💥Projection Poppycock: Casper vs. Mattress Firm💥

🛏 Casper Joins Long List of Unicorns & Prospective IPOs 🛏

News emerged this week that Casper — the direct-to-consumer mattress company that is now becoming less-and-less direct-to-consumer and more-and-more brick-and-mortar (solo, and at Costco and Target) — intends to join the frenzied rush of money-losing companies headed towards a public offering in the midst of once-inverted yield curves and fears of recession. The appetite for IPOs is so frenetic that Lyft’s IPO was over-subscribed after a mere two days of roadshow — this, notwithstanding the fact that the company (a) has blown through crazy piles of money and (b) is unsure of its business model and whether it will ever even earn a profit. It then priced above the high end of its initial range and then popped like a champagne cork once shares opened for trading.

Source: Yahoo Finance

Source: Yahoo Finance

Because, you know, whatevs: details shmetails. IPO!!*

The Information got its hands on some leaked Casper financials (paywall) and…spoiler alert! It, too, “continued to lose money” ($18mm in Q3). That said, in Q3 of 2018, the mattress maker reportedly had net revenue of $105.3mm (a 60% YOY increase) on $34.9mm of marketing spend (“only” a 12.9% increase), projecting net revenue of $373mm for fiscal year 2018 and $8mm of EBITDA for 2019. Per The Information, here is a summary of Casper’s financials:

Source: The Information

Source: The Information

Also:

Casper’s presentation also contained bullish forecasts for the future, with net revenue jumping to $1.655 billion and $2.135 billion in 2022 and 2023 respectively, and EBITDA of $33 million and $450 million during those years. (emphasis added)

For North America, which accounts for the vast majority of the company’s business, ecommerce represented over 68% of its third quarter gross revenue, while retail was just over 11%. (emphasis added)

The Information piece includes no data points about the number of stores that Casper ultimately expects to deploy for its growth push but CNN reported last year that Casper hopes to have 200 stores by 2021 (a figure reiterated by Fortune in the tweet below). News surfaced recently that Casper also just closed on a $100mm Series D financing provided by, among others, Target Corp ($TGT), the CEO of Canada Goose Holdings ($GOOS) and the former co-founder and chairman of Crate & Barrel. Total funding is up to $340mm. Per Fortune, “[t]he startup will use the capital to expand internationally and grow its physical retail stores.

In total, those are some bullish projections considering the competitive landscape:

The online mattress market has seen increasing competition in recent years from retailers including Amazon and Walmart. There are also other startups, such as Purple and Tuft & Needle, which was acquired by the mattress manufacturer Serta Simmons Bedding last year. A large mattress store chain, the Mattress Firm, filed for bankruptcy protection last year, which Casper noted in its presentation as a favorable event for the competitive landscape. (emphasis added)

Oy, Mattress Firm. SAVAGE BURN, BRO!! 🔥

Speaking of Mattress Firm, we have projections there too: thank you bankruptcy!! And this allows for a fascinating juxtaposition.

Source: Mattress Firm Disclosure Statement

Source: Mattress Firm Disclosure Statement

With a fraction of the brick-and-mortar presence, Casper projects to have net revenue that is merely $300mm less than Mattress Firm by 2023! How’s that for a commentary about disruption, e-commerce and brick-and-mortar retail? Note that Mattress Firm expects to have $630mm in fixed store expenses (for approximately 2500 stores)** while Casper would have approximately $127mm. Per The Information:

Casper said each new store in the U.S. typically involves $635,000 in capital expenditures and $70,000 in inventory, with an average payback of less than 24 months.

If we’re doing our math right, that means Casper has a significantly larger per-store capex spend than Mattress Firm. On the plus side, unless they’re total frikken morons (or trolls), Casper likely won’t have competing stores sitting literally across the highway from one another.*** So, there’s that.

CEO Philip Krim once said, “We’ve never been anti-retail — just anti-mattress retail.

ANOTHER SAVAGE BURN, BRO!! 🔥🔥

He also said:

"Normally you open a store, have to build presence, then the store loses money and eventually pays back after many years," Krim said. "We have such a productive digital business that we’re profitable on day one of opening a store."

(PETITION Note: not sure how you’re “profitable on day one of opening a store” when the average payback is “less than 24 months” but who are we to call out competing narratives?)

Casper projects $450mm in EBITDA by 2023. In contrast, Mattress Firm projects merely $274mm. Casper has the benefit of landing brick-and-mortar space at a time when landlords are more forgiving with rents; it also has the hyped-up DTC narrative blowing at its back — a clear contrast to the old and stodgy market view of Mattress Firm (which, to be fair, also was able, over the course of its bankruptcy, to renegotiate a meaningful number of its leases with landlords). Said another way, Casper simply seems better positioned to omni-channel its way to success while incumbents like Mattress Firm continue to play catchup. 

Now, these are projections, right? So, query which kind of projection is more full of sh*t? Startup projections or bankrupted debtor projections? It’s a coin flip. In reality, the competitive posture of Casper vs. Mattress Firm four years from now is anyone’s guess. More likely than not, one or both of them are overly optimistic here. But if Casper is right about its projections, that could lead to a significant surprise for Mattress Firm. And given Mattress Firm’s previous strategies, would you want to put your money on Mattress Firm over Casper?

Continue to short strip mall landlords.

