🇺🇸Forever 21: Living the (American) Dream🇺🇸

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Back in June we kicked off coverage of Forever 21 Inc. with “💥Nothing in Retail is "Forever💥".

We then issued quick follow-ups in “💥Fast Forward: Forever21 is a Hot Mess💥” and “🍩Forever21 is Forever F*cking Up.🍩”

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Forgive us, then, for feeling like the company’s inevitable bankruptcy filing — which happened earlier this week — was a wee bit anticlimactic. After all, we all knew it was coming. As such, we felt the need to crank up some Kanye West to help get us through this additional coverage…

What you doing in the club on a Thursday?
She say she only here for her girl birthday
They ordered champagne but still look thirsty
Rock Forever 21 but just turned thirty — Kanye West in “Bound 2”

Just kidding, y’all. Kanye is garbage. We don’t listen to Kanye.*

Anyway, we’ve talked time and time again about how the papers that accompany a company’s chapter 11 bankruptcy petition are a perfect opportunity for a company to frame the narrative for the judge, parties in interest, the media and more. A company’s First Day Declaration, in particular, is the bankruptcy equivalent of home field advantage. Coupled with the first day hearing — usually held within a day or two of the bankruptcy filing — a debtor can leverage the First Day Declaration and the opportunity to present first to a courtroom to gain some sympathy from the judge for their current predicament and plant the seeds in the judge’s ears as to the direction of the case.

Except, over time, the judges must begin to get bored. After all, repetitive themes begin to emerge when you track bankruptcy cases. Themes like “the retail apocalypse.” Blah blah blah. The “Amazon Effect.” Oh, f*ck off. Disruption overcame the business! Zzzzzzz. Private equity is evil because they dividended themselves all of the company’s value! Yawn. There’s too much debt on the balance sheet! Typical. The lenders won’t play ball! Mmmm hmmm. The prior management was corrupt AF. Yup, it happens. Weather this year was uncharacteristically bad. Riiiight…that’s retail excuse-making 101.

And, so, it was with great excitement that we read that the Forever 21 bankruptcy stemmed from…wait for it…the American Dream. That’s right, the American Dream.

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In other words, this is a story about unbridled ambition and optimism.

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Here’s the short version: two immigrants came to this country in the early 80s from South Korea. They had nothing; they worked hard; they sought out opportunity:

During his time as a gas station attendant, Mr. Chang took notice of the customers that drove the most luxurious cars—the customers working in the garment industry. This realization piqued Mr. Chang’s interest. He recognized that together with his wife, they were perfectly suited to enter the fashion industry. This would enable the couple to capitalize on Mr. Chang’s relationship-building prowess and Mrs. Chang’s keen sense of fashion.

Putting aside how shady the notion of your gas station attendant creeping on you is, this is pretty amazing sh*t.

Mrs. Chang, and her nearly-clairvoyant ability to predict trends, were part of the catalyst that boosted Forever 21’s upswing.

Take note, people: this is the kind of pandering you should get when you pay $1,600/hour.

Anyway, over the years, the Changs built a business that employed tens of thousands of people and generated billions in sales. The Changs put their two daughters through ivy league schools and they subsequently joined the family business. This is a beautiful story, folks. Especially so in today’s fraught political environment where immigration remains a hot button issue. Together, as a family, the Changs grew this company to be a behemoth:

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And therein lies the rub. The company went from 7 international stores in 2005 to 251 by 2015.

Unfortunately, this rapid international expansion challenged Forever 21’s single supply chain and the styles failed to resonate over time across other continents despite its initial success.

It appears that the same entrepreneurial spirit that allowed the Changs to conquer the US led them astray internationally. Indeed, those European and Asian adventures — and the Chang daughters’ vanity project, Riley Rose — proved to be too costly. As you can see, while the domestic business has been in decline,** it still shows some promise. The international business, on the other hand, has really sucked the air out of the business⬇️.

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Sure, aside from the international issue, some of the usual excuses exist. Mall traffic is down. Not enough attention to e-commerce. Product assortment could have been better. The company had borrowing base issues under its asset-backed loan. Yada yada yada. But this doesn’t appear to be the absolute train wreck that other recent retailers have been. At least not yet.

So what now?

At the first day hearing, company counsel spared us any in-court singing,*** but did rely on some not-particularly-complex imagery. He said the company’s predicament is like a puzzle and that, to paraphrase, you sometimes just need to get all of the pieces to fit.

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Those pieces are:

The Footprint. Right-sizing the business by shuttering underperforming locations, domestically and internationally. The company currently spends $450mm in annual rent, spread across 12.2mm total square feet. The company will close 178 stores in the US and 350 in total. In other words, the company is mostly erasing its overzealous expansion; it will focus on selling cheaply made crap to Americans and our southern friends down in Latin America rather than poisoning the clothes racks in Canada, Europe and Asia. The new footprint will be around 600 stores. Or, at least, that’s the plan for now. Let’s pour one out for the landlords. Here is CNBC mapping out where all of the closures are and which landlords are hit the most. Also per CNBC:

At one point, two of Forever 21′s largest landlords, Simon Property Group and Brookfield Property Partners, were trying to come up with a restructuring deal where they would take a stake in the company to keep it afloat. It would’ve been similar to when Simon and GGP, which is now owned by Brookfield, bought teen apparel retailer Aeropostale out of bankruptcy back in 2016. But talks between Forever 21 and its landlords fell through, according to a person familiar with the talks. Simon and Brookfield are listed in court papers as two of Forever 21′s biggest unsecured creditors. Simon is owed $8.1 million, while Brookfield is owed $5.3 million, and Macerich $2.7 million.

Only one of the locations marked for closure, however, belongs to Simon Property Group ($SPG).

The company notes:

To assist with the initial component of the strategy, Forever 21’s management team and its advisors worked with its largest landlords to right size its geographic footprint. Four landlords hold almost 50 percent of its lease portfolio. To date, Forever 21 and its landlords have engaged in productive negotiations but have not yet reached a resolution. The parties have exchanged proposals and diligence is ongoing. Forever 21 looks forward to continuing to work with its landlords to reach a mutually agreeable resolution and proceeding through these chapter 11 cases with the landlords’ support.

In tandem with these negotiations, Forever 21 and its advisors met with nearly all of its individual landlords to discuss potential postpetition rent concessions and other relief on a landlord-by-landlord basis. Many of these smaller, individual negotiations proved more fruitful than negotiations with the larger landlords. Although Forever 21 has not finalized the terms of a holistic landlord deal as of the Petition Date, Forever 21 anticipates that good-faith negotiations with its landlord constituency will continue postpetition, and that all parties will work together to reach a consensual, value-maximizing transaction.

Company counsel asserts that, for landlords, Forever 21 is “too big to fail.” This kinda feels like this:

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But don’t worry: the A Malls are totally fine. 

And don’t worry about the loans (CMBX) at all. Noooooo.

Merchandising. Getting “Back-to-Basics” on the merchandising front and focus on the company’s “core customer base.” Here is Bloomberg’s Jordyn Holman casting some shade on this plan. And here is Bloomberg’s Sarah Halzack. While the bankruptcy papers certainly don’t highlight the competition, bankruptcy counsel made a point of highlighting H&MZara and Fashion NovaRetail Dive writes:

They did not grow with their target customer and the Millennials have graduated to Zara & H&M,’ Shawn Grain Carter, professor of fashion business management at the Fashion Institute of Technology, told Retail Dive in an email. ‘Gen. Z is more interested in rental fashion and vintage hand-me-downs because they are more environmentally conscious.’

Interestingly, Stitch Fix Inc. ($SFIX) was up 5% on Monday while the RealReal Inc. ($REAL) was up 15%. (PETITION Note: both got clobbered on Tuesday, but so did everything else).

The Washington Post piles on:

“Slimming down the operation and reducing costs is only one part of the battle,” Neil Saunders, managing director of GlobalData Retail, said in a note to clients. “The long-term survival of Forever 21 relies on the chain creating a sustainable and differentiated brand. This is something that will be very difficult to accomplish in a crowded and competitive sector.

Indeed, we’ve been writing for some time now that fast fashion seems out of sorts. Going “back to basics” may not actually be the right move in the end.

