Over the last several weeks there has been a significant amount of discussion across the United States about the financial condition of the major airlines post-COVID-19 and whether and when air travel will resume in earnest. In parallel, there has also been fervent debate as to whether government assistance ought to be available to the airlines and, if so, what conditions ought to be attached (if any). One view against — that of Chamath Palihapitiya — went viral and sparked widespread debate that placed people firmly in one of two camps. That camp — the “f+ck the airlines and f+ck bailouts” camp, urged the federal government to let free markets be free markets, regardless of whether that might mean a wave of bankruptcies. On the other side, there are folks who think that, given the extraordinary externalities at play — including, significantly, worldwide government-mandated shutdowns — fairness dictates that the airlines ought to be given a lifeline to avoid costly and drawn out bankruptcy processes that will ultimately destroy a lot of value and potentially result in meaningful job losses. After all, a deal around a plan of reorganization and eventual emergence from bankruptcy requires some ability to determine a “fulcrum security.” Good luck doing doing that in this unprecedented environment.
For now the debate is moot. The United States government agreed to provide assistance with the understanding that jobs would be preserved. Much of this money has no strings attached:
Claire Bushey @Claire_BusheyThe US Treasury has received warrants—the right to buy shares at a predetermined price—for Delta, Southwest and JetBlue. https://t.co/nzRvv9PkVt via @financialtimes
Similarly, United Airlines Inc. ($UAL) obtained $5b through the CARES Act split between $3.5b of direct grants and $1.5b of low interest loans. United noted at the time:
These funds secured from the U.S. Treasury Department will be used to pay for the salaries and benefits of tens of thousands of United Airlines employees. In connection with the Payroll Support Program, the airline's parent company also expects to issue warrants to purchase approximately 4.6 million shares of UAL common stock to the federal government.
Airlines are cash burning machines. No doubt, these funds are critical. To help matters further, certain airlines tapped the capital markets — some, like Delta Airlines Inc. ($DAL), successfully and others, like United, unsuccessfully. Per Bloomberg:
United Airlines Holdings Inc. abandoned a $2.25 billion sale of junk bonds because it wasn’t satisfied with the terms, said people familiar with the transaction.
The airline ultimately reached a deal but decided to pull it to seek more favorable terms and potentially a different structure later, said one of the people, who asked not to be named discussing a private transaction. The offering fell flat with investors on concerns about the planes backing the debt.
Enticed by the hot market for junk bonds, United had been planning to use the new debt to refinance a $2 billion one-year term loan that the company signed with a group of four banks on March 9. At a yield of 11% based on unofficial price discussions, the potential interest rate was significantly higher than that on the loan, which pays a rate of as much as 2.5 percentage points above the London interbank offered rate over the course of the year.
United said Monday that it expected to cut its management staff by at least 30%, starting in October, according to a memo sent to employees. The cuts amount to about 3,450 workers. United is receiving $5 billion in payroll support under the government’s Cares Act program, which includes restrictions on compensation and layoffs. But the money doesn’t cover payrolls entirely and it will run out in September, giving United more flexibility to reduce its workforce.
Even with government support, “we anticipate spending billions of dollars more than we take in for the next several months, while continuing to employ 100% of our workforce,” United’s chief operating officer, Greg Hart, said in a memo to workers. “That’s not sustainable for any company.”
Moreover, news surfaced that United was effectively downgrading the status of its employees, circumventing the spirit of the CARES Act. This set a bunch of people off:
Here is crypto enthusiast Anthony Pompliano bemoaning this series of events (which, coming from a crypto fanboy, implies a certain level of government distrust to begin with):
At the end of the day, we are now seeing the downsides to bailing out corporations. A bailout is really the government trying to prevent a natural market correction. If they didn’t intervene, United Airlines would file for bankruptcy protection and the assets / equity would be bought by new ownership. That transition would hopefully land the company in better hands that would be better prepared in the future. This is the risk that equity holders take. By not allowing this natural market function to occur though, the government is changing the risk-reward framework for equity owners and actually incentivizing bad behavior.
