πŸ₯‘#BustedTech: Munchery Filed for Bankruptcy.πŸ₯‘

Short VC-Backed Hyper-Growth

We've previously discussed the process of an assignment for the benefit of creditors and posited that, as the private markets increasingly become the public markets, (later stage) "startups" will be more likely to file for chapter 11 than go the ABC route. Our conclusion was based primarily on three factors: (a) a number of these startups would have highly-developed and potentially valuable intellectual property and data, (b) more venture-backed companies have "venture debt" than the market generally recognizes, and (iii) parties involved, whether that's the lenders or the VCs, would want releases with respect to any failure and subsequent chapter 11 bankruptcy filing. Given continuing low β€” and as of this week, lower β€” yields and a system awash in capital looking for alternative sources of yield (read: venture capital), there's been a dearth of high profile startup failures of late. And, so, technically, we've been wrong. 

Yet, on February 28th, Munchery Inc. filed for bankruptcy in the Northern District of California (we previously noted the failure here and again here in a broader discussion of what we dubbed, β€œThe Toys R Us Effect”). Munchery was a once-high-flying "tech" company founded in 2011 with the intent of providing freshly prepared meals to consumers. It made and fulfilled orders placed on its own app and also had a meal kit subcription business where customers received weekly kits with recipes and ingredients. Its greatest creation, however, might be its shockingly self-aware first day declaration β€” a piece of work that functions as a crash course for entrepreneurs on the evolution and subsequent trials and tribulations of a failing startup. 

Interestingly, the meal kit business wasn't part of the original business model. This represented the quintessential startup pivot: originally, the company's model was predicated upon co-cooking (another trend we've previously discussed) where professional chefs would leverage Munchery's kitchens (and, presumably, larger scale) to sell their products directly through Munchery's website and mobile apps. Of late, the co-cooking concept β€” despite some recent notable failures β€” has continued to gain traction. Apparently, former Uber CEO, Travis Kalanick, is very active in this space (see CloudKitchens). 

At the time, "food delivery was in its early stages." But local restaurant delivery has exploded ever since: Grub HubSeamlessDoor DashPostmatesCaviar, and Uber Eats are all over this space now. Similarly, in the meal kit space, Blue Apron inc. ($APRN)PlatedHello Fresh and SunBasket are just four of seemingly gazillions of meal kit services that time-compressed workaholics or parents can order to save time. 

As you can probably imagine, any company worth anything β€” especially after nearly a decade of operation and tens of millions of venture funding β€” will have some interesting proprietary technology. Here's the company's description of its tech (apologies in advance for length but it marks the crux of the bankruptcy filing): 

"The team’s early focus was to develop a proprietary technology platform to operate and optimize the entire process of making and delivering fresh food to customers. The technology developed and deployed by the company included: a front-end ecommerce platform, which allowed the company to post items daily and consumers to select, purchase and pay for meals through the company’s website and native apps; the production enterprise resource management (β€œERP”) system, which enabled the company to develop and launch new recipes, manage the supply chain for fresh ingredients and supplies, produce the meals through batch cooking, and plate individual meals; the logistics and last-mile platform, which enabled the company to accurately and quickly pack-and-pack individual items and assemble orders using modified hand scanners, distribute orders via a hub-and-spoke system where refrigerated trucks would transport orders to specific zones and hand-off the orders to the assigned drivers; and, a driver app that assisted in managing and routing orders to arrive in the windows specified by customers. All of this was managed through a set of proprietary tracking and administrative tools used by the teams to monitor and mitigate operational issuesβ€”and connected to a customer relationship management platform. The team later developed algorithms to optimize the various aspects of the service to scale operations, increase efficiency, and improve the quality of the service. In addition, the company developed over three thousand meal recipes, including descriptions, nutritional information, and photographs. Over the life of the business, the company invested significantly in its technology capabilities, believing that the company’s ability to efficiently scale its operations leveraging technology would be a competitive advantage in the food delivery market."

All of that tech obviously required capital to develop. The company raised $120.7mm in three preferred equity financing rounds between 2013 and 2015. Investors included Menlo VenturesSherpa Capital, and E-Ventures. The company also had $11.8mm in venture debt ($8.4mm Comerica Bank and $3.4mm from TriplePoint Venture Growth BDC Corp.). 

