💩Acosta = Not a Good Look, Carlyle💩

Acosta Inc. Launches Solicitation, Permian Pain & Approach Resources + More

Disruption Flummoxes Carlyle. Destroys Billions of Value.

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Back in September 2018’s “Trickle-Down Disruption from Retail Malaise (Short Coupons),” we noted a troubled trio of “sales and marketing agencies.” We wrote:

With the “perfect storm” … of (i) food delivery, (ii) the rise of direct-to-consumer CPG brands, (iii) increased competition from private-brand focused German infiltrators Aldi and Lidl, and (iv) the increasingly app-powered WholeFoods, there are a breed of companies that are feeling the aftershocks. Known as “sales and marketing agencies” (“SMAs”), you’d generally have zero clue about them but for the fact that you probably know someone who is addicted to coupon clipping. Or you’re addicted to coupon clipping. No shame in that, broheim. Anyway, that’s what they’re known for: coupons (we’re over-simplifying: they each perform other marketing, retailing, and data-oriented services too). The only other way you’d be familiar is if you have a private equity buddy who is sweating buckets right now, having underwritten an investment in one of three companies that are currently in distress. Enter Crossmark Holdings Inc., Acosta Inc., and Catalina Marketing (a unit of Checkout Holding Corp.). All three are in trouble.

What’s happened since?

  • Catalina Marketing filed for chapter 11 bankruptcy. ✅

  • Crossmark Holdings Inc. effectuated an out-of-court exchange transaction, narrowing averting a chapter 11 bankruptcy filing. ✅

  • And, as of last week, Acosta Inc. launched solicitation of a prepackaged chapter 11 bankruptcy filing. It will be in bankruptcy in the District of Delaware very very soon. We’ve basically got ourselves an SMA hat-trick. ✅💥

Before we dive into what the bloody hell happened here — and it ain’t pretty — let’s first put some more meat on those SMA bones. In doing so, mea culpa: we WAY over-simplified what Acosta Inc. does in that prior piece. So, what do they do?

Acosta has two main business lines: “Sales Services” and “Marketing Services.” In the former, “Acosta assists CPG companies in selling new and existing products to retailers, providing business insights, securing optimal shelf placement, executing promotion programs, and managing back-office order-to-cash and claims deduction management solutions. Acosta also works with clients in negotiations with retailers and managing promotional events.” They also provide store-level merchandising services to make sure sh*t is properly placed on shelves, stocks are right, displays executed, etc. The is segment creates 80% of Acosta’s revenue.

The other 20% comes from the Marketing Services segment. In this segment, “Acosta provides four primary Marketing Services offerings: (i) experiential marketing; (ii) assisted selling and training; (iii) content marketing; and (iv) shopper marketing. Acosta offers clients event-based marketing services such as brand launch events, pop-up retail experiences, mobile tours, large events, and trial/demo campaigns. Acosta also provides Marketing Services such as assisted selling, staffing, associate training, in-store demonstrations, and more. Under its shopping marketing business, Acosta advises clients on consumer promotions, package designs, digital shopping, and other shopper marketing channels.

In the past, the company made money through commission-based contracts; they are now shifting “towards higher margin revenue generation models that allow the Company to focus on aligning cost-to-serve with revenue generation to better serve clients and maximize growth.” Whatever the f*ck that means.

We’re being flip because, well, let’s face it: this company hasn’t exactly gotten much right over the last four years so we ought to be forgiven for expressing a glint of skepticism that they’ve now suddenly got it all figured out. Indeed, The Carlyle Group LP acquired the company in 2014 for a staggering $4.75b — a transaction that “ranked … among the largest private-equity purchases of that year.Score for Thomas H. Lee Partners LP(which acquired the company in 2011 from AEA Investors LP for $2b)!! This was after the Washington DC-based private equity firm reportedly lost out on its bid to acquire Advantage Sales & Marketing, a competitor which just goes to show the fervor with which Carlyle pursued entry into this business. Now they must surely regret it. Likewise, the company: nearly all of the company’s $3b of debt stems from that transaction. The company’s bankruptcy papers make no reference to management fees paid or dividends extracted so it’s difficult to tell whether Carlyle got any bang whatsoever for their equity buck.*

Suffice it to say, this isn’t exactly a raging success story for private equity (calling Elizabeth Warren!). Indeed, since 2015 — almost immediately after the acquisition — the company has lost $631mm of revenue and $193mm of EBITDA. It gets worse. Per the company:

“Revenue contributions from the top twenty-five clients in 2015 have declined at approximately 14.6 percent per year since fiscal year 2015. Furthermore, adjusted EBITDA margins have decreased year-over-year since fiscal year 2015 from over 19 percent to approximately 16 percent as of the end of fiscal year 2018.”

When you’re losing this money, it’s awfully hard to service $3b of debt. Not to state the obvious. But why did the company’s business deteriorate so quickly? Disruption, baby. Disruption. Per the company:

Acosta’s performance was disrupted by changes in consumer behavior and other macroeconomic trends in the retail and CPG industries that had a significant impact on the Company’s ability to generate revenue. Specifically, consumers have shifted away from traditional grocery retailers where Acosta has had a leadership position to discounters, convenience stores, online channels, and organic-focused grocers, where Acosta has not historically focused.

