👜Retail May Get Marie Kondo'd👜

👠Marie Kondo is Coming to a First Day Declaration Near You (Long Thrift Shopping)👠

2019 has already been a rough year for retailBeauty Brands LLC, a Kansas City-based brick-and-mortar retailer with 58 stores in 12 states filed for chapter 11 bankruptcy in the first week of January. Then, last week, both Shopko (367 stores) and Gymboree (~900 stores) filed for chapter 11 bankruptcy — the former hoping to avoid a full liquidation and the latter giving up hope and heading straight into liquidation (it blew its first chance in bankruptcy). And, of course, there’s still Charlotte RusseThings RememberedPayless and others to keep an eye on.

All of this has everyone on high alert. Take this piece from The Wall Street Journal. Pertaining to J.C. Penney ($JCP) and Sears Holding Corporation ($SHLDQ), the WSJ notes:

J.C. Penney Co.’s sales are falling, its stores are stuck in malls and the turnaround strategy keeps changing. Now, three months after the embattled retailer hired a new chief executive, a handful of senior positions remain vacant.

The series of events is prompting analysts and other industry experts to question whether Penney can avoid the fate of fellow department-store operator Sears Holdings Corp., which filed for bankruptcy and barely staved off liquidation.

The Plano, Texas-based chain was once the go-to apparel retailer for middle-class families. It and Sears had once dominated American retailing but lost their customers, first to discounters like Walmart , then to fast-fashion retailers and off-price chains like T.J. Maxx. The shift to online shopping hastened their decline.

First, the Sears Holding Corporation ($SHLDQ) drama continues as the company heads towards a contested sale hearing in the beginning of February. To say that it “staved off liquidation” is, at this juncture, factually incorrect. While the company’s prospects have improved along with Mr. Lampert’s purchase offer, it is not a certainty that the company will be able to avoid liquidation. At least not until the Official Committee of Unsecured Creditors’ objection is overruled and the bankruptcy court judge blesses the Lampert deal. The sale hearing is slated for February 4.

Second, we were relieved to FINALLY see an article about retail that didn’t pin the blame solely at the feet of Amazon Inc. ($AMZN). As we’ve been arguing since our inception, the narrative is far more nuanced than just the “Amazon Effect.” To point, Vitaliy Katsenelson recently wrote in Barron’s:

Retail stocks have been annihilated recently, even though retail sales finished 2018 strong. The fundamentals of the retail business look horrible: Sales are stagnating, and profitability is getting worse with every passing quarter.

Jeff Bezos and Amazon.com get most of the blame, but this is only part of the story. Today, online sales represent only 8.5% of total retail sales. Amazon, at about $100 billion in sales, accounts only for 1.6% of total U.S. retail sales, which at the end of 2018 were around $6 trillion. In truth, the confluence of a half-dozen unrelated developments is responsible for weak retail sales.

He goes on to cite a shift in consumer spending to more expensive phones, more expensive phone bills, more expensive student loan bills and more expensive health care costs as contributors to retail’s general malaise (PETITION Note: yes, it appears that lots of things are getting more expensive. Don’t tell the FED.). More money spent there means less discretionary income for the likes of J.C. Penney. Likewise, he highlights the change in consumer habits. He writes:

We may not care about clothes as much as we may have 10 or 20 years ago. After all, our high-tech billionaires wear hoodies and flip-flops to work. Lack of fashion sense did not hinder their success, so why should the rest of us care about the dress code?

And:

Consumer habits have slowly changed, including the advent of rental clothes from companies like Rent the Runway and LeTote.

We’ve previously written extensively about the rental and resale wave. We wrote:

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

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

Lots of good charts here to bolster the point.

That wave just got a significant shot of steroids.

Earlier this month Netflix Inc. ($NFLX) debuted “Tidying Up with Marie Kondo,” a show that springs off of Ms. Kondo’s hit 2014 book, “The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organizing.” The news since is not too encouraging for retailers.

Per NPR, “Thrift Stores Say They’re Swamped With Donations After ‘Tidying Up with Marie Kondo’” (audio and audio transcript). Indeed, thrift stores like Goodwill are seeing an uptick in donations across the country (and Canada). The Wall Street Journal published a full feature predicated upon “throw a lot of sh*t out.”

Of course, all of this decluttering is an opportunity. Anna Silman writes in The Cut:

Well, congrats to all the people who have committed to the KonMari life and ridded themselves of the burden of their unwanted possessions, and who now have to waste 15 minutes a day folding their underwear into tiny rectangles. But also, good for us! Imagine how many bad choices people are liable to make in a feverish post New Year’s Kondo-inspired purge? Mistakes will be made. Purgers are going to see that lavish fur cape they never wore and deem it impractical; come Game of Thrones finale cosplay time, they’re going to rue their hastiness. Conscientious closet cleaners will dispose of the low-rise jeans they haven’t worn since the mid-aughts, but the joke’s on them, because low-rise jeans are coming back, bitches!