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🤔

Vendor Management. A quick digression: back in May, we wrote about Modell’s Sporting Goods avoidance of bankruptcy. Mr. Modell himself worked the phones and reassured most of his vendors, prompting them to continue doing business with the shrinking sporting goods retailer. This is a feature that you don’t get in PE-backed retail bankruptcies where you have hired guns on management. There, Mr. Modell’s legacy was at stake. He hustled. Likewise, here, the Changs personal business is threatened. Accordingly, the company met with 100 vendors representing 80+% of the vendor base and got them comfortable with continued business; they secured 130 vendor support agreements for equal or better terms. Everyone is invested in making a viable go of the ‘19 holiday season. Sometimes it pays to have someone who is truly invested be all over the supply chain.

Financing. The company’s capital structure is rather simple:

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The ABL is with JPMorgan Chase Bank NA as agent. The term loans were provided by the family. One from Do Won Chang for $10mm and the second from the Linda Inhee Chang 2012 Trust. Because nothing says “American Dream” like raiding your kid’s trust fund.

In conjunction with the bankruptcy, the company proposed a DIP credit facility in the form of (a) a $275 million senior secured super-priority ABL revolving credit facility, which includes a $75 million sub-limit for letters of credit and a “creeping roll up” of the pre-petition ABL Facility, and (b) a $75 million senior secured super-priority term loan credit facility, reflecting $75 million of new money financing. The company sought access to $60mm of the term loan at the hearing, indicating that with $40mm due in rent and $18mm in payroll, it would run out of cash without it. The judge approved this request.

And so here we are. The company intends to march forward with negotiations with its landlords, close tons of locations, sure up the vendor base, locate exit financing, and get this sucker out of bankruptcy in Q1 next year.

Ending up in bankruptcy certainly isn’t part of the American Dream. But living long enough to fight another day might just be.

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*H/t to @JordynJournals, retail reporter for Bloomberg News on this.

**The company notes that domestic sales have increased over the last 4 quarters.

***For those new to PETITION, the same lawyer from Kirkland & Ellis LLP that represents Forever 21 represented Toys R Us. In the now-infamous “first day” hearing in Toys, the attorney sang the Toys R Us jingle — “I don’t want to grow up…” — in the courtroom. Suffice it to say considering the outcome of that case, that tactic didn’t particularly age well. Indeed, this will age better, we reckon (won’t play in email, only in browser):

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📚Resources📚

We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. We recently added “Super Pumped: The Battle for Uber” by Mike Isaac, which we blew through rather quickly. Next up on our list: “What it Takes: Lessons in the Pursuit of Excellence” by Stephen A. Schwarzman, “The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company” by Bob Iger, and “That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea,” by Netflix co-founder Marc Randolph.


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Email us at petition@petition11.com and write “Opportunities” in the subject line if you’re interested in information about posting your opportunities with us.


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🗞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?

🚴‍♂️The Rise of Home Fitness: Peloton Files its S-1 (Long Twitter Fodder)🚴‍♂️

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In case you haven’t heard, Peloton Inc. filed its S-1 earlier this week. An S-1 is like a bankruptcy First Day Declaration. It’s an opportunity to sell and control a narrative. In the case of the S-1, the filer wants to appeal to the markets, drum up FOMO, and maximize pricing for a public capital raise (here, $500mm). So, yeah, want to call yourself a technology / media / software / product / experience / fitness / design / retail / apparel / logistics company? Sure, go for it. In an age of WeWork, a la-dee-da-kibbutz-inspired-community-company-that-may-or-may-not-be-valued-like-a-tech-company-despite-being-a-real-estate-company, hell, anything is possible.

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Frankly, we’re surprised Peloton didn’t throw in that it’s a “CBD-infused-augmented-reality-company-that-transacts-in-Pelotoncoin-on-the-blockchain company” for good measure. Go big or go home, dudes! PETITION Note: the bankruptcy/First-Day-Declaration equivalent of this absurdity must be every sh*tty retailer on earth claiming to be an “iconic” brand with loyal shoppers who, despite that loyalty, never spend a dollar at said retailers, all while some liquidators are preparing to sell them for parts:

But we digress.

For those who don’t live in Los Angeles or New York and are therefore less likely to know what the hell Peloton is (despite its 74 retail showrooms in the US, Canada and UK and pervasive ad-spend), it is a home fitness company that sells super-expensive hardware ($2,245 for the flagship cycle and $4,295 for the treadmill)* and subscription-based fitness apps ($39/month). It’s helped create the celebrity cycling trainer and aims to capture the aspirational fitness enthusiast. And, by the way, it’s a real company. Here are some numbers:

  • $196mm net loss (boom!) on $915mm of revenue in the fiscal year ended June 30, 2019 ((both figures up from 2018, which were $47.8mm and $435mmmm, respectively, meaning that the loss is over 4x greater (boom!!) while revenue grew by over 2x));

  • Hardware revenues increased over 100%, subscription grew over 100% and “other” revenue, i.e., apparel, grew over 100%;

  • 511,202 subscribers in 2019, up from 245,667 in 2018;

  • 577k products sold, with all but 13k in the US;

  • a TAM that, while not a ludicrous as WeWork’s the-entire-planet-is-an-opportunity-pitch, is nonetheless…uh…aggressive with total capture at approximately 50% of ALL US HOUSEHOLDS

and;

  • $994mm VC raised, $4+b valuation;

A big part of that net loss is attributable to skyrocketing marketing spend. But, Ben Thompson highlights:

Peloton spends a lot on marketing — $324 million for 265,535 incremental Connected Fitness subscribers (a subscriber that owns a Peloton bike or treadmill), for an implied customer acquisition cost (CAC) of $1,220.18 — but that marketing spend is nearly made up by the incremental profit ($1,161.40) on a bike or treadmill. That means that subscription profits are just that: profits.

The company also claims very low churn** — 0.70%, 0.64%, and 0.65% in 2017, 2018 and 2019, respectively — though this thread ⬇️ points out some obfuscation in the filing and questions the numbers (worth a click through):

Ben Thompson hits on churn too, noting that major company promotions haven’t rolled off yet:

Only the 12 month prepaid plans have rolled off; the 24 and 39 month plans are still subscribers whether or not they are using their equipment (and given the 0% financing offer, I wouldn’t be surprised if there were a lot of them). 

Surely roadshow attendees will have questions on this point and then, market froth being market froth, totally disregard whatever the answers are. 😜

The company also highlights some tailwinds: (a) an increasing focus on health and fitness, especially at the employer level given rising healthcare costs and a general desire to offset them;** (b) the rise of all-things-streaming; (c) the desire for community; and (d) significantly, the demand for convenience. We all work more, weather sucks, the kids wake up early, etc., etc.: it’s a lot easier to work out at home. This thread ⬇️ sure captured it (click through, it’s hilarious):

Which is not to say that the company doesn’t have its issues.*** It appears that like most other fitness products, there’s seasonality. People buy Pelotons around the holidays, after making New Year’s resolutions they undoubtedly won’t keep. There are also some lawsuits around music use. As we noted above, the marketing spend is through the roof ($324mm, more than double last year) and SG&A is also rising at a healthy clip. Many also question whether Peloton’s cult-like status will fizzle like many of its fitness predecessors. And, of course, there’s that cost. Lots or people — ourselves included — have questioned whether this business can survive a downturn.

Indeed, among a TON of risk factors, the company notes:

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates.

And:

To date, our business has operated almost exclusively in a relatively strong economic environment and, therefore, we cannot be sure the extent to which we may be affected by recessionary conditions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services could have an adverse effect on our business, financial condition, and operating results. (emphasis added)

Now ain’t that the truth. This will be an interesting one to watch play out.

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Questions about the company’s stickiness in a downturn notwithstanding, we ought to take a second and admire what they’ve done here. Take a look ⬇️

Sure, sure, it’s a ridiculous metric in an SEC filing but…but…look at the total number of workouts. Look at the average monthly. Unless Peloton is truly expanding the category, those workouts are coming out of someone else’s revenue stream. Remember: SoulCycle did pull its own IPO some time ago.

In a recent piece about the rise of home fitness and the threat it poses to conventional gyms and studios, the Wall Street Journal noted:

U.S. gym membership hit an all-time high in 2018, but the rate of growth cooled to 2% after a 6% rise the year before, according to the International Health, Racquet & Sportsclub Association. Much of the decade’s growth has been fueled by boutique studios like CrossFit, Orangetheory and SoulCycle, whose ability to turn fitness into a communal experience has sparked fierce loyalty to their brands. IHRSA says it’s too early to tell whether streaming classes will reduce club visits. CrossFit, SoulCycle and Orangetheory say they don’t see at-home streaming fitness programs as a threat.

