🔥Private Equity. WeWork. One Call.🔥

Elizabeth Warren en Fuego, Automation, Malls & More

💥A War is Brewing: Elizabeth Warren vs. Private Equity💥

It’s hard to take policy positions seriously at this stage in the run-up to Election 2020 but that’s not stopping Elizabeth Warren. Following up on her dead-on-arrival venue reform proposal of last year, Ms. Warren released her “plan” for a “Stop Wall Street Looting Act” in July and it came back again this week in the context of collapsing private equity owned media companies.* Oh boy. EW is about to have the fury of private equity fat cats rain down upon her. That is, if they think it has even the slightest chance of ever becoming reality (it likely doesn’t but…maybe increasingly does?). 

Ms. Warren minces no words. She starts broadly:

“To raise wages, help small businesses, and spur economic growth, we need to shut down the Wall Street giveaways and rein in the financial industry so it stops sucking money out of the rest of the economy.”

She then narrows her aim:

“Private equity firms raise money from investors, kick in a little of their own, and then borrow tons more to buy other companies. Sometimes the companies do well. But far too often, the private equity firms are like vampires — bleeding the company dry and walking away enriched even as the company succumbs.”

And: 

“…the firms can use all sorts of tricks to get rich even if the companies they buy fail. Once they buy a company, they transfer the responsibility for repaying the debt they took on to the company that they just bought. Because they control the company, they can transfer money to themselves by charging high “management” and “consulting” fees, issuing generous dividends, and selling off assets like real estate for short-term gain. And the slash costs, fire workers, and gut long-term investments to free up more money to pay themselves.” 

“When companies buckle under the weight of these tactics, their workers, small business suppliers, bondholders, and the communities they serve are left holding the bag. But the managers can just walk away rich and move on to their next victim.” 

PETITION NOTE: See, e.g., Toys R Us, Payless Shoesource, Gymboree, rue21, Nine West, Shopko. Retail has been a particularly bloodied victim of PE gone awry but there are no limits. She continues:

“These firms are gobbling up more and more of the economy. They own companies that employ almost 6 million people. They own the nation’s second-largest nursing home operator, the largest single-family rental landlord, the second-largest grocery store chain, and one of the nation’s largest payday lenders. But some of the hardest-hit industries are retail and local news.” 

Insert the likes of Sun Capital Partners and Alden Global Management here. At this point in her diatribe, Warren unleashes some hellfire with a vicious summary of the Shopko bankruptcy case and current state of affairs of Denver Post. You have to read it.

And she doesn’t stop there: she then EW unleashes a fury of napalm all over the PE model. For example, she wants PE firms to guarantee the debt put on the balance sheet of acquisition targets. Yup, you read that right: GUARANTEE the debt.

Think about this: PE firm XYZ takes Jesse Pinkman Media private. It puts $200mm of equity behind $1b of secured debt split between a revolving credit facility and two term loans. XYZ then engages in the usual PE playbook: within two years the company issues two new tranches of unsecured notes, the proceeds of which are used to pay dividends to XYZ. The company sells real estate, the proceeds of which are used to pay dividends to XYZ, and then leases back the real estate to the company. The company RIFs 150 employees, the cost savings of which are used to pay dividends to XYZ. The company then struggles to generate revenue, has very little cost cutting flexibility, no non-core assets to sell, and ends up in default. Noteholders can then go after the company AND XYZ?!? And not just for fraudulent conveyances in bankruptcy which, as we all know, hasn’t exactly played out so well?!? POP US THE GREATEST TASTING POPCORN OF ALL TIME. SH*T WOULD GET JUICY. 

Warren also wants to hold PE firms responsible for pension obligations of the companies they buy. Ooof. That would eliminate PE backing of a lot of industrial companies. Given that Warren would also like to regulate banks more stringently, where would these businesses get financing to grow and expand their businesses? How, then, would they be able to make pension contributions? 

She also wants to eliminate management fees and limit PE firms’ ability to pay themselves dividends (which would presumably include eliminating dividend recaps). This, in effect, completely redefines equity risk. 

She also wants to modify the bankruptcy rules so that workers get paid and management teams can’t pocket special bonuses. She’s basically saying that the Bankruptcy Code is doing a poor job of guarding workers rights and enforcing restrictions on incentive plans. Remember Toys R Us? Those clowns paid themselves bonuses on the eve of bankruptcy and then had the audacity to pursue another round of bonuses immediately after filing. Bold a$$ mofos. 

She also wants to prevent lenders and investment managers from making “reckless loans” and then passing along the danger to outside investors without maintaining any of the risk. In other words, she’s got her eyes on the syndication market too.

