🍔Another Restaurant Chain Crashes into BK🍔
McDermott Has Itself a Deal
|Jan 22|| 29|
Georgia-based quick-service restaurant chain, The Krystal Company filed for bankruptcy in the Northern District of Georgia over the holiday weekend. This chain features cheap — some might say “iconic” (and by “some” we mean the company) — square burgers among other horrendous-for-your-health fare (eggnog shakes, anyone?). We’re guessing that most of you snobby coastal elites haven’t heard of Krystal and, well, neither had we, to be honest. To our surprise, Krystal is purportedly “the oldest quick-service restaurant chain in the South and the second oldest in the United States, the Krystal brand has a prominent place in the South’s cultural landscape.” You learn something new every day.
The chain operates 182 restaurant locations across nine states; it has approximately 4900 employees; it doesn’t own its real estate; it does have 116 franchisees. It also has over $65mm in debt.
Why the bankruptcy? PETITION readers are very familiar with the trends afflicting quick service restaurants. A number have stumbled into bankruptcy in recent years. To point, the company’s Chief Restructuring Officer also recently worked with Kona Grill and Ignite Restaurant Group. There are plenty of distressed restaurant chains to keep the fee meter running, it seems.
So, what are these trends?
Shifting consumers tastes and preferences (PETITION Note: people are becoming more health-conscious and — well, as delightful as the above-pictured burgers look — a slab of previously-frozen meat stacked between a gnarled bun, diced onions, a pickle and some stadium mustard don’t really pass muster anymore). ✅
Fast casual and online delivery are crushing quick service chains (PETITION Note: we’re going to have to start referring to “The Chipotle Effect”). ✅
It is increasingly hard to find and retain qualified employees in the current labor market, as turnover exceeds 200% (PETITION Note: #MAGA!!). ✅
Commodity costs continue to rise (PETITION Note: but there’s virtually no inflation folks). ✅
Unfavorable lease terms. ✅
Facing all of this, the company did what struggling companies tend to do: they hired an expensive consultant. Boston Consulting Group came in to advise the company with respect to “competitive positioning” and this led to a capital intensive rebuilding project of nine of its locations. Yes, it completely demolished and rebuilt nine locations in ‘18 and ‘19. Ultimately, this led to increased sales at those locations but it clearly couldn’t course correct the entire enterprise.
Consequently, the company breached a financial covenant in Q4 ‘18. It obtained an equity infusion which stopped the bleeding…for like a hot second. The company then defaulted under its credit agreement because it couldn’t obtain a “going concern” qualification for the fiscal year ending December 31, 2018. It has been in forbearance since October. Meanwhile, it has been shedding costs: people have been fired and stores have been closed.
About those stores. The average occupancy cost of the company’s locations is $482k/month. Because of this, the company regularly reviews profitability and recently has turned several of its stores “dark” by ceasing all business there. On day one of its chapter 11 bankruptcy filing, the company filed a motion seeking to reject (i) these “dark” leases (38 of them) as well as (ii) several other locations that franchisees operate under subleases that are not profitable (40 total locations).
So, what now? The papers don’t really say much. Oddly enough, the first day declaration ends with some information about a payment processing data breach and says nothing about DIP financing (there isn’t any) or the direction of the case. In a press release, however, the company says that it intends to use the bankruptcy process to pursue “an orderly sale of its business and assets as a going concern.” Now, in the past, we’ve certainly made fun of debtors who have used their first day papers as de facto marketing materials. Not because it’s stupid: it’s rather smart. Smart and also blatant and shamelessly spinful. Here, though, Krystal doesn’t even mention anything about a marketing process in its papers or, for that matter, a banker (which happens to be the newly merged Piper Sandler).
These guys are off to a rockin start.
Wells Fargo Bank NA ($WFC), the agent under the company’s secured loan, agrees. It filed an objection to the company’s motion seeking authorization to use cash collateral. They wrote:
As the Debtors’ largest stakeholder, the Agent is extremely concerned with the manner in which the Debtors are positioning these cases. The Debtors have yet to file their budget for either the interim period until the second interim hearing or a longer-term budget, but based on the draft budgets that were provided to the Agent prior to filing, it appears that operating on cash collateral alone will not provide the Debtors with sufficient liquidity to make it through a sale process and affords almost no margin for error. The Bankruptcy Code does not permit the Debtors to avoid their obligation to provide adequate protection to the Prepetition Secured Parties on the basis that the Debtors elected a budget that will not permit it. Were the Debtors to run out of cash during the sale process, as they are likely to do, the attendant disruption could jeopardize the entire going concern value of the business and the sale process.
Nothing like a contested cash collateral hearing to get things off on the right foot.
We had a number of reader reactions to Sunday’s Members’-only coverage entitled “💰DIPs = Rent Extraction (Long DIP Lenders)💰,” wherein we discussed a recent study of DIP credit facility economics. Some noted that there have been a number of recent DIP defaults, citing Exide and Edgemarc as two examples (PETITION Note: the study only covered through 2014 so, yes, sure, there are more recent examples that weren’t captured therein).
One reader wrote:
As a lender in the ‘alternative credit space’ I had one quick comment to share regarding your DIP post today.