We find that incredibly hard to believe. Is there correlation between the slowdown and growth and Peloton’s 128% and 108% growth from ‘17-’18-’19? Peloton may be more disruptive than the naysayers give it credit for.

Back to Ben Thompson:

Like everyone else, Peloton claims to be a tech company; the S-1 opens like this:

We believe physical activity is fundamental to a healthy and happy life. Our ambition is to empower people to improve their lives through fitness. We are a technology company that meshes the physical and digital worlds to create a completely new, immersive, and connected fitness experience.

I actually think that Peloton has a strong claim, particularly in the context of disruption. Clay Christensen’s Innovator’s Dilemma states:

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

It may seem strange to call a Peloton cheap, but compared to Soul Cycle, which costs $34 a class, Peloton is not only cheap but it gets cheaper the more you use it, because its costs are fixed while its availability is only limited by the hours in the day. Sure, a monitor “underperforms” the feeling of being in the same room as an instructor and fellow cyclists, but being able to exercise in your home is massively more convenient, in addition to being cheaper.

Moreover, this advantage scales perfectly: one Peloton class can be accessed by any of its members, not only live but also on-demand. That means that Peloton is not only more convenient and cheaper than a spinning class, it also has a big advantage as far as variety goes.

The key breakthrough in all of these disruptive products is the digitization of something physical.

In the case of Peloton, they digitized both space and time: you don’t need to go to a gym, and you don’t have to follow a set schedule. Sure, the company does not sell software, nor does it have software margins, but then neither does Netflix. Both are, though, fundamentally enabled by technology.

If Thompson is right about that value proposition, is it possible that, in a downturn, Peloton can win? At $40/class, it would take 57 classes to break even on the hardware and then you’re getting a monthly subscription for the cost of one class. Will people come around to the value proposition because of the downturn?****🤔

Before then, we’ll find out whether the market values this company like a tech hardware company or a SaaS product. And the company can use the IPO proceeds to market, market, market and try and lock-in new customers before any downturn happens. Then we’ll really test whether those churn numbers hold up.

*The company doesn’t break out the success of the two other than to say that the majority of hardware revenue stems from the bike. We would reckon a guess that the treadmill is losing gobs of money.

**It stands to reason that the company would have strong retention rates given the high fixed/sunk cost nature of its product.

***One risk factor is curiously missing so we took the initiative to write it for them:

We sell big bulky products that appeal more to coastal elites.

Unfortunately, given the insanity if housing prices and spatial constraints, a lot of our potential customers in Los Angeles, San Francisco and New York simply may not have room for our sh*t.

****Unrelated but WeWork’s Adam Neumann insists that WeWork presents an interesting value proposition in a downturn: viable office space without the long-term locked in capital commitment. It’s not the craziest thing we’ve heard the man say.


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⚡️Data, Baby, Data (Long Ambitious Lawyers)⚡️

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Man. The hits just keep on coming for retailers. 

First, a callback to 2014. 

Back in 2014, Twilio Inc. ($TWLO) was a lesser known private company that solved a basic problem: it allowed software developers to programmatically make and receive phone calls, send and receive text messages, and perform other communication functions using its web service APIs. In English? It connected businesses to customers. It was the ultimate "be where your customers are" power move: increasingly, customers are writing or reacting to texts. Twilio enables text message blasts to large groups. This was a total game changer for businesses: it gave them an avenue to connect in a more personal way to their customers and rise above the muck of email (PETITION Note: which is not to say that we don't LOVE email). And now Twilio is an a $18b market cap company:


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🕸Spiderman Can’t Save Everyone (Short iPic Entertainment)🕸

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Most moviegoers probably think $17 for a movie ticket is expensive enough and so, more likely than not, they go to the nearby AMC or Regal theater to get their latest shot of Disney-fed superhero drivel. For those who REALLY want to make an event out the movies, however, there is another option: iPic Entertainment Inc’s ($IPIC) “upscale” theater experience. This “experience” includes cocktails, plush pleather couches and waitered food service. All of that pampering can cost upwards of $30/ticket — and that’s just for the movie. Add in the food and this chain probably contributes its fair share to the personal bankruptcy market.

The chain has 123 locations across 16 states, including California, Florida and New York City. How on earth does it make sense to go that route when a month of Netflix costs a fraction of that? Throw in some “chill” and, well, it seems pretty obvious which option has more appeal (insert creepy wink here). Spoiler alert: it ain’t iPIC. 


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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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👚Resale is Real Real. Eff “The Amazon Effect.”👚

The #RetailApocalypse is More Than Amazon Inc.

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In September 2017 in “Minimalistic Consumption by Inheritance,” we wrote:

Much has been made about the death of retail and the "Amazon Effect." We mention it quite a bit … but we are also on record as calling the Amazon narrative lazy. After all, there's a reason why resale apps are among the highest downloaded apps in the Itunes app store. We've noted this before: millennials have no problem buying, reselling, buying, and reselling. I mean, sh*t, we're now seeing commercials for OfferUp on television. We've noted the rise of Poshmark and other apps here and here. Perhaps there's more here than meets the eye.

We doubled down with “Enough Already With the ‘Amazon Effect’” in April 2018. Citing the ThredUp 2018 Resale Report, we noted:

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

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

Finally, we wrote in January — in “ Retail May Get Marie Kondo'd ,” — that the Force is now strong(er) with the resale trend.

We concluded:

The RealReal is signaling that resale is so big that it’s ready to IPO. Talk about opportunistic. No better time to do this than during Kondo-mania. The company has raised $115mm in venture capital … most recently at a $745mm valuation.

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

So, where are we going with all of this?

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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?

Millennials Benefit from Venture Capital, Feel Guilty (Long Subsidies)

Oh man. THIS. Is. Precious. Herein a Wall Street Journal writer feels guilty about the secondary effects of his penchant for cheap home food delivery, two-day shipping, unlimited movies for $9.99/month and 100-day mattress trials. He asks:

These “Where’s the catch?” deals are practically everywhere now, each causing me a similar dilemma:

*I take Uber Pools home at night, knowing even if nobody else gets in the car the ride’s still going to be cheaper. Are we stiffing drivers?

*I let MoviePass buy me tickets for next to nothing when I used to gladly pay full price. Will this contribute further to the decline in nonsuperhero Hollywood films?

*I demand two-day shipping for everything I buy on Amazon. Am I destroying the Earth, one cardboard box at a time?

*I use the Blue Apron free trial, cancel it and switch to HelloFresh , then rinse and repeat with Sun Basket and Plated. Can decent, easy food delivery survive?

We almost mistook this for an Onion article.

Here are some answers.

Yes. Probably. Yes. No. These answers are pretty self-evident.

The very same people that the writer is concerned about affecting is riding Uber in his off time, ordering the free Blue Apron trial, and taking advantage of 2-day shipping. So, nothing to worry about there.

As for it being a “deal”? We’re giving away our data every single time we eat a subsidized meal, take a subsidized ride, or recycle an extra cardboard box. Isn’t that information valuable? Isn’t there a whole world of people hacking away trying to obtain it? If you’re not paying for the product, you are the product. Not sure that’s such a great deal, in the end.

So, with that said, we’re now going to do this:

That’s right: $20/month.

Ah, co-working.

💣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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#BustedTech's Secret: Assignment for the Benefit of Creditors

Long Private Markets as Public Markets

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⚡️🤓Nerd alert: we need to lay a little foundation in this one with some legal mumbo-jumbo. Consider yourself warned. Solid payoff though. Stick with it.🤓⚡️

Allow us to apologize in advance. It’s summer time and yet we’ve been nerding out more often than usual: on Sunday, we dove into net-debt short activism, for goodness sake! We know: you want to just sit on the beach and read about how Petsmart implicates John Wick. We get it. Bear with us, though, because there is a business development aspect to this bit that you may want to heed. So attention all restructuring professionals (and, peripherally, start-up founders and venture capitalists)!

Recently the Turnaround Management Association published this piece by Andrew De Camara of Sherwood Partners Inc, describing a process called an “assignment for the benefit of creditors” (aka “ABC”). It outlines in systematic fashion the pros and cons of an ABC, generally, and relative to a formal chapter 11 filing. When the bubble bursts in tech and venture capital, we fear a number of you will, sadly, become intimately familiar with the concept. But there’ll be formal bankruptcies as well. ABCs won’t cut it for a lot of these companies at this stage in the cycle.