We should have let the airlines fail, rather than bail them out and now force me to write this letter today about all the dumb and nefarious things that the companies are doing. The US government has a “God-complex” when it comes to the markets. They think they can do no wrong and they believe that they can solve any problem by interfering. The issue is that they are actually making the situation worse. They are preventing a free market from going through the natural cycle. The allure of a short term bandaid actually drives a much larger, long-term problem.
United Airlines should be forced to give the money back if they cut workers hours.
What Mr. Pompliano says should have happened in the US is EXACTLY what is happening in many other parts of the world.
Like Colombia for instance. Per its recently filed bankruptcy papers, Avianca Holdings S.A. is “…the second largest airline group in Latin America and the most important carrier in the Republic of Colombia and in the Republic of El Salvador.” It is the largest airline in Colombia and is one of 26 members in the Star Alliance (along with United), the world’s largest global airline alliance. Its history goes back 100 years; it generates $3.9b of annual revenues and employs 21.5k people; and it, like many of the US-based airlines, was perfectly healthy prior to COVID-19 halting worldwide air travel. Despite “…Avianca’s importance to the Colombian domestic air transportation market…” and while “…the Debtors anticipate that the Republic of Colombia may be one of the key stakeholders in the Debtors’ restructuring efforts…,” no government stepped up to bail Avianca out. Hence the chapter 11 bankruptcy petition it (and its debtor affiliates, the “debtors”) filed on Sunday. No government. Not Colombia. Nor the Republics of El Salvador, Ecuador or Peru.
The debtors required the chapter 11 filing to preserve its cash in a non-operating environment; they have $275mm of unsecured trade payables and a boat load of debt secured up by all kinds of stuff — from credit card receivables to aircraft. The debtors incurred the debt in an effort to expand capacity in an increasingly competitive space beset by low cost carriers nibbling away at market share. One of the lenders? United Airlines. How poetic!
Back to the aircraft. Given what travel trends are likely to be and new aircrafts that the debtors are contractually on the hook for, it stands to reason that the debtors will use the bankruptcy to reject a number of aircraft lease agreements in addition to addressing their balance sheet. The market is about to be flush with planes for sale. Query what new airline may rise from the ashes.
Luckily, the debtors have a meaningful amount of unrestricted cash to fund their cases and so, at least for now, they’re not seeking a DIP credit facility. That may change, however, if the travel environment doesn’t improve and the cases drag on. Which they very well may given the uncertainty in the markets and the very real possibility that air travel doesn’t recover. Notably, tourism is a major driver of Avianca’s traffic. Something tells us that there aren’t a whole lot of people planning extensive getaways to Bogota at the moment. 🤔
This will be an interesting test case for a lot of other airlines that, unlike the US-based airlines, aren’t lucky enough to receive governmental intervention.
Which “other airlines”? For starters, we know that Virgin Australia entered voluntary administration in Australia two weeks ago after the Australian government declined Virgin’s entreaties for a $888mm loan.
There will be others. Here is Bloomberg suggesting that, due to sovereign issues throughout Latin America, other Latin American airlines are in trouble. In the piece published before Avianca’s chapter 11 filing, they noted:
But while just about everyone agrees it will be up to governments to help save the industry, there’s a disconnect between what’s needed and what nations can -- or even want to -- do. Brazil and Colombia seem willing to step up; Mexico and Chile don’t. Latin America was already the lowest-growth major region in the world and budgets were stretched thin even before oil collapsed and the coronavirus crippled the global economy.
As we now know, Colombia didn’t step up. Which leaves Latin America’s other air carriers in a bad spot, including Latam Airlines Group SA (the finance unit of which has debt bid in the 30s and 40s), Gol Linhas Aereas Inteligentes SA ($GOL)(the finance unit of which has debt bid in the low 40s), and Aerovías de México SA de CV (Aeromexico)(which has debt bid in the 30s). Will one of these be one of the next airlines in bankruptcy court?