All of the factors you listed were spot on as to why there is limited new money coming in, but one key one was also missing: MOIC. While the stated interest rate is higher than what appears to be market for the risk, the actual $ return is not that significant when you consider that most DIPs are in place for a shorter period of time. A L+600 deal (~8%) that is only outstanding 3 months will only earn 2% return on capital invested. This may also be why you see higher rates on new money — in order to incentivize new capital to spend time underwriting the initial deal and tracking the deal through the bankruptcy process, there needs to be an adequate return on time/resources for those credit teams vs. other regular way deals that will be outstanding longer and lead to a higher MOIC.
Another backed this up:
One issue with looking at DIP IRRs or yields is that they are much shorter dated than typical paper, so the brain damage to MOIC ratio is all messed up. Rates and IRRs need to be high to make the MOIC even remotely worth engaging.
PETITION Note: This makes total sense and, no, the study’s authors did not necessarily factor this in. Thanks for writing.
⛽️New Chapter 11 Bankruptcy Filing - McDermott International Inc⛽️
Not to pat ourselves on the back but you really need to revisit this Members’-only masterpiece from back in September: “⛽️McDermott International Inc. Seesaws (Short the Shorts)⛽️.” It speaks volumes about oil and gas, the restructuring cabal, and market movements. It took all of four months for the company to essentially mislead the investing public with their “routinely hires” bullsh*t and march into bankruptcy:
So this investor relations approach — “routinely hires” — needs to be put out to pasture:
We saw this play out horribly with Forever21 and now, this week, the smartypants over at Houston-based McDermott International Inc. ($MDR) dropped that line after the stock and bonds got pummeled upon news that the company had hired AlixPartners to advise on efforts to improve cash flow. Here’s a hot tip for management teams: if you’re afraid of giving any impression that bankruptcy is a possibility, consider hiring one of the heaps of financial advisors not particularly known for big time bankruptcies like Westinghouse, Purdue Pharma, and PG&E. Just saying. Maybe try…hmmm…MCKINSEY?? (Too soon?).
The stock and bonds fell off a cliff that week after The Wall Street Journal reported about “market chatter” that AlixPartners had been hired. The bonds never really recovered.
Suffice it to say, this company’s early experience with the bankruptcy world was unsatisfactory.
Now though? Well, on the surface, it looks like McDermott has achieved a phenomenal result. At the time of this writing, the company hasn’t actually filed for bankruptcy just yet but this much is known:
The company has a deal with 2/3 of all its funded debt creditors.
The deal would cut $4.6b of debt — YES, BILLION OF DEBT — from the company’s balance sheet.
The deal will be effectuated pursuant to a prepackaged plan of reorganization which means that (a) the case will be relatively short (two months), (b) all trade creditors (e.g., suppliers) will ride through and be fully paid, and (c) McDermott will avoid a contested drawn-out bankruptcy process which would otherwise be potentially very disruptive to its international business.
The company has a commitment for $2.81b of DIP financing.
The company has a commitment for $2.4b in exit financing.
The company has a stalking horse bidder (The Chatterjee Group and Rhône Group) and form asset purchase agreement for the sale of its Lummus Technology assets for $2.75b, a higher figure than that originally reported four months ago by various financial media. These funds will pay off the DIP facility and provide additional liquidity to the reorganized company post-emergence from bankruptcy.
Jared Ellias@jared_elliasIs this the same Lummus that filed for bankruptcy 20 years ago to resolve asbestos-related lawsuits? https://t.co/ZQFYGjdARz
The company will come out on the other side with merely $500mm of debt.
Again, we’re impressed with the result here. Sure, sure, the company made some ill-advised M&A moves — we’re looking at you Chicago Bridge & Iron Company N.V. ($3.5b)— that, ultimately, led to this MASSIVE value destruction but at least the parties involved realize that this business would suffer even more value leakage without a deal. Score one for the process here.
🤯Tweet of the Mid-Week🤯
Yes. Our own (follow us here).
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Please note that one of our favorite events is coming up: the 16th Annual Wharton Restructuring and Distressed Investing Conference is on February 21st at The Plaza Hotel in NYC. The Conference offers a great learning and networking opportunity for industry professionals and those interested in investment banking, operational/ turnaround consulting, and private equity and hedge fund investing.
Howard Marks (Co-Founder of Oaktree Capital), Mark Brodsky (Founder of Aurelius Capital), and Judge Shelley Chapman (Southern District of New York) will keynote. There will also be a variety of different panel discussions. Tickets are available at https://wrdic-2020.ticketleap.com/wrdic-2020/, more information at https://www.wrdic.org.
Please note: we have two free passes available to lucky PETITION Members. Please email us at email@example.com, note “Wharton Tix” in the subject line, and let us know one subject area that we should be focusing more attention on (and why) and you’ll be entered to win one of the free passes. Cheers.
Alyssa Lozynski joined Portage Point Partners from Alvarez & Marsal.
Florian Kawohl joined HIG Bayside Capital from Strategic Value Partners.
Jeff Gasbarra joined Portage Point Partners from AlixPartners.
Doug McGovern on his promotion to Partner at Perella Weinberg Partners.
Mark Berger on his promotion to Managing Director at Portage Point Partners LLC.
Ryan Mersch on his promotion to Vice President at Portage Point Partners LLC.
Zach Rose on his promotion to Senior Vice President at Portage Point Partners LLC.
The fine folks recently promoted to Managing Director at Alvarez & Marsal LLC: Klaus Gerber, Christopher Kelly, Michael Leