🇺🇸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.

*****

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.


💰New Opportunities💰

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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.


Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.


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💥Sungard Napalms the United States Trustee💥

New Chapter 11 Filing - Sungard Availability Services Capital Inc Part I

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Pennsylvania-based Sungard Availability Services Capital Inc. — a provider of “critical production and recovery services to global enterprise companies,” with $977mm of net revenue and $203mm of EBITDA in fiscal 2018 — filed a prepackaged chapter 11 plan in the Southern District of New York on Wednesday. And, if you blinked, you may have missed its residency in bankruptcy. Indeed, some lost their minds because Kirkland & Ellis LLP was able to shepherd the case in and out of bankruptcy in less than 24 hours — breaking the previous record only recently set in FullBeauty. Yes, people care about these things.*

The upshot of this expeditious bankruptcy case is that (a) the company shed nearly $900mm of debt from its balance sheet (reducing debt down to approximately $400-450mm) and (b) transferred 89% ownership to a variety of debt-for-equity swapping funds such as GSO Capital PartnersFS InvestmentsAngelo Gordon & Co., and Carlyle Group (who will also receive $300mm in senior secured term loan paper). Major equity holders — Bain Capital Integral Investors LLCBlackstone Capital Partners IV LPBlackstone GT Communications Partners LPKKR Millennium Fund LPProvidence Equity Partners V LPSilver Lake Partners II LPTPG Partners IV LP — had their equity wiped out (we had previously highlighted KKR’s investment here in “A Hot-Potato Plan of Reorganization. Short BDC Retail Exposure,” discussing the broader context of BDC lending).

This is what the capital structure looked like and will look like:

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That balance sheet is the driver behind the bankruptcy filing. Per the company:

This legacy capital structure was created based upon the Company’s historical operating model and performance and is unsustainable under current market conditions. When the capital structure was put in place, the Company benefited from a larger revenue base with substantially higher free cash flow. As business conditions evolved and the Company’s revenue declined, cash flow available to service debt and invest in products and services substantially declined. Consolidated net revenue declined by approximately 18% from approximately $1.2 billion in 2016 to approximately $977 million in 20188 while adjusted EBITDA margins remained within a range of approximately 20% to 22%. Negative net cash flow from 2016 to 2018 was approximately $80 million.

In other words, this is as clear-cut a balance sheet restructuring that you can get. Indeed, general unsecured claims are — as you might expect from a prepackaged plan of reorganization — riding through unimpaired. This consensual restructuring is clearly the right result. Getting it in and out of court so quickly is a bonus.


WANT TO SEE THE REST? THAT EDGE IS JUST ON THE OTHER SIDE OF THIS LINK. DISCOVER MORE WITH PETITION.

💥Sycamore Partners is a B.E.A.S.T. Part I.💥

🔥Rinse Wash & Repeat (Long Sycamore Partners)🔥

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Sycamore Partners is a private equity firm that specializes in retail and consumer investments; it “partner[s] with management teams to improve the operating profitability and strategic value of their businesses.” Back in the summer of 2017, Sycamore Partners acquired Massachusetts-based office retailer Staples Inc. for $6.9b — a premium to the company’s then-trading price but a significant discount from its 2014 high. Your office supplies, powered by private equity! The acquisition occurred shortly after Staples ran afoul of federal regulators who prevented Staples from acquiring Florida-based Office Depot Inc. ($ODP)(which, itself, appears to just trudge along).

Sycamore’s reported thesis revolved around Staples’ delivery unit, a B2B supplier of businesses. Accordingly, per Reuters:

Sycamore will be organizing Staples along three lines: its stronger delivery business, its weaker retail business and its business in Canada, two sources familiar with the deal said. This structure will give Sycamore the option to shed Staples’ retail business in the future, one of the sources said.

The retailer had 1255 US and 304 Canadian stores at the time of the deal. The business reportedly had 48% of the office supply market, generating $889mm of adjusted free cash flow in 2016.

*****

Fast forward 18 months and, Sycamore is already looking to take equity out of the company. According to Bloomberg, the plan is for Staples to issue $5.2b of new debt ($3.2b in term loans and $2b of other secured and unsecured debt), which will be used to take out an existing $3.25b ‘24 term loan and $1b of 8.5% ‘25 unsecured notes (which Sycamore reportedly owns roughly $71mm or 7% of).* This is textbook Sycamore, so much so that it’s actually cliche AF — or as Dan Primack said, “…this sort of myopic greed gives ammunition to private equity’s critics.” Like this guy:

And this gal:

Talk about reputations preceding…

Anyway, here’s what the deal would look like once consummated:

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That $1b difference is the equity that Sycamore is taking out of the company. What does the company get in return? F*ck all, that’s what. Zip. Zero. Dan Primack also wrote:

Dividend recaps are a mechanism whereby private equity-owned companies issue new debt, and then hand proceeds over to the private equity firm (as opposed to using it to grow the business). Sometimes they don't matter too much. Sometimes they form leveraged anchors around a company's neck. (emphasis added)

Yup. That about sums it up. Here is Sycamore placing a leveraged anchor on…uh…improving “the strategic value” of Staples:

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This is the market reacting to Sycamore’s strategy for Staples:

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If the above GIF looks familiar, that’s because this is like the Taken series: Sycamore has a very particular set of skills. Skills it has acquired over a very long run. Skills that make them a nightmare for retailers like Staples. They look poised to deploy those particular skills over the course of a repetitive trilogy: the first chapter centered around Aeropostale. And here’s how that ended:

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The sequel was Nine West and this is how that ended:

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And, well, you get the point. Staples looks like it may be next to experience those very particular skills.

———

Okay, so the above was a bit unfair. In Aeropostale, the company went after Sycamore Partners hard, seeking to ding Sycamore, among others, for equitable subordination and recharacterization of their (secured) claims. Why? Well, Sycamore was not only the company’s term lender (to the tune of $150mm), but it was also a major equity holder with 2 board seats and the majority-owner of Aeropostale’s largest (if not, second largest) merchandise sourcer and supplier, MGF Sourcing Holdings Ltd.

NERD ALERT: for the uninitiated, equitable subordination is an equitable remedy that a bankruptcy court may apply to render justice or right some unfairness alleged by a debtor (or some other party in the shoes of the debtor, if applicable). It is generally VERY DIFFICULT TO WIN on this argument because the burden of proof is on the movant and there are multiple factors and subfactors that the accuser needs to satisfy — because, like, this is the law and so everything has a test, a sub-test, and a sub-sub-test and maybe even a sub-sub-sub-test. Judges love tests, sub-tests, and multi-pronged sub-tests. Three-prongs. Four-prongs. Everywhere a prong prong. Just take our word for it. It’s true.

Recharacterization is another equitable remedy that, if satisfied and granted by the court, would have resulted in Sycamore’s $150mm secured term loan position being reclassified as equity. This is a big deal. This would be like Mike Trout being on the verge of winning the MVP and the World Series AND securing a $350mm 10-year contract only to, on the eve of all of that, get (a) caught partying with R. Kelly til six in the morning with enough PED needles lodged in his butt to kill a team of horses, (b) suspended from baseball, (c) exiled into an early retirement a la Alex Rodriguez or Barry Bonds, and (d) forced into personal bankruptcy like Latrell Sprewell or Antoine Walker. Or, more technically stated, since secured debt is way higher in “absolute priority” than equity, this would instantaneously render Sycamore’s position worthless and juice the potential recovery of unsecured creditors. Then there is the practical side: for this remedy to apply, the bankruptcy court would have to make a “finding” that prong after prong has been satisfied and issue an order saying you’re the shadiest m*therf*cker on the planet because you’re actually dumb and careless enough to have met all of the prongs. So, as you might imagine, this is pretty much the worst case scenario for any secured party in bankruptcy and a career ender for the poor schmo who orchestrated the whole thing.

In Aeropostale, the Debtors argued that Sycamore and its proxy MGF engaged in inequitable conduct prior to Aeropostale’s filing, including (a) breach of contract, (b) “a secret and improper plan to buy Aeropostale at a discount” and (c) improper stock trading while in possession of material non-public information. This one had the added drama of arch enemies Kirkland & Ellis LLP (Sycamore) and Weil Gotshal & Manges LLP (Aeropostale) duking it out to the ego-extreme. Just kidding: this was all about justice! 😜

Anyway, there was a trial with fourteen testifying witnesses over eight presumably PAINFUL days that, in a nutshell, went like this:

WEIL GOTSHAL: “Sycamore are a bunch of conspiratorial PE scumbags who ran this company into the ground, your Honor!

JUDGE LANE: “Not credible. Good day, sir. I said GOOD DAY!

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KIRKLAND & ELLIS/SYCAMORE:

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In the end, Sycamore fared pretty well. They got nearly a full recovery** and releases under the plan of reorganization. Relatively speaking, the company also fared well. It didn’t liquidate.*** Instead, two members of the official committee of unsecured creditors — GGP and Simon Property Group ($SPG)— formed a joint venture with Authentic Brands Group and some liquidators and roughly 5/8 of the stores survived — albeit as a shell of its former self and with heaps of job loss (improved strategic value!!). Sure, millions of dollars were spent pursuing losing claims but that’s exactly the point: when Sycamore is involved, they win**** and others lose.***** The extent of the loss is just a matter of degree.

———

Speaking of degrees, all the while Nine West was lurking in the shadows all like:

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WHOA. BOY. THIS ONE WAS A COMPLETE. AND UTTER. NEXT LEVEL. SH*TSHOW.

We’ve discussed Nine West at length in the past. In fact, it won our 2018 Deal of the Year! We suggest you refresh your recollection why (including the links within): it’s worth it. But what was the end result? We’ll discuss that and the (impressively) savage tactics deployed by Sycamore Partners therein in Part II, coming soon to an email inbox near you.

*At the time of this writing, the unsecured bonds last traded at $108.01 according to TRACE. This potentially gives Sycamore the added benefit of booking significant gains on the $71mm of unsecured notes in its portfolio.

**It’s unclear whether Sycamore recovered 100% but given that they got $130mm under the cash collateral order out of an approximately $160mm claim, it’s likely to have been close. Now, they did lose $53mm on AERO stock.

***A f*cking low bar, sure, but still. Have you seen what’s happening in these other retail cases?

****Putting aside nation-wide destruction, hard to blame LPs for investing in the fund. They get returns. Plain and simple. This ain’t ESG investing, people.

*****Sure, Weil “lost” its attempt to nail Kirkland…uh Sycamore…here but they got paid $15.3mm post-petition and $4.4mm pre-petition so that’s probably the best damn consolation prize we’ve ever heard of in the history of mankind. Weil has, to date, also avoided having a chapter 22 and liquidation in its stable of quals so there’s that too. In retail, you have to take the victories where you can get them.

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We (STILL) Have a Feasibility Problem (Long the “Two-Year Rule”)

Payless ShoeSource Files for Chapter 11. Again.

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Man. That aged poorly AF.

That’s one + two + three…yup, three total “success” claims and that’s just the heading, subheading and intro paragraph. EEESH. This has turned into the bankruptcy equivalent of Oberyn Martell taking a victory lap in the fighting pits of King’s Landing.

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And, sadly, it almost gets as cringeworthy:

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Of course, we obviously know now that the Payless story is about as ugly as Oberyn’s fate.

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Payless is back in bankruptcy court — a mere 18 months after its initial filing — adorning the dreaded Scarlet 22. It will liquidate its North American operations, shutter over 2000 stores, and terminate nearly 20k employees. All that will remain will be its joint venture interests in Latin America and its franchise business — a telltale sign that (a) the brick-and-mortar operation is an utter sh*tshow and (b) the only hope remaining is clipping royalty and franchise fee coupons on the back of the company’s supposed “brand.” And so we come back to this:

That’s right. We have ourselves another TWO YEAR RULE VIOLATION!!

Okay. We admit it. This is all a little unfair. We definitely wrote last week’s piece entitled, “💥We (Still) Have a Feasibility Problem💥,” knowing full-well — thanks to the dogged reporting of Reuters and other outlets — that a Payless Holdings LLC chapter 22 loomed around the corner to drive home our point. Much like Gymboree and DiTech before it, this chapter 22 is the culmination of an abject failure of epic proportions: indeed, nearly everything Mr. Jones stated in the press release reflected above proved to be 100% wrong.

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Let’s start, given a dearth of new financial information, with the most obvious factor here as to why this company has round-tripped into bankruptcy — destroying tons of value and irreversibly hurting retail suppliers en masse along the way. In the company’s financial projections attached to its 2017 disclosure statement, the company projected fiscal year 2018 EBITDA of $119.1mm (PETITION NOTE: we’d be remiss if we didn’t highlight the enduring optimism of debtor management teams who consistently offer up, and get highly-paid investment bankers to go along with, ridiculous projections that ALWAYS hockey stick up-and-to-the-right. Frankly, you could strip out the names and, in a compare and contrast exercise, see virtually no directional difference between the projected revenues of Payless and the actual revenues of Lyft. Seriously. It’s like management teams think that they’re at the helm of a high growth startup rather than a dying legacy brick-and-mortar retailer with sh*tty shoes at not-even-discounted-for-sh*ttiness prices.

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On what realistic basis on this earth did they think that suddenly — POOF! — same store sales would be nearly 10%.

Seriously. Give us whatever they’re smoking out in Topeka Kansas: sh*t must be lit. Literally.

So what did EBITDA actually come in at? Depending on which paragraph you read in the company’s First Day Declaration filed in support of the chapter 22 petition: negative $63mm or negative $66mm (it differs on different pages). For the mathematically challenged, that’s an ~$182mm delta. 🙈💩 “Outstanding leadership team,” huh? The numbers sure beg to differ.

This miss is SO large that it really begs the question: what the bloody hell transpired here? What is this dire performance attributable to? In its 2017 filing the company noted the following as major factors leading to its bankruptcy:

Since early 2015, the Debtors have experienced a top-line sales decline driven primarily by (a) a set of significant and detrimental non-recurring events, (b) foreign exchange rate volatility, and (c) challenging retail market conditions. These pressures led to the Debtors’ inability to both service their prepetition secured indebtedness and remain current with their trade obligations.

The company continued:

Specifically, a confluence of events in 2015 lowered Payless’ EBITDA by 34 percent—a level from which it has not fully recovered. In early 2015, the Debtors meaningfully over purchased inventory due to antiquated systems and processes (that have since undergone significant enhancement). Then, in February 2015, West Coast port strikes delayed the arrival of the Debtors’ products by several months, causing a major inventory flow disruption just before the important Easter selling period, leading to diminished sales. When delayed inventory arrived after that important selling period, the Debtors were saddled with a significant oversupply of spring seasonal inventory after the relevant seasonal peak, and were forced to sell merchandise at steep markdowns, which depressed margins and drained liquidity. Customers filled their closets with these deeply discounted products, which served to reduce demand; the reset of customer price expectations away from unsustainably high markdowns further depressed traffic in late 2015 and 2016. In total, millions of pairs of shoes were sold below cost in order to realign inventory and product mix. (emphasis added)

You’d think that, given these events, supply chain management would be at the top of the reorganized company’s list of things to fix. Curiously, in its latest First Day Declaration, the company says this about why it’s back in BK:

Upon emergence from the Prior Cases, the Debtors sought to capitalize on the deleveraging of their balance sheet with additional cost-reduction measures, including reviewing marketing expenses, downsizing their corporate office, reevaluating the budget for every department, and reducing their capital expenditures plan. Notwithstanding these measures, the Debtors have continued to experience a top-line sales decline driven primarily by inventory flow disruption during the 2017 holiday season, same store sales declines resulting in excess inventory, and challenging retail market conditions. (emphasis added).

Like, seriously? WTF. And it actually gets more ludicrous. In fact, the inventory story barely changed at all: the company might as well have cut and pasted from the Payless1 disclosure statement:

The Debtors also faced an oversupply of inventory in the fall of 2018 leading into the winter of 2019. As a result, the Debtors were forced to sell merchandise at steep markdowns, which depressed margins and drained liquidity. Customers filled their closets with these deeply discounted products, which served to reduce customer demand for new product. In total, millions of pairs of shoes were sold at below market prices in order to realign inventory and product mix. (emphasis added)

As if that wasn’t enough, the company also noted:

The delayed production caused a major inventory flow disruption during the 2017 Holiday season and a computer systems breakdown in the summer of 2018 significantly affected the back to school season, leading to diminished sales and same store sales declines.

Sheesh. Did the dog also eat the real strategy? Bloomberg writes:

The repeat bankruptcies are a sign the original restructuring may have been rushed through too quickly or didn’t do enough to solve the retailers’ industry-wide and company-specific problems.

And this quote, clearly, is dead on:

“One of the easiest ways to waste time and money in Chapter 11 is to use the process only to effect a change in ownership but not to take the time and protections afforded by the bankruptcy process to fix underlying operations,” Ted Gavin, a turnaround consultant and the president of the American Bankruptcy Institute, told Bloomberg Law. 

This begs the question: what did the original bankruptcy ACTUALLY accomplish? Apparently, it accomplished this pretty looking chart:

Screen Shot 2019-02-22 at 11.59.20 AM.png

And not a whole lot more.*

The company also failed to achieve another key strategic initiative upon which its post-bankruptcy business plan was based: investment in its stores and the deployment of omni-channel capabilities that, ironically, would make the company less dependent upon its massive brick-and-mortar footprint. Per the company:

…the Debtors’ liquidity constraints prevented the Debtors from investing in their store portfolio to open, relocate, or remodel targeted stores to keep up with competitors.

And:

Moreover, Payless was unable to fulfill its plan for omni-channel development and implementation, i.e., the integration of physical store presence with online digital presence to create a seamless, fully integrated shopping experience for customers. As of the Petition Date, the completion of this unified customer experience has been limited to approximately two hundred stores. Without a robust omni-channel offering, Payless has been unable to keep up with the shift in customer demand and preference for online shopping versus the traditional brick-and-mortar environment.

In other words “success” really means “still too much effing debt.” This would almost be funny if it didn’t tragically end with the termination of thousands of jobs of people who, clearly, mistakenly put their faith in a management team so entirely in over their heads. Literally nothing was executed according to plan. Nothing.

Seven months after emerging from bankruptcy the company was already in front of its lenders with its hand out seeking more liquidity. Which…it got. In March 2018, the company secured an additional $25mm commitment under the first-in-last-out portion of its asset-backed credit facility. What’s crazy about this is that, never mind the employees, the supplier community got totally duped again here. In the first case, the debtors extended their suppliers by ONE HUNDRED DAYS only for them, absent critical vendor status, to get nearly bupkis** as general unsecured claimants. Here, the debtors again extended their suppliers by as much as 80 days: the top list of creditors is littered with manufacturers based in Hong Kong and mainland China. Who needs Donald Trump when we have Payless declaring a trade war on China twice-over? (PETITION NOTE: we know this is easier said than done, but if you’re a supplier to a retailer in today’s retail environment, you need to get your sh*t together! Pick up a newspaper for goodness sake: how is it that the entire distressed community knows that a 22 is coming and yet you’re extending credit for 80-100 days? It’s honestly mind-boggling. The company cites over 50k total creditors (inclusive of employees) and $225mm of unsecured debt. That’s a lot of folks getting torched.)

Some other notes about this case:

Liquidators. Much like with Things Remembered and Charlotte Russe, they mysteriously have bandwidth again such that they no longer need to JV up as a foursome as they did in Gymboree. Instead, we’re back to the slightly-less-anti-competitive twosome of Great American Group LLC ($RILY) and Tiger Capital Group.

Kirkland & Ellis. There’s something strangely ironic here about the fact that the firm went from representing the company in the chapter 11 to representing its liquidators in the 22. Seriously. You can’t make this sh*t up.

Independent Directors. Here we go again. Remember: the Payless 11 led us to Nine West Holdings which led us to Sears Holding Corp. ($SHLD). We have documented that whole string of disasters here. In the first case, Golden Gate Capital and Blum Capital got away with two separate dividend recaps totaling millions of dollars in exchange for a piddling $20mm settlement. Moreover, to incrementally increase the pot for general unsecured creditors, senior lenders had to waive their deficiency claims that would have otherwise diluted the unsecured pool and made recoveries even more insubstantial. So, here we are again. Two new independent directors have been appointed to the board and they will investigate whether controlling shareholder Alden Capital Management pillaged this company in a similar way that it has reportedly and allegedly pillaged newspapers across the country.***

Fees. If you want to quantify the magnitude of this travesty, note that the first Payless chapter 11 earned the following professionals the following approximate amounts:

  • Kirkland & Ellis LLP = $4.995mm

  • Armstrong Teasdale LLP = $495k

  • Guggenheim Securities LLC = $6.825mm

  • Alvarez & Marsal = $1.9mm

  • Munger Tolles = $898k

  • Pachulski Stang Ziehl & Jones LLP (as lead counsel to the UCC) = $2.5mm

  • Province Inc. = $2.6mm

  • Michel-Shaked Group = $560mm

Now THAT was money well spent.****


*Via three separate store closing motions, the company shuttered 686 stores. The second store closing motion proposed 408 store closures but was later revised downward to only 216.

