Retail Roundup (Long Tourniquets, Long Headwinds).

The retail bloodbath continues.

Earlier this week, Abercrombie & Fitch Co. ($ANF) joined Ralph Lauren Corp. ($RL)Gap Inc. ($GPS), and Calvin Klein ($PVH) by ditching “flagship” stores situated in expensive parts of town. The stock got crushed on earnings. But the “Peace Out Flagship Square Footage” club didn’t stop growing there. To the contrary, it is expanding. Rapidly.

On Wednesday, J. Crew announced that it plans to shutter 20 flagship and outlet stores. “Why might it be trying to shrink its footprint,” you ask? Good question. And the comps give you all the answers you need. While total revenue rose 7% across the enterprise, J.Crew sales fell 4% with comps down 1%. In contrast, Madewell sales rose 15% and comps rose 10%. 


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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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🏦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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🚴 Peloton = Gympocalypse? 🚴

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

Source: Mirror

Source: Mirror

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

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

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

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

Web Smith frames it another way

He writes:

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

He continues:

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

And:

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

He finished by saying:

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

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

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

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

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

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

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

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

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

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

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

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

Initiate the Deluge of Lehman Retrospectives (Short History)

10 Years Have Passed Since the Great Recession. What has Changed?

The onslaught of “10 years ago” retrospectives about the collapse of Lehman Brothers, the “Great Recession,” and lessons learned (and not learned, as the case may be), has officially begun. Brace yourselves.

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💣Diebold. Disrupted.💣

Are Point-of-Sale & Self-Checkout Systems Effed (Short Diebold Nixdorf)?

Forgive us for returning to recently trodden ground. Since we wrote about Diebold Nixdorf Inc. ($DBD) in “💥Millennials & Post-Millennials are Killing ATMs💥,” there has been a flurry of activity around the name. The company…

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💰Private Equity Own Yo Sh*t (Short Health. And Care)💰

Forget Toys R Us. Private Equity Now Owns Your Eyes and Teeth

It has been over a month since media reports that Bernie Sanders and certain other Congressman questioned KKR about its role in the demise of Toys R Us (and the loss of 30k jobs). At the time, in “💥KKR Effectively Tells Bernie Sanders to Pound Sand💥,” we argued that the uproar was pretty ridiculous — even if we do hope that, in the end, we are wrong and that there’s some resolution for all of those folks who relied upon promises of severance payments. Remember: KKR declared that it is back-channeling with interested parties to come to some sort of resolution that will assuage people’s hurt feelings (and pocketbooks). Since then: we’ve heard nothing but crickets.

This shouldn’t surprise anyone. What might, however, is the degree to which private equity money is in so many different places with such a large potential societal impact. It extends beyond just retail.

Last week Josh Brown of Ritholtz Wealth Management posted a blog post entitled, “If You’re a Seller, Sell Now. If you’re a Buyer, Wait.” Here are some choice bits (though we recommend you read the whole thing):

I’ve never seen a seller’s market quite like the one we’re in now for privately held companies. In almost any industry, especially if it’s white collar, professional services and has a recurring revenue stream. There are thirty buyers for every business and they’re paying record-breaking multiples. There are opportunities to sell and stay on to manage, or sell to cash out (and bro down). There are rollups rolling up all the things that can be rolled up.

In my own industry, private equity firms have come in to both make acquisitions as well as to back existing strategic acquirers. This isn’t brand new, but the pace is furious and the deal size is going up. I’m hearing and seeing similar things happening with medical practices and accounting firms and insurance agencies.

Anything that can be harvested for its cash flows and turned into a bond is getting bought. The competition for these “assets” is incredible, by all accounts I’ve heard. Money is no object.

Here’s why – low interest rates (yes they’re still low) for a decade now have pushed huge pools of capital further out onto the risk curve. They’ve also made companies that rely upon borrowing look way more profitable than they’d ordinarily be.

This can go on for awhile but not forever. And when the music stops, a lot of these rolled-up private equity creations will not end up being particularly sexy. Whether or not the pain will be greater for private vs public companies in the next recession remains to be seen.

The Institutional Investor outright calls a bubble in its recent piece, “Everything About Private Equity Reeks of Bubble. Party On!” They note:

The private equity capital-raising bonanza has at least one clear implication: inflated prices.