The US isn’t the only country to entertain bailouts of airlines. In mid-March, Norway offered 3 billion Norwegian crown ($537mm) credit guarantees to Norwegian Air Shuttle SA ($NWARF). There are strings attached, though. Reuters noted:
To receive the full 3 billion, the company must first persuade creditors to postpone installment payments for loans and forego interest payments for three months.
DNB Markets analyst Ole Martin Westgaard said in a note the package was likely too small, calculating that it would only cover the total cost of grounding all Norwegian Air aircraft for one-and-a-half months.
“We are doubtful the company will be able to attract any interest from a commercial bank at interest rates that would make sense,” Westgaard said.
It is struggling to get it done. In late April, Bloomberg reported:
Norwegian Air Shuttle ASA, the low-cost carrier fighting to qualify for a bailout, presented a plan to relieve part of its heavy debt burden that would largely wipe out existing shareholders and warned most flights would stay grounded until next year.
The airline is racing against the clock to meet terms set by Norway to access the bulk of a 3 billion-krone ($283 million) package in loan guarantees. With most of its fleet grounded, the company has proposed a debt restructuring and capital increase by mid-May that would unlocking [sic] the cash it needs to survive the coronavirus crisis.
The company has debt bid in the low 20s as it attempts to address its conundrum.
Boeing Co.’s top executive sees a rocky road ahead for U.S. airlines, saying it’s probable that a major carrier will go out of business as the Covid-19 pandemic keeps passengers off planes.
The recovery is going to be slow, with air traffic languishing at depressed levels for months, Boeing Chief Executive Officer Dave Calhoun said in an interview to be aired Tuesday on NBC. Asked by ‘Today’ show host Savannah Guthrie if a major airline might have to fold, Calhoun replied, “Yes, most likely.” (emphasis added)
Take cover y’all. He continued:
“Something will happen when September comes around,” Calhoun added, referring to the month when the U.S. government’s payroll aid to the airline industry expires. “Traffic levels will not be back to 100%. They won’t even be back to 25%. Maybe by the end of the year we approach 50%. So there will definitely be adjustments that have to be made on the part of the airlines.”
If this happens, the sh*t storm that will be sure to unfurl from those who were anti-bailout will be hard to contend with (though there is something to be said for buying time to make a bankruptcy more “orderly”). The warrants the government received in exchange for the billions of dollars will become worthless exposing them for the mere window dressing they obviously were. Why didn’t the government take a more aggressive approach that both assisted the airlines and shunned moral hazard? Why didn’t it pursue a General Motors-style transaction and serve as effective DIP lender to the airlines in bankruptcy? These are questions that are sure to re-emerge.
When all is said and done, we’re going to have a number of different data points to determine which approach was best. For the next several months, however, the question will remain salient all over the world: to bailout or not to bailout?
🥾New Chapter 11 Bankruptcy Filing - Stage Stores Inc.🥾
Houston-based Stage Stores Inc. ($SSI) marks the second department store chain to file for chapter 11 bankruptcy in Texas this week — following on the heels of Neiman Marcus. With John Varvatos and J.Crew also filing this week, the retail sector is clearly starting to buckle. All of these names — with maybe the exception of Varvatos — were potentially headed towards chapter 11 pre-COVID. As were J.C. Penney Corp. ($JCP) and GNC Holdings Inc. ($GNC), both of which may be debtors by the end of this week. Sh*t is getting real for retail.
We first wrote about Stage Stores in November ‘18, highlighting dismal department store performance but a seemingly successful experiment converting 8 department stores to off-price. At the time, its off-price business had a 9.9% comp sales increase. Moreover, the company partnered with ThredUp, embracing the secondhand apparel trend. While we have no way of knowing whether this drove any revenue, it, in combination with the conversions, showed that management was thinking outside the box to reverse disturbing retail trends.
