Dov Charney = Bankruptcy Pro

This is a long holiday weekend in need of a longform beach read. So here is a recent piece about American Apparel's founder and iconoclast, Dov Charney. Why bother? Well, because Charney probably knows more about retail restructurings at this point than half of you. We kid, we kid. 

Anyway, trust us and take a look. The article demonstrates how in ten short years the retail space has dramatically changed. Charney expanded from a B2B wholesaler to a B2C brick-and-mortar destination in an astounding amount of time (sidenote: Charney's architect running the expansion was none other than WeWork co-founder, Miguel McKelvey). Will we ever see that level of retail expansion again? It doesn't seem likely. 

Otherwise, American Apparel's double vault into bankruptcy is well documented by this point. Charney tried to buy the company out of the first bankruptcy for $300mm; he was denied. He didn't try to buy it the second time which came a cold 6 months later and the company sold its intellectual property to Gilden Apparel for $88mm. Gilden then shut down the entirely of the retail footprint (and the company's Los Angeles warehouse). Now Charney is launching "Los Angeles Apparel" and going all Clint Eastwood on Gilden. We love a good showdown. 

If, at this point, you're thinking "This is my long holiday weekend and I don't want to stress out by reading something about that dumba$$, Charney," well, we get it. So, a few highlights to otherwise spare you:

Choice Quote #1: "...the private equity firms can't wait to get out. They want a pay day. They're not looking to hang around or create something unique, or win accolades for their creativity. They're measured by how much money they can extract from the business. They're not interested in the customer; it's not about authenticity." PETITION note: see, e.g., Payless Shoesource, rue21 Inc., Gymboree, Claire's Stores...arggh, you get the point. 

Choice Quote #2: "'The money's not talented...[t]he money doesn't create the value. Basically the hedge funds and the private equity firms - and it's not all of them - they hire these consulting firms. What these guys do, they just come in, they raid the company - basically the suits take over. But it hasn't worked out in fashion, as far as I can tell." PETITION note: see, e.g., Wet Seal, rue21, Gymboree, Claire's Stores...arggh, you get the point. Query also: which consulting firm is he referring to? Hmmm.

Choice Quote #3: "To avoid over-production, some of those smaller players go as far as crowdfunding their inventory, waiting for a minimum order from their customers before they even contemplate production...." PETITION Note: we've been wondering whether inventory-by-crowdfunding would become more of a trend. Significantly, Elon Musk has been doing that with new Tesla models: make an order and pay a deposit. He he can then know precisely how many new models to manufacture and project cash needs accordingly. Andreesen Horowitz folks cover this topic in this interesting podcast. Moreover, other big brands are using crowdsourcing for consumer product goods. Retail is a tough business these days: we wonder whether additional brands will deploy crowdsourcing to create awareness/buzz and manage inventory simultaneously. Stay tuned and watch this trend.

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Questioning Venue

For those of you who aren’t interested in restructuring/legal inside baseball, feel free to just scroll down to the News section below. Why? Well, we about to get legal up in this m*ther$%&$*, that's why. 

Thanks to that pesky little thing called federalism, every state has their own court system. This makes "venue" a big deal in bankruptcy cases as companies on the verge of a bankruptcy filing generally have several venue options based on various factors (i.e., principal place of business, location of an affiliate, etc.). Historically, Delaware has been an obvious choice of venue because most companies are incorporated there. It also helps that the jurisdiction's law is debtor-friendly and the judges are viewed as smart, sophisticated, and fit to handle the most complex and commercial of issues. 

Right now, though, there are a number of Delaware practitioners wondering what's behind a recent shift of significant bankruptcy filings to other venues. There are a number of theories swirling around. 

