☁︎More Dark Clouds (Short Debt-Fueled Acquisition Sprees)☁︎

TierPoint LLC Gets a Beat Down from Moody’s

In “⛈A Dark "Cloud" on the Horizon⛈,” we noted, in the context of Fusion Connect Inc’s recent troubles ($FSNN), that not all cloud businesses are created equal. This week, another cloud-company, TierPoint LLC, came into view after Moody’s changed the company’s outlook to negative from stable. The private, Missouri-based company provides “colocation, cloud computing, backup and business continuity, managed security, firewall, and professional services,” creating an “Infrastructure-as-a-Service” stack for its customers in the education, energy, financial, healthcare, legal, manufacturing, retail and tech industries.

The company has been on an acquisition spree over the years, gobbling up data center company, Cosentry, data services provider, AlteredScale, and the data services business of Windstream Holdings in 2016. The company, by virtue of the Consentry deal, is a TA Associates Management LP portfolio company.

As you might imagine, with great acquisition sprees come great loads of debt. The company’s balance sheet sports a $700mm first lien term loan, a $220mm first lien revolver and a $220mm second lien term loan. Moody’s points to near-term challenges that might affect the company’s ability to delever including, among other things, “unexpected customer churn volatility in late 2017” proving difficult to overcome. Moreover, margins and growth are down, further complicating efforts to drive the debt leverage down — yes, down — to 7x.

Is Fairway Group Holdings Corp. Headed for Chapter 22?

We were tempted to just leave it alone at “yes,” but we’ll at least add what Moody’s had to say:

"Despite the lower debt burden following the company's emergence from bankruptcy in 2016, we believe Fairway's capital structure is unsustainable given weaker than anticipated operating performance and upcoming debt maturities," stated Moody's Vice President and lead analyst for the company, Mickey Chadha. "Fairway is facing an extremely promotional business environment, and with competitive openings in its markets expected to continue, the ability to improve profitability at a level sufficient to support the current capital structure looks highly suspect, rendering a further debt restructuring highly likely in our estimation over the next 12-18 months," added Chadha.

Furthermore:

The ratings reflect elevated risk of another requisite debt restructuring or distressed exchange given Fairway's deemed untenable capital structure, evidenced in part by very weak credit metrics, weak and eroding liquidity, and upcoming debt maturities including a $25 million LC facility that matures October 2018 and more than $100 million (including PIK interest) of senior secured term loans that mature in January 2020. Moody's estimates lease adjusted debt-to-EBITDA in excess of 10 times, and EBIT-to-interest of less than 1.0 time over the next twelve months.

Remember: this company already shed $140mm of secured debt and $8mm in annual interest expense in the last bankruptcy a mere two years ago. In the company’s Disclosure Statement, company counsel Weil Gotshal & Manges LLP wrote:

Upon emergence from bankruptcy, all borrowings under the DIP Term Loan will be converted into an exit facility on a first out basis leaving an estimated $42 million of cash and cash equivalents on Fairway’s balance sheet that will allow it to maintain its operations and satisfy its obligations in the ordinary course of business and position Fairway for long term success.

Not to get ahead of ourselves here as Moody’s can surely be wrong. But, are we crazy or has the definition of “long term success” dramatically changed?

Which begs an interesting series of questions. First, at what point do professionals who have multiple chapter 22s attached to their names start to feel the affect of that in the marketplace? At what point do they get credibility checked on plan feasibility by judges at the confirmation hearing? “Mr. Lawyer ABC and Mr. Restructuring Advisor XYZ. Could you please explain why I should believe a thing you say about feasibility given that your last [insert applicable number here] grocery restructurings have all ended up back in bankruptcy court within short order? Have you properly guided your client to a truly ‘feasible long term success’ trajectory? Or are you really just succumbing to the wishes of stakeholders at the other side of the table (cough, GSO) whose business you hope to obtain in the future?

To be fair, we suppose if you service a monopoly of cases is a given sector and that sector is going to hell in a hand basket the way the grocery space is the likelihood of repeat bankruptcies goes up. Still, you’d think management teams (and/or the sponsors) would start to question the value of “quals” when those quals all ultimately result in an expensive round-trip ticket back to bankruptcy court.

🚗Where’s the Auto Distress? Part II (#MAGA!!)🚗

In “🚗Where's the Auto Distress?🚗,” we poked fun at ourselves and our earlier piece entitled “Is Another Wave of Auto-Related Bankruptcy Around the Corner?” because the answer to the latter has, for the most part, been “no.” But both pieces are worth revisiting. In the latter we wrote,

Production levels, generally, are projected to decline through 2021. Obviously, reduced production levels and idled plants portend poorly for a lot of players in the auto supply chain. 

And in the former we noted,

So, sure. Distressed activity thus far in 2018 has been light in the automotive space. But dark clouds are forming. Act accordingly.

And by dark clouds, we didn’t exactly mean this but:

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With a seeming snap-of-the-finger, Harley Davidson ($HOG) announced that it would move some production out of the US to Europe, where HOG generates 16% of its sales, to avoid EU tariffs on imported product. Per the Economist:

It puts the cost of absorbing the EU’s tariffs up to the end of this year at $30m-45m. It has facilities in countries unaffected by European tariffs that can ramp up relatively quickly.

Trump was predictably nonplussed, saying “don’t get cute with us” and this:

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AND this:

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More from the Economist:

AMERICAN companies “will react and they will put pressure on the American administration to say, ‘Hey, hold on a minute. This is not good for the American economy.’” So said Cecilia Malmström, the European Union’s trade commissioner, on news that Harley-Davidson plans to move some production out of America to avoid tariffs imposed by the EU on motorcycles imported from America.

Will react? Harley Davidson has reacted. Likewise, motorcycle-maker Polaris Industries Inc. ($PII) indicated Friday that it, too, is considering moving production of some motorcycles to Poland from Iowa on account of the tariffs. Per the USAToday:

In its first quarter earnings released in April, Polaris projected around $15 million in additional costs in 2018. Rogers said the latest tariffs would raise costs further, declining to estimate by how much. "But we're definitely seeing an increase in costs," she said.

General Motors Co. ($GM) also weighed in. Per Reuters:

The largest U.S. automaker said in comments filed on Friday with the U.S. Commerce Department that overly broad tariffs could "lead to a smaller GM, a reduced presence at home and abroad for this iconic American company, and risk less — not more — U.S. jobs."

Zerohedge noted:

The Auto Alliance industry group seized on the figure, arguing that auto tariffs could increase the average car price by nearly $6,000, costing the American people an additional $45 billion in aggregate.

Moody’s weighed in as well:

US auto tariff would be broadly credit negative for global auto industry. Potential US tariffs on imported cars, parts are broadly credit negative for the auto industry. The Commerce Department is conducting a review of whether auto imports harm national security. A similar probe resulted in 25% tariffs on imported steel and 10% on aluminum being implemented 1 June. A 25% tariff on imported vehicles and parts would be negative for most every auto sector group – carmakers, parts suppliers, dealers, retailers and transportation companies.

Relating specifically to Ford Motor Company ($F) and GM, it continued further:

US automakers would be negatively affected. Tariffs would be a negative for both Ford and GM. The burden would be greater for GM because it depends more on imports from Mexico and Canada to support US operations – 30% of its US unit sales versus 20% of US sales for Ford. In addition, a significant portion of GM's high-margin trucks and SUVs are sourced from Mexico and Canada. In contrast, Ford's imports to the US are almost exclusively cars — a franchise it is winding down. Both manufacturers would need to absorb the cost of scaling back Mexican and Canadian production and moving some back to the US. They would also probably need to subsidize sales to offset the tariffs for a time, with higher costs eventually passed on to consumers.