So, my fellow anti-Kondoers, if you’re in a post-holiday shopping mood, get thee to thy nearest second-hand clothing store Beacon’s (or Goodwill, or Buffalo Exchange, or Crossroads, or the internet) and get started on building your 2019 wardrobe. And if you arrive at your nearest resale outlet and see a long line, don’t worry: Those people are there to sell. Those aren’t your people. Forget them. Focus on the racks — those sweet, newly stocked, overflowing racks, where so much joy awaits.

It’s just like the old adage: One woman’s trash is another woman’s treasure, especially because most of it was never trash to begin with.

Likewise, Lia Beck writes in Bustle, “…get out there and find some things that spark joy for you.

And reseller The RealReal is signaling that resale is so big that it’s ready to IPO. Talk about opportunistic. No better time to do this than during Kondo-mania. The company has raised $115mm in venture capital from Perella Weinberg PartnersSandbridge Capital and Great Hill Partners, most recently at a $745mm valuation.

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

Advertising - Short(ened) Ad Time and Short(ed) Ad Companies

Did Netflix Lose a Potential Rev Stream Before Activating it? 

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Earlier this week Fox Networks Group’s ad sales chief floated the idea of cutting commercial ad time down from 13 minutes to 2 minutes an hour in a speech he gave in Los Angeles. This is interesting on a number of levels.

First, this would pose a real challenge to advertisers who, undoubtedly, would have to fight for limited but costly supply. Yes, television advertising has flat-lined, but it is still one of the most effective means to get brand messaging out.

Second, such a maneuver could have the effect of squeezing Netflix ($NFLX). Numerous underwriters highlight that Netflix can always open the ad spigot to help it grow into its ever-growing capital structure. And they’re not talking about product placement. If ads are eliminated elsewhere, will consumers focused on the ultimate user experience tolerate ads before watching treasured content like Ozark or 13 Reasons Why? Or will that result in friction and, in turn, leakage? If this decision gains traction, this as-of-yet-untapped revenue stream for Netflix could be collateral damage.

Ultimately, minimal advertising may help draw users back to content. But it will create all sorts of issues for brands trying to sell product AND, by extension, the advertising companies trying to place those brands.

To point, earlier this week the Financial Times reported that “[h]edge funds have amassed bearish bets of more than $3bn against the world’s largest advertising companies in an attempt to profit as the industry undergoes wrenching disruption and slowing growth.” Publicis, WPP, Omnicom Group ($OMC), and Interpublic Group of Companies ($IPG) are all short targets of funds like Lone Pine and Maverick Capital. With corporates like Proctor & Gamble ($PG) cutting ad spend and Facebook ($FB) and Google ($GOOGL) monopolizing same and building custom tools that cut out the middlemen, this is an area worth continued watching.

More Retail Dominos Fall

Tax Credits Can't Save Failing Bon-Ton Stores

We're going to stay thematically on-point. If you missed us last week, we recommend that you go back and read our take on the Cenveo bankruptcy. In fact, we owe an apology to some of you: there were about 400 of you who did not get our a$$-kickingness at all due to an inexplicable Mailchimp screw-up. Mailchimp ≠ a$$-kicking (more on this soon). Anyway, here is a link to the entire newsletter.

A quick preface:

Protection of dying industry extends beyond federally-imposed #MAGA (see, e.g., coal, solar tariffs), and trickles down to local communities. Indeed, local-level legislators are looking at tax credits to prop up industry in the wake of, among other things, Appvion’s chapter 11 bankruptcy (and job cuts) and Kimberly-Clark’s reorganization (and mass job cuts). This is familiar: tax incentives to prop up industry aren’t extraordinary. Sheesh, just look at all the governors getting bent in the hope of drawing Jeff Bezos’ attention. The question is, though, how sound is the social contract? How many dying industries can we as taxpayers prop up all at once? We don’t have an answer. But keep reading.

******

Inside and outside of the startup context, people often ask stupid questions about companies. "How many employees does it have?” That’s a regular one. Or “How many locations?” Also common. “What’s revenue?” Irrelevant on its own. Uber makes a ton of revenue but is still bleeding cash. Netflix has gobs of revenue but is free cash flow negative. Cenveo, as we noted last week, had $1.59 billion of gross revenue in ’17. Now it’s in bankruptcy court. 

What if we told you about a particular business that had 23,000 employees and that those employees had an average tenure of 12 years? That had 256 locations. That owned 22 properties. That made $2.55 billion - yes, BILLION - in revenue in 2017. That would sound like a pretty damn successful company wouldn’t it? 