Let’s take a step back. What is the concept? Per Mr. De Camara:

An ABC is a business liquidation device governed by state law that is available to an insolvent debtor. The ABC procedure has long existed in law and is sometimes addressed in state statutes. In an ABC, a company, referred to as the assignor, transfers all of its rights, title, and interest in its assets to an independent fiduciary known as the assignee, who liquidates the assets and distributes the net proceeds to the company’s creditors. The assignee in an ABC serves in a capacity analogous to a bankruptcy trustee in a Chapter 7 or a liquidating trustee in a Chapter 11.

He goes on to state some characteristics of an ABC:

  • Board and shareholder consent is typically required. “If a company is venture-backed, it may be required to seek specific consent from both preferred and common shareholders. It is possible to enter publicly traded companies into an ABC; however, the shareholder proxy process increases the difficulty of effectuating the ABC and results in a much longer pre-ABC planning process.”

  • There is no discharge in an ABC.

  • Key factors necessitating an ABC include (a) negative cash burn + no access to debt or equity financing, (b) lender wariness, (c) Board-level risk as a lack of liquidity threatens the ability to pay accrued payroll and taxes, and (d) diminished product viability.

And some benefits of an ABC:

  • ABC assignees have a wealth of experience conducting liquidation processes;

  • The assignee manages the sale/liquidation process — not the Board or company officers — which, as a practical matter, tends to insulate the assignee from any potential attack relating to the process or sale terms;

  • Lower admin costs;

  • Lower visibility to an ABC than a bankruptcy filing;

  • Secured creditors general support the process due to its time and cost efficiency, not to mention distribution of proceeds; and

  • Given all of the above, the process should result in higher distributions to general unsecured creditors than, say, a bankruptcy liquidation.

Asleep yet? 😴

Great. Sleep is important. Yes or no, stick with us.

ABCs also have limitations:

  • Secured creditor consent is needed for use of cash collateral.

  • Buyers cannot assume secured debt without the consent of the secured creditor nor is there any possibility for cramdown like there is in chapter 11.

  • There is, generally, no automatic stay. This bit is critical: “While the ABC transfers the assets out of the assignor and therefore post-ABC judgments may have no practical value or impact, litigation can continue against the assignor, and the assignee typically has neither the funding nor the economic motivation to defend the assignor against any litigation. In addition, hostile creditors may decide to shift their focus to other stakeholders (i.e., board members or officers in their capacity as guarantors or fiduciaries) if they believe there will likely be no return for them from the ABC estate.”

  • Assignees have no right to assign executory contracts, diminishing the potential value of market-favorable agreements.

  • No free-and-clear sale orders. Instead you get a “bill of sale.” Choice quote: “A bill of sale, particularly from an assignee who is a well-known and well-regarded fiduciary, is a very powerful document from the perspective of creditor protection, successor liability, etc., but it does not have the same force and effect as a free-and-clear sale order from a bankruptcy court.”

The question right now is, given the robust nature of the capital markets these days, should you care about any of the above? Per Pitchbook:

This is a golden age for venture capital and the startup ecosystem, as illustrated by PitchBook's latest PitchBook NVCA-Venture Monitor. So far this year, $57.5 billion has been invested in US VC-backed companies. That's higher than in six of the past 10 full years and is on pace to surpass $100 billion in deal value for the first time since the dot-com bubble.

Fundraising continues at breakneck speed. Unicorns are no longer rare, and deal value in companies with a $1 billion valuation or more is headed for a new record. The size of VC rounds keeps swelling. Deep-pocketed private equity players are wading in.

Signs of success (or is it excess?) are everywhere you look. On the surface, delivering a resounding verdict that the Silicon Valley startup model not only works, it works well and should be emulated and celebrated.

But what if that's all wrong? What if this is another mere bubble and the VC industry is in fact storing up pain…?

That's the question posited by Martin Kenney and John Zysman—of the University of California, Davis, and the University of California, Berkeley, respectively—in a recent working paper titled "Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance?"

Instead of spending millions, or billions, in the pursuit of unicorns that could emulate the "winner-takes-all" technology platform near-monopolies of Apple and Facebook and the massive capital gains that resulted, VC investors and their LP backers could instead be buying a bunch of fat Cheshire cats. Bloated by overvaluation, and likely to disappear, leaving just a smile and big losses, since many software-focused tech startups have no tangible assets.

They then ask whether there’s more here than meets the eye. More from Pitchbook:

The problem is that this cycle has been marked by easy capital and a fetishization of the early-to-middle parts of the tech startup lifecycle. Lots of incubators and accelerators. "Shark Tank" on television. "Silicon Valley" on HBO. Never before has it been this easy and cheap to start or expand a venture.

Yet on the other end of the lifecycle, exit times have lengthened, as late-series deal sizes swell, reducing the impetus to IPO (in search of public market capital) or sell before growth capital runs out.

So, what’s the problem?

…in the view of Kenney and Zysman, the VC industry lacks discipline, seeking disruption and market share dominance without a clear path to profitability. You see, VC-fueled startups aren't held to the same standard as existing publicly traded competitors who must answer to investors worried about cash flows and operating earnings every three months. Or of past VC cycles where money was tighter, and thus, time to exit shorter.

We’ll come back to the public company standard in a second.

The interesting thing about the private markets becoming the new public markets (with funding galore) is that when the crazy frenzy around funding (PETITION NOTE: read the link) eventually stops, the markets will just be the markets. And all hell will break lose. The question then becomes whether a company has enough liquidity to stem the tide. What happens if it doesn’t?

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An ABC may very well be a viable alternative for dealing with the carnage. But with private markets staying in growth stages privately for longer, doesn’t that likely mean that there’s more viable intellectual property (e.g., software, data, customer lists)? That a company has a bigger and better San Francisco office (read: lease)? That directors have a longer time horizon advising the company (and, gulp, greater liability risk)? Maybe, even, that there’s venture debt on the balance sheet as an accompaniment to the last funding round (after all, Spotify famously had over $1b of venture debt on its balance sheet shortly before going public)?

All of which is to say that “the bigger they come, the harder they fall.” When the music stops — and, no, we will NOT be making any predictions there, but it WILL stop — sure, there will be a boatload of ABCs keeping (mostly West Coast) professionals busy. But there will also be a lot of tech-based bankruptcies of companies that have raised tens of millions of dollars. That have valuable intellectual property. That have a non-residential real property lease that it’ll want to assign in San Francisco’s heated real estate market. That have a potential buyer who wants the comfort of a “free and clear” judicial order. That have shareholders, directors and venture capital funds who will want once-controversial-and-now-very-commonplace third-party releases from potential litigation and a discharge.

Venture capitalists tend to like ABCs for private companies because, as noted above, they’re “lower visibility.” They like to move fast and break things. Until things actually break. Then they move fast to scrub the logos off their websites. What’s worse? Visibility or potential liability?

And then there are the public markets.

A month ago, we discussed Tintri Inc., a California-based flash and hybrid storage system provider, that recently filed for bankruptcy. Therein we cautioned against IPOs of companies with “massive burn rates.” We then went on to highlight the recent IPO of Domo Inc. ($DOMO) and noted it’s significant cash burn and dubious reasons for tapping the public markets, transferring risk to Moms and Pops in the process. The stock was trading at $19.89/share then. Here is where it stands now:

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In the same vein, on Monday, in response to Sunday’s Members’-only piece entitled “😴Mattress Firm's Nightmare😴,” one reader asked what impact a potential Mattress Firmbankruptcy filing could have on Purple Innovation, Inc. ($PRPL), the publicly-traded manufacturer and distributor of Purple bed-in-a-box product. Our response:

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And we forgot to mention rising shipping costs (which the company purports to have mitigated by figuring out…wait for it…how to fold its mattresses).*

And then yesterday, Bloomberg’s Shira Ovide (who is excellent by the way) reported that “Cash Wildfire Spreads Among Young Tech Companies.” She wrote:

It’s time to get real about the financial fragility of young technology companies. Far too many are living beyond their means, flirting with disaster and putting their investors at risk. 

Bloomberg Opinion examined 150 U.S. technology companies that had gone public since the beginning of 2010 and were still operating independently as of Aug. 10. About 37 percent had negative cash from operations in the prior 12 months, meaning their cash costs exceeded the cash their businesses had generated. 

A handful of the companies, including online auto dealer Carvana Co., the mattress e-commerce company Purple Innovation Inc. and health-care software firm NantHealth Inc., were on pace to burn through their cash in less than a year, based on their current pace of cash from operations and reserves in their most recent financial statements.