Just like we said a year ago. Let’s call this “The Aldi/Lidl/Amazon/Dollar Tree Effect.” Other trends have also taken hold: (a) people are eating healthier, shying away from center-store (where all the Campbell’s, Kellogg’s, KraftHeinz and Nestle stuff is — by the way, those are, or in the case of KraftHeinz, were, all major clients!); and (b) the rise of private label.

Moreover, according to Acosta, consumer purchasing has declined overall due to the increased cost of food (huh? uh, sure okay). The company adds:

These consumer trends have exposed CPG manufacturers to significant margin pressure, resulting in a reduction in outsourced sales and marketing spend. In the years and months leading to the Petition Date, several of Acosta’s major clients consolidated, downsized, or otherwise reduced their marketing budgets.

By way of example, here is Kraft Heinz’ marketing spend over the last several years:

Compounding matters, competition in the space is apparently rather savage:

“Acosta also faced significant pressure as a result of the Company’s heavy debt load. Clients have sought to diversify their SMA providers to decrease perceived risk of Acosta vulnerability. In fact, certain of Acosta’s competitors have pointed to the Company’s significant indebtedness, contrasting their own de-levered balance sheets, to entice clients away from Acosta. Over time, these factors have tightened the Company’s liquidity position and constrained the Company from making necessary operational and capital expenditures, further impacting revenue.”

So, obviously, Acosta needed to do something about that mountain of debt. And do something it did: it’s piling it up like The Joker, pouring kerosene on it, and lighting that sh*t on fire. The company will wipe out the first lien credit facility AND the unsecured notes — nearly $2.8b of debt POOF! GONE! What an epic example of disruption and value destruction!

So now what? Well, the debtors clearly cannot reverse the trends confronting CPG companies and, by extension, their business. But they can sure as hell napalm their balance sheet! The plan would provide for the following:

  • Provide $150mm new money DIP provided by Elliott, DK, Oaktree and Nexus to satisfy the A/R facility, fund the cases, and presumably roll into an exit facility;

  • First lien lenders will get 85% of the new common stock (subject to dilution from employee incentive plan, the equity rights offering, the direct investment preferred equity raise, etc.) + first lien subscription rights OR cash subject to a cap.

  • Senior Notes will get 15% of new common stock + senior notes subscription rights OR cash subject to a cap.

  • They’ll be $250mm in new equity infusions.

So, in total, over $2b — TWO BILLION — of debt will be eliminated and swapped for equity in the reorganized company. The listed recoveries (which, we must point out, are based on projections of enterprise value) are 22-24% for the holders of first lien paper and 10-11% for the holders of senior notes.

We previously wrote about how direct lenders — FS KKR Capital Corp. ($FSK), for instance — are all up in Acosta’s loans. Here’s what KKR had to say about their piece of the first lien loan:

We placed Acosta on nonaccrual due to ongoing restructuring negotiations during the quarter and chose to exit this position after the quarter end at a gain to our third quarter mark.

This was the mark back in December 2018 = $2.4mm fair value:

And this is the mark as of Q3 close, September 2019 = $1.3mm fair value:

Soooooo….HAHAHAHA. Now THAT is some top-notch spin! Even if they did mark to a gain versus the Q3 mark, they undoubtedly lost money on this position: the mark was cut in half in less than a year.

You have to take the benefits of quarterly reporting where you can, we suppose. 😬😜

*There have been two independent directors appointed to the board; they have their own counsel; and they’re performing an investigation into whether “any matter arising in or related to a restructuring transaction constituted a conflict matter.” There is no implication, however, that this investigation has anything to do with potential fraudulent conveyance claims. Not everything is Payless, people.

⛽️Another E&P Deadbeat Enters Bankruptcy Court⛽️

Hello Approach Resources Inc.! We’re looking at ya, baby!!

The Texas-based company FINALLY — AND WE MEAN FINALLY — filed for bankruptcy after months of forbearance agreements with its lenders delayed the inevitable. It marks another in an increasingly-LENGTHY string of oil and gas exploration and production companies to descend into bankruptcy court. And this is notwithstanding the fact that it and its debtor affiliates operate in the Midland Basin of the greater Permian Basin in West Texas — an area that, not long ago, was touted as the creme de la creme of E&P.*

A quick tangent: the morning after Approach’s bankruptcy filing, KLX Energy Services ($KLXE), a Florida-headquartered oil field services company, issued an unscheduled announcement that is illustrative of how much of a sh*t show the Permian has become. The announcement addressed “a major cost reduction program to address the abrupt deterioration in industry conditions, which accelerated downward through the end of the third quarter ended October 31, 2019.” This is brutal, despite the assurances about free cash flow towards the end:

“Contemporaneously with the abrupt decline in activity, we took steps to align our business with current customer demand. Specifically, we implemented an approximate 17 percent reduction in force, as compared with the Company’s July 31, 2019 staffing levels, consistent with the approximate 18 percent sequential quarterly decline in our third quarter revenues. We aggressively cut costs in every area of our business, and we warm stacked the vast majority of our Permian based wireline assets. As a result of these and other measures, we expect to take a third quarter charge of approximately $13 million. Notwithstanding the precipitous decline in industry conditions, we generated approximately $44 million in cash flow from operations and approximately $31 million in free cash flow, bringing our cash balance to approximately $121 million for the quarter ended October 31, 2019. In addition, our $100 million credit facility remains undrawn.”