On the supply side, Moody’s continued:

Tariffs would also hurt major auto-parts manufacturers. The largest parts suppliers match automakers' production and vehicles and may struggle to adapt following any tariffs. Suppliers' efforts to keep cost down often result in multiple cross-border trips for goods and could incur multiple tariff charges. Avoiding those costs may disrupt the supply chain. Some parts makers have US capacity they could restart at a price. Companies with broad product portfolios, large market share, or that are sole suppliers of key parts will fare better.

And what about dealers and parts retailers? More from Moody’s:

Significant negative for US auto dealers, little change for parts retailers. Dealers heavily weighted toward imports (most of those we rate) will suffer. Penske Auto and Lithia would fare best. Many brands viewed as imports, such as BMW and Toyota, are assembled in the US, so there could be model shifting. Tariffs would be fairly benign for part retailers insulated by demand from the 260 million vehicles now on the road.

Upshot: perhaps its too early to give up on our predictions. Thanks to President Trump’s trade policy, there may, indeed, be auto distress right around the corner as big players adjust their supply chain and manufacturing models. Revenue streams are about to be disrupted.

Where’s the Auto Distress? (Short PETITION’s Prognistications)

Back in October, we asked “Is Another Wave of Auto-Related Bankruptcy Around the Corner?” The (free) piece is worth revisiting — particularly in light of Tesla’s recent travails. Among many other things, we wrote:

Supply Chain Distress. Last year we saw DACCO Transmission Parts Inc. file for bankruptcy. During the Summer, Takata Inc. filed for bankruptcy (on account of a massive liability, but still) and Jack Cooper Enterprises Inc., a finished-vehicle logistics/transportation provider, reached a consensual agreement with its noteholders that kept the company out of bankruptcy court. For now. Then, a little over a week ago, GST Autoleather Inc. filed for bankruptcy, citing declining auto output. Is this the canary in the coal mine? Hard to say. Literally on the same day that GST filed for bankruptcy - again, citing declining auto output - General MotorsFord and other OEMs reported the first YOY sales increase (10%), surprising to the upside. It seems, however, that the (sales) uptick may be artificial: in part, it's attributable to (a) Hurricane Harvey damage and mass vehicle replacement; and (b) heavy vehicle discounting. On a less positive note, Ford announced that it will be slashing billions in costs to shore up its financial condition; it also announced back in September that it would slash production at five of its plants. And General Motors Co. announced earlier this week that it would be idling a Detroit factory and cutting production. Production levels, generally, are projected to decline through 2021. Obviously, reduced production levels and idled plants portend poorly for a lot of players in the auto supply chain. 

But, with limited exception (like Nissan’s announcement this week that it would cut U.S. production by 20%), the auto world has been largely quiet since then. Another exception: International Automotive Components Group S.A., a Detroit-based interior parts manufacturer with 77 manufacturing plants worldwide, announced, in April, a new financing transaction through the issuance of $215 million of ‘23 second lien notes funded by Gamut Capital Management LP. Perhaps we just need to be more patient?

Rumblings abound around two more names that may be in more near-term trouble. First, American Tire Distributors’ suffered downgrades on the heels of the announcement that Goodyear Tire & Rubber Co. ($GT) opted to discontinue use of ATD as a distributor. Notably, GT’s stock, itself, is down 20% in the last year:

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Anyway, back to ATD. Per Crain’s Cleveland Business,

The news cratered the market value of ATD's $975 million of bonds and its $700 million term loan. S&P Global Ratings quickly cut the company's credit grade deeper into junk and Moody's followed suit, saying its capital structure was no longer sustainable.

Then, on May 9, the 800-pound gorilla entered the industry, as Amazon.com Inc. teamed up with Sears Holdings Corp. to allow customers to buy replacement tires online and have them installed at the troubled department store.

The moves signal radical changes in the replacement-tire market. Manufacturers are taking control of their own distribution, cutting out wholesalers like ATD, and along with retailers are developing their own internet capabilities to reach consumers directly, according to New York-based research firm CreditSights.