  1. Jurisdictional Competition. One theory is that that other jurisdictions, i.e., Texas and Missouri, want in on the recent surge of restructuring action. And to get in, they’re intentionally exhibiting a greater willingness to work with Yankee professionals and ensure a smooth case. Otherwise known as "playing ball." This is why some believe Payless Shoesource landed in the lap of a Missouri judge (note: curiously, the judge, by certain accounts, has virtually no track record to speak of - yes, there are plenty of folks who monitor judicial leanings). It stands to reason, then, that a $100mm+ critical vendor ask would slide by without as much as a batted eye by the judge (note: even the company must have anticipated some controversy here; it filed a declaration in support of the relief - not something typically deserving of a separate evidenciary filing). Query this: if many of these vendors were already stretched to 100-day terms - per the company's own declaration - what real difference would another 10-20 days make so that a creditors' committee could form to evaluate the request? Hmmm.
  2. Releases. Play ball with what, exactly? This may be the bigger question. We’re not going to opine on the current state of the law vis-a-vis third-party releases but, suffice it to say our favorite topic of late - dividend recaps - seems in play here too. After all, Payless is another private equity backed retailer and, by all accounts, there were dividends to speak of within the relevant lookback period. Why WOULD those guys want to take the likelier risk that releases would be in question in Delaware? Well, they wouldn’t. And so the question is: will they be in question in Missouri? The fact is that, more and more, these cases are driven by the interests of those other than the debtor.  Delaware is often looked upon as a solid choice of venue because of the vast and relatively predictable case law. If you're funding and/or driving a case, that may be part of the problem. Sometimes it may just be worth rolling the dice (Caesars notwithstanding).
  3. Too sophisticated? The third theory relates to whether the Delaware judges are TOO sophisticated. Apparently practitioners scare easily. When the Texas bench filleted investment bankers early on in the oil and gas wave (see BPZ Resources Inc.), bankers on subsequent deals purportedly grew increasingly skittish about United flights and advocated for Delaware filings instead. But this was short-lived. Once the Delaware bench dropped Paragon Offshore’s plan confirmation attempt faster than Pepsi drops distasteful ads and demonstrated that we have a feasibility problem, that mood quickly shifted. Fickle bunch. Clearly nobody wants to be on the wrong side of a bad feasibility opinion. After all, why risk losing the chance to refile the case in approximately 12 months and collect on a second round of fees, right? See, e.g., American ApparelRadio Shack/General WirelessGlobal Geophysical Services. Had the Delaware judge turned a blind eye to day rates, utilization and refinancing ability - sophisticated inputs that factor into valuation and feasibility - maybe there’d be discounted shoes lining up outside the Delaware courthouse steps. Then again, maybe not...releases!

It’ll be interesting to see where the next set of cases file... 

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Things That Caught Our Attention in the Waning Weeks of '16

It's easy for small matters to get lost in translation over the holidays and so we wanted to highlight a few developments that may have flown under the radar. 

American Apparel

The company is looking to hire FTI Consulting to provide supplementary services to its current financial advisor, Berkeley Research Group. FTI will be paid $100k to prepare the Schedules and Statement of Financial Affairs and $300k for "other services" given institutional knowledge gained from the original Chapter 11 filing (note: this is a Chapter 22). Sadly, FTI had to waive its $2mm+ claim stemming from the original filing to secure this minor mandate. Ouch.

The company and the official committee of unsecured creditors have submitted an application for CBIZ to serve as financial advisor to both concurrently. We've been around the business for a while but cannot think of any prior instances when the same financial advisor sat on both sides of the table. What are other instances of this, if any?

The negotiating table just got a lot more interesting.

The negotiating table just got a lot more interesting.


Just when the unintentional comedy that is France couldn't get any funnier, the country instituted a law codifying a right to disconnect, applicable to all companies with 50 or more employees. That's right: 35 hour work weeks, 14 months a year of vacation, and now the right not to be bothered by a partner at 7 pm with a request for a memo due by 9 am even though he won't look at it until 12 pm...9 days later. The Paris office of a lot of law firms just got much more interesting.

We Have a Feasibility Problem

We're thankful this week for Judge Sonchi's decision last week in the Paragon Offshore bankruptcy cases. The decision was more than just a victory for the company's term loan lenders: it was a much-needed warning signal to the restructuring industry. 

First, a quick synopsis of the opinion. In short, Judge Sonchi sustained most, but not all, of the term lenders objections on the basis that the Debtors' (i) deployed unrealistic rig utilization and day rate assumptions and (ii) failed to take into consideration macro considerations that would affect the Debtors' eventual ability to refinance debt upon maturity in 2021 (if they didn't run out of cash before then). 

With respect to the former, the opinion underscores some dire trends (particularly provided correlations: rig supply up + price of oil down = dayrates down). Some highlights:

  • "E&P companies are currently seeking to drive excessive costs out of the supply chain and are working to sustain this reduced cost environment to avoid over-inflation and 'boom and bust principle' that has been seen in recent years and in the current cycle." (emphasis added)
  • "This 'vast oversupply' of rigs is creating a 'challenging commodity price environment' that is expected to last at least an additional 3.2 years...." (emphasis added)
  • "The oversupply of rigs is 'historical' even excluding newbuild rigs; and the only prior comparable downturn occurred in 1986, which had less of an overhang and did not have the additional newbuild overhang." (emphasis added)

Clearly, this is no bueno for revenue/EBITDA go-forward. Accordingly, an investment banker performing an analysis maybe ought to consider all publicly available resources to configure proper assumptions. Clearly, that didn't happen here and Judge Sonchi made it known. The term lenders' expert testified that, with respect to ongoing projected flat day rates, there wasn't "a single analyst that took a contrary view." But the Managing Director for the Debtors did. Curious.

Regarding the latter refinancing point, the Judge highlighted that "$110 billion of debt associated with severely strained oilfield services and drilling (OFS) companies will mature or expire over the next five years" - hitting RIGHT at the time Paragon would need to tap the capital markets. $110 BILLION. The Debtors' banker explained this massive number away by indicating that there is a $1 trillion E&P market and financing, therefore, would be available. The Judge demurred - calling the analysis "superficial" - and agreed with the term lenders' expert that (a) the market for "asset-based" lending for drilling companies generally is smaller and more specialized and (b) the historical capital used to support the market is no longer as prevalent as it was in previous cycles. Indeed, as this Bloomberg piece notes, fears about refinancing are starting to gain traction in the market.

