Previously in PETITION. Part II (Short Tony the Tiger)

In June 23rd’s “Plastic is Ripe for a Reckoning (Long Ridiculous Branded Water)and in a short follow-up on June 30, we talked about how plastic has a bullseye on it. In the latter, we wrote:

Meanwhile, we were curious whether all of this talk about aluminum and glass taking over for plastic was having an effect elsewhere. Compare the bids for Anchor Glass Container Corp’s $150mm second lien term loan maturing 2024:

On May 6, the bid was 55.6 with a yield-to-worst of 25.2%.

On June 24, the bid was 71.4 with a yield-to-worst of 18.5%.

Long bullishness on glass containers?

S&P clearly doesn’t think so:

Here is where the second lien term loan traded this week: 70.7.



Eddie Lampert Speaks (Short Sears, Long Principled Kidnappers)

This week William Cohan and Vanity Fair released a once-in-fifteen-years piece with the infamous Sears Holding ($SHLD) investor, Eddie Lampert. It’s a whopper and worth a read.

The mess that is Sears is quantified here:

“But today those triumphs are largely obscured by his worst mistake: the 2005 merging of Sears, the iconic retailer whose doorstop mail-order catalogue was once a fixture in nearly every American home, with the downmarket Kmart chain, which he had brought out of bankruptcy in 2003. Twelve years on, this blundering into retail has made him a poster boy for what some people think is wrong with Wall Street and, in particular, hedge funds. Under his management the number of Sears and Kmart stores nationwide has shrunk to 1,207 from 5,670 at its peak, in the 2000s, and at least 200,000 Sears and Kmart employees have been thrown out of work. The pension fund, for retired Sears employees, is underfunded by around $1.6 billion, and both Lampert and Sears are being sued for investing employees’ retirement money in Sears stock, when the top brass allegedly knew it was a terrible investment.”

To put this in perspective, people are in an uproar about the liquidation of Toys R Us which has 33,000 employees. Sears, while still in business, has had attrition of 6x that. But wait. That’s just on the human capital side. What about the actual capital side:

“In 2013, Lampert, who was chairman of the board, had himself named C.E.O. of Sears Holdings, as the combined company is known. He’s had a rough four years since then. The company has suffered some $10.4 billion in losses and a revenue decline of 47 percent, to $22 billion.”

And on the financial side:

“…Sears Holdings stock price has slumped to $2 a share, down considerably from the high of $134 per share some 11 years ago. Sears Holdings now has a market value of around $250 million, making Lampert’s nearly 60 percent stake worth $150 million.”

How. The. Eff. Is. This. Business. Still. Alive. Well, this:

“The vultures are circling, waiting for Lampert to throw in the towel so they can try to make money by buying Sears’s discounted debt. But Lampert continues to claim that’s not going to happen if he can help it.”

Gotta give the guy credit for perseverance.

For those who may be too young or too weathered to remember, KMart was actually a successful turnaround for the first few years after Lampert converted his (acquired) debt position into equity. Operating profit was $1.3 billion in 2004 and 2005. But then he decided to combine KMart and Sears. Thereafter, the big issues began.

Interestingly, the piece suggests that Lampert was “ahead of his time” by de-emphasizing investment in the in-store experience and focusing on e-commerce. But shoppers didn’t buy online. Cohan writes,

“At the time they were just not comfortable enough with the technology to do so. Whatever the reason, Sears’s Web site never remotely rivaled the sales in the stores. Or on Amazon.”

Maybe because, even today, the website is a cluttered mess that will give even those with the most robust heart arrhythmia. In that respect, the online experience mirrors the offline experience. And this runs afoul of current theories of retail. Jeremy Liew of Litespeed Venture Partners writes about new “omnichannel” retailers like Bonobos, Allbirds, Away, Modcloth and Glossier and the new “customer acquisition channel”:

“All retailers need to be wherever their customers are. And for all retailers, their best customers are in every channel. This is just as true for DNVBs. For Bonobos for example, customers who buy first in store spend 2x more and have half the return rate. But more importantly, they spend 30% more online over the next 12 months.

But these DNVBs think about physical retail in a very different way than incumbent retailers. They are not measured purely on “four wall profitability” or $/sq foot, some of the traditional metrics in retail. Many of the stores are showrooms, they don’t carry full inventory. Most support iPads or other ways to browse the online catalogue.