It’s not. 

We omitted some key data points: like the company’s capital structure and business vertical. 

Here’s the capital structure:

  • a Tranche A revolving credit facility of up to $730mm
  • a Tranche A-1 term facility of up to $150mm

The interest rate on the debt is a formula but, if we understand it correctly, it was no less than 9.5%. Funded debt as of Monday was $339mm under Tranche A (ex-interest), $150mm under Tranche A-1 (ex-interest of $3.9mm), and millions more in letters of credit.  

The company also has $350mm of 8% senior secured notes outstanding (Wells Fargo Bank NA) and due in 2021. Combined with the above debt, that’s a hefty interest expense. Oh, and the company is publicly-traded. Because this particular company is NOT successful - and with equity ranking in “absolutely priority” below debt - we reckon that there are a lot of Moms and Pops eating sh*t right now in their personal accounts. They won’t be the only ones.

The problem is that this company operates in an “increasingly challenging retail environment.” And, therefore, its story  - The Bon-Ton Stores story - is wildly unoriginal. In the company’s words, "Like many other department store and retail companies, the Debtors have been subjected to adverse trends in the retail industry, including consumers’ shift from shopping in brick-and-mortar stores to online retail channels. Bon-Ton, with a significant geographic operating footprint and operating presence, is dependent on store traffic, which has decreased as customers shift increasingly toward online retailers. In addition to competing against online retailers, Bon-Ton faces competition from other established department stores, such as J.C. Penney, Kohl’s and Macy’s.” It's like a zombie cage fight.

More specifically, it continues, "The department store segment of the U.S. retail industry is a highly competitive environment that has evolved significantly in response to new and evolving competitive retail formats, such as the increased prominence of mass merchandisers and increased competition among national chain retailers, specialty retailers and online retailers, as well as the expansion of the internet and, most significantly, the ubiquitous role that mobile technology and social media now play in the retail consumer shopping experience. The Debtors’ results and performance (and that of their competitors) has been significantly impacted by the aforementioned factors in the U.S. retail industry. Presently, numerous business and economic factors affect the retail industry, including the department store sector. These include underemployment and the low labor participation rate, fluctuating consumer confidence, consumer buying habits and slow growth in the U.S. economy and around the globe.” But, but…#MAGA?!?

Given these factors, the company has been engaged in a tug-of-war with its senior creditors for the better part of months. We’ll spare you the back-and-forth but suffice it to say, no concrete long-term plan that would’ve avoided bankruptcy came to pass. Only the retention of a liquidation agent to close 42 stores. And acquisition of a new $725mm credit facility to fund the cases while the company scrambles to find a buyer. Or liquidate.

Remember all of those shiny, positive numbers up above? Um, yeah. 

It gets worse. Though they were ultimately shot down - at least for now - in court yesterday (Feb 6), the bondholders argued “that the best and only available path for the Debtors to maximize value for their creditors in these freewill bankruptcy cases is to conduct an immediate orderly liquidation of the Debtors’ inventory and other assets. The Second Lien Noteholders made this determination after conducting their own due diligence, and following repeated missteps by the Debtors and their various boards and management teams, who proved themselves unwilling and/or unable to adapt to the fierce headwinds facing brick and mortar retailers and in particular, department stores”(emphasis in original). Savage.

Unwilling. Or unable. To adapt. Sadly, this seems to sum up a lot of distressed retailers these days. 

Even sadder, remember those long-tenured 23k employees we mentioned above? Per the company, “[Bon-Ton] has been part of its employees’ and customers’ lives in their communities for years.”

Probably not for much longer. At this point, no tax credits can change that. 

Entertainment 3.0 (Short Hollywood, Long Subsidized Data Plays & Will Smith?)

More Data = More Crap Like "Bright" 

We've addressed algorithmic-based books and music, we might as well triple-down with movies. It's well known by now that Netflix ($NFLX) and Amazon ($AMZN) are using their respective data sets to develop new original projects. This circumvents the otherwise costly endeavor of licensing deals for outside content which, naturally, is fragmented in such a way that is costly to Netlfix/Amazon and frictionful in certain respects for the end user. Why is some content available internationally while other content is not? Why is certain content downloadable but other isn't? All of that has to do with "rights" for licensable content. 

This is precisely why we get "Bright," the new Will Smith vehicle that "feels like it was produced by an algorithm to fit in as many genres as possible (crime, fantasy, cops, etc.)." Netflix has said that 11mm people watched the movie in the first three days of release. At an average movie price of $8.90/ticket, that's the equivalent of nearly $98mm in revenue in three days. A sequel has been green-lit. This movie was an experiment dripping with data-based motivation and it seems to have worked. What does this portend for Hollywood?