**Unsecured creditors received their pro rata share of two recovery pools in the aggregate amount of $32.3mm, $20mm of which came from the company’s private equity sponsors as settlement of claims stemming from two pre-petition dividend recapitalization transactions. In exchange, the private equity firms received releases from potential liability (without having to admit any wrongdoing).

***Alden Global Capital is no stranger to controversy over its media holdings. In the same week it finds itself in bankruptcy court for Payless, Alden found itself in the news for its reported desire to buy Gannett. This has drawn the attention of New York Senator Chuck Schumer who expressed concerns over Alden’s “strategy of acquiring newspapers, cutting staff, and then selling off the real estate assets of newsrooms and printing presses at a profit.” 

***This is but a snapshot. There were several other professionals in the mix including, significantly, the real estate advisors who also made millions of dollars.

💰All Hail Private Equity💰

Private Equity Rules the Roost (Long Following the Money)

So, like, private equity is apparently a big deal. Who knew?

Readers of PETITION are very familiar with the growing influence, and impact of, private equity. We wouldn’t have juicy dramatic bankruptcies like Toys R UsNine West and others to write about without leveraged buyouts, excessive leverage, management fees, and dividend recapitalizations. Private equity is big M&A business. Private equity is also big bankruptcy business. And it just gets bigger and bigger. On both fronts.

The American Lawyer recently wrote:

Private equity is pushing past its pre-recession heights and it is not expected to slow down. Mergermarket states that the value of private equity deals struck in the first half of 2018 set a record. PricewaterhouseCoopers expects that the assets under management in the private equity industry will more than double from $4.7 trillion in 2016 to $10.2 trillion in 2025.

With twice as much dry powder to spend on deals, private equity firms will play a large role in determining the financial winners and losers of the Am Law 100 over the next five-plus years. It amounts to a power shift from traditional Wall Street banking clients and their preferred, so-called white-shoe firms to those other outfits that advise hard-charging private equity leaders.

Indeed, PE deal flow through the first half of the year was up 2% compared to 1H 2017:

In August, the American Investment Council noted that there was $353 billion of dry powder leading into 2018. No wonder mega-deals like Refinitiv and Envision Healthcare are getting done. But, more to the point, big private equity is leading to big biglaw business, big league. Say that five times fast.

The American Lawyer continues:

It is hard to find law firm managing partners who don’t acknowledge the attraction of private equity clients. Their deals act as a lure, catching work for a variety of practice groups: tax, M&A, finance and employee benefits. And lawyers often end up handling legal work for the very companies they help private equity holders buy. Then, of course, there is always the sale of that business. A single private equity deal for one of the big buyout firms can generate fees ranging from $1 million to $10 million, sources say.

“It’s kind of like there’s a perfect storm taking all those things into consideration that makes private equity a big driver in the success of many firms, and an aspirational growth priority in many more firms,” says Kent Zimmermann, who does law firm strategy consulting at The Zeughauser Group.

Judging by league tables that track deals (somewhat imperfectly, as they are self-reported by firms), Kirkland has a leading position in the practice. According to Mergermarket, the firm handled 1,184 private equity deals from 2013 through this June. Latham is closest with 609. Ropes & Gray handled 323, while Simpson Thacher signed up 319.

Hey! What about “catching work” for the restructuring practice groups? Why is restructuring always the red-headed step child? Plenty of restructuring work has been thrown off by large private equity clients. And Kirkland has dominated there, too.

Which would also help explain Kirkland’s tremendous growth in New York. Per Crain’s New York Business:

In just three years, Kirkland & Ellis has grown massively. The company, ranked 12th on the 2015 Crain's list of New York's largest law firms, has increased its local lawyer count by 61% to climb into the No. 4 spot.

Screen Shot 2018-10-07 at 8.25.31 PM.png

Much of that growth has come in its corporate and securities practice, where Kirkland's attorney count has nearly doubled in three years. The 110-year-old firm's expansion in this area is by design, said Peter Zeughauser, who chairs the Zeughauser Group legal consultancy.

"There aren't many firms like Kirkland that are so focused on strategy," Zeughauser said. "Their strategy is three-pronged: private equity, complex litigation and restructuring. New York is the heart of these industries, and Kirkland has built a lot of momentum by having everyone row in the same direction. They've been able to substantially outperform the market in terms of revenue and profit."

Kirkland's revenue grew by 19.4% last year, according to The American Lawyer, a particularly remarkable increase, given that it was previously $2.7 billion. Zeughauser has heard that a growth rate exceeding 25% is in the cards for this year. The firm declined to comment on whether that prediction will hold, but any further expansion beyond the $3 billion threshold will put Kirkland's performance beyond the reach of most competitors.

Screen Shot 2018-10-07 at 8.27.09 PM.png

Zeughauser, the consultant featured in both articles, thinks all of this Kirkland success is going to lead to law firm consolidation. Kirkland has been pulling top PE lawyers away from other firms. To keep up, he says, other firms will need to join forces — especially if they want to retain and/or draw top PE talent at salaries comparable to Kirkland. We’re getting PTSD flashbacks to the Dewey Leboeuf collapse.

As for restructuring? This growth applies there too — regardless of whether these outlets want to acknowledge it. Word is that 40+ first year associates started in Kirkland’s bankruptcy group recently. That’s a lot of mouths to feed. Fortunately, PE portfolio companies don’t appear to stop going bankrupt anytime soon. Kirkland’s bankruptcy market share, therefore, isn’t going anywhere. Except, maybe,…up.

That is a scary proposition for the competition. And those who don’t feast at Kirkland’s table — whether that means financial advisors or…gulp…judges.

*****

Apropos, on Monday, Massachusetts-based Rocket Software, “a global technology provider and leader in developing and delivering enterprise modernization and optimization solutions,” announced a transaction pursuant to which Bain Capital Private Equity is acquiring a majority stake in the company at a valuation of $2b.

Dechert LLP represented Rocket Software in the deal. Who had the private equity buyer? Well, Kirkland & Ellis, of course.

We can’t wait to see what the terms of the debt on the transaction look like.

*****

Speaking of Nine West, Kirkland & Ellis and power dynamics, we’d be remiss if we didn’t point out that a potential fight in the Nine West case has legs. Back in May, in “⚡️’Independent’ Directors Under Attack⚡️,” we noted that the Nine West official committee of unsecured creditors’ was pursuing efforts to potentially pierce the independent director narrative (a la Payless Shoesource) and go after the debtor’s private equity sponsor. We wrote:

In other words, Akin Gump is pushing back against the company’s and the directors’ proposed subjugation of its committee responsibility. They are pushing back on directors’ poor and drawn-out management of the process; they are underscoring an inherent conflict; they are highlighting how directors know how their bread is buttered. Put simply: it is awfully hard for a director to call out a private equity shop or a law firm when he/she is dependent on both for the next board seat. For the next paycheck.

Query whether Akin continues to push hard on this. (The hearing on the DIP was adjourned.)

The industry would stand to benefit if they did.

Well, on Monday, counsel to the Nine West committee, Akin Gump Strauss Hauer & Feld LLP, filed a motion under seal (Docket 717) seeking standing to prosecute certain claims on behalf of the Nine West estate arising out of the leveraged buyout of Jones Inc. and related transactions by Sycamore Partners Management L.P. This motion is the culmination of a multi-month process of discovery, including a review of 108,000 documents. Accompanying the motion was a 42-page declaration (Docket 719) from an Akin partner which was redacted and therefore shows f*ck-all and really irritates the hell out of us. As we always say, bankruptcy is an inherently transparent process…except when it isn’t. Which is often. Creditors of the estate, therefore, are victims of an information dislocation here as they cannot weigh the strength of the committee’s arguments in real time. Lovely.

What do we know? We know that — if Akin’s $1.72mm(!!) fee application for the month of August (Docket 705) is any indication — the committee’s opposition will cost the estate. Clearly, it will be getting paid for its efforts here. Indeed, THREE restructuring partners…yes, THREE, billed a considerable amount of time to the case in August (good summer guys?), each at a rate of over $1k/hour (nevermind litigation partners, etc.). Who knew that a task like “Review and revise chart re: debt holdings” could take so much time?🤔

Screen Shot 2018-10-14 at 12.05.17 PM.png

That’s a $10k chart. That chart better be AI-powered and hurl stats and figures at the Judge in augmented reality to justify the fees it took to put together (it’s a good thing it’s redacted, we suppose).

Speaking of fees it takes to put something together, this is ludicrous:

Screen Shot 2018-10-08 at 5.16.08 PM.png

The debtor has to pay committee counsel $100k for it to put together an application to get paid? For heaven’s sake. Even committee members should be up in arms about that.

And people wonder why clients are reluctant to file for bankruptcy.

*****

Speaking of independent directors, one other note…on the fallacy of the “independent” director in bankruptcy. Yesterday, October 9, Sears Holdings Corporation ($SHLD)announced that it had appointed a new independent director to its board. To us, this raised two obvious questions: how many boards can one human being reasonably sit on and add real value? At what point does a director run into the law of diminishing returns? Last we checked, it’s impossible to scale a single person.

But we may have been off the mark. One PETITION reader emailed us and asked:

The question you want to be asking is "what sham transaction that probably benefits insiders is the independent director being appointed to bless" or "what sham transaction that benefitted insiders is the independent director being appointed to "investigate" and find nothing untoward with?"

Those are good questions. Something tells us we’re about to find out. And soon.

Something also tells us that its no coincidence that the rise of the “independent fiduciary” directly correlates to the rise of fees in bankruptcy.

Tell us we’re wrong: petition@petition11.com.

More Shenanigans in Retail: Neiman Marcus Edition

Retail Schmetail (Long Shenanigans; Long Litigation-Based Investment)

Just when retail was starting to get boring, Neiman Marcus stepped up this week to provide some real entertainment for bond investors. Thanks Neiman Marcus!