Ah, there it is: Amazon ($AMZN). Is a PETITION entry complete without the mandatory Amazon reference? Indeed, Moody’s noted,

“All else being equal, the magnitude of the associated earnings and cash flow decline will compound an already levered financial risk profile, rendering a pre-emptive debt restructuring increasingly likely, in our estimation.”

The Huntersville North Carolina company is a wholesale distributor of tires, custom wheels and other related auto equipment; it is a behemoth with $5.3 billion in revenues in 2017 and 140 distribution centers located across the U.S. and Canada. It also happens to have $1.8 billion of debt. The company is equally owned by private equity firms Ares Management LP and TPG Capital.

The debt — coupled with the loss of a major customer — is a big concern. More from Crain’s,

But ATD's capital structure is stretched tight, said Lawrence Orlowski, a director in corporate ratings at S&P. While the company has access to $465.4 million in asset-based lending facilities and $22.7 million in cash as of the end of 2017, even that liquidity may not be enough to stay solvent if ATD permanently loses Goodyear's business or if any other major tire makers pressure the company for concessions, according to Orlowski.

Something tells us (restructuring) advisors may be circling around trying to determine whether it can get together a group of the company’s term lenders.

*****

Second, Tweddle Group Inc., a The Gores Group-owned manufacturer of automotive owners’ manuals (that nobody ever reads) likewise suffered a disastrous blow when Fiat Chrysler Automobiles N.V. announced back in April that it was no longer using Tweddle’s services. Fiat reportedly accounted for 40% of Tweddle’s 2017 revenue and will be hard to replace. Consequently, Moody’s issued downgrades noting,

“The downgrades reflect a credit profile that is expected to be significantly weakened following Tweddle's loss of certain work from a key customer, and the resultant mismatch between the company's earnings and cash flow prospects and its now much more levered balance sheet.”

This reportedly put pressure on the company’s $225mm ‘22 first lien term loan and now the company reportedly has hired Weil Gotshal & Manges LLP for assistance. While it will likely take some time for the loss or revenue to trip any leverage ratios in the company’s credit agreement, this is a name to watch.

*****

Finally, Bloomberg New Energy Finance recently released its “Electric Vehicle Outlook 2018” report. Therein in noted that there are a variety of factors driving EV sales forward:

  • Lithium-ion battery prices have tumbled, dropping 79% in seven years. Meanwhile, the batteries’ energy density has improved roughly 5-7% per year.

  • Chinese and European policies are pushing fleet electrification.

  • Automakers are aggressively pushing the electrification of their fleets. Choice bit: “The number of EV models available is set to jump from 155 at the end of 2017 to 289 by 2022.”

Bloomberg notes:

Our latest forecast shows sales of electric vehicles (EVs) increasing from a record 1.1 million worldwide in 2017, to 11 million in 2025 and then surging to 30 million in 2030 as they become cheaper to make than internal combustion engine (ICE) cars.

Marinate on that for a second. That is a massive 10x increase in the next 7 years followed by an additional 3x increase in the following 5 years.

Bloomberg continues,

By 2040, 55% of all new car sales and 33% of the global fleet will be electric.

But what about President Trump (#MAGA!) and efforts to limit future alternatives subsidies?

The upfront cost of EVs will become competitive on an unsubsidized basis starting in 2024. By 2029, most segments reach parity as battery prices continue to fall.

So, sure. Distressed activity thus far in 2018 has been light in the automotive space. But dark clouds are forming. Act accordingly.

DO. NOT. MESS. WITH. DAISY. CHAPTER 2 of 3 (Short Pet Retailers) 🔫🔫

🐶 Petsmart Inc.: "Outlook Negative" 🐶 

On this day exactly one year ago, Recode first reported that Petsmart acquired Chewy.com for $3.35 billion — the “largest e-commerce acquisition ever.” Venture capitalists — and the founders — of course, rejoiced. This was an a$$-kicking exit — particularly for a company that, at the time, was only six years old. The reported amount of venture funding topped out at $451 million, a massive sum, but sufficiently low enough for the VCs to make a substantial return. Recode wrote,

“The deal is a huge one by any standard — bigger than Walmart’s $3.3 billion deal for Jet.com last year — and especially for a retail company like PetSmart, which was itself valued at only $8.7 billion when private equity investors took it over in 2015.