By March ‘19, the company was on record with plans to close between 40-60 department stores. In August ‘19, it became public knowledge that Berkeley Research Group was working with the company. The company reported Q2 ‘19 results that — the hiring of a restructuring advisor with a lot of experience with liquidating retailers, aside — actually showed some promise. We wrote:
Thursday was a big day for the company. One one hand, some big mouths leaked to The Wall Street Journal that the company retained Berkeley Research Group to advise on department store operations. That’s certainly not a great sign though it may be a positive that the company is seeking assistance sooner rather than later. On the other hand, the company reported Q2 ‘19 results that were, to some degree, somewhat surprising to the upside. Net sales declined merely $1mm YOY and comp sales were 1.8%, a rare increase that stems the barrage of consecutive quarters of negative turns. Off-price conversions powered 1.5% of the increase. The company reported positive trends in comps, transaction count, average transaction value, private label credit card growth, and SG&A. On the flip side, COGs increased meaningfully, adjusted EBITDA declined $2.1mm YOY and interest expense is on the rise. The company has $324mm of debt. Cash stands at $25mm with $66mm in ABL availability. The company’s net loss was $24mm compared to $17mm last year.
Some of the reported loss is attributable to offensive moves. The company’s inventory increased 5% as the company seeks to avoid peak shipping expense and get out ahead of tariff risk (PETITION Note: see a theme emerging here, folks?). There are also costs associated with location closures: the company will shed 46 more stores.
What’s next? Well, the company raised EBITDA guidance for fiscal ‘19: management is clearly confident that the off-price conversion will continue to drive improvements. No analysts were on the earnings call to challenge the company. Restructuring advisors will surely want to pay attention to see whether management’s optimism is well-placed.
As we wrote in February ‘20, subsequent results showed that “management’s optimism was, in fact, misplaced.” Despite over $1b in sales in both fiscal ‘18 and ‘19, the business continued to bleed cash. Now, three months later, the company is in court.
We should take a second to note that this is a potential sale case. The first day papers, therefore, are meant to elicit interest from potential buyers. And so it’s all about the conversion of stores to the Gordmans off-price model (PETITION Note: the company acquired Gordmans out of bankruptcy. The company deigns to suggest that the stock price increase from under a dollar in January ‘19 to $9.50 in early ‘20 is indicative of the market’s support of the off-price conversion and the potential for success post-conversion — as if stock prices mean sh*t in this interest rate environment. 😜). For some insane reason, the “treasure hunt” experience is still a thing. Indeed, the company asserts that its transformation WAS, in fact, taking hold as it moved beyond the initial small batch of store conversions to a more fulsome approach to off-price. The company now has 289 off-price stores in total (including the Gordmans acquisition) and 437 department stores.
Enter COVID-19 here. No operations = no liquidity. The company’s conversion plan stopped in its tracks. Like every other retailer in the US, the company stopped paying rent and furloughed thousands of employees. “Combined with zero revenue and uncertainty associated with consumer demand in the coming months, Stage Stores, like so many others, is in the middle of a perfect storm.”
Landlords don’t like storms. As you might know from every retail/mall-REIT earnings conference call that’s ever taken place in the history of earnings calls, weather is the bane of retail’s existence. And these landlords started agitating, in many cases exercising remedies against the debtors. The chapter 11 “automatic stay” ought to put a stop to that for a bit.
And, so, with the luxury of the stay’s breathing spell, the company’s plan in bankruptcy appears to be to leave open any and all optionality. One one hand, it will stagger store openings over the course of May and June as states open up, liquidate inventory, wind-down operations and close stores. On the other hand, it will pursue a sale process, managing inventory in such a way “…to increase the likelihood of a going-concern transaction and, to the extent one materializes … pivot to cease store closings at any stores needed to implement the going-concern transaction.” To aid this plan, the company seeks court latitude as it relates to post-petition rent. These savings coupled with cash collateral and proceeds from sales will avail the company of liquidity needed to finance this dual-path approach (PETITION Note: the company suggests that, if needed, the company will explore a DIP credit facility at a later time).
We should note that Wells Fargo Bank NA ($WFC) is the company’s lender and has permitted the use of over $10mm for cash collateral. We previously wrote:
Wells Fargo Bank NA ($WFC) is the company’s administrative agent and primary lender under the company’s asset-based credit facility. Prior to Destination Maternity’s ($DEST) chapter 11 filing, Wells Fargo tightened the screws, instituting reserves against credit availability to de-risk its position. It stands to reason that it is doing the same thing here given the company’s sub-optimal performance and failure to meet projections. Said another way, WFC has had it with retail. Unlike oil and gas lending, there are no pressures here to play ball in the name of “relationship banking” when, at the end of the day, so many of these “relationships” are getting wiped from the earth.
Nailed it. That is precisely what happened. But at least now Wells is providing a little bit of leash here to give the company at least some chance of (i) liquidating inventory and paying down its debt or (ii) locating a White Knight that will provide value above and beyond liquidation value (however you calculate that these days)* and keep this thing alive. Neither avenue is likely to give much solace to the staggering $173mm worth of unsecured trade creditors out there. 😬
Not that the unsecureds should be the only concerned parties here. With first day relief totaling over $2mm, employee wage obligations running potentially as high as $8mm, and high-priced professionals, this thing could very well be administratively insolvent from the get-go. A lot depends, in many respects, on the debtors’ ability to satisfy the projections in the cash collateral budget:
Where do they get these “sales receipts” numbers? Out of their a$$es, that’s where. Nobody knows to what degree shoppers will return to stores to — ay matey — search for “treasure.” Call us crazy: but there’s a big difference between running in and out of a store laser focused on the one thing you already know you want versus going to a store to take your time running through aisles sifting through shelves and racks in search of a Chinese-made “treasure,” all the while avoiding other (hopefully masked) shoppers. Count us out. We don’t exactly think the risk/reward ratio there works in our favor.
Unfortunately for Stage Stores, it needs a large number of shoppers to disagree.
*Perhaps news coming out of T.J. Maxx (TJX) will help spark interest from a buyer. There are also some potentially valuable NOLs here.
This is an article by Princeton Energy Advisors entreating the federal government to “save the Shale Sector.”
🔥Tweets of the Week🔥
Uh…right. The stock market doesn’t appear to give two sh*ts.
This following one is fascinating. While malls are getting smoked (no surprise), the two sectors that are positive are industrial (makes sense…warehouses and all) and … wait for it … manufactured home parks. 🤔
We love when our readers point out that we’re morons. Last week one reader pointed out that we mis-interpreted Madewell’s revenue numbers in our rundown of the J.Crew bankruptcy filing:
I want to reconcile your note this morning … regarding the apparent discrepancy in J Crew's First Day Declaration. If you take a look at J Crew's 2019 10-K, you'll see that Madewell's FY '18 revenue was $529.2m. The $614m number that you referred to from the S-1 is a pro forma adjusted revenue that the company predicted would have been realized had the Madewell spinoff occurred prior to FY '18. Pages 66–67 of the S-1 explain this discrepancy. Either way, since the spinoff did not in fact occur before FY '18 (nor ever, for that matter), the $529.2m revenue number for Madewell in the First Day Declaration is correct.
Your site's great—keep up the good work. I'll continue to be an avid follower.
This is what happens when we regularly invite our readers to call us morons.
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’ve added “No Filter: The Inside Story of Instagram,” which is next up on our “To-Read” list.
Mark Davis (Managing Director) joined SierraConstellation Partners from Jordana/Milani Cosmetics Company.
Peter Fitzsimmons (Managing Director) re-joined AlixPartners LLP from private equity firm Tower Three Partners.
Restructuring Candidate. A seasoned management professional with significant experience in restructuring, is looking to return to the industry to help advise distressed situations on a full time or contract basis. Strong focus on technology, media and telecommunications (TMT), as well as financial modeling, operations, strategic analysis and technology related disruption. BS/EE Caltech with MBA and post-grad degree in Machine Learning and Artificial Intelligence from Columbia University. For more information, please contact us at firstname.lastname@example.org.
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