She also wants to eliminate carried interest which lets money managers pay lower capital gains rates rates rather than ordinary income tax rates. We’re old enough to remember when President Trump also said he’d go after this. Somehow, nobody ever does. Will Warren buck the trend?

She concludes:

“These changes would shrink the sector and push the remaining private equity firms to make investments that help companies rather than stripping them down for parts.”

Said another way, these changes could decimate the PE market.** 💥

*The news that sparked Ms. Warren’s renewed fire was the announcement that Splinter, a digital media company, was shutting down. G/O Media, backed by private equity firm Great Hill Partners, purchased the the news site from Univision back in April after Univision acquired the property post-Gawker dismantling. Ironically, as Dan Primack points out, the transaction was financed with all equity, not debt, which calls into question whether Warren’s plan even applies.
**Ms. Warren has already started targeting PE-owned for-profit colleges and prison service companies.

*****

A recent study of private equity by researchers at Harvard University, University of Chicago, University of Michigan, University of Maryland, and the U.S. Census Bureau may or may not help matters. The study demonstrates that private equity does, in fact, lead to increased employment in certain scenarios while resulting in decreased employment in others. In a nutshell, within two years of a transaction, employment:

  • ⬇️13% in buyouts of listed companies;

  • ⬇️16% in carveouts (i.e., deals for a part of a company);

  • ⬆️13% in buyouts of private companies; and

  • ⬆️10% in private-to-private sales from one PE shop to another.

These contrasting outcomes call into question sweeping proposals like Ms. Warren’s — and y’all know we’re not exactly apologists for private equity. Indeed, the authors write:

In his presidential address to the American Finance Association, Zingales (2015) makes the case that we “cannot argue deductively that all finance is good [or bad]. To separate the wheat from the chaff, we need to identify the rent-seeking components of finance, i.e., those activities that while profitable from an individual point of view are not so from a societal point of view.” Our study takes up that challenge for private equity buyouts, a major financial enterprise that critics see as dominated by rent-seeking activities with little in the way of societal benefits. We find that the real-side effects of buyouts on target firms and their workers vary greatly by deal type and market conditions. To continue the metaphor, separating wheat from chaff in private equity requires a fine-grained analysis.

This conclusion cast doubts on the efficacy of “one-size-fits-all” policy prescriptions for private equity. Our results also highlight how buyouts can lead to large productivity gains on the one hand and job and wage losses for incumbent workers on the other. This mix of consequences presents serious challenges for policy design, particularly in an era of slow productivity growth (which ultimately drives living standards) and concerns about economic inequality. (emphasis added)

🤔


💨WeWork (Long Death Spirals & Cascading Effects)💨

Alison Griswold’s Oversharing newsletter has been all over the WeWork mess and this recent missive includes a solid and stunning collection of links-all-things-WeWork. Things could get even worse if a financing doesn’t get done. Like, soon. Per The Financial Times:

WeWork’s bankers are scrambling to complete a new debt financing package as soon as next week to buy time to restructure after the company’s failed initial public offering left it running short of cash at a faster rate than expected.

Two people briefed on the fundraising efforts said the office company’s cash crunch was so acute that it had to raise new financing no later than the end of November. Fitch Ratings downgraded WeWork’s credit rating last week to CCC+, warning that the lossmaking company’s liquidity position was “precarious”.

Fitch estimates WeWork’s current funding arrangements might only carry it through another four to eight quarters unless it rapidly reduced the rate at which it has been burning cash.

Interest payments are, of course, small potatoes relative to massive lease obligations but WeWork has $702mm of 7.875% unsecured notes with biannual interest payments. Its next payment is due 11/1/19. That would be a $27.9m nut. The timing couldn’t possibly be worse.

This barrage of bad news has the haters drooling:

In other words, nearly 10% of the outstanding unsecured bonds are short. Man, the vibe around this thing isn’t exactly Kibbutz-like.

Some other bits here: (i) JPMorgan Chase & Co. ($JPM) is trying to get other banks to participate in the “emergency financing package” but the-always-winning-to-the-point-of-the-game-seeming-rigged Goldman Sachs Group Inc. ($GS) is currently not in talks to participate, effectively walking away from an earlier IPO-based commitment to the company; and (ii) Softbank may sink more money into this pit but is renegotiating the price of its earlier issued shares in the process (read: this is leverage baby).

If you’re wondering why a senior lender might be hesitating to join JPM in a syndicated senior secured loan, the issue may very well be this: secured by what, exactly? In terms of assets, the company has roughly $15b in leases (which, obviously, have an offsetting liability, and the quality of which will be variable and in need of examination) and $7b of property and equipment, i.e., desks, chairs, barista equipment, yogababble, etc. Given all of the beer swilling and hooking up that occurs at these places, equipment has a questionable lifespan and, by extension, value.

Compounding matters is the fact that enterprise tenants — a key component to WeWork’s go-forward viability — appear to be balking. Per The Information:

“We were looking at doing a couple deals [with WeWork], and thinking about it quite differently now. Are they going to invest in the market?” said Robert Teed, vice president of real estate and workplace for ServiceNow, a publicly traded cloud computing company that puts some of its employees in WeWork spaces. “It’s making us stop and think. It’s awfully noisy. Will they do what they say they’re gonna do?”

And, so, people are beginning to fear what happens if…uh…as?…WeWork falls. Here is a Wall Street Journal article about the President of the Federal Reserve Bank of Boston’s concerns about WeWork, co-working and CRE. It seems his concerns may not be misplaced: cracks are beginning to form in Boston’s commercial real estate market, generally. Here is a Financial Times piece about WeWork halting new lease agreements, a move that “will rattle commercial property owners across the globe who rented to WeWork, which often upgraded the spaces so the group could re-let the buildings to its own customers.” This change in pace will “cut[] out a significant source of demand in large urban property markets where it operates.” Landlords are battening down the hatches. Per Financial Times:

Two landlords of large WeWork sites in London, who asked not to be named, said they would not sign new leases for the foreseeable future and were making contingency plans for their existing WeWork offices in the event of a restructuring.

“It would not be prudent for us to do anything [new] with them until we see how the new management will operate,” one landlord said.

The magnitude of this cannot be overstated. WeWork accounts for over 7mm square feet of office space in New York City alone — making it the largest tenant in the Big Apple. Its $47b in lease obligations is well-documented — including $2.3b in obligations due in 2020 — but to put that in perspective, that figure puts WeWork in third in terms of lease commitments IN THE WORLD.

So, the first question is, “what happens to the existing money-losing properties if WeWork cannot sure up liquidity?”

Back to the FT:

Alex Snyder, assistant portfolio manager at CenterSquare Investment Management in Philadelphia, said: “WeWork has structured many of its leases so that they can simply collapse the special purpose entity it’s trapped in and walk away. This vacancy pressure on the market [would] be painful.”

This ⬆️ is a nuance that a lot of the media — quick to push a sensationalist bankruptcy narrative — seems to miss. The company is set up like a REIT with each individual property non-recourse to the parent. If properties fail, WeWork will just “mic drop” the keys and walk away, leaving landlords with large spaces to fill. What happens then is anyone’s guess. Another co-working space takes over? 🤔

Which gets us to the second question, “if WeWork is no longer expanding, who will fill CRE supply?” These charts ought to give you a sense of the magnitude of WeWork’s reach ⬇️. With this halting, landlords will need to start looking elsewhere.

To add an another layer to this, all of this has people concerned about CMBS exposure. Trepp recently issued a report on this issue. They conclude:

WeWork is certainly a growing exposure for the CMBS market; one that concerns people. The volume of WeWork loans in CMBS, post 2010, is approaching 1% of the entire CMBS market and about 4% of loans backed by offices, so that exposure is meaningful.

The biggest issue is not the pulling of the IPO per se, but the broader concerns about the firm’s viability. The worst-case scenario would be that the firm continues to burn through cash and can no longer support all of its lease obligations. If that were followed by a period of non-payment of rent by WeWork, but physical occupancy and current payments by the firm’s sub-lessees, that would make for some interesting work for landlords and special servicers. Stay tuned.

Wolf Richter — someone who has a reputation for alarmist takes — adds:

These “special servicers” may already be licking their chops. When a CMBS loan defaults, or sometimes even when the building loses a critical tenant but the loan hasn’t defaulted yet, servicing gets switched from the master servicer to a special servicer, as laid out in the pooling and servicing agreement (PSA). The special servicer’s role is to figure out if the borrower can become current via a loan modification or a debt workout. Under many PSAs, special servicers have the right to purchase the building at a discount if the very same special servicer decides the loan cannot be brought current. So, yeah — this might get interesting.

And there are additional complications. WeWork is so large in some markets that a reduction in leasing demand from WeWork, or an outright unwinding of its leases, would put downward pressure on rents and prices in those markets, making it that much more difficult to sort through the fallout in the market from problems at WeWork.

Stay tuned indeed.