But Chewy.com has been one of the fastest-growing e-commerce sites on the planet, registering nearly $900 million in revenue last year, in what was only its fifth year in operation. The company had been a potential IPO candidate for this year or next, but was taken out by its brick-and-mortar competitor before that. It was not profitable last year.”

Recode continued,

“The deal seems like the type of bet-the-company acquisition by a traditional retailer that commerce-focused venture capitalists have been betting on for some time. While Walmart’s acquisition of Jet.com was a huge deal by e-commerce standards, it represented just a fraction of Walmart’s market value.”

Toss of the dice notwithstanding, most talking heads seemed to think that the acquisition made “strategic sense.” Nevertheless, Recode’s sentiment was more prescient than they likely suspected — mostly due to the havoc it has wreaked to Petsmart’s cap stack.

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

One year later, CEO Michael Massey is gone and hasn’t been replaced. More recently, Ryan Cohen, the CEO and co-founder of Chewy.com has departed. Blue Buffalo Pet Products Inc., which reportedly accounted for 11-12% of PetSmart’s sales, opted to supply its food products to mass-market retailers like Target ($T) and Kroger ($KR). The notes backing the Chewy.com deal are trading (and have basically, since issuance, traded) at distressed levels. Petsmart’s EBITDA showed a 34% YOY decline in Q3. And, worse even (for investors anyway), the bondholders are increasingly concerned about asset stripping to the benefit of the company’s private equity sponsors. S&P Global Ratings downgraded the company in December. It stated,

“The downgrade reflects our view that the capital structure is unsustainable at current levels of EBITDA, although we do not see a default scenario over the next year given liquidity and cash generation. Such underperformance came from the company's rapid e-commerce growth that generated higher losses, and unanticipated negative same-store sales at its physical stores. As Chewy aggressively expands its customer base, we believe operating losses will widen because the company has not yet garnered the size and scale to offset the unprofitable business volume from new customers.”

Financial performance and ratios were a big consideration: margin is compressed, in turn negatively affecting the company’s interest coverage ratio and leverage ratio (approximately 8.5x).

Moody’s Investor Service also issued a downgrade in January. It wrote,

“We still believe the acquisition of Chewy has the potential of being transformative for PetSmart as it will exponentially increase its online penetration which was previously very modest. However, as Chewy continues to grow its topline aggressively and incur increasing customer acquisition costs we expect its operating losses to increase. More importantly, the increasingly competitive business environment particularly from e-commerce and mass retailers has led to increased promotional activity which has negatively impacted PetSmart's top line and margins. We expect this trend to continue in 2018.”

Bloomberg adds,

“Buying Chewy.com was supposed to be a coup for PetSmart Inc. For debt investors who funded the deal, it’s been more like a dog.”

See what they did there?

With 1600 stores, the company isn’t light with its footprint and same store sales and pricing power are on the decline. Still, the company’s liquidity profile remains relatively intact and its services businesses apparently still drive foot traffic. Which is not to say that the situation doesn’t continue to bear watching — particularly if Chewy.com’s customer-acquisition-costs continue to skyrocket, overall brick-and-mortar trends continue to move downward, and the likes of Target ($T), Walmart ($WMT) and Amazon ($AMZN) continue to siphon off market share. A failure to stem the decline could add more stress to the situation.

*****

💥We’ll discuss Petco Holdings in “DO. NOT. MESS. WITH. DAISY. CHAPTER 3 of 3 (Short Pet Retailers 2.0) 🔫🔫🔫” in our Members’-only briefing on Sunday.💥