First, lending an additional boost the now-popular narrative that the "#retailapocalypse story is over, the luxury department store retailer reported earnings on September 18 that reflected (i) a 2.3% increase in quarterly revenue YOY, (ii) a dramatically reduced Q4 net loss on a YOY basis, and (iii) an increase in adjusted EBITDA. For fiscal year 2018, it reported total revenues of $4.9 billion, a 4.9% increase YOY. Free cash flow was $122.6mm vs. negative $57.7mm last year. Online revenues were up 12.5% for the quarter and accounted for 35% of the overall business.

And that last bit is where the rubber meets the road. At the tail end of its press release, Neiman slipped in this doozy like a slickster:

Subsequent to the end of the fourth quarter, the Company effected an organizational change as a result of which the entities through which the Company operates the MyTheresa business now sit directly under Neiman Marcus Group, Inc., the Company’s ultimate parent entity. These entities were unrestricted, non-guarantor subsidiaries under the Company’s debt instruments. As a result of this change, going forward the financial results of the MyTheresa entities will no longer be included in the Company’s publicly reported financial statements. The change is not expected to meaningfully affect operations for Neiman Marcus or MyTheresa.

Indeed, the company’s term loan and bonds — part of its $4.7 billion debt stack — did trade down but it wasn’t due to misplaced optimism. Rather, it was more likely attributable to the fact that the company, in a Petsmart-PTSD-inducing maneuver, just significantly weakened the bondholder collateral package.

Per the Wall Street Journal:

Before the transfer of MyTheresa to the parent company, Neiman Marcus Group Inc., there was some anticipation that the retailer would use the MyTheresa shares to entice bondholders to swap their debt for bonds with a longer maturity.

“Some bondholders may have incorrectly assumed that the company would embark on a distressed debt exchange involving MyTheresa shares as collateral,” said Steven Ruggiero, an analyst at Pressprich & Co.

It appears so.

James Goldstein, a retail analyst at CreditSights, noted that proceeds from any sale could now go directly to the investment companies that control the Neiman parent company, with bondholders likely having no claim. The parent company is owned by Ares Management LP and the Canada Pension Plan Investment Board.

“MyTheresa was already in an unrestricted subsidiary, but the way it’s structured now proceeds of any sale of MyTheresa goes straight to sponsors’ pockets without having to deal with the bondholders,” Mr. Goldstein said.

For now, this is a (potential) win for pensioners and a loss for hedge funds holding the debt. And one such hedge fund was, shall we say, a wee bit nonplussed. On Friday September 21, Marble Ridge Capital LP sent a letter to the company’s board of directors (and subsequently issued a very public press release about said letter) stating:

"…what these transactions appear to be is an attempt to move the MyTheresa business beyond the reach of existing creditors sitting between the sponsors' equity and the valuable MyTheresa assets. Most troubling, we understand that Ares and CPPIB usurped this massive benefit and took the MyTheresa business for no consideration."

"Marble Ridge has reason to believe that the Company was insolvent at the time of the Transactions or was rendered insolvent thereby. The Company is the issuer and/or guarantor of at least $4.7 billion of indebtedness. Based on LTM EBITDA of $478.2 million, the Company's indebtedness prior to the Transactions implies nearly a 10x leverage multiple (far in excess of any of its peers). Moreover, a dividend or other form of a spinoff by an insolvent guarantor to its equity sponsors, for no consideration, has all the hallmarks of an intentional or constructive fraudulent transfer (or illegal dividend) and raises serious questions of breaches of duties of care and loyalty, with exposure for Ares and CPPIB, as controlling shareholders, and for the Company's board. As noted above, Marble Ridge also has concerns that the Transactions do not comply with the Indentures."

The Wall Street Journal had previously reported that:

Neiman Marcus hired Lazard Ltd. and Kirkland & Ellis last year for advice on how to restructure its debt.

Looks like they deployed some of that advice.

Asset Values Soar: Human Asset Values. (Long Inflation)

Asset values have been soaring off into the stratosphere to the point that even Warren Buffett is complaining about a dearth of reasonably-priced opportunities (hence his short dalliance with Uber?). The FED, meanwhile, is keeping tabs on inflation; perhaps the Fed ought to look no farther than the legal world. It is experiencing two forms of inflation this week.

First, Milbank Tweed Hadley & McCloy announced that it was raising first year associate salaries to $190k and generally all associate salaries between $10k-15k. Choice bit from The American Lawyer:

“Two years have now gone by, and there is cost-of-living increases and inflation,” Edelman said. “We want to signal to the market that we do want the best, and we’re willing to pay for the best, and we think after two years, an additional increase is appropriate.”

Inflation indeed. As one biglaw partner told us a year ago, a clear cut sign of a market top is when biglaw firms raise first year associate salaries. Well, then…let the recession commence!

Indeed, nothing says "good timing" (or income inequality) like a pay raise to know-nothing lawyers at a time when Toys R Us’ fees are front page news and mad-as-hell employees are picketing KKR's offices. Sometimes biglaw can be its own worst enemy. More:

Edelman said the change would not have “a material effect on firm finances,” adding that he didn’t expect partner capital contributions to change.

Right. Because with 500 associates, the extra $5 million in expense will surely be passed on to the clients. Get ready for a fee increase folks. That’s something worth singing about in court even.

Anyway, we’re not hating. After all, Milbank needs to incentivize people to go to law school AND choose them over several other biglaw firms. Why would anyone do that if they can make $40k/month as a social media influencer? Why would anyone do that if they can be “Running a $500,000 Retail Empire by iPhone?” Good and serious question. That is the competition these days.

*****

Second, Weil Gotshal & Manges LLP announced that, in an effort to incentivize lawyers to stay, partnership (and, for some, counsel position) will now be offered to lawyers that have been with the firm for a mere 7.5 years. Per the ABA Journal,

Weil, Gotshal & Manges hopes to improve associate retention by cutting the wait for partnership by two years. 

Except, those "partners" will be non-share partners making “fixed income” rather than receiving partner distributions. And, except, further,

Lawyers in the niche counsel category for specialty practices can remain there as long as they stay at the firm. Lawyers in the other category get, at most, three years in the position. During that time, they may be promoted to partner. Those who don’t make it will be transitioned out of the firm.

Hahaha. C’mon. So you’ll basically have 10.5 years to prove that you merit equity partner before they unceremoniously toss you out into the wilderness…uh, sorry…”transitioned.” You know, rather than 9.5 years. But that new title though!! Title inflation!!

Query: where did Weil get that idea from? (Cough, Kirkland & Ellis). What's that saying: imitation is the sincerest form of flattery? We guess they’re waiting 7.5 years before labeling someone a “partner” rather than 6 years so, uh, there’s that. Just what biglaw needs: more lawyers running around with an inflated sense of self.

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On point.

2018 Q1 Preliminary Review (Part 3: Financial Advisors)

In 2018 Q1 Preliminary Review (Long Duopolies = Long Kirkland & Weil), we noted the ongoing duopolistic slugfest between Weil Gotshal & Manges LLP and Kirkland & Ellis LLP with respect to company-side mandates. We subsequently noted in 2018 Q1 Preliminary Review (Part 2: Investment Banking) the following,

But then the question becomes, who benefits from this duopoly? In Q1 anyway, it appears that it was Evercore ($EVR) and PJT Partners ($PJT). The former was involved in three of the four Weil cases noted above; the latter in two of the four Kirkland & Ellis cases (as well as two other big Q1 deals, Bon-Ton Stores and Ascent Resources Marcellus Holdings LLC). Notably, Moelis & Co. ($MO) and Lazard Ltd. ($LAZ) were also company-side banker in 3 deals each in Q1. Read: relationships matter and it pays to be at the top of the duopolists’ list.

In the financial advisory world, no firm has worked those relationships for company-side mandates better than...to read this rest of this a$$-kicking commentary, you must be a Member.

2018 Q1 Preliminary Review (Part 2: Investment Banking)

In 🌑Trouble Brews in Coal Country🌑, we acknowledged a company-side duopoly, writing,

We wanted to answer this question: who is dominating the restructuring industry? Well, Captain Obvious: Kirkland & Ellis LLP and Weil Gotshal & Manges LLP.

We admit: we’re not surprised by this. We’ve been paying attention. In Q1 2018, Kirkland & Ellis LLP filed EXCO Resources Inc.PES Holdings LLCCenveo Inc.iHeartMedia Inc., and the Toys R Us “propco.” Weil Gotshal & Manges LLP filed Fieldwood Energy LLCTops Holdings II Corp.Claire’s Stores Inc. and Southeastern Grocers. That’s a meaningful and significant share of the large bankruptcy filings in the quarter. The industry is definitely a two-horse race when it comes to law firms and debtor filings. If we could long these firms, we would.

Subsequently in✌🏾Peace Out Nine West✌🏾, we added,

Last week in our preliminary Q1 report, we noted the slugfest transpiring between Weil Gotshal & Manges and Kirkland & Ellis LLP. Well, only one week into Q2 and Kirkland has thrown down the gauntlet by filing three cases: Nine West Holdings LLCVER Technologies and EV Energy. Savage.

We highlight this because, whether you’re an investor (and this is certainly not investment advice), a B-school student or law student, it is often very difficult to ascertain who is doing what in restructuring. The above ought to give you a better idea on the legal side.

But then the question becomes, who benefits from this duopoly?

To read this rest of this a$$-kicking commentary, you must be a Member...

Nine West Finally Bites It

Another Shoe Retailer Strolls into Bankruptcy Court

A few weeks back, we wrote this in “👞UGGs & E-Comm Trample Birkenstock👞,”

“Mere days away from a Nine West bankruptcy filing, we can’t help but to think about how quickly the retail landscape is changing and the impact of brands. Why? Presumably, Nine West will file, close the majority of - if not all of - its brick-and-mortar stores and transfer its brand IP to its creditors (or a new buyer). For whatever its brand is worth. We suppose the company’s lenders - likely to receive the company’s IP in a debt-for-equity swap, will soon find out. We suspect ‘not a hell of a whole lot’.”

Now we know: $123 million. (Frankly more than we expected.)

Consistent with the micro-brands discussion above, we also wrote,

“Saving the most relevant to Nine West for last,

Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.

Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages. Query whether this factor will be featured in Nine West’s First Day Declaration with such specificity. Likely not.”

Now we know this too: definitely not.

But Nine West Holdings Inc., the well-known footwear retailer, has, indeed, finally filed for bankruptcy. The company will sell the intellectual property and working capital behind its Nine West and Bandolino brands to Authentic Brands Group for approximately $200 million (inclusive of the above-stated $123 million allocation to IP, subject to adjustment) and reorganize around its One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments. The company has a restructuring support agreement (“RSA”) in hand with 78% of its secured term lenders and 89% of its unsecured term loan lenders to support this dual-process. The upshot of the RSA is that the holders of the $300 million unsecured term loan facility will own the equity in the reorganized entity focused on the above-stated four brands. The case will be funded by a $247.5 DIP ABL which will take out the prepetition facility and a $50mm new money dual-draw term loan funded by the commitment parties under the RSA (which helps justify the equity they’ll get).

Regarding the cause for filing, the company notes the following:

“The unprecedented systemic economic headwinds affecting many brick-and-mortar retailers (including certain of the Debtors’ largest customers) have significantly and adversely impacted the operating performance of the Debtors’ footwear and handbag businesses over the past four years. The Nine West Group (and, prior to its sale, Easy Spirit®), the more global business, faced strong headwinds as the macro retail environment in Asia, the Middle East, and South America became challenged. This was compounded by a difficult department store environment in the United States and the Debtors’ operation of their own unprofitable retail network. The Debtors also faced the specific challenge of addressing issues within their footwear and handbag business, including product quality problems, lack of fashion-forward products, and design missteps. Although the Debtors implemented changes to address these issues, and have shown significant progress over the past several years, the lengthy development cycle and the nature of the business did not allow the time for their operating performance within footwear and handbags to improve.”

Regarding the afore-mentioned “macro trends,” the company further highlights,

“…a general shift away from brick-and-mortar shopping, a shift in consumer demographics away from branded apparel, and changing fashion and style trends. Because a substantial portion of the Debtors’ profits derive from wholesale distribution, the Debtors have been hurt by the decline of many large retailers, such as Sears, Bon-Ton, and Macy’s, which have closed stores across the country and purchased less product for their stores due to decreased consumer traffic. In 2015 and 2016, the Debtors experienced a steep and unanticipated cut back on orders from two of the Debtors’ most significant footwear customers, which led to year over year decreases in revenue of $16 million and $46 million in 2015 and 2016, respectively. These troubles have been somewhat offset by e-commerce platforms such as Amazon and Zappos, but such platforms have not made up for the sales volume lost as a result of brick-and-mortar retail declines.”

No Allbirds mention. Oh well.

But wait! Is that a POSITIVE mention of Amazon ($AMZN) in a chapter 11 filing? We’re perplexed. Seriously, though, that paragraph demonstrates the ripple effect that is cascading throughout the retail industrial complex as we speak. And it’s frightening, actually.

On a positive note, The One Jeanswear Group, The Jewelry Group, the Kasper Group, and Anne Klein business segments, however, have been able to “combat the macro retail challenges” — just not enough to offset the negative operating performance of the other two segments. Hence the bifurcated course here: one part sale, one part reorganization.

But this is the other (cough: real) reason for bankruptcy:

Source: First Day Declaration

Source: First Day Declaration

Soooooo, yes, don’t tell the gentlemen mentioned in the Law360 story but this is VERY MUCH another trite private equity story. 💤💤 With $1.6 billion of debt saddled on the company after Sycamore Partners Management LP took it private in 2014, the company simply couldn’t make due with its $1.6 billion in net revenue in 2017. Annual interest expense is $113.9 million compared to $88.1 million of adjusted EBITDA in fiscal year 2017. Riiiiight.

A few other observations:

  1. Leases. The company is rejecting 75 leases, 72 of which were brick-and-mortar locations that have already been abandoned and turned over to landlords. Notably, Simon Property Group ($SPG) is the landlord for approximately 35 of those locations. But don’t sweat it: they’re doing just fine.

  2. Liberal Definitions. As Interim CEO, the Alvarez & Marsal LLC Managing Director tasked with this assignment has given whole new meaning to the word “interim.” Per Dictionary.com, the word means “for, during, belonging to, or connected with an intervening period of time; temporary; provisional.” Well, he’s been on this assignment for three years — nearly two as the “interim” CEO. Not particularly “temporary” from our vantage point. P.S. What a hot mess.

  3. Chinese Manufacturing. Putting aside China tariffs for a brief moment, if you're an aspiring shoe brand in search of manufacturing in China and don't know where to start you might want to take a look at the Chapter 11 petitions for both Payless Shoesource and Nine West. A total cheat sheet.

  4. Chinese Manufacturing Part II. If President Trump really wants to flick off China, perhaps he should reconsider his (de minimus) carried interest restrictions and let US private equity firms continue to run rampant all over the shoe industry. If the recent track record is any indication, that will lead to significantly over-levered balance sheets borne out of leveraged buyouts, inevitable bankruptcy, and a top 50 creditor list chock full of Chinese manufacturing firms. Behind $1.6 billion of debt and with a mere $200 million of sale proceeds, there’s no shot in hell they’d see much recovery on their receivables and BOOM! Trade deficit minimized!!

  5. Yield Baby Yield! (Credit Market Commentary). Sycamore’s $120 million equity infusion was $280 million less than the original binding equity commitment Sycamore made in late 2013. Why the reduction? Apparently investors were clamoring so hard for yield, that the company issued more debt to satisfy investor appetite rather than take a larger equity check. Something tells us this is a theme you’ll be reading a lot about in the next three years.

  6. Athleisure & Casual Shoes. The fleeting athleisure trend took quite a bite out of Nine West’s revenue from 2014 to 2016 — $36 million, to be exact. Jeans, however, are apparently making a comeback. Meanwhile, the trend towards casual shoes and away from pumps and other Nine West specialties, also took a big bite out of revenue. Enter casual shoe brand, GREATS, which, like Allbirds, is now opening a store in New York City too. Out with the old, in with the new.

  7. Sycamore Partners & Transparency in Bankruptcy. Callback to this effusive Wall Street Journal piece about the private equity firm: it was published just a few weeks ago. Reconcile it with this statement from the company, “After several years of declines in the Nine West Group business, part of the investment hypothesis behind the 2014 Transaction was that the Nine West® brand could be grown and strong earnings would result.” But “Nine West Group net sales have declined 36.9 percent since fiscal year 2015—from approximately $647.1 million to approximately $408 million in the most recent fiscal year.” This is where bankruptcy can be truly frustrating. In Payless Shoesource, there was considerable drama relating to dividend recapitalizations that the private equity sponsors — Golden Gate Capital Inc. and Blum Capital Advisors — benefited from prior to the company’s bankruptcy. The lawsuit and accompanying expert report against those shops, however, were filed under seal, keeping the public blind as to the tomfoolery that private equity shops undertake in pursuit of an “investment hypothesis.” Here, it appears that Sycamore gave up after two years of declining performance. In the company’s words, “Thus, by late 2016 the Debtors were at a crossroads: they could either make a substantial investment in the Nine West Group business in an effort to turn around declining sales or they could divest from the footwear and handbag business and focus on their historically strong, stable, and profitable business lines.” But don’t worry: of course Sycamore is covered by a proposed release of liability. Classic.

  8. Authentic Brands Group. Authentic Brands Group, the prospective buyer of Nine West's IP in bankruptcy, is familiar with distressed brands; it is the proud owner of the Aeropostale and Fredericks of Hollywood brands, two prior bankrupt retailers. Authentic Brands Group is led by a the former CEO of Hilco Consumer Capital Corp and is owned by Leonard Green & Partners. The proposed transaction means that Nine West's brand would be transferred from one private equity firm to another. Kirkland & Ellis LLP represented and defended Sycamore Partners in the Aeropostale case as Weil Gotshal & Manges LLP & the company tried to go after the private equity firm for equitable subordination, among other causes of action. Kirkland prevailed. Leonard Green & Partners portfolio includes David's Bridal, J.Crew, Tourneau and Signet Jewelers (which has an absolutely brutal 1-year chart). On the flip side, it also owns (or owned) a piece of Shake Shack, Soulcycle, and BJ's. The point being that the influence of the private equity firm is pervasive. Not a bad thing. Just saying. Today, more than ever, it seems people should know whose pockets their money is going in to.

  9. Official Committee of Unsecured Creditors. It’ll be busy going after Sycamore for the 2014 spin-off of Stuart Weitzman®, Kurt Geiger®, and the Jones Apparel Group (which included both the Jones New York® and Kasper® brands) to an affiliated entity for $600 million in cash. Query whether, aside from this transaction, Sycamore also took out management fees and/or dividends more than the initial $120 million equity contribution it made at the time of the transaction. Query, also, whether Weil Gotshal & Manges LLP will be pitching the committee to try and take a second bite at the apple. See #8 above. 🤔🤔

  10. Timing. The company is proposing to have this case out of bankruptcy in five months.

This will be a fun five months.

Q1 2018 Preliminary Review

Long Duopolies = Long Kirkland & Ellis & Weil Gotshal & Manges

As we think about duopolies today, Google ($GOOGL) and Facebook ($FB) come to mind. The two large companies - recent controversies notwithstanding - represent a significant amount of annual ad revenue generation and have increasingly siphoned off market share and revenue from other advertising mediums; in other words, they have dominated the advertising industry. But this isn’t the kind of duopoly that we’re focused on today.

Over last week’s brief holiday respite, we set out to examine restructuring activity in Q1 2018. We wanted to answer this question: who is dominating the restructuring industry? Well, Captain Obvious: Kirkland & Ellis LLP and Weil Gotshal & Manges LLP.

We admit: we’re not surprised by this. We’ve been paying attention. In Q1 2018, Kirkland & Ellis LLP filed EXCO Resources Inc., PES Holdings LLC, Cenveo Inc., iHeartMedia Inc., and the Toys R Us “propco.” Weil Gotshal & Manges LLP filed Fieldwood Energy LLC, Tops Holdings II Corp., Claire’s Stores Inc. and Southeastern Grocers. That’s a meaningful and significant share of the large bankruptcy filings in the quarter. The industry is definitely a two-horse race when it comes to law firms and debtor filings. If we could long these firms, we would.

