. That position, however, would be wrong.

Legacy is a publicly-traded energy company engaged in the acquisition, development, production of oil and nat gas properties; its primary operations are in the Permian Basin (its largest operating region, historically), East Texas, and in the Rocky Mountain and Mid-Continent regions. While some of these basins may produce gobs of oil and gas, acquisition and production is nevertheless a HIGHLY capital intensive endeavor. And, here, like with many other E&P companies that have recently made their way into the bankruptcy bin, “significant capital” translates to “significant debt.”

Per the Company:

Like similar companies in this industry, the Company’s oil and natural gas operations, including their exploration, drilling, and production operations, are capital-intensive activities that require access to significant amounts of capital.  An oil price environment that has not recovered from the downturn seen in mid-2014 and the Company’s limited access to new capital have adversely affected the Company’s business. The Company further had liquidity constraints through borrowing base redeterminations under the Prepetition RBL Credit Agreement, as well as an inability to refinance or extend the maturity of the Prepetition RBL Credit Agreement beyond May 31, 2019.

This is the company’s capital structure:

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The company made two acquisitions in mid-2015 costing over $540mm. These acquisitions proved to be ill-timed given the longer-than-expected downturn in oil and gas. Per the Company:

In hindsight, despite the GP Board’s and management’s favorable view of the potential future opportunities afforded by these acquisitions and the high-caliber employees hired by the Company in connection therewith, these two acquisitions consumed disproportionately large amounts of the Company’s liquidity during a difficult industry period.

WHOOPS. It’s a good thing there were no public investors in this thing who were in it for the high yield and favorable tax treatment.*

Yet, the company was able to avoid a prior bankruptcy when various other E&P companies were falling like flies. Why was that? Insert the “drillco” structure here: the company entered into a development agreement with private equity firm TPG Special Situations Partners to drill, baby, drill (as opposed to acquire). What’s a drillco structure? Quite simply, the PE firm provided capital in return for a wellbore interest in the wells that it capitalized. Once TPG clears a specified IRR in relation to any specific well, any remaining proceeds revert to the operator. This structure — along with efforts to delever through out of court exchanges of debt — provided the company with much-needed runway during a rough macro patch.

It didn’t last, however. Liquidity continued to be a pervasive problem and it became abundantly clear that the company required a holistic solution to its balance sheet. That’s what this filing will achieve: this chapter 11 case is a financial restructuring backed by a Restructuring Support Agreement agreed to by nearly the entirety of the capital structure — down through the unsecured notes. Per the Company:

The Global RSA contemplates $256.3 million in backstopped equity commitments, $500.0 million in committed exit financing from the existing RBL Lenders, the equitization of approximately $815.8 million of prepetition debt, and payment in full of the Debtors’ general unsecured creditors.

Said another way, the Permian holds far too much promise for parties in interest to walk away from it without maintaining optionality for the future.

*Investors got burned multiple times along the way here. How did management do? Here is one view (view thread: it’s precious):

😬

☄️Future First Day Declaration: Forever21☄️

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We figured we'd take the first crack at the First Day Declaration for Forever21 Inc.'s potential bankruptcy* and spare the company some professional fees.

******
"Preliminary Statement in Support of Forever21's Chapter 11 Petition"

As you know, retail sucks. The list of bankrupted retailers is long and “iconic” and so we got FOMO and decided, what the heck! Everyone’s failing, so we might as well also!

But first, we did want to make sure that we could explain to our uber-loyal fanbase (who clearly isn’t buying enough of our sh*t) that we did everything in our power to stay out of bankruptcy court. And so we did what all retailers today do: we focused on omni-channel; upped our Insta spend; updated the lighting in our stores and refurbished our “look”; stretched our vendors; sh*tcanned some employees; negotiated extensively with our landlords; closed a few underperforming locations; negotiated with our lenders, and more! According to Bloombergwe’ve hired Latham & Watkins LLP to deal with this hot mess, including our $500mm asset-backed loan. We’ve been busy bees!!

We had one Hail Mary trick up our sleeves that we thought would really save the business: partnerships. With first class brands. Like Cheetos. That’s right Cheetos!! GET PUMPED!!! Everything is so 🔥🔥🔥.

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This sh*t got ~45k likes (“worst things since the Kardashians!” haha). Which pales compared to this doozy, which got ~47k likes:

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This is the most ridiculous clothing line I’ve ever seen.

Nothing drives sales sales sales like thoughts of “ball cheese” (PETITION Note: sorry…we had to). #Fail.

But, wait! There’s more. We brought back Baby Phat too!!

May G-d have mercy on all of us.

*Sources tell us that the company may not be as close to a bankruptcy filing as some previous media reporting implied. Nevertheless, the name has been kicking around for some time now within the lender community and it does appear that the company is focused on some operational fixes. This “mock” first day declaration should not be construed as indicating that a bankruptcy is, in fact, imminent.