In addition to Purple Innovation, Ms. Ovide points out that the following companies might have less than 12 months of cash cushion: ShiftPixy Inc. ($PIXY), RumbleON Inc. ($RMBL), RMG Networks Holding Corp. ($RMGN), NantHealth Inc. ($NH), Carvana Co. ($CVNA), and LiveXLive Media Inc. ($LIVX).

She continued:

The big takeaway for me: Young technology companies in aggregate are becoming more brittle during one of the longest bull markets ever for U.S. stocks. This trend is not healthy. Companies that persistently take in less cash than they need to run their businesses risk losing control of their own destinies. They need continual supplies of fresh cash, which could hurt their investors, and the companies may be in a precarious position if they can’t access more capital in the event of deteriorating market or business conditions.

It’s not unusual for young companies, especially fast-growing tech firms, to burn cash as they grow. But the scope of the companies with negative cash from operations, and the persistence of some of those cash-burning companies for years, was a notable finding from the Bloomberg Opinion analysis.

Notable, indeed. There will be tech-based ABCs AND bankruptcies galore in the next cycle. Are you ready? Are you laying the foundation? Are you spending too much time skating to where the puck is rather than where it will be?


*We’ll take this opportunity to state what should be obvious: you should follow us on Twitter.

But, seriously, and more importantly, we know we tout the disruptive effects of the direct-to-consumer model. But make no mistake: we are WELL aware that a number of these upstarts are going to fail. Make no mistake about that.

😴Mattress Firm's Nightmare😴

Mattress Firm May File for Bankruptcy (Long Cardboard Box Manufacturers)

Source: PETITION LLC

Source: PETITION LLC

⚡️Nerd alert: we need to lay a little foundation here.⚡️

For the uninitiated, a First Day Declaration (“FDD”) typically accompanies a chapter 11 petition when a debtor-company files for bankruptcy. The FDD is the first opportunity for a representative of a chapter 11 debtor to sell a particular narrative to the Bankruptcy Judge and other parties in interest; it sets the tone for the company’s “first day hearing,” which is the first formal appearance the company makes in bankruptcy court (typically within 24-48 hours after filing for chapter 11). The FDD is a descriptive document that often spells out the what, why and when of a company’s demise. Nearly all FDDs follow the same format: they (i) provide some color about the declarant, (ii) describe the history and nature of a business, (iii) delineate the capital structure, (iv) outline the events leading to bankruptcy, (iv) articulate the hopes for the bankruptcy case, and (v) summarize the relief sought on the first day. Lawyers often request that the FDD be admitted into the record at the first day hearing (subject to cross examination of the declarant).

Frustratingly, lawyers also often seem compelled to regurgitate the FDD once at the podium at the hearing. This is typically the role of the senior most partner on the matter, i.e., the person who — as it relates to certain firms — probably knows the least about the company, why it’s in bankruptcy and how the hell its going to grind its way out of it. We’re not entirely sure why they feel the need to do this: the judge has presumably read the papers. Perhaps they feel it’s necessary to repeat the narrative to set the tone for the case and establish credibility (more important in controversial cases than in uncontested hearings); perhaps they just like hearing themselves speak; or — the most likely justification — perhaps they bill by the hour and need to justify their (a) existence, (b) exorbitantly high billing rate and/or (c) first billing on the case caption. Maybe it’s all of the above. In any event, this custom is exactly the opposite of what lawyers are taught in law school: be concise and to the point.

We often like to imagine what the FDD would look like in certain situations. Long time PETITION readers may recall our mock FDD for Remington Outdoor Company. Well, we’re at it again. This time for Mattress Firm Holding Corp. Hopefully this will spare the estate some expenses.

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💰Goldman Sachs Has its Cake and Eats it Too💰

Short GNC Holdings Inc. Long Care/of. 

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We’ve written extensively hereherehere and here about GNC Holdings Inc. ($GNC) and the challenges that the company faces. We won’t revisit all of that here other than to note that GNC was, upon information and belief, preparing for a bankruptcy filing prior to it amending and extending its term loan, entering into a new ABL, and obtaining $275mm of asset-backed FILO term loans. We quipped that this was the quintessential “kick-the-can-down-the-road” transaction. Goldman Sachs ($GS) advised the company on the entire capital structure fix. Suffice it to say, then, that Goldman Sachs is intimately familiar with the GNC business.

Which, naturally, makes the fact that Goldman Sachs Investment Partners (a division of Goldman Sachs Asset Management) served as the lead investor in vitamin startup Care/of’s Series B financing all the more interesting.

Now, of course, we know Goldman is a big shop. They’re probably talking to WeWorkabout how to design their spaces to balance the sheer volume of “Chinese walls” with the need for an aesthetic that appeals to the millennial mindset. And, surely, Goldman Sachs’ capital advisory arm is entirely different and separate from Goldman’s asset management and venture arm.

But still.

Earlier this week Care/of, a direct-to-consumer wellness brand that specializes in monthly subscriptions of personalized vitamins and supplements, announced the new round of $29mm. In addition to Goldman, investors included Goodwater Capital, Juxtapose, RRE Ventures and Tusk Ventures. Former President of GNC, Beth Kaplan, also invested and will be joining the Board. 🤔

Bloomberg notes:

Care/of, a startup selling vitamins and herbal supplements online, raised funds from investors including Goldman Sachs Group Inc.’s venture arm that value the company at $156 million, within striking distance of publicly traded retail chains that are among the industry’s leaders.

The startup’s $156 million valuation isn’t far from Vitamin Shoppe Inc., with 3,860 employees and a market capitalization of about $203.5 million, or GNC Holdings Inc., which has a market value of $254.2 million with 6,400 employees. Care/of has about 100 workers, Chief Executive Officer Craig Elbert said.

“Consumers are increasingly shifting spend online and so I think large retail footprints have the potential to be a liability,” Elbert said in an interview. “There’s a lot of growth ahead of us and lot of reasons why this should be an e-commerce business.”

This is so Goldman-y. Collect an advisory fee to extend the life of the dominant brick-and-mortar retailer with one hand while investing in a nimble direct-to-consumer upstart that will chip away on that very same retailer on the other hand. Even before the former requires capital markets advice from a Goldman-type in a few years — which, it undoubtedly will — it may be on the lookout for an M&A banker. Perhaps to sell itself. Perhaps to buy a start-up and build a moat against Amazon. How convenient that Goldman will have familiarity with both businesses. We’d say that maybe there’d be a conflict somewhere in there but, well…do those really even exist anymore??

🛋There's Disruption Afoot in the Furniture Space🛋

Add Furniture to the List of Disrupted Categories (Home Heritage Group Inc. Filed for Bankruptcy)

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“New Chapter 11 Filing!” Or is it technically a Chapter 22? 🤔

We know what you’re thinking. You’re thinking “this filed a few days ago and I’ve already read all about it.” You may have read something about it, but not like this. Bear with us…

Home Heritage Group Inc. (“HHG”) is a North Carolina-based designer and manufacturer of home furnishings; it sells product via (i) retail stores, (ii) interior design partners, (iii) multi-line/independent retailers, and (iv) mass merchant stores.” In addition, the company has an international wholesale business.

Why do we mention Chapter 22? For the uninitiated, Chapter 22 in bankruptcy doesn’t actually exist. It is a somewhat snarky term to describe companies that have round-tripped back into chapter 11 after a previous stint in bankruptcy court. That, to some degree, is the case here.

WAAAAAAAY back in November 2013, KPS Capital Partners LP formed the newly bankrupt HHG entity to acquire a brand portfolio and related assets out of the bankruptcy estate of Furniture Brands International Inc. (“FBI”). FBI had been, in the early 2000s, a very successful purveyor of various furniture brands — to the tune of $2b in annual sales. But in the 12 months prior to the acquisition, the company’s sales were down to $940mm and, more importantly, its EBITDA was negative $58mm. At the time of filing, it had $142mm in total funded debt outstanding, $200mm in unfunded pension obligations and another $100mm in general trade obligations.

Given this debt, a decline in sales at the time was devastating. The company noted in its court filings on September 9, 2013 (Docket #16):

As a manufacturer and retail of home furnishings, Furniture Brands’ operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Economic conditions deteriorated significantly in the United States and worldwide in recent years as part of a global financial crisis. Although the general economy has begun to recover, sales of residential furniture remain depressed due to wavering consumer confidence and several, ongoing global economic factors that have negatively impacted consumers’ discretionary spending. These ongoing factors include lower home values, prolonged foreclosure activity throughout the country, a weak market for home sales, continued high levels of unemployment, and reduced access to consumer credit. These conditions have resulted in a decline in Furniture Brands’ sales, earnings and liquidity.