But, there are some changes afoot. Quintessential creditor-side firms are encroaching on the debtor shops and vice versa. Milbank Tweed Hadley & McCloy LLP filed Remington Outdoor Company and Akin Gump Strauss Hauer & Feld LLP filed Rand Logistics Inc. and FirstEnergy Solutions Corp. In turn, Weil Gotshal & Manges LLP seems to be positioning itself to take a chunk of revenue out of other firm’s debtor-side deals where it can — by sitting in other seats at the table. Weil represents both the potential buyer and the private equity sponsors in iHeartMedia Inc. and the ad hoc first lien group in Cobalt International Energy. Said another way, while Akin and Milbank are no longer creditor-only shops, Weil is no longer a debtor-shop only.

Getting even more granular, Weil Gotshal - along with Evercore Group LLC ($EVR) and FTI Consulting Inc. ($FTI) - have dominated the beleaguered grocery space. After working on the A&P Chapter 22 (which, for all three firms, was a round trip), the trifecta secured both Tops’ and Southeastern’s chapter 11 filings.

Meanwhile, DLA Piper LLP seems to be securing a foothold in the healthcare space. It was involved in Adeptus Health last year and recently filed Orion Healthcare Corp. and 4 West Holdings LLC. This is a firm to watch as people suspect more healthcare flow on the horizon.

🌑Trouble Brews in Coal Country🌑

Enter FirstEnergy, MurrayEnergy & Westmoreland

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Earlier this week we posted our brief summary of FirstEnergy Solutions Corp’s chapter 11 bankruptcy filing on our free website. We wrote,

The issue, though, is whether the rejection of the nine PPAs will cause disruption to the continued supply of wholesale electricity or impact the reliability of the transmission grid in the regional transmission organization that governs FES and FG. That generally means YOUR electricity - if you live in the Northeast. Naturally, the debtor argues it won't. The federal government may think otherwise. And this is precisely why the company filed an action seeking a declaratory judgment and injunction against the Federal Energy Regulatory Commission ("FERC") to prevent the feds from hindering -- on the basis of the Federal Power Act -- the company's attempts to reject the PPAs under the federal bankruptcy code. FERC regulates the wholesale power market. It is also why the company has filed a request for assistance from Rick Perry, President Trump's Energy Secretary. This is some real dramatic sh*t folks: a conflict between federal statutes with efforts for executive branch intervention. Someone dial up Daniel Day-Lewis and bring him out of retirement: this could be the next "Lincoln." 

Hyperbolic as that may be, this bankruptcy filing does, indeed, put the President in an odd spot. FirstEnergy has asked President Trump to intervene under his purported “202(c) emergency authority” under the Federal Power Act by compelling the nation’s largest electric grid operator, PJM Interconnection LLC, to deploy power from FirstEnergy’s coal and nuclear units in priority before any other power provider. The main argument is that too much reliance on natural gas, a volatile commodity, could create a natural security risk. And in the absence of intervention — or a sale to another entity — FirstEnergy will close its nuclear plants by 2021 heightening that risk. Proponents of intervention argue that, in addition to avoiding national security risks, thousands of nuclear and coal-related jobs would be saved — at FirstEnergy and further down the stack.

Apropos, Murray Energy Corp., a coal supplier to FirstEnergy, has sent a number of high profile letters to the Trump Administration advocating the use of 202(c) powers. In a letter dated August 17, 2017, Robert Murray wrote about the prospect of FirstEnergy filing for chapter 11,

"Their bankruptcy will force Murray Energy Corporation into immediate bankruptcy, terminating our 6,500 coal mining jobs. Each of our coal mining jobs spins off up to eleven (11) more jobs in our coal mining communities, according to university studies. This would be a disaster for President Trump and for our coal miners and employees."

Mr. Murray continued,

"Absent immediate action to preserve these power plants, many thousands of jobs in Ohio, West Virginia and elsewhere will be at dire risk. In addition, the risk to the grid and national security will reach a level that is unacceptable. You fully understand the war on coal that was waged during the previous Administration and you have taken steps to end that war and provide for a potential future once again for coal. But the wounds from that war have not healed and the future of coal is dependent upon surviving the present. As more plants shut down, the future of coal becomes bleaker and bleaker. The storm is here and we will suffer significant harm if the Secretary fails to take emergency action. Not only are coal jobs at risk, but nuclear jobs are also at risk as well as the nuclear infrastructure in the United States that is vital to our global nuclear dominance."

Shall we commence the Murray Energy Corp. bankruptcy countdown? 🤔🤔

Opponents call this whole scheme a big “bailout” and note that intervention on behalf of higher-cost fossil-based power will lead to increased prices for the end user — companies and consumers across a bunch of states.

*****

Elsewhere in coal land, Colorado-based Westmoreland Coal Company ($WLB) reported its fourth quarter and full year 2017 financial results on Monday, April 2. The company has U.S. coal operations in Montana, Wyoming, North Dakota, Texas, New Mexico and Ohio; it also has operations in Alberta and Saskatchewan Canada. While certain EBITDA metrics — primarily US-based results — surprised minimally to the upside, the overall results aren’t good enough given revenue declines, a large debt load and macro coal sales trends.

In the US, consolidated EBITDA was up 18% YOY in Q4 and 2% YOY for the fiscal year. In Canada, consolidated EBITDA was down 41% YOY in Q4 and up 2% YOY for the fiscal year. Finally, in its “Coal - MLP” segment (which governs Ohio operations), consolidated EBITDA was down 25% YOY in Q4 and down 13% YOY for the fiscal year. Here, according to the company’s recent 10-K filing, is a snapshot of coal tons sold from 2015-2017 for the company’s US-based mines:

Source: Westmoreland 10-K

Source: Westmoreland 10-K

A pretty marked downward trends across most of the mines.

This, of course, makes it challenging for the company to service its capital structure. The company carries an $50 million untapped revolver (CIBC and East West Bank), $350 million of 8.75% secured notes due 2022 (US Bank NA), a $425 million secured term loan due 2020 (Bank of Montreal), a $125 million San Juan loan due 2020 (NM Capital Utility Corporation), and a $295 million WMLP term loan due in December 2018 (US Bank NA). For the math challenged, that is $1.075 billion of total debt.

Some other disturbing facts included in the filing:

  • #1 Risk Factor. “We may seek protection from our creditors under Chapter 11 of the United States Bankruptcy Code ("Chapter 11") or an involuntary petition for bankruptcy may be filed against us, either of which could have a material adverse impact on our business, financial condition, results of operations, and cash flows and could place our shareholders at significant risk of losing all of their investment in our shares.” Kirkland & Ellis LLP, Centerview Partners and Alvarez & Marsal North America LLC continue to advise the company. Yup, more Kirkland and Alvarez.

  • Going Concern Warning. The company’s auditor has issued an explanation that “the Company has a substantial amount of long-term debt outstanding, is subject to declining industry conditions that are negatively impacting the Company’s financial position, results of operations, and cash flows, and has stated that substantial doubt exists about the Company’s ability to continue as a going concern“. This constitutes a breach of the company’s revolver covenants and its San Juan term loan. Currently there is a waiver in place with respect to the potential event of default and this, in turn, has kept potential cross-defaults under the company’s term loan and senior notes at bay. Substantially all of the company’s debt is now classified as current. The waiver expires on May 15, 2018.

  • Competition for the publicly-traded WMLP segment ($WMLP). “WMLP's principal direct competitors are other coal producers, including but not limited to (listed alphabetically) Alliance Resource Partners, L.P., Alpha Natural Resources, CONSOL Energy, Foresight Energy, Hallador Energy Company, Murray Energy Corporation, Peabody Energy Corp., Rhino Resource Partners, L.P. and various other smaller, independent producers.” There are a number of familiar names there for those who have been following bankruptcy. Note, also, Murray Energy Corporation!

  • No CEO. “Westmoreland has suspended the search for a permanent Chief Executive Officer until the conclusion of the capital structure negotiations.” Must be having a hard time recruiting for this sh*tshow.

In summary, like a lot of its coal-producing competitors before it, Westmoreland looks effed.

*****

Earlier this week, Riccardo Puliti, the World Bank's global head of energy and extractives, indicated in a CNBC interview that coal reliance will dramatically decline in the next 30 years.

Given the FirstEnergy drama and Westmoreland’s current state of affairs, will President Trump have anything (more) to say about that?

Cenveo Inc. = Poster Child for Disruption

Envelope Manufacturer Succumbs to Technology. And Debt.

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As loyal PETITION readers know, our tagline is “Disruption, from the vantage point of the disrupted.” After its Chapter 11 bankruptcy last week, Cenveo Inc. may very well be the poster child for disruption.

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

And, yet, it sells a lot of product. In fiscal year ended December 31 2017, Cenveo generated gross revenue of $1.59 billion with EBITDA of $102.8mm. Those are real numbers. But so are those on the other half of the company’s balance sheet.

After years of acquisitions (16 between 2006 and 2013, representing a strategic shift from print-focus to envelope manufacturing), Cenveo has more than $1 billion of funded debt on its balance sheet and a corresponding $99.4mm in annual debt payment obligations (inclusive of cash and “principle” payments). That’s the problem with a lot of debt: eventually you’re going to have to pay it back. And the only way to do that is to have sustained and meaningful cashflows that are, hopefully, trending upwards rather than down. Therein lies the problem with Cenveo. As liquidity gets tight, a business may start getting a bit looser with payments, a bit less reliable. Savvy trade creditors sniff this from a mile away. With the company (very) publicly struggling under the weight of its balance sheet, vendors started hedging by contracting trade terms and de-risking; they start throwing off business to Cenveo’s competitors, further challenging Cenveo’s liquidity — to the tune of a net liquidity reduction of approximately $20mm. Initiate death spiral.

But, wait! There’s more. And it’s textbook disruption. Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo. More from the company,

“As society has become increasingly dependent on digital technology products such as laptops, smartphones, and tablet computers, spending on advertising and magazine circulation has eroded, resulting in an overall decline in the demand for paper products, and in-turn lowering reliance on certain of Cenveo’s print marketing business. In addition, there is generally a decline in supply of paper products in the industry, such that only a handful of paper mills control the majority of the paper supply. As a result, paper mills and other vendors that sell paper products have a large amount of leverage over their customers, including Cenveo. The overall decline in the paper industry combined with the diminished supply in paper products has led to overall decline in the industry, dramatically impacting Cenveo’s revenues.”