Buyout multiples last year climbed to a record 10.2 times earnings before interest, taxes, depreciation, and amortization, according to S&P Global Market Intelligence. This year they remained elevated at an average of 9.5 times ebitda through May, a level surpassing the 2007 peak of the precrisis buyout boom.

Screen Shot 2018-08-18 at 11.54.58 AM.png

When you’re buying assets at inflated prices/values and levering them up to fund the purchase, what could possibly go wrong?

*****

What really caught our eye is Brown’s statement about medical practices. Ownership there can be direct via outright purchases. Or they can be indirect, through loans. Which, in a rising rate environment, may ultimately turn sour.

Consider for a moment the recent news that private equity is taking over from and competing with banks in the direct lending business. KKR, Blackstone Group, Carlyle Group, Apollo Global Management LLC and Ares Management LP are all over the space, raising billions of dollars, the latter recently closing a new $10 billion fund in Q2. They’re looking at real estate, infrastructure, insurance, healthcare and hedge funds. Per The Wall Street Journal:

Direct loans are typically floating-rate, meaning they earn more in a rising-rate environment. But borrowers accustomed to low rates may be unprepared for a jump in interest costs on what’s often a big pile of debt. That risk, combined with increasingly lenient terms and the relative inexperience of some direct lenders, could become a bigger issue in a downturn.

Regulators like that banks are wary of lending to companies that don’t meet strict criteria. But they are concerned about what’s happening outside their dominion. Joseph Otting, U.S. Comptroller of the Currency, said earlier this year: “A lot of that risk didn’t go away, it was just displaced outside of the banking industry.”

What happens when the portfolio companies struggle and these loans sour? The private equity fund (or hedge fund, as the case may be) may end up becoming the business’ owner. Take Elements Behavioral Health, for instance. It is the US’s largest independent provider of drug and alcohol addiction treatment. In late July, the bankruptcy court for the District of Delaware approved the sale of it the centers to Project Build Behavioral Health, LLC, which is a investment vehicle established by, among others, prepetition lender BlueMountain Capital Management. In other words, the next time Britney Spears or Lindsay Lohan need rehab, they’ll be paying a hedge fund.

The hedge fund ownership of healthcare treatment centers thing doesn’t appear to have worked out so well in Santa Clara County.

These aren’t one-offs.

Apollo Global Management LLC ($APO) is hoping to buy LifePoint Health Inc. ($LPNT), a hospital operator in approximately 22 states, in a $5.6 billion deal. Per Reuters:

Apollo’s deal - its biggest this year - is the latest in a recent surge of public investments by U.S. private equity, the highest since the 2007-08 global financial crisis.

With a record $1 trillion in cash at their disposal, top private equity names have turned to healthcare. Just last month, KKR and Veritas Capital each snapped up publicly-listed healthcare firms in multi-billion dollar deals.

Indeed, hospital operators are alluring to investors, Cantor Fitzgerald analyst Joseph France said. Because their operations are largely U.S.-based, hospital firms benefit more from lower tax rates than the average U.S. company, and are also more insulated from global trade uncertainties, France said.

Your next hospital visit may be powered by private equity.

How about dentistry? Well, in July, Bloomberg reported KKR & Co’s purchase of Heartland Dental in that “Private Equity is Pouring Money Into a Dental Empire.” It observed:

In April, the private equity powerhouse bought a 58 percent stake that valued Heartland at a rich $2.8 billion, the latest in a series of acquisitions in the industry. Other Wall Street investment firms -- from Leonard Green & Partners to Ares Management -- are also drilling into dentistry to see if they can create their own mega chains.

Here’s a choice quote for you:

"It feels a bit like the gold rush," said Stephen Thorne, chief executive officer of Pacific Dental Services. "Some of these private equity companies think the business is easier than it really is."

Hang on. You’re saying to yourself, “dentistry?” Yes, dentistry. Remember what Brown said: recurring revenue. People are fairly vigilant about their teeth. Well, and one other big thing: yield baby yield!

The nitrous oxide fueling the frenzy is credit. Heartland was already a junk-rated company, with debt of 7.4 times earnings before interest, taxes, depreciation and amortization as of last July. KKR’s takeover pushed that to about 7.9, according to Moody’s Investors Service, which considered the company’s leverage levels "very high."

Investors were so hungry that they accepted lenient terms in providing $1 billion of the leveraged loans that back the deal, making investing in the debt even riskier.