As if the financial metrics aren’t daunting enough, note the operability numbers:

“The second quarter to third quarter decrease in aggregate operating frac spreads in the DJ, Niobrara and Williston basins was approximately 20 percent, while our Rocky Mountains segment revenues declined approximately 9 percent. In the gassier basins, including the Marcellus, Utica, Woodford and Haynesville, the number of operating frac spreads declined approximately 50 percent, while our Northeast/Mid-Con segment revenues declined approximately 20 percent. In the Permian and Eagle Ford shale basins, the operating frac spread count declined approximately 22 percent, while our Southwest segment revenues were down approximately 28 percent as we elected to warm stack the vast majority of our wireline assets due to the weak pricing environment.”

For the uninitiated, a “frac spread” (a/k/a “frac fleet”) is an equipment-set that an oil field services company uses for hydraulic fracturing. What those numbers above translate to is basically an across-the-board reduction in online assets. The Permian, to reiterate, was down 22%. 😬

KLXE’s stock plummeted to a new 52-week low on the announcement:

Note: this was a $30/stock back in February! 😬😬

In summary, there has been a lot of Permian Pain recently induced upon oil and gas investors. 😬😬😬😬

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Speaking of performance, back to Approach:

“For the second quarter of 2019, the Debtors reported revenue of approximately $14.7 million, and a net loss of approximately $13.6 million. As of December 31, 2018, the Debtors’ estimated proved reserves were 180.1 million barrels of oil equivalent, made up of 29% oil, 31% NGLs and 40% natural gas, of which 37% were classified as proved developed.”

The reasons for this bankruptcy should be a surprise to absolutely no one. That is, unless you’re Steven Rogers and you’ve been frozen in a block of ice for the past 70 years.

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That is, ⬇️commodity prices + 💩debt level + ⬆️interest expense = ⬇️drilling activity, ⬇️revenue, and ⬆️leverage metrics = breach of financial covenants in the debtors’ credit facility. Take a snapshot people: this sh*t is evergreen.

Despite reducing drilling activity (read: opex), employee headcount and SG&A, the debtors’ problems persisted. Taking costs out, alone, is just putting lipstick on a pig. An exchange transaction whereby Wilks Brothers LLC and other holders of senior notes tendered and exchanged their notes for common stock also didn’t do the trick. Hence the bankruptcy filing. This, among other things, would allow the debtors to obtain desperately needed financing to continue operating and pursue a sale of the “assets” on a free and clear basis.**

The Wilks Brothers LLC (and SDW Investments LLC) remain large equity holders; they own approximately 48% of the outstanding common stock; they also own $62.3mm of the senior notes. While Wilks previously held three board seats, someone realized that this might present a wee bit of a conflict in the context of restructuring discussions and so those directors resigned from the board and the company (cough: the company’s professionals) reconstituted the board to comprise of only (4) independent directors (not that the website reflects that…WTF!). Unable to reach a consensual restructuring transaction with Wilks out-of-court and in need of liquidity, the independents on the board authorized the chapter 11 filing. The filing will enable the debtors to access an ~$40mm DIP credit facility, if approved by the bankruptcy court, that would provide $16.5mm of new money and roll-up $24.75mm of pre-petition debt. This liquidity will buy the company time to pursue a sale process: the DIP includes a milestone that, no later than 20 days from the filing, the debtors file a motion seeking approval of a sale of bid procedures and within 105 days, the debtors file a plan of reorganization.

We’ll see soon enough to what extent there’s asset value here.

*This is…interesting…and not likely to last. Per Bloomberg:
The New York city area may boast the largest share of personal income in the U.S., but pay is growing the fastest in the much smaller oil-boom towns of Odessa and Midland, Texas, according to new Commerce Department data.
Indeed, Midland’s per capita personal income of more than $122,000 a year was higher than that of San Jose, San Francisco, Boston or New York last year, the data show. Midland and Odessa -- bases for Permian basin shale production -- have benefited from a boom that last year drove the U.S. to surpass Russia to become the world’s largest oil producer.
The trend could change, however. A recent drop in energy rigs in the area -- a sign of future activity -- has coincided with the moderation of job opportunities and in some cases a drop wages, according to the latest data from the Federal Reserve Bank of Dallas.
**To over-simplify for the non-restructuring professionals among you, a bankruptcy sale allows for “free and clear” status which basically means that a buyer can get clean title without much fear of successor liability.

💥Tweet of the (Mid-)Week💥

We agree: this is straight-up gangster move by Amazon Inc. ($AMZN). The power of data, ladies and gentlemen!! (Also scary AF, to some degree).


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