Oh, Hollywood. This week we also learned that moviegoing has fallen to its lowest rate in a generation: theater admissions fell nearly 6% in 2017.  Choice quote“'The industry should be concerned if the metric falls again in 2018,' said Geetha Ranganathan, a Bloomberg Intelligence analyst. 'Especially with a stronger film slate for this year, fewer moviegoers would be a warning sign that the industry may be in secular decline.'” Ruh Roh. 

And so should we really be surprised that there's a company out there now attempting to exploit data relating to Hollywood-produced theatrically-released movies? Enter Moviepass, a subscription-based business that lets movie-goers go to an unlimited amount of movies per month for only $9.95/month (subject to a one movie in 24 hours restriction). The movie theaters are like, "What the hell?" but consumers are like, "Sign me up!" 1 million of them. The movie theaters are like, "That's our data!" and Moviepass is like, "We don't care, go fly a kite home-slice." 

This Tren Griffin piece does a deep dive into the Moviepass business and leaves much to unpack. The piece is long but it provides some real insights into the movie theater business and the numbers are bleak. For theaters. For Moviepass. For basically everyone other than the moviegoers who ought to enjoy the Moviepass-subsidized movie-going while it lasts. And that probably includes malls - many of which are betting their futures on moviegoers seeking the moviegoing "experience." 

All of which would explain the recent waive of consolidation. In the past month alone, Cineworld Group Plc agreed to buy #2 U.S. movie chain Regal Entertainment Group for $3.6 billion. And Walt Disney Co. ($DIS) awaits approval of its proposed $52.4b acquisition of 21st Century Fox Inc., including the company’s movie studio. Content is king right now. It helps drive more data for more content. Yes, this is becoming very circular. 

And so back to Will SmithRumor has it that the actor famously performed a data-based analysis to determine how he could best catapult himself to stardom. Then came Independence Day. And Men in Black. Those movies weren't luck: they were strategy. Which is to say that if streamers are all about data, and Hollywood is (now) all about data, and actors are all about data, consumers probably ought to get used to movies like Bright. 

The Great Escape

"The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds." - John Maynard KeynesThe General Theory of Employment, Interest and Money (13 December 1935).

This past week, Michael Batnick, from Ritholtz Asset Management deployed a version of this quote to make a point about investing; he provided a nice callback to Blockbuster and an equity analyst's repeated bad calls vis-a-vis Netflix (which popped this week after impressive subscription growth - despite negative free cash flow (-$600mm+) and an increasingly levered balance sheet). TL;DR: don't be too wed to your ideas. 

This applies to the actual businesses that investors pour money into too. In today's rapidly transforming environment, businesses must now, more than ever, pivot, and innovate. They can't be too wed to legacy ideas. Recognizing that is the first step. It then becomes a question of execution in the face of constraints.  

Enter Avaya Inc., a privately-held provider of contact center, "legacy" unified communications and networking products and services with 176 global entities, $940mm of adjusted EBITDA, 200,000 customers and 9700 employees. To Avaya's credit, the company pivoted in 2009 away from its historical hardware-based operating model - recognizing the shift towards software-based and cloud-oriented services solutions. It undertook a massive reinvention, adapting its revenue model and streamlining operating performance in a manner that cut $700mm in costs since 2014. To some degree, the company's private equity overlords - TPG Capital and Silver Lake Partners - deserve some credit, too, for working with management and reconciling the need to pivot. After all, they had a $8.2 billion LBO to rationalize. 

But sometimes the constraints are insurmountable. Avaya has $6 billion of debt on its balance sheet; it has $440mm of annual interest expense along with an additional $180mm nut for annual pension and OPEB obligations. And it faces stiff competition from the likes of Microsoft, Cisco, and others, necessitating another ~$400mm in expenditures to fund R&D and other investments. It's been bleeding cash, losing over $505mm in the fourth quarter and over $750mm in fiscal '16.

And so the company is now a bankruptcy filer. Notably, the papers accompanying the filing have zero specificity about the company's go-forward business plan. Its one small victory is a robust DIP financing commitment and milestones intended to achieve a rapid turn in bankruptcy court. But then what? 

We rarely see big freefall bankruptcy cases anymore. Clearly there seems to be disagreement among the various constituencies about how best to proceed with this business in the face of competition and technological headwinds. That said, the company was able to secure $425mm of its proposed DIP facility at the "First Day" hearing on Friday. So there's that. 

"Software is eating the world," we noted last week (per Marc Andreesen). We'll see very soon whether Avaya gets swallowed along with TPG and Silver Lake's investment. Yes, they pivoted. But was it too little too late?

Thoughts? Opinions? Let us know at petition@petition11.com. 

Odd ad to place in the WSJ on the day after bankruptcy.

Odd ad to place in the WSJ on the day after bankruptcy.