Nevermind this aspect:

Corporate dentistry has come under fire at times for pushing unnecessary or expensive procedures. But private equity firms say they’re drawn by efficiencies the chains can bring to individual dental practices, which these days require sophisticated marketing and expensive technology. The overall market for dental services is huge: $73 billion in 2017, according to investment bank Harris Williams & Co. Companies such as Heartland pay the dentists while taking care of everything else, including advertising, staffing and equipment. (emphasis added)

Your next dental exam powered by private equity.

Sadly, the same applies to eyes. Ophthalmology practices have been infiltrated by private equity too.

Your next cataracts surgery powered by private equity.

Don’t get us wrong. Despite the fact that we harp on about private equity all of the time, we do recognize that not all of private equity is bad. Among other positives, PE fills a real societal need, providing liquidity in places that may not otherwise have access to it.

But we want some consistency. To the extent that Congressmen, members of the mainstream media and workers want to bash private equity for its role in Toys R’ Us ultimate liquidation and in the #retailapocalypse generally, they may also want to ask their emergency room doctor, dentist and ophthalmologist who cuts his or her paycheck. And double and triple check whether a recommended procedure is truly necessary to service your eyes and mouth. Or the practice’s balance sheet.

L Brands (Long "Misplaced Optimism in Retail")

On Valentine’s Day, in “Misplaced Optimism in Retail: L Brands - What the Holy F*#*?,” we clowned on Leslie Wexner’s aggressive approach to retail and said “tell us that you don’t want to short the sh*t out of the stock.” It was trading at $49.87/share. Now...

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Direct-to-Consumer Food (Short the Butcher Section)

We have spoken a lot about direct-to-consumer digitally native brands having a tremendous — and understated (in restructuring circles) — affect on brick-and-mortar retail. Apparel in particular. PETITION readers are already familiar with Wish, a unicorn shopping platform with a valuation north of $8 billion. It’s secret sauce is allowing consumers to purchase clothes directly from Chinese factories. Imagine all of the middlemen cut out of that equation. No “brand tax” either.

Earlier this week Sequoia Capital China led an investment in Jollychic, a China-based e-commerce startup that lets Middle Eastern shoppers order unbranded products from Chinese factories.

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Dentistry (Long Unnecessarily Techie Toothbrushes)

Subscription-based razors? Check. Subscription-based contact lenses? Check. Now the direct-to-consumer digitally-native-vertical-brand world is coming for your teeth. Direct to consumer teeth alignment? Check. Subscription-based dental floss? Check. Subscription-based bluetooth compatible toothbrushes. Check. No. This is not a joke.

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🚲Well-Funded Machines Terrorize Sidewalks 🚲

The Rise of the Electric Scooter

Screen Shot 2018-05-19 at 8.42.01 AM.png

Do y’all remember the segway? It was supposed to revolutionize transportation but it never took off as anything more than the butt of a joke. Why? Look at the above photo. Homeboy can pump as many curls as he needs to but all the bulging biceps in the world won’t make him look bada$$ riding one of those things. Plus, watch the eye level broheim.

Anyway, there is a new mode of transportation that is all the rage. Introducing the dockless electric scooter…

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BJ's Wholesale Files for IPO

Use of Proceeds? Pay Back Dividend Recap Incurred Debt

CVC and Leonard Green & Partners have filed for a $100 million IPO of portfolio company, BJ’s Wholesale Club Holdings Inc. With Costco ($COST) killing it of late and the IPO marking champing at the bit for more new issues, this reeks of (sound capitalistic) opportunism. BJ’s has 215 locations nation-wide; it generated net income of $50 million on total sales of $12.8 billion for fiscal 2017. The company highlights that new implementations "delivered results rapidly, evidenced by positive and accelerating comparable club sales over the last two quarters and net income growth of over 109% and Adjusted EBITDA growth of 31% in aggregate over the last two fiscal years."

The BJ’s story is an interesting one for private equity. Take a look at these numbers from the company’s S-1 filing:

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Ponder This: The Bankruptcy Code's Treatment of Veterans

By: Ted Gavin, Managing Director & Founding Partner of Gavin/Solmonese

In recent years, ABI Presidents have pursued lengthy agendas, including the ABI Chapter 11 Commission, launching an ethics task force, and creating the Consumer Bankruptcy Commission – all worthy projects deserving our respect. I have a tough act to follow as the incoming president.