The bankruptcy filing illustrates what happens when investors (the board) lose faith in founders and insist upon rejiggering the business to be operationally focused. First, they bring in a new operator and relegate the founders to other positions. With new management as cover, they then cut costs. Here, the new CEO's "first action" was to RIF 30 people from company HQ. Founders generally don't like to lose control and then see friends blown out, and so here, both founders resigned shortly after the RIF. This, in turn, gives the investors more latitude to bring in skilled operators which is precisely what they did.

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Is Delivery Killing Fast Casual Too? (Long Busted Narratives)

Zoe's Kitchen is Latest Restaurant Showing Signs of Trouble

Fast casual is supposed to be a bright spot for restaurants. But as the segment has grown in recent years, there are bound to be winners and losers. Zoe’s Kitchen Inc., a fast casual Mediterranean food chain with 250 locations in 20 states ($ZOES), is increasingly looking like the latter.

Last week the company reported sh*tty earnings. Comp restaurant sales declined by 2.3% despite rising prices pushed on to the consumer. The decline is attributable to the usual array of externalities (e.g., weather) but also location cannibalization. Apparently, the company’s growth strategy is pulling consumers from previously established locations. Moreover, the company noted β€œinflationary pressures in produce and freight costs, that are expected to impact cost of goods sold for the balance of the year.” Wages also increased 3.3%, an acceleration from the 2.9% realized in Q4 β€˜17. Accordingly, adjusted EBITDA decreased 30.9%. The net loss for the quarter was $3.6mm or -$0.19/share. The company lowered guidance. The stock tumbled.

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Before you get too excited, note that this is a debt-light company: it currently has a β€˜22 $50mm revolving credit facility with JPMorganChase Bank NA, of which $16.5mm is outstanding (with $3.7mm of cash on hand, net debt is only $12.8mm). It also, believe it or not, has covenants β€” leverage and interest coverage, among others β€” and the company is in compliance as of April 16, 2018. It also plans to continue its expansion: in the sixteen weeks ended 4/16/18, the company opened 11 company-owned restaurants with a plan to open approximately 25 (inclusive) over the course of fiscal year β€˜18. That said, it does intend to rationalize existing locations (and expects some impairment charges as a result), cut G&A and take other operational performance improvement measures to combat its negative trends. There’s a potential opportunity here for low-to-middle-market FAs and real estate advisors.

For our part, we found this bit intriguing (unedited):

We are definitely seen more competitive intrusion, more square footage growth in some of those smaller kind of mid to kind of large markets where we've been there for some time now that's a little bit of what we're seeing in those markets.

We've also seen more competitive catering competition as every ones ramped up catering. And also the value and discounting as we spoke to in the call, in the prepared remarks we've seen that $10 check with that single user kind of moving around and we think that's so from the new competition square footage growth, the value and discounting and then the delivery interruption, we've seen or felt that in many of our markets.

There’s a lot to unpack there. Clearly competition, as we noted upfront, is increasing in the $10-check size cohort of fast casual. Catering is always a competitive business for restaurants like this too. But, the point that really got out attention was that about delivery. The company says pointedly, β€œWe also believe that disruption from delivery and discounting has created headwinds.” The company further states,

Digital comps were 26% positive in Q1 as we leverage improvements from last year's investments in web and mobile platforms to build greater convenience for our guests. Early in Q2, we relaunched and upgraded our loyalty program, which is expected to help drive traffic by making it easier and clearer for our guest to earn and redeem rewards. Delivery sales grew in both our non-catering and catering businesses by 155%. And we have a clear plan to build out the channel for more profitable growth in 2018.

The impact of mobile food ordering and the need for delivery cannot be overstated. Companies need to act fast to activate delivery capabilities that makes sense to a mobile consumer who, more and more, goes to Postmates, Caviar, UberEats and other food delivery services for discovery. This is precisely why Shake Shack ($SHAK) is now on Postmates and Chipotle Mexican Grill Inc. ($CMG) is now available on Doordash. Others, like privately-owned Panera Bread are taking a step farther by building out its own delivery infrastructure in an attempt to own all its data and deliver without owing a cut to a middleman. Query whether this is far too much dependence on the likelihood of people to go directly to Panera’s app when they’re hungry…?

It sounds like the Zoe folks are increasing their focus on delivery. The question is whether they can execute fast enough to offset in-store dining declines. And whether they can do it on their own.