*****

More on WeWork: here is a provocative thread about WeWork’s effect on the venture system and what its failure presages for other unicorns in growth-at-alls-costs-even-if-the-business-model-is-faulty mode; here is the WSJ and here is Bloomberg’s Matt Levine, respectively, discussing the personal loans to Adam Neumann; and here is a pointed must-read Harvard Business School study discussing the company’s business model. We particularly enjoyed this bit:

Fundamentally, WeWork engages in “rent arbitrage” by signing long term leases, generally 15 years, at one rate and subleasing the space to SMEs and Enterprise members at with shorter durations. While the cost per desk is lower for the member, the aggregate rent WeWork receives is higher for the space due to the density.

The practice obviously creates a duration mismatch which leaves WeWork, or the special purpose vehicle that entered into the lease, exposed to market fluctuations in the event of a downturn. The short duration of the subleases leaves WeWork exposed to the risk that tenants might abandon the space on short notice leaving WeWork liable for the master lease obligation. They are also exposed to the credit risk of the SME subleasees.

WeWork does not believe a market downturn will impair their business. To the contrary, WeWork maintains that as businesses contract, they will be attracted to WeWork’s business model as it will offer SMEs and larger Enterprises the needed flexibility and lower cost structure per employee during a recession. Indeed, Neumann highlights that the Company was founded during the Great Recession and attracted tenants. Time will only tell if this will be accurate, but it is worth noting that their main competitor, Regus, now IWG, went bankrupt during the Great Recession. (emphasis added)

BURN.


💩Workers’ Compensation, Powered by Private Equity💩

One Call Corporation is a Florida-based private equity-owned (Apax Partners) provider of “cost containment services to the workers’ compensation industry.” It’s a B2B service in that its clients are payors, i.e., insurers. The company formed in 2013 after Apax Partners acquired One Call Care Management, the predecessor entity, from private equity firm Odyssey Investment Partners (terms undisclosed) and contemporaneously acquired Align Networks from growth equity firm General Atlantic and The Riverside Company and merged the two together to form Once Call Corporation.

We bet you’re wondering: how complex can a workers’ comp solutions provider really be? We mean…this has to be the least sexy business ever. That said, we’re glad you asked. This company has a stupefying amount of debt on its balance sheet! $2b, in fact. You really have to love private equity.

You also have to really love poop-frosted layer cake capital structures:

  • $56.6mm ‘22 revolver;

  • $842.6mm ‘22 L+5.25% Term Loan B;

  • $37.9mm ‘20 L+4% Term Loan B

  • $343mm ‘24 7.5%/11% PIK new first lien toggle notes;

  • $349mm ‘20 L+3.75%/6% PIK 1.5 first lien term loan (KKR, GSO Capital Markets);

  • $94.7mm ‘24 7.5% first lien notes;* and

  • $291mm ‘24 10% second lien notes.*

You get all of that? This may be the first time a capital structure for a company single-handedly put us across our newsletter length limitations. Sheesh that’s a lot of debt. And this is after an exchange transaction earlier this year in which the two tranches above with asterisks were (clearly not wholly) exchanged for the $343mm PIK toggle notes. That transaction — and, no doubt, all the fees that came with it — bought the company…

Image result for looks at watch gif

…a rather insignificant amount of time, it seems. The company’s performance apparently cannot sustain that much debt. Per Bloomberg:

Cash has been running short at One Call, which recently drew $50 million from its $56.6 million revolver…. Leverage was around 6.95 times earnings at mid-year, bumping up against the 7-times limit in its lender agreement….

So, the company has covenant issues and a lack of liquidity. It therefore failed to make an interest payment on the $291mm second lien notes on October 1 and it’s now operating amidst a customary 30-day grace period. No cash and little covenant room = no bueno. But, you know what it does have? A blog. That’s right, a blog. And the company is a prolific poster:

For the past couple of weeks, we have been engaging with our lenders on a comprehensive solution that will ensure One Call has an appropriate capital structure to support our long-term business objectives. As these constructive discussions continue, we decided to take advantage of an available grace period for making an interest payment due October 1 under the terms of one of our debt agreements. This grace period, which is fairly standard, allows us to defer this payment for 30 days – without constituting an event of default – while we work together on a solution.

S&P promptly downgraded the company to CC from CCC and put it on CreditWatch.

Per Bloomberg, negotiations are ongoing as to how the capital structure will be dealt with. Suffice it to say, this sucker will file for bankruptcy. And they’ll likely try and make quick work of it. We can’t wait to see how the company manufactures venue in White Plains given that its legal and restructuring advisory professionals are the same dynamic duo from FullBeauty, Sungard and Deluxe Entertainment. Lately, with these characters, “quick work of it” is a matter of relative degree.