Last month, I was pleased to announce the formation of the ABI Task Force on Veterans Affairs. Led by members and U.S. veterans John Ames, John Penn and Jack Williams, the group is comprised of individuals who are committed to changing veterans’ lives in a meaningful way. The Task Force will examine how the bankruptcy system treats veterans differently, and unfortunately— less favorably. Recommendations and corrective steps will be proposed to Congress or the Rules Committee in the coming year to improve bankruptcy outcomes for all veterans.

Consider what it’s like for vets to return home with any one of the many issues our brave warriors experience after serving their country. And then add to that the financial burden imposed by their service— a burden exacerbated by the cost of transitioning to civilian life; the medical fees associated with caring for injuries; transportation expense to healthcare professionals located at inconveniently-located VA hospitals; and lost income each time they have to see a VA doctor.

Then imagine as the crushing burden of medical or consumer debt mounts, you may be treated in an unfavorable way under the current Bankruptcy Code— especially if you’re a disabled vet.

When a civilian qualifies for and receives social security disability payments, those payments are based on their past income, and in the event of a bankruptcy filing, are not counted as income under the means test. When a disabled veteran files a bankruptcy petition, their disability payments are counted as income under the means test. The effect of this disparity is that someone on veteran disability has a lower likelihood of being able to avail themselves of the complete discharge offered by chapter 7 than a debtor who receives social security disability payments. This is but one of the ways in which the Code fails to work for veterans and service members.

I look at this problem, and I am reminded that ABI’s membership has shown, time and time again, that when its talents are utilized and focused, we can literally redefine our field. And I ask, what solutions to this problem might be unlocked by the brainpower of our members? I know that we haven’t done enough to change the things we can for veterans.

For an organization that many associate with corporate mega-bankruptcies, we’ve achieved quite a lot to improve outcomes for individuals whose lives are impacted by bankruptcies – either their own, their employer’s, or the companies they have built that have fallen on hard times. And now, we’re going to make bankruptcy function better for those who have served our country.


   Ted Gavin is a Certified Turnaround Professional and the managing partner of Gavin/Solmonese. In 2016,  The Deal Pipeline  ranked Ted the #1 Crisis Manager in the U.S. based upon the number of active engagements. He has over 20 years of experience working with distressed companies and their stakeholders in diverse industries, including retail, transportation, regulated and non-regulated manufacturing, pharmaceutical and healthcare, professional services, construction, and metal-forming. He has served in leadership roles in engineering, manufacturing, information technology, and regulatory affairs functions. Ted has extensive experience in strategic planning and process re-engineering, with hands-on management experience in nonprofit, for-profit, and public sector operations. Ted testifies frequently as an expert witness on matters such as ordinary course of business issues in preference litigation, as well as on fiduciary duties of management in distressed companies.

 

Ted Gavin is a Certified Turnaround Professional and the managing partner of Gavin/Solmonese. In 2016, The Deal Pipeline ranked Ted the #1 Crisis Manager in the U.S. based upon the number of active engagements. He has over 20 years of experience working with distressed companies and their stakeholders in diverse industries, including retail, transportation, regulated and non-regulated manufacturing, pharmaceutical and healthcare, professional services, construction, and metal-forming. He has served in leadership roles in engineering, manufacturing, information technology, and regulatory affairs functions. Ted has extensive experience in strategic planning and process re-engineering, with hands-on management experience in nonprofit, for-profit, and public sector operations. Ted testifies frequently as an expert witness on matters such as ordinary course of business issues in preference litigation, as well as on fiduciary duties of management in distressed companies.

What to Make of the Credit Cycle (Part 1)

Moody's, Fitch & Guggenheim Partners Chime In

Earlier this week, Moody’s Default and Ratings Analytics team forecasted that the US’ trailing 12-month high-yield default rate will sink to 2% — from its February 2018 3.6% level — by February 2019. That is not a good sign for restructuring professionals itching for an uptick in activity.

FitchRatings chimed in as well, noting that underwriting standards underscore that the leveraged debt market is in the later stages of the credit cycle. But, it added,

“Aggressive documentation terms now prevalent could challenge recoveries in the next downturn. However, a surge in refinancing activity since 2016 should increase time between the credit cycle's bottom and peak in default rates. Looser documentation, such as the prevalence of covenant-lite (cov-lite) loans, should also lower the risk of technical default while enabling issuers to access additional funding via secured debt and unrestricted subsidiary provisions.” (emphasis ours)

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