*****

Elsewhere in sleep disruption, S&P Global Ratings downgraded Serta Simmons Bedding LLC from B- to CCC+, stating:

…operating performance deteriorated in the fourth quarter of 2018 well below our expectations due to large volume declines with top customers and industry headwinds, leading to adjusted leverage increasing to near 11x as of Dec. 29, 2018.

😳


*Who stands to make money from such an IPO? Investors include Target Corp. ($TGT), Lerer Hippeau Ventures, IVP and New Enterprise Associates. Leonardo DiCaprio, Kyrie Irving and 50 Cent are also early backers.

**Mattress Firm had approximately 3250 stores on its chapter 11 bankruptcy petition date. According to certain bankruptcy materials, the company indicated that it would shed approximately 700 locations.

***Callback to “Mattress Firm Finally Rips the Band-Aid Off (Short Landlords),” wherein we wrote:

Thanks to an overly aggressive growth-by-acquisition strategy, you could essentially turn left and see a Mattress Firm, turn right, see a Mattress Firm, and turn around and see a Mattress Firm. 

And the company actually noted in its bankruptcy filing:

While these acquisitions have allowed Mattress Firm to enter major markets in which it previously did not have a significant presence, and to significantly expand its share of the retail market, they also left Mattress Firm with too many newly-rebranded stores in close proximity to existing Mattress Firm stores. The result has been a significant increase in Mattress Firm’s occupancy and related costs and a negative impact on the profitability of hundreds of its stores. There are many examples of a Mattress Firm store being located literally across the street from another Mattress Firm store.

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.💥

DO. NOT. MESS. WITH. DAISY. CHAPTER 1 of 3 (Short Pet Suppliers) 🔫

🐶 Phillips Pet Food & Supplies: "Outlook Negative" 🐶

john wick lionsgate GIF by John Wick Chapter 2-downsized (1).gif

We have covered a lot of ground since our inception and, for the most part, the path has been trodden with depressing stories of disruption and destruction. The root causes of that run the gamut - from (i) Amazon ($AMZN) and other new-age retail possibilities (e.g., resale and DTC DNVBs) to (ii) busted PE deals to (iii) fraud and mismanagement. Through it all, nothing has really gotten us too fired up — not the hypocrisy surrounding Bank of America’s ($BAC) loan to Remington Outdoor or the hubris around Toys R Us. But, once you start effing with our dogs’ diets, that’s when we have to start getting all-John-Wick up in this mofo. 

Enter PFS Holding Corp., otherwise known as Phillips Pet Food & Supplies (“PFS”). PFS is a distributor of pet foods, grooming products and other useless over-priced pet gear. It is private equity-owned (sponsor: Thomas H. Lee Partners) and has $450+ million of LBO-vintage debt spread out across a recently-refinanced $90 million revolving credit facility (pushed to 2024 from January 2019), a cov-lite ‘21 $280 million term loan, and a cov-lite ‘22 $110 million second lien term loan.

The company recently got some breathing room with a freshly refi’d revolver but still has some issues. While quarterly sales increased in Q4 from $293 million to $327 million, gross margins were down — a reflection of price compression. EBITDA was roughly $62 million on a consolidated adjusted basis clocking the company in at right around a 7.4x leverage ratio. The ‘21 and ‘22 term loans both trade at distressed levels, reflecting the market’s view of the company’s ability to pay the loan in full at maturity. Upon information and belief, the new revolver includes a 90-day springing maturity which means that the company is effed if it is unable to refi out the term loan prior to its maturity (which, admittedly, seems lightyears away from now).

All in, S&P Global Ratings appears to think that the Force is weak with this one; it issued a corporate downgrade and a term loan downgrade of the company on April 10, 2018. Why? Well, S&P doesn’t pull any punches:

“The downgrade reflects our view that, absent significantly favorable changes in the company’s circumstances, the company will seek a debt restructuring in the next six to 12 months, particularly given very low trading levels on its second-lien debt, between 30 and 40 cents on the dollar. It also reflects our view that cash flow will not be sufficient to support debt service and maintain sufficient cash interest coverage, resulting in an unsustainable capital structure. We forecast adjusted leverage in the mid-teens. PFS recently lost a substantial portion of business with one of its largest customers, which we believe represented over half of the company’s EBITDA. Management implemented several cost savings initiatives last year, but we do not believe savings achieved will be sufficient to offset this dramatic profit loss. Further, we expect the company will continue to be pressured by a secular decline in the independent pet retail market, which we view as PFS’ core customer base. Independent pet shops continue to lose market share to e-commerce and national pet retailers, as consumer adoption of e-commerce for pet products purchases grows.”

There’s a lot there. But, first, who writes these dry-as-all-hell reports? If any of you has a connection at S&P, consider putting us in touch. We could really spice these reports up.

Here’s our take:

“The downgrade reflects the fact that this business is turning into garbage. The company was hyper-correlated to one buyer, is over-levered and is, in real-time, succumbing to the cascading pressures of e-commerce and Amazon. In the age of the internet, nobody needs a distribution middleman. Particularly at scale. The lost customer reflects that. Godspeed, PFS.”

Just saved like 1,382,222 words.

S&P further predicts a double-digit sales decline and negative free cash flow in 2018 and 2019, “with debt service and operating expenses funded largely with asset-backed loan (ABL) borrowings.” Slap a mid 5s multiple on this sucker and it looks like the first lien term loan holders will eventually be the owners of a shiny not-so-new pet food distributor! Dogs everywhere lament.