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📉Charts of the Week📈


Tweet of the Week


⛓Notable: What We're Reading (5 Reads)⛓

1. Automation (Long Andrew Yang?). A new report from the Federal Reserve Bank of San Francisco highlights the dangers of automation to the American worker:

The portion of national income that goes to workers, known as the labor share, has fallen substantially over the past 20 years. Even with strong employment growth in recent years, the labor share has remained at historically low levels. Automation has been an important driving factor. While it has increased labor productivity, the threat of automation has also weakened workers’ bargaining power in wage negotiations and led to stagnant wage growth. Analysis suggests that automation contributed substantially to the decline in the labor share.

2. Experiences (Long the “Data is the New Oil” Narrative). In response to “🎯Experiences Galore: Dave & Buster’s Complains of Cannibalization (Short Arcades)🎯,” one loyal PETITION reader sent us this piece, wherein Bloomberg describes how Steve Cohen’s Point72 analyzed geo-location data linked to (allegedly) anonymous credit card information to determine that there’s a direct negative correlation between Topgolf and Dave & Buster’s Entertainment Inc. ($PLAY). They noted “when customers went to entertainment venue Topgolf for the first time, their spending at a nearby Dave & Buster’s went down immediately….” The fund shorted PLAY as a result. Similarly, it used data to determine that alternative diets, i.e., Keto, were taking a bite out of Weight Watchers’ ($WW) business.

Topgolf, meanwhile, seems poised to IPO in 2020…maybe. We’ll see what the IPO markets are like in the wake of WeWork. Per Pitchbook, “[i]t’s unclear if the company is currently profitable.” 🤔

3. Malls (Long the “Over-Malled” Theme). This is a bit older, but here, Garrick Brown, Vice-President of Retail Intelligence at Cushman & Wakefield has some interesting numbers about malls:

I just finished crunching mall tenant sales per square foot data and the news may surprise some of you. Trophy malls (those with sales of $900 psf or more) currently average $1,257 psf. This has increased by 16.7% over the last three years. Class A malls ($600 - $900 psf) now average $714 psf and have increased 9.3% over the past three years. Class B malls ($300 - $600 psf) now average $402. This has fallen 1% since 2016. However if you exclude 18 centers that invested in significant upgrades the decline overall would have been -7.8%. Class C (-$300 psf) now average $213 and have seen a 13.7% decline over the past three years. Bifurcation is real. Strong getting stronger. Weak getting weaker. Quality wins.

Now, we would love to see how, even in the A malls, that average has changed over the last three years. We’d have to think that, even there, the trends are declining somewhat. Also, this was pre-Forever 21 filing for bankruptcy so the effects of that won’t flow through these numbers for some time.

4. Restaurants (Short Franchisees). Franchisee debt levels are starting to cause concern. Per Restaurant Business:

Franchise systems like McDonald’s, Wendy’s, Burger King, Jack in the Box and many others have been selling corporate stores to franchisees, relying on operators to provide the capital needed to fund remodels and build new units.

Lenders have been eager to make loans to these operators. And franchise systems have taken advantage of this availability of capital to fuel remodel programs.

As a result, debt levels have soared for franchisees. In a note this week, Bernstein Research analyst Sara Senatore noted that the leverage ratio for McDonald’s franchisees grew to 3.1 times earnings before interest, taxes, depreciation and amortization, or EBITDA, in 2018. In 2008, that ratio was just 1.3.

For Wendy’s, that ratio is even worse: 7 times EBITDA, from 5.7 in 2008.

🤔

5. Retail Ad Budgets (Long Ingenuity). Are all of those retailers who are planning on spending more on social media and marketing going to get bang for their buck? This suggests there’s reason for skepticism. Given the decrease in mall foot traffic, retailers are increasingly getting stuck between a rock (e-commerce saturation, limited ad supply, questionable tracking metrics and performance) and a hard place (brick-and-mortar leases, environmentalism).


💰New Opportunities💰

Force Ten Partners, an advisory firm specializing in corporate restructuring, challenged businesses, litigation, and other special situations, is growing. They seek Associates and Directors with 5-10 years of bankruptcy and restructuring experience. If you are interested, please visit here.

*****

Looking for quality people? PETITION lands in the inbox of 1000s of bankers, advisors, lawyers, investors and others every week. Email us at petition@petition11.com to learn about posting your opportunities with us.


📚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, “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.


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

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