Sales have continued to be depressed as a result of a sluggish recovery in the U.S. economy, continuing high unemployment, depressed housing prices, tight consumer lending practices, the reluctance of some households to use available credit for big ticket purchases including furniture, and continuing volatility in the retail market.

PETITION Note: My, how things have changed. Just reflect on that synopsis of the economy a mere five years ago. The company also noted that:

…some of the Company’s larger brands have lost some of their market share primarily due to competition from suppliers who are able to produce similar products at lower costs. The residential furniture industry is highly competitive and fragmented. Furniture Brands competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own store-branded products.

All of these factors stormed together to constrain the company’s liquidity and force a chapter 11 filing and eventual sale. KPS purchased several of the FBI brands for $280mm (subject to working capital adjustments), including Thomasville, Broyhill, Lane, Drexel Heritage, Henredon, Pearson, Hickory Chair, Lane Venture, and Maitland-Smith. In other words: brands that your grandfather would know and you would shrug at the mere mention of. Well, some of you anyway.

Fast forward five years and the successor entity HHG has $280mm of debt and…you guessed it…severe liquidity constraints. In its first day filing papers, HHG notes that the previous bankruptcy continues to have lasting effects on its business; it highlights:

Following years of sales declines, many furniture retailers had lost faith in the ability of the Company to produce, deliver, and service its products, and the bankruptcy led many of them to shift their purchases to a variety of competitors or even further utilize their own private label offerings.

This is what people still nostalgically refer to as “bankruptcy stigma.” Indeed, it still exists. The company continued:

In addition, the Company’s operations and performance depend significantly on economic conditions, particularly in the United States, and their impact on levels of existing home sales, new home construction, and consumer discretionary spending. Although economic conditions have been steadily improving in recent years, the Debtors have struggled to adjust to certain shifts in consumer lifestyles, which include: (i) lower home-ownership levels and more people renting; (ii) more apartment living and single-person households; (iii) older consumers that want to age in place; and (iv) cash-strapped millennials that are slow in forming households relative to prior generations.

Haha! The poor millennials. Apparently an entire generation is “cash-strapped” and prefers to sleep in a tent under their WeWork desks. Blame the avocado toast and turmeric lattes. But, wait, there’s more:

Consumer browsing and buying practices are rapidly shifting as well toward greater use of social media, internet- and app-based catalogs and e-commerce platforms, and the Company has been unable to develop a substantial sales base for its brands through this key growth channel.

Furthermore, the residential furniture industry is highly competitive and fragmented. The Company competes with many other manufacturers and retailers, some of which offer widely advertised, well-known, branded products, and other competitors are large retail furniture dealers who offer their own private label products. This competitive landscape has proved challenging for some of the Company’s larger brands as well-capitalized competitors continue to gain market share at the expense of the Debtors. (emphasis added)

PETITION Note: My, how things have remained the same. Sound familiar? Have to hand it to the professionals here: why reinvent the wheel when you can just crib from the prior filing? We guess being a repeat customer in bankruptcy has its benefits!! Chapter 22!!!

<p>Meanwhile a short digression relevant to those last two quoted paragraphs. According to Statistaworldwide online furniture and homewares sales are expected to be close to $190 billion. Take a look at this chart:

RetailDive notes:

E-commerce furniture sales have emerged as a major growth area, rising 18% in 2015, second only to grocery, according to research from Barclays.

Accordingly, GartnerL2 cautions that:

…home brands now have an outsized onus to produce best-in-class product pages for the influx of online shoppers. However, many brands have failed to deliver and aren’t keeping pace with industry disruptors.

Sounds like HHG has, admittedly, fallen into this category.

GartnerL2 highlights the disparate user experiences offered by Williams-Sonoma-owned West Elm and Chicago-based DTC disruptor Interior Define, which was founded in 2013 and has raised $27mm in funding (most recently a Series B in March). The latter offers extensive imagery, a visual guide and an augmented reality mobile app. All of these things appeal to the more-tech-savvy (non-cash-strapped??) millennial buyer.

And that is precisely the demographic that La-Z-Boy Incorporated ($LZB) is going after with its purchase of Joybird, a California-based direct-to-consumer e-commerce retailer and manufacturer of upholstered furniture. Founded in 2014, its $55mm in reported revenue last year took a chunk out of, well, someone. Other players in that space include Burrow ($19.2mm in total funding; most recent Series A in March from New Enterprise Associates) and, of course, Amazon’s in-house furniture brandsRivet and Stone & Beam. <p><end>

All of these factors resulted in continual YOY declines in sales and a liquidity squeeze. Now, therefore, the company is in bankruptcy to effectuate a sale — or sales — of its brands to prospective bidders. It has one purchaser in line for the “Luxury Group” and, according to the court filing, appears close to an agreement with a stalking horse buyer of the Broyhill and Thomasville & Co. properties. In the meantime, the company has a commitment from prepetition lender PNC Bank NA for a $98mm DIP, of which $25mm Judge Gross granted on an interim basis.

#BustedIPO: Tintri Inc. Files for Bankruptcy

What is the statute of limitations for declaring an IPO busted?

We previously wrote about Tintri Inc. ($TNTR) here and, frankly, there isn’t much to add other than the fact that company has, indeed, filed for bankruptcy. The filing is predicated upon a proposed 363 sale of the company’s assets as a “going concern” or a liquidation of the company’s intellectual property in what should be a fairly short stint in bankruptcy court. Shareholders likely to be wiped out include New Enterprise Associates (yes, the same firm mentioned above in the Tamara Mellon bit), Insight Venture PartnersLightspeed Venture Partners and Silver Lake Kraftwerk.

Meanwhile, in the above-cited piece we also wrote:

Nothing like a $7 launch, a slight post-IPO uptick, and then a crash and burn. This should be a warning sign for anyone taking a look at Domo — another company that looks like it is exploring an IPO for liquidity to stay afloat.

This bit about Tintri''s financial position offers up an explanation for the bankruptcy filing -- in turn serving as a cautionary tale for investors in IPOs of companies that have massive burn rates:

"The company's revenue increased from $86 million in fiscal 2016 to $125.1 million in fiscal 2017, and to $125.9 million in fiscal 2018, representing year-over-year growth of 45% and 1 %, respectively. The company's net loss was $101.0 million, $105.8 million, and $157.7 million in fiscal 2016, 2017, and 2018, respectively. Total assets decreased from $158.1 million as of the end of fiscal 2016 to $104.9 million as of the end of fiscal 2017, and to $76.2 million as of the end of fiscal 2018, representing year-over-year change of 34% and 27%, respectively. The company attributed flat revenue growth in fiscal 2018 in part due to delayed and reduced purchases of products as a result of customer concerns about Tintri's financial condition, as well as a shift in its product mix toward lower-priced products, offset somewhat by increased support and maintenance revenue from its growing installed customer base. Ultimately, the company's sales levels have not experienced a level of growth sufficient to address its cash burn rate and sustain its business."

With trends like those, it's no surprise that the IPO generated less capital than the company expected. More from the company:

"Tintri's orders for new products declined, it lost a few key customers and, consequently, its declining revenues led to the company's difficulties in meeting day-to-day expenses, as well as long-term debt obligations. A few months after its IPO, in December 2017, Tintri announced that it was in the process of considering strategic options and had retained investment bank advisors to assist it in this process."

As we previously noted a few weeks ago, "[t]here's no way any strategic buyer agrees to buy this thing without a 363 comfort order."  With Triplepoint Capital LLC agreeing to provide a $5.4mm DIP credit facility, this is precisely the path the company seeks to take.

*****

Meanwhile, Domo Inc. ($DOMO) is a Utah-based computer software company that recently IPO’d. Per Spark Capital’s Alex Clayton:

Domo recently drew down $100M from their credit facility and currently only has ~6 months of cash left with their current burn rate. Given they raised $730M in equity capital from investors and another $100M through their credit facility, it implies they have spent roughly $750M over the past 8 years to reach a little over $100M in ARR, an extraordinary and unprecedented amount of cash burn for a SaaS company. They have $72M in cash.

That was before the IPO. This is after the IPO:

Screen Shot 2018-07-10 at 7.55.42 PM.png

Draw your own conclusions.

Direct-to-Consumer Retail Gets Big Funding

Away, Hims & Parachute All Get Growth Capital

This week was a big financing week for startups. In addition to the Pillpack purchase noted above, there was a ton of action in the direct-to-consumer consumer products space that should definitely have incumbents concerned.

Away, the NY-based “thoughtful” startup that makes travel products that “solve real travel problems” raised $50mm in fresh Series C funding from prior investors Forerunner Ventures, Global Founders Capital and Comcast Ventures. The company intends to use the funds to tap into global markets, expand its product line and continue its clicks-to-bricks initiative with six new retail stores in the second half of 2018. The company recently moved its headquarters within New York City in part thanks to a $4mm Empire State Development performance-based tax credit through the Excelsior Jobs Program.

Hims, the one-year old SF-based company that sells men’s prescription hair and sex products, raised $50mm in Series B-2 funding at a $400mm post-money valuation. Investors include IVP, Founders Fund, Cavu Venture Partners, Thrive Capital, Redpoint Ventures, Forerunner Ventures (notice a pattern here?), and SV Angel.

Earlier this year, beauty products maker Glossier raised $52mm in Series C funding (and subsequently added Katrina Lake from Stitch Fix to its board of directors), shaving company Harry’s raised $112mm in Series D funding, and athleisure brand Outdoor Voices raised $32mm.

But, wait. There’s more: here, there are a variety of startups going after your kitchenware and your bed. Parachute announced this week that it raised $30 million in Series C funding led by H.I.G. Growth Partners. Other investors include Upfront Ventures, Susa Ventures, Suffolk Equity, JAWS Ventures, Grace Beauty Capital and Daher Capital. With three stores currently, the company intends to take the funding to, like Away, expand its clicks-to-bricks plan with 20 more locations in the next 2 years.

Meanwhile, mattress e-tailer Purple is (strangely) doubling-down on its relationship with Steinhoff-owned Mattress Firm, the struggling bed B&M retailer. The tie-up now includes Mattress Firm locations in Sacramento, Austin, DC, Chicago and SF. We hope Purple has baked in bankruptcy protections into its deal agreements so that there’s not question as to ownership.

If you don’t think all of this has incumbent CPG executives worried, you’re not paying close enough attention.

Not to mention the private equity bros:

More from Ryan Caldbeck’s interesting thread here.

Slight tangent: note that nowhere is there any mention of disruption from consumer product subscription boxes.

🔥Amazon is a Beast🔥

The "Amazon Effect" Takes More Victims

Scott Galloway likes to say that mere announcements from Amazon Inc. ($AMZN) can result in billions of dollars of wiped-out market capitalization. Upon this week’s announcement that Amazon has purchased Boston-based online pharmacy startup Pillpack for $1 billion — beating out Walmart ($WMT) in the process — his statement proved correct. Check this out:

Screen Shot 2018-07-01 at 9.20.31 AM.png

We like to make fun of the Amazon narrative because we’re of the view that it’s overplayed — particularly in restructuring circles — and reflects a failure to understand broader macro trends (like the direct-to-consumer invasion noted below). Still, the market reaction to this purchase reflects the undeniable power of the “Amazon Effect” and we’d be remiss not to acknowledge as much. This purchase will likely be a turning point for pharmacies for sure; perhaps also, farther down the line, for benefits managers and pharmaceutical manufacturers. It also may provide Amazon with meaningful cross-pollination opportunities with its payments business — a subject that nobody seems to be talking about (more on this below).

Putting aside the losers for now, there are a variety of winners. First, obviously, are Pillpack’s founders, TJ Parker and Elliot Cohen. They stand to make a ton of money. Also its investors — Accel Partners, Atlas Venture, CRV, Founder Collective, Menlo Ventures, Sherpa Ventures and Techstars — at an 8x return, at least. Oh, and Nas apparently. And then there is Amazon itself. Pillpack isn’t a massive revenue generator ($100mm in ‘17) and it isn’t a big company (1k employees) but it packs a big punch: licenses to ship drugs in 50 sates. With this purchase, Amazon just hurdled over a significant regulatory quagmire.

So what is Pillpack? Per Wired (by way of Ben Thompson):

PillPack is trying to solve the problem of drug adherence by simplifying your medicine cabinet. Medication arrives in the mail presorted into clear plastic packets, each marked in a large font with vital information: day, time, pills inside, dosages. These are ordered chronologically in a roll that slots into the dispenser. Let’s say you need to take four different pills in the morning and two others in the afternoon every day: Those pills would be sorted into two tear-off packets: one marked 8am, followed immediately by the 2pm packet.

Put another way, Pillpack specializes in the convenience of getting you your medications directly with a design and user-experience focus to boot. The latter helps ensure that you’re taking the proper levels of medication at the right time.

Still, there are some limitations. Per The Wall Street Journal:

Amazon will be limited in what it can do, especially to start. PillPack’s specialty—packaging a month’s supply of pills for chronic-disease patients—is a small part of the overall market. It has said it has tens of thousands of customers versus Amazon’s hundreds of millions.

Current limitations notwithstanding, Thompson notes how much Pillpack’s service aligns with Amazon:

Amazon, particularly for Prime customers, is seeking to be the retailer of habit. That is, just as a chronic condition patient may need to order drugs every month, Amazon wants to be the source of monthly purchases of household supplies, and anything else one might want to buy along the way.

Like all aggregators, Amazon wins by providing a superior user experience, particularly when it comes to delivering the efficient frontier of price and selection. To that end, moving into pharmaceuticals via a company predicated on delivering a superior user experience makes total sense.

Thompson notes further:

The benefit Amazon will provide to PillPack, on the other hand, is primarily about dramatically decreasing the customer acquisition costs for a solution that is far better for consumers; to put it another way, Amazon will make a whole lot more people aware of a much more customer-friendly solution. Frankly, I have a hard time seeing why that is problematic.

To be sure, Amazon will benefit beyond its unique ability to supercharge PillPack’s customer acquisition numbers: just as Walgreen and CVS’s pharmacies draw customers to their traditional retail stores, PillPack’s focus on regular ordering fits in well with Amazon’s desire to be at the center of its customers day-to-day lives. This works in two directions: first, that Amazon now has a direct connection to a an ongoing transaction, and second, that would-be Amazon customers are dissuaded from visiting a retail pharmacy and, inevitably, buying something else along the way. This was a point I made in Amazon’s New Customer:

This, though, is why groceries is a strategic hole: not only is it the largest retail category, it is the most persistent opportunity for other retailers to gain access to Prime members and remind them there are alternatives.

A similar argument could be made for prescription drugs: their acquisition is one of the most consistent and predictable ways by which potential customers exist outside of the Amazon ecosystem. It makes a lot of sense for Amazon to reduce the inclination to ever go elsewhere.

It seems that Amazon is doing that lately for virtually everything. Consistently, further expansion beyond just chronic-disease patients seems inevitable. Margin exists elsewhere in the medical chain too and, well, Jeff Bezos once famously said “Your margin is my opportunity.” David Frankel of Founder Collective writes:

The story of the last five years has been that of bricks and mortar retailers frantically trying to play catch-up with Amazon. By acquiring PillPack, Amazon is now firmly attacking another quarter trillion dollars of TAM. Bezos is a tenacious competitor and has just added the most compelling consumer pharmacy to enter the game since CVS was founded in 1963.

TJ Parker understands the pharma business in his bones, has impeccable product sensibilities, and now has the backing of the most successful retail entrepreneur in history.

Expect some real healthcare reform ahead.

Screen Shot 2018-07-01 at 9.21.40 AM.png
Screen Shot 2018-07-01 at 9.22.25 AM.png

No wonder those stocks all sh*t the bed. That all sounds downright horrifying for those on the receiving end.

*****

Recall weeks back when we noted this slide in Mary Meeker’s “Internet Trends” presentation:

Screen Shot 2018-07-01 at 9.23.24 AM.png

Healthcare spending continues to rise which, no doubt, includes the cost of medication — a hot button issue of price that even Donald Trump and Hillary Clinton have agreed on. This purchase dovetails nicely with Amazon’s overall health ambitions. Per the New York Times:

But Mr. Buck and others said Amazon might have a new opportunity. A growing number of Americans are without health insurance or have such high deductibles that they may be better off bargain shopping on their own. He estimated that 25 million Americans fell into that category.