Putting aside the specifics of this case, the decision is important for another reason: it highlights the importance of feasibility. Now, granted, the term lenders had to object for Sonchi to arrive at his conclusion in Paragon but there is an increasing likelihood of Judges scrutinizing feasibility. This Fox Business piece notes, "Some critics say bankruptcy judges too often focus on hammering out an agreement without paying enough attention to companies' chances of long-term survival." Will this continue?

Maybe we need Judges to be activists and save us from ourselves. Deals are being cut, sure, but are they for the right reasons? Are they cut to ensure the viability of the companies underneath capital structures or to uphold "castles in the air" theory and line the pockets of distressed investors? Hard to say: seemingly, these deals aren't doing them any favors either. Without greater transparency to the markets, it's hard to know.

Here's what we do know. In the last several years, there have been a number of repeat restructurings: American Apparel LLC. Global Geophysical Services LLC. Hercules Offshore Inc. Essar Steel Algoma Inc. Fresh and Easy. A&P. Sbarro LLC. Revel Casino. Catalyst Paper. Perhaps we all -- judges included -- ought to ask ourselves why that might be.

American Apparel is the Latest Retail Trainwreck

So Many Caught With Their Pants Down

Add a prestigious lineup of distressed investors and professionals to the roster of folks pantsed by American Apparel.  

In October 2015, American Apparel filed for bankruptcy. It converted $200mm of secured debt into (a) equity and (b) a $120mm post-bankruptcy exit Term Loan (subsuming $30mm of new money). The Company was supposed to benefit from $10mm of new equity and a new $40mm asset-backed lending facility. But sometimes things don't go according to plan: on November 14 2016, the Company again filed for chapter 11. Now it wears the "Chapter 22" label (see what we did there?).  

The company's bankruptcy filings are riddled with incriminating statements about misguided management expectations and professional performance. The company suffered from "unfavorable market conditions" that were "more persistent and widespread than the Debtors anticipated" and "particularly detrimental to retailers." This is called tunnel vision. 

Post-bankruptcy, the Company suffered from 32.7% YOY sales decline and $40mm EBITDA decline. It could never nail down the $40mm of asset-backed lending that its business plan depended upon. The Company blames this, in part, on the CFO leaving the business. Maybe they should blame it on the reasons why the CFO left the business, i.e., the business sucked. Apropos, the Company notes that it failed in myriad ways: (i) it could not optimize its product and merchandizing, (ii) it suffered from chronic quality problems and defects (ah, American production!), (iii) it had no unified and consistent marketing plan (give founder Dov Charney this: there used to be one!), and (iv) it failed to improve its e-commerce platform. Wait what? FAILED TO IMPROVE E-COMMERCE?! Indeed. Its sales declined post-bankruptcy and amounted to only 10% of sales - 10% LOWER than the industry average. 

And so the plan is to sell the Company for parts. Gilden Activewear SRL, a Canadian company, is spending $66mm mostly for, among some other things, the company's intellectual property. The company's previously secured lenders - Monarch Alternative Capital LP, Coliseum Capital Management LLC, Goldman Sachs Asset Management LP, Pentwater Capital Management LP, and Standard General - "will likely recover only a fraction of the funds that they have advanced." (emphasis added). Somewhere Charney is smoking a cigar, sipping bourbon and laughing his a$$ off. 

Restructuring professionals are also getting burned here. Among the company's largest unsecured creditors this go-around are prestigious firms like FTI Consulting and Moelis & Co., owed $2.03mm and $645k, respectively. 

We are ripping on this a bit but, jokes and jabs aside, there is a sad social commentary here. First, the restructuring process clearly failed this Company. We could spend time digging into the millions that were surely paid out in fees but why bother? It's safe to assume it was a lot. Second, clearly the Judge got duped into thinking the company's plan of reorganization was feasible. Expect more scrutiny from judges on this point go-forward - and not just in the oil and gas space. Third, this is yet another example of US manufacturing being uncompetitive in the world market. Notably, Gilden is buying the intellectual property only. This is why Shark Tank's Kevin O'Leary is constantly telling entrepreneurs to ship their manufacturing to China: Los Angeles simply doesn't make sense - regardless of who is President. Finally, popularity doesn't last forever - particularly, in the retail space. Undoubtedly retail is suffering lately - a point exemplified by the onslaught of recent retail filings, e.g., Golfsmith, Nasty Gal, etc., - but failures there will only be amplified when quality slips, e-commerce is ignored, and execution is poor.

As for Carney? His new startup venture is featured on Gimlet Media's newest "Startup" podcast...