These brands understand the importance of experiential marketing, and they see their physical spaces as a platform to engage deeply with their customers. In short, they see physical retail as customer acquisition channels for their online business. In some cases, a contribution positive customer acquisition channel. In others, a customer acquisition channel whose costs you can compare to Facebook, Instagram, Google or other customer acquisition channels. But always the online business grows.”

For this to work, Everlane’s Michael Preysman says you “must make it look good.” If only Lampert bought in to this premise. Instead, Sears’ online experience mirrors the offline experience: horrible user experience + dilapidated stores = a wholesale contravention of, as Liew points out, everything that successful retailers are doing today. It’s the customer rejection channel. Hence the suspicions from outsiders — which Lampert vehemently denies — that he’s treating Sears like a private company, milking the company for his own benefit, and slowly liquidating it to the point of bankruptcy. Once in bankruptcy, Lampert will allegedly be able to leverage his place in the capital structure to own the company on the backend. It would be a leaner version of Sears — free of debt, onerous leases and pension obligations. Why invest in customer or employee experience now if this is a possibility later? Good question.

Is Charming Charlie's Bankruptcy a Canary in the Coal Mine?

Chapter 11 Filing May be Warning Sign for "Treasure Hunt" Retailers

In its December 11 issue, Barron's noted the following (firewall): "Even the companies that look immune to the impact of the internet could be at risk. Consider off-price retailers like TJX ($TJX) and Ross Stores ($ROST). Bulls have argued that the experience of digging through the racks looking for buried treasure is something that can't be replicated online -- and that, they argue, puts them at an advantage to other retailers."Acknowledging some contrarians among the analyst ranks, Barron's continues "There may even come a day when the bargain-hunting experience loses its thrill. Already, companies are creating the technology that allows shoppers to have their measurements taken at home, and then create the clothes people want without having to search for it...." 

Enter Charming Charlie Holdings Inc. The company filed for bankruptcy earlier this week, capping a bloodbath of a year for retail. For the unfamiliar, Charming Charlie is a Houston-based specialty retailer focused on colorful fashion jewelry, handbags, apparel, gifts, and beauty products. It has 350 domestic stores and a core demographic of 35-55 year-old women. The company blamed (i) "adverse macro-trends" and (ii) operational shortfalls (e.g., merchandising miscalculations, lack of inventory, an overly broad vendor base) for its underperformance and reduced sales. EBITDA declined 75% "in the last several fiscal years." 75-effing-percent! With a limited amount of money available under its revolving credit facility and even less cash on hand, "Charming Charlie is out of cash to responsibly operate its business." Ouch. Two weeks before Christmas. Rough timing.

As it relates to "merchandising miscalculations," this bit caught our eye: "Historically, Charming Charlie utilized a sophisticated inventory system to position products according to their color and theme. Merchandise is offered in as many as 26 different hues and arranged at each store according to the item’s color and theme, creating what has been referred to as a “treasure hunt” experience. While this approach initially provided Charming Charlie with a strategic benefit, and engendered significant brand loyalty, it eventually caused Charming Charlie to be saddled with excess merchandise in underperforming color offerings." Curious. 

Long time PETITION readers know that we love to discuss what we call "busted narratives." Reminder: our focus is "disruption" and not necessarily "restructuring." And we'll acknowledge upfront that we may be cherrypicking one statement in an otherwise lengthy court document. But one ongoing narrative is that off-price "treasure hunt" retailers are safe from e-commerce. We're not so sure. It stands to reason that as things become more convenient at home - with 3D-printing, Amazon Echo Show, Amazon private label (see below), free returns, etc. - retailers will continue to focus more and more on inventory management. That is, if they have inventory at all. Obviously, direct-to-consumer is the not new retail trend and newer brick-and-mortar locations supporting the likes of BonobosWarby Parker, etc., are merely showrooms in furtherance of brand enhancement rather than inventory and supply chain management. Indeed, Charming Charlie announced that is reducing its vendor base down from 175 to 80. As inventories are more streamlined, that strikes us as an obvious headwind to discounted "treasure hunt" retailers. After all, they benefit from inefficient inventory management. And, notably, TJX had a relatively rough quarter recently. Now, TJX isn't filing for bankruptcy anytime soon, but query whether this is a trend to watch going forward. Query whether the "off price" narrative holds. 

Some other notes on Charming Charlie while we have your attention:

  • The company has also commenced the closure of ~100 of its 370 stores (350 domestic + 20 international), a meaningful reduction in its brick-and-mortar footprint. Note some carefully crafted language, "The Debtors anticipate 276 go-forward locations following the first round of store closures." Key words, "FIRST ROUND." We wouldn't be shocked if the company shutters more. That depends on the landlords, it seems...
  • ...and the landlords are getting squeezed too. The company seeks "to amend lease terms to reduce occupancy costs and obtain rent abatements for the first quarter of 2018...." As Starbucks ($SBUX) and Whole Foods ($AMZN) recently discovered, there's a big difference handling leases in vs. out of bankruptcy court.
  • The fashion industry has suffered a 15% downturn in fashion jewelry sales and the company experienced a disproportionate 22% decline itself. Query whether the direct-to-consumer model is helping to disproportionately batter brick-and-mortar fashion jewelers.

Diving into Retail I (M&A'ing Like a Boss)

With Walmart's rumored acquisition of Bonobos, perhaps we can finally do away with the narrative that these fashion startups will alleviate some of the brick-and-mortar vacancy. Walmart isn't buying Bonobos for its 31 "guideshops"; it is buying Bonobos because it needs to increase its e-commerce skillset and acquire a different demographic of shopper than the typical Walmart shopper. Or, we could be wrong: perhaps with Walmart's resources behind it, Bonobos will, in fact, be able to open more guideshops. But will they be independent of Walmart, or within Walmart? So many questions. And here's another one: if brick-and-mortar retailers continue to go the way of the showroom, which suppliers get hammered? Paper (shopping bag) producers? Meanwhile, speaking of bargain shopping at places like Walmart, it appears that Neiman Marcus shoppers are now getting price conscious too: it's amazing what comparative information at your fingertips can do. 

Caspar the Friendly (Non-)Restaurant

Walk through the streets of Manhattan these days and you are bound to see a lot of “for rent” signs taped to the windows of empty commercial spaces. In Captain Obvious fashion, Crain’s New York last week noted that Amazon is affecting a lot of mom-and-pop brick-and-mortar: revenue is down due to the online competition and rents in New York, despite tons of vacancy, remain unsustainable for many business owners. 

It’s rather simple: online retailing is eating up brick and mortar and there aren’t enough Bonobos, Birchbox and Warby Parker showrooms to fill the gap. After expanding to seemingly every corner of the City, banks are in contraction mode: there are now a number of shuttered Capital One and Chase locations in the City. And restaurants? We’ve covered that in detail: forget about it. Art galleries? Mwahahahahaha.  

Under the radar are the ghost restaurants that are quietly undermining the commercial real estate market and contributing to the over-supply of space. Wait, what? Ghost restaurants? Picture this: you're on billable hour 26 for the day and you're hungry. You go on Seamless and find a restaurant with glossy food-porn photos and reasonable prices. You order and 35 minutes later you're indulging in your tasty delights while questioning the meaning of life.

A week later, you've got 20 minutes free from the office and your significant other suggests going out to eat. You say, "I know a great restaurant with awesome food. Let's go." You look for an address but you can't find one. Because there isn't one. The place you ordered from has no physical presence whatsoever or, alternatively, is just a kitchen with no seating space. Now you're rubbing your belly and really having an existential crisis. WTF.  

With sky-high rents and quick turnover the norm, companies like the Green Summit Group are coming up with varying and unique restaurant concepts, locating themselves online only (or, at best, securing a small commercial space with no seating), skipping the long-term onerous lease with commercial landlords, partnering with commercial kitchens, and using Seamless and Grubhub for distribution.

This model promotes improvisation. One benefit of avoiding an actual storefront is the ability to test different food concepts and pivot menus if there are lower-than-anticipated sales. Rebranding is remarkably easy: just a new name, some different food porn photos, and an update to Seamless. To the extent that one company is running different concepts - say, Middle Eastern and Greek - it can also cross-pollinate by offering the exact same menu items per "restaurant" and sharing ingredients in the kitchen. This limits the need to source new ingredients or engage in extensive food prep training for each and every concept. 

It is questionable how sustainable these experiments are long-term. You can read more about some of the cons - loss of alcohol-related sales, no walk-ins, logistics complications - here. The fact is, though, that this represents yet another headwind confronting established restaurant companies. And that potentially means EVEN MORE restaurant bankruptcies in the near future.