Until now, he said, PillPack has not aggressively competed on price. With Amazon in charge, “how about they start posting prices that are really, really aggressive?” Mr. Buck said.

As Pillpack increases its scale, Amazon will be able to exert more leverage in the space. This could have the affect of compressing (certain) pharmaceutical prices. To get there, Amazon will undoubtedly seize the opportunity to subsume Pillpack/pharma into Amazon Prime, providing Members discounts on medicine much like it provides Whole Foods shoppers discounts on bananas.

There is other opportunity to expand the user base as well. People are looking to save money on healthcare as much as possible. With cash back rewards, Amazon can offer additional discounts if consumers were to carry and use the Amazon Prime Rewards Visa Signature Card — which already offers 5% back on Amazon.com and WholeFoods purchases (plus money back elsewhere too). Pillpack too? We could envision a scenario where people scrap their current plastic to ensure that they’re getting discounts off of one of the most rapidly rising expenditures out there. Said another way, as more and more consumer staples like food and medicine are offered by Amazon, Amazon will be able to entice Pillpack customers with further card-related discounts. And grow a significant amount of revenue by way of its card offering. No doubt this is part of the plan. And don’t forget the data that they would compile to boot.

Per Forbes shortly after Amazon launched its Amazon Prime Rewards Visa Signature Card,

Given that Amazon credit card holders spend the highest on its platform, the company is looking at ways to expand its credit card consumer base. CIRP estimates that approximately 15% of Amazon’s U.S. customers have any one of Amazon’s credit cards, representing approximately 21 million customers. However, growth of its card base has not kept pace with its growing Prime membership. In June 2016, it was estimated that Amazon has around 63 million Prime members. Assuming that only Prime members have an Amazon credit card, it would mean that only a third of its Prime customers have one of its credit cards. According to a survey by Morgan Stanley, Amazon Prime members spend about 4.6 times more money on its platform than non-prime members. Its credit card holders spend even greater amounts than what Prime members spend. By enticing its prime customers to own its credit cards, Amazon will be encouraging them to spend more on its platform. Its latest card is aimed at attracting Prime customers by offering deals not only on Amazon.com but on other shopping destinations as well. This can lead to higher spending by existing Prime customers and help convert the fence sitters into Prime memberships.

And those numbers are dated. Amazon Prime now has 100mm members. Imagine if they could all get discounts on their meds. 💰💥💰💥

All of which begs the question: who gets hurt and who benefits (other than Visa ($V)) from this potential secondary effect? 🤔

#BustedTech (Short Busted IPOs…cough…DOMO)

Tintri Inc., a publicly-traded ($TNTR) Delaware-incorporated and Mountain View California based provider of enterprise cloud and all-flash and hybrid storage systems appears to be on the brink of bankruptcy. There's no way any strategic buyer agrees to buy this thing without a 363 comfort order. 

In an SEC filing filed on Friday, the company noted:

"The company is currently in breach of certain covenants under its credit facilities and likely does not have sufficient liquidity to continue its operations beyond June 30, 2018."

Furthermore, 

"Based on the company’s current cash projections, and regardless of whether its lenders were to choose to accelerate the repayment of the company’s indebtedness under its credit facilities, the company likely does not have sufficient liquidity to continue its operations beyond June 30, 2018. The company continues to evaluate its strategic options, including a sale of the company. Even if the company is able to secure a strategic transaction, there is a significant possibility that the company may file for bankruptcy protection, which could result in a complete loss of shareholders’ investment."

And yesterday the company's CEO resigned from the company. All of this an ignominious end for a company that IPO'd almost exactly a year ago. Check out this chart:

Screen Shot 2018-06-19 at 10.21.47 AM.png

Nothing like a $7 launch, a slight post-IPO uptick, and then a crash and burn. This should be a warning sign for anyone taking a look at Domo — another company that looks like it is exploring an IPO for liquidity to stay afloat. But we digress. 

The company's capital structure consists of a $15.4mm '19 revolving credit facility with Silicon Valley Bank, a $50mm '19 facility with TriplePoint Capital LLC, and $25mm of 8% convertible notes. Revenues increased YOY from $86mm in fiscal 2016 to $125.1mm in fiscal 2017 to $125.9mm in fiscal 2018. The net loss, however, also moved up and right: from $101mm to $105.8mm to $157.7mm. The company clearly has a liquidity ("net cash") covenant issue (remember those?). Accordingly, the company fired 20% of its global workforce (~90 people) in March (a follow-on to a 10% reduction in Q3 '17). The venture capital firms that funded the company — Lightspeed Venture Partners among them — appear to be long gone. Silver Lake Group LLC and NEA Management Company LLC, unfortunately, are not; they still own a good amount of the company.

"Isn't cloud storage supposed to be all the rage," you ask? Yeah, sure, but these guys seem to generate product revenue largely from sales of all-flash and hybrid storage systems (and stand-alone software licenses). They're mainly in the "intensely competitive IT infrastructure market," sparring with the likes of Dell EMCIBM and VMware. So, yeah, good luck with that.

Don’t. Mess. With. Daisy. Chapter 4. (Petsmart: Long Asset-Stripping Shenanigans)

Man this dog series (and John Wick referencing) is fun. With regard to Petsmart Inc., we previously we wrote:

The company financed the purchase with a two-part debt offering of (a) $1.35 billion of ‘25 8.875% senior secured notes and (b) $650 million of ‘25 5.875% unsecured notes. Rounding out the capital structure is a $750 million ABL, a $4.3 billion cov-lite first-lien term loan and $1.9 billion cov-lite ‘23 senior unsecured notes. Let us help you out here: 1+2+3+4 = $8.2 billion in debt. The equity sponsors, BC PartnersGICLongview Asset ManagementCaisse de dépôt et placement du Québec and StepStone Group, helped by writing a $1.35 billion new equity check.

That capital structure refresher is important…

Taking a page out of J.Crew’s asset-stripping, litigation-inducing, bird-flip-to-senior-lenders-activating playbook, Petsmart this week announced that it moved a 16.5% stake in Chewy.com (a/k/a the savior) to an unrestricted subsidiary — unironically using a sponsor dividend mechanic for the transaction; it also dividended 20% of the equity in Chewy.com to its parent company, Argos Holdings, an entity controlled by private equity firm BC Partners. Consequently, Chewy.com is no longer a wholly-owned subsidiary of Petsmart. Moreover, per The Financial Times,

“Chewy will no longer guarantee PetSmart's debt, according to Xtract Research, though the remaining 63.5 per cent of the shares will still be pledged to secure term loans and senior bonds.”

We love financial shenanigans that weaken lender collateral packages to the apparent benefit of junior creditors and private equity sponsors. Particularly when they’re done so quickly after the original transaction!

How did the market react? Well, per Bloomberg, initially:

PetSmart’s bonds rallied as the move of the online vendor’s assets was seen as less aggressive than what bondholders had originally priced in, according to the people, who said the initial buyers of the notes have unloaded the positions. Investors sold PetSmart’s debt last year on fears it would sell or spin off as much as 100 percent of the Chewy equity to the private equity owner, removing it from the pool of assets they have recourse to as bondholders.

Haha, right. So instead of getting potentially 100% effed, bondholders only got 33% effed. Can you say: Credit positive!? This is what makes the distressed world just so unmistakably poetic and nasty at the same time: everything is largely a function of…well…you guessed it: asset price and asset value. With the par guys out and buyers at distressed levels in, “credit positive” is entirely relative.

Anyway, more from Bloomberg,

The company’s management said that said they will continue to actively monitor the capital structure and potentially pursue additional strategic opportunities to extend debt maturities, reduce overall leverage and invest in the business, according to the people. Management didn’t have a question and answer portion at the end of the call.

Of course not. Why would they? The first question would be “By ‘reduce overall leverage’ does that mean issuing new bonds secured by the newly siphoned off equity of (valuable?) IP in exchange for the cov-lite unsecured notes?” Even Eli Manning couldn’t so obviously telegraph his next move (The Financial Times, citing Covenant Review, cites some other options here).

This bit is great:

Petsmart’s transfer of assets to an unrestricted subsidiary was not surprising given what J. Crew was able to do with its transfer of intellectual property under its loan documents, James Wallick of Xtract Research said in an interview. The move is “symptomatic” of the current market for loans and bonds, where agreements “are so flexible that you can do a transaction such as this.”

Hahaha. Man people love to gripe about the capital markets these days. Said another way,

Mmmm hmmm. Yield, baby, yield.