Consequently, the company has spent years trying to implement an operational restructuring (read: streamline operations and cut costs). The company adds,

“Faced with an industry in transformation, Cenveo, beginning in 2014, commenced a strategic review of a significant portion of its businesses and concluded that it needed to focus its portfolio on profitable segments that would be better-positioned to grow in the future and to divest non-core, unprofitable segments. To implement this strategy, between 2014 and 2017, Cenveo applied a number of broad-based cost savings and profitability initiatives, which included downsizing its workforce, reducing its geographic footprint, and divesting certain non-core business segments, which was designed to reduce costs, minimize the possible effect of decreased sales volume for underperforming product lines, and remain competitive.”

While the company notes that it currently employs nearly 5200 people in the US, it is clear that many people have lost their jobs. 100 people in Orchard Park, New York108 people in Exton, Pennsylvania112 people in the Twin Cities91 people in Portland, Oregon. You get the point. You should read theGlassdoor reviews for this company. The employees sound miserable. The comment board is riddled with critiques of management, allegations of squandering, tales of job cuts and no raises. Even sexual harassment. We can’t wait for the uproar over the inevitable Key Employee Incentive Plan.

So what now? The company claims it’s ready for the e-commerce age and that it can make a ton of money on package labels. Provided that it can shed its debt. Accordingly, the company engaged the holders of its first and second lien debt and was able to secure a (shaky?) restructuring support agreement (RSA) and a commitment of $290mm in financing. The RSA exhibits the company’s intent to equitize the first lien holders’ debt. Notably, Brigade Capital Management — representing over 60% of the second lien debt and a meaningful percentage of first lien debt — isn’t on board with the RSA and noted in a filing that the bankruptcy may be “more contentious and protracted than indicated” by the company. Indeed, they are already agitating against the company and certain insiders alleging, among other things, that the Burton family has received approximately $80mm of disclosed compensation between 2005 and 2016 that ought to be investigated. And that the RSA seeks to enrich the insiders with a generous post-reorg equity grant of 12%. In other words, this could get ugly. Fast.

We should also note that the company will also need to address its underfunded pensions (approximately $97.3mm) and 18 active collective bargaining agreements. Funding contributions for 2018 are over $10mm. The pension plan(s) cover 5700 retirees and 734 active employees. And so while sophisticated funds duke it out over valuation and the corresponding value of their claims/recoveries, thousands of employees and retirees will be left in the lurch. Yikes.

As you can see, disruption is hard. Silicon Valley types love to talk about their big revolutionary products and how they’re going to change the world. That sexy stuff gets CEOs on magazine covers. Cameos in Iron Man movies. And more. The attorney from Kirkland & Ellis LLP representing Cenveo used an IPad in court. Symbolic.

But there is a dark underbelly to disruption too. As new technologies come online and habits change, long-standing businesses like Cenveo falter. People lose jobs — or struggle one day at a time to keep them. People lose pensions they’d planned to live on. Hopefully the professionals who make money managing these elements in-court don’t lose sight of these factors and work hard to optimize efficiency in the process. And hopefully the engineers and disrupters take note of what their “big revolution” may mean for others. Cenveo is a great reminder.


 

Toys R Us Plan to Pay Execs Makes Waves

Toys R Us' Execs Seek Hefty Bonuses, Piss People Off

Happy holidays, ya'll. You're fired. In what should be a surprise to no one, Toys R Us isn't immune to store closures. In the first instance, it plans to close 25 UK-based locations. If you think the US won't see closures and/or consolidation of Toys/Babies shops, you're smoking some serious crack (as we've said before). Indeed, the company recently filed a motion establishing procedures to extend the time to deal with its non-residential real property leases. Buckle your seat belts, landlords. 

Speaking of smoking crack, the U.S. Trustee for the Department of Justice (UST) apparently thinks the company and its advisors have been at it with the good stuff; it went full-on Demi Moore with its vigorous objection to the company's mid-November motion to pay executives up to $32mm in bonuses if "Stretch" EBITDA targets are met (and slightly less upon achievement of a "Target" EBITDA level). These numbers - on the heels of millions of dollars of pre-bankruptcy bonuses paid to the very same executives - made their way through the mainstream (and not so mainstream) media and garnered some well-deserved outrage. PETITION NOTE: All of the sudden everyone is an executive compensation expert, it seems. To be fair, it is awfully counter-intuitive that the very same professionals at the helm when the ship hit Iceberg #1 need incentives to avoid Iceberg #2. Like, "eff you, guys, good luck getting a job elsewhere after this dumpster fire of a hot mess" seems to be the general public sentiment. But therein lies the push-pull bankruptcy dynamic. Switch out management now - while credit terms are non-existent, vendor/supplier relationships are strained, customers are nonplussed, competitors are champing at the bit, etc. - and its possible that, with the absence of institutional knowledge, the company could end up in even WORSE shape and stumble towards liquidation. And so this is where the Kirkland & Ellis LLP attorneys - all SEVEN of the partners listed on their filed papers - really earn their billing rate (a point we're guessing they hammer home whilst pitching management teams); they need to convince the Judge, the UST and, here, the public, that the lofty amounts they seek approval for derive value in return. And "value," here, is unequivocally a "going concern" business that can continue to employ people and contribute to the tax base. 

But, first, the company (and Kirkland) had to deal with the Official Committee of Unsecured Creditors (UCC), a fiduciary body that represents all similarly-situated unsecured creditors in the bankruptcy process (read: most vendors, suppliers, customers, employees). Late Friday night the UCC filed its "Statement" in response to the company's motion. The statement expresses support for the company's proposed plan but ONLY after the UCC negotiated various changes to the extent and timing of the compensation sought. The UCC states, "[t]he Committee recognizes the importance of maintaining strong employee morale and ensuring that management and employees are collectively working towards the common goal of a successful holiday season and a strong and viable reorganized company." So, now, per the UCC's agreement with the company (and subject, still, to the UST and the Court), ONLY $16mm and $21mm will be payable to executives if "Target EBITDA" and "Stretch EBITDA" goals, respectively, are met. And the timing of payment has been altered as well, deferring and pinning greater amounts to the consummation of a reorganization. The UCC continues, "This feature...is particularly important to the Committee in the absence of a plan support agreement or defined business plan for the case, and in the face of the distinct business pressures imposed on retail companies in chapter 11." In other words, the UCC is worried about enriching execs only to see the company liquidate. And, given the state of retail today, they damn well should be - particularly since, we assume, the UCC has insight into how the business fared on Black Friday and Cyber Monday. Marinate on that.   

Lastly, permit us to issue you your weekly reminder that DIP Lenders justify the $3+b loan to Toys R Us on, what we now dub, a "there must be one" basis. In other words, "there must be one" bigbox toy retailer. Just like there is, you know, for sports (Dick's Sporting Goods ($DKS)) and books (Barnes & Noble ($BKS)). So, how IS the "one" doing in books? Well, BKS reported earnings this past week and it wasn't pretty. Sales were down 7.9%, comps were down 6.3% and earnings per share continued to trend deeper into the negative. But have no fear: the company has a creative and revolutionary go-forward strategy: "place a greater emphasis on books." Yup, you read that right. 

That Escalated Quickly: Toys R' Us Continues to Fade...

Distressed Investors and Private Equity Owners Seemingly Surprised

People can't seem to get enough of it and so we'll lead again with...you guessed it...Toys R' Us. Let's warm you up with a brief history lessonLast week we speculated that supplier concerns were turning a stressed situation into a distressed situation. Looks like we may have been right. And so investors who may have been caught off guard are sending CDS coverage flying through the roof in an effort to hedge the value of rapidly declining debt holdings. Speaking of investors who may be worried...CMBS anyone? Now, rumors are that Alvarez & Marsal LLCand Prime Clerk LLC have been hired by the company to complement the previous retentions of Kirkland & Ellis LLP and Lazard Ltd. The smart money seems to think that that full array of professional retentions means a bankruptcy filing is IMMINENT. Alternatively, perhaps the public's newfound awareness of that full array of professional retentions means a bankruptcy filing is imminent. These things have a way of being self-fulfilling. Especially if vendors are paying attention. And it certainly seems like they are. Meanwhile, query what this all means for Vornado Realty Trust ($VNO). Sheesh. Anyway, we're old enough to remember when there was talk of an IPO

Geoffrey is on the Ropes: Toys R' Us is in Trouble

Private Equity Backed Retail is in the Dumps

"No Reason to Exist" - Restructuring Banker

Big news this week was CNBC's report that Toys R' Us hired Kirkland & Ellis LLP to complement Lazard ($LAZ) in a potential restructuring transaction.This was followed by an S&P downgrade (firewall). This is "Death by self-commoditization," someone said. Sure, that's part of it but the more obvious and immediate explanation is the $5+ billion of debt the company is carrying on its balance sheet (and the millions of dollars of annual interest payments). Which, naturally, quickly gets us to private equity: KKR ($KKR), Bain and Vornado Realty Trust ($VNO) own Toys R' Us and so some are quick to blame those PRIVATE EQUITY shops for YET ANOTHER retailer hitting the skids. Post-LBO, this company simply never could grow into its capital structure given (i) the power of the big box retailers (e.g., Walmart ($WMT) & Target ($TGT)) and (ii) headwinds confronting specialty brick-and-mortar retail today (yeah, yeah, blah, blah, Amazon). That said, the gravity of the near-term maturity, the company's current cash position, and the bond trading levels don't necessarily scream imminent bankruptcy. There must be more to this. Speculating here, but this could just be an international value grab. Alternatively, given the tremendous amount of blood in the (retail) waters, we're betting that suppliers are squeezing the company. Badly. Like very badly. And/or maybe the company is trying to scare its landlords into concessions. We mean, seriously, we're in September. And the company is talking about bankruptcy NOW? Mere months from peak (holiday) toy shopping? Strikes us as odd. Someone has an agenda here. 

On a positive note, we want to give the company some credit: it tried its best to control the narrative by releasing its list of must-have toys for the holidays on the same day the Kirkland news "leaked."

*For anyone taking notes, this is a genius stroke of business development by Lazard: pinpoint a potential distressed corporate candidate and then poach that company's Vice President of Corporate Finance. Power. Move. We dig it. 

Divided Recaps Under Attack in Payless Holdings Case

Niiiiiiiiiice. We're impressed that Reuters and Bloomberg both picked up on something that happens - or at least appears to happen - often in bankruptcy cases: a conflict. 

Here's the drill: the official committee of unsecured creditors (UCC) in the Payless Holdings LLC case filed an application seeking to employ The Michel-Shaked Group as expert consultants. The mandate included providing "expert consulting services and expert testimony regarding the Debtors' estates' claims relating to the pre-petition dividend recapitalizations and leveraged buyout, including solvency and capital surplus analysis." As a quick refresher, Payless' private equity overlords Golden Gate Capital and Blum Capital dividended themselves hundreds of millions of dollars of value via debt incurred - albeit under relatively low interest rates - on the company's balance sheet. The company's debt load - in addition to various other factors characteristic of retail players today - was a major factor in the company's eventual bankruptcy filing.

Payless Holdings LLC - through Munger Tolles & Olson LLP ("MTO") as counsel to "the independent director of the Debtors" - subsequently objected to the UCC's application. The independent director (the "ID") claimed that the application is, at a maximum, duplicative of the services to be rendered by another UCC professional and at a minimum, premature. Why premature? Well, because the ID is conducting, through MTO, his own investigation into the dividend recapitalization claims the company might have against the private equity firms. That investigation is ongoing. Having a simultaneous analysis runs the danger of not only being duplicative and premature but also hindering the Debtors' aggressive proposed timeline for emergence from bankruptcy. 

As loyal readers of PETITION know, we're big fans of the (shadiness of the) dividend recap and, as such, we really enjoyed Bloomberg's snark: "That's right, someone close to private equity is investigating private equity firms for doing a very private equity thing." To be clear, separate counsel at the direction of an independent director is investigating the private equity firms. But, close enough. 

Let's pull the thread. Payless' main counsel, Kirkland & Ellis LLP, does a ton of private equity work - including, upon information and belief, work for the private equity sponsors implicated here. According to its own retention application, K&E has been representing Payless since 2012 as general corporate counsel. The private equity transaction dates back to 2012. Curious. K&E began representing the Debtors in connection with restructuring matters in November 2016; its engagement letter is dated January 4, 2017. 

The ID presumably got his mandate because he has "served as an independent or disinterested director for various companies in financial distress and restructurings." Among his qualifications are four other current director engagements including iHeartMedia Inc. and Energy Future Intermediate Holding Company LLC. Recognizing that the recap might be at issue, the ID hired separate counsel shortly after joining the board in January 2017 - right around the same time that K&E got hot-and-heavy on the restructuring side (if the engagement letter date is any indication). 

So, to summarize, K&E and management have been working with the private equity owners for five years. During that time, the dividend recaps occurred. The ID came on board right around the same time that K&E's restructuring team got enmeshed with the company. The same ID has a board portfolio of 5 directorships, 60% of which are for companies that are using K&E as restructuring counsel as we speak. Meanwhile, we have to assume that the ID gets paid tens of thousand of dollars for each board mandate with, perhaps, some equity consideration thrown in for good measure. Defensively, the objection drops a nice little footnote to assure us all that the ID is truly independent:

From the Debtors' Objection to the Shaked Application.

From the Debtors' Objection to the Shaked Application.

Perhaps the benefit of the doubt ought to be given to the ID and approval of the Shaked application delayed until after the ID completes his investigation. After all, if he comes down against the private equity shops, the application is moot. On the flip side, well, he won't. Notably, the objection already lays the case that the company relied in its business judgment on the opinions of Duff & Phelps, which issued a solvency opinion and presentation at the time of the transaction(s). Naturally, the UCC won't believe it and will push, again, for this engagement. Presumably, the company will jam them with the "train has left the station" defense. The upshot: if we were litigating this on behalf of the UCC we would certainly call into question the actual "independence" of the investigation sooner rather than later and see if the Judge bites. If done tastefully and in a way that doesn't impugn the character of the ID (which we are in no way advocating), it will at least somewhat offset the impression the Debtors are leaving with the Duff & Phelps bit and plant the seed in the Judge's mind for consideration upon the results of the investigation.

The hearing on the matter was scheduled for May 31 but was subsequently pushed indefinitely. 

Professional-Services.ai

Short junior attorneys...the machines are coming for them. And, frankly, why shouldn't they come for attorneys at ALL levels? After all, are there situations where there is "overzealous advocacy and hyperactive legal efforts"? When there are "so many attorneys and their respective billings"? "When the hourly rates and amount of time billed are simply unreasonable"? "Staggering," in fact?  Suffice it to say, you won't see Weil filing any cases in Southern District of Iowa anytime soon (see below). Frankly, "overzealous advocacy and hyperactive legal efforts" seems like it could have just as easily applied to the pissing contest that was the equitable subordination claim in Aeropostale but who are we to judge a grudge match between Weil and Kirkland & Ellis (which the the latter convincingly won)? We were too busy popping popcorn and putting our feet up. Switching gears and looking elsewhere in changing labor markets, here's to wondering: is the "gig economy" working? And what becomes of those 89,000 lost retail jobs?

Speaking of retail jobs, it looks like the bankers have all of them. Now there's M&A noise around Neiman Marcus, which is heating up with Hudson's Bay sniffing around hard but trying to avoid assumption of Neiman's substantial debt-load. Meanwhile Nine West Holdings has hired Lazard to figure out its capital structure. Elsewhere in retail, Macy's ($M), Kohl's ($KSS), Nordstrom ($JWN) and J.C. Penney ($JCP) all reported earnings that looked like a dumpster fire and the stocks promptly got decimated. We're sure the bankers are salivating. And speaking of retailers with jacked-up debt (and bankers), GNC Holdings Inc. and its agent bankers JPMorgan reportedly attempted but ultimately failed to extend GNC's $1.13b loan by three years. Now GNC says it will use its "strong" free cash flow to fund ops and deal with its '18 maturity. This is an interesting story on many levels. First, there have been a TON of share buybacks in recent years (the public equivalent of a dividend recap - our favorite) and so it was only a matter of time before one of them bit an uncreative and misled -- uh, we mean, generous shareholder-minded - management team in the bum. Second, the "Amazon-effect" apparently applies to meatheads too with vitamin sales allegedly shifting online. Who knew Biff could function in an m-commerce world? Go Biff. Third, despite a variety of downward trending financials, GNC's loan is still trading at a tick below par and so the proposed transaction might have affected the lenders' yield metrics (hence the rejection). Which gets us to #4: with crappy loans like GNC's ticking up so far upward, most distressed players can't stop complaining about a dearth of opportunities to target: everything is priced to perfection. Sadly, everyone needs the yield wherever they can get it hoping (praying?) that when the going gets rough, they'll be the first to hit eject. No, no (rate-fueled) bubble to see here.  

The Phantom Menace

Apologies for the cringe-inducing Star Wars prequel reference. Hopefully your PTSD meds are within reach because that movie SUUUUUUUCKED...

That said, we can't help but to think that the concept of a "phantom menace" applies to Puerto Rico. See, on January 11th, the Puerto Rico government - now led by governor Ricky Rossello - announced the winner of the legal sweepstakes that played out down in the Commonwealth. Some big guns were, at one point or another, in the mix for the juicy and lucrative mandate representing the government in the restructuring of its debt-laden morass (and replacing Cleary Gottlieb Steen & Hamilton LLP). This includes the likes of Kirkland & Ellis LLP and Morrison & Foerster LLP, among others.

Given those heavy hitters, many seemed surprised by the Dentons US sleeper victory. This is not to take away from what is a fine firm and, by all accounts, a fine lawyer leading the project, Sam Alberts.  The team also includes Claude Montgomery, Jonathan Ballan and Michael Zolandz. The team brings some serious bona fides to the table with experience representing the retirees in Detroit, work with, among other clients, the PBGC and the FDIC. The team seems well-rounded to handle the various legal disciplines that will be called into play - public private partnerships, litigation, securities, securitization, contracting, healthcare, tax, and Puerto Rican law. The government also noted that the Dentons team is "notable" for its "vast experience in the areas of government finance and public policy." 

What absolutely NONE of the public announcements note is what sources tell PETITION is a major consideration that factored in Dentons favor. And that is the presence of none other than "Senior Advisor" Newt Gingrich, who is alleged to be a critical piece to this puzzle. See, back in 2015, Newt joined Dentons "Public Policy" practice. If only the PR government highlighted the importance of public poli...oh wait. Hmm.  

With the Trump administration taking root and a complex restructuring required, it stands to reason that an ambassador with deep ties to the administration could be helpful towards driving a resolution. But this seems very swamp-y. Just like Puerto Rico

Comeback Kids

Everyone loves a comeback. And Weil is most definitely back.

Post-Lehman and GM, Weil settled into a notable rut as Kirkland & Ellis and others stole market share and preeminence in the restructuring world. Though Kirkland & Ellis arguably remains the dominant player in the industry, Weil is swiftly climbing back up the ranks. How have they done it?

We're going to stay away from crediting any specific individuals here because it is difficult to say what is outside deal flow origination and what is platform-based. 

But one thing is clear: Weil has diversified its practice. Sure, debtor work - across an array of industries - remains its bread and butter and debtor work abounds: Golfsmith, Aeropostale Inc., Breitburn Energy Partners, Fairway, Halcon Resources, Basic Energy, American Gilsonite, Paragon Offshore, CHC Group, A&P, Vantage Drilling Company, and Chassix Holdings Inc. But now Weil is also doing lender, bondholder, and equityholder work as in Seventy-Seven Energy, Things Remembered, Aspect Software, Performance Sports Group and DirectBuy Holdings. And unsecured creditor committee work, e.g., SunEdison and Ultra Petroleum. Wait, what? Weil does UCC work now? 

It's not all sunshine, though. Last week, Weil's attempted confirmation of Paragon Offshore's plan of reorganization over the objection of crammed-up term lenders failed in a rare judicial recognition of the feasibility standard. Now exclusivity may be in danger. In Breitburn Energy Partners, equity holders (represented by Weil alumni) successfully argued for an equity committee over vehement Weil objection (in contrast, this week Kirkland & Ellis successfully defeated an equity holder attempt to form an official equity committee in C&J Resources). In Aeropostale, the Southern District of New York judge handily denied Weil's attempts to recharacterize and equitably subordinate Sycamore Partners' claims.  

As we near the end of 2016, PETITION offers a hearty congratulations to Weil: it's been a great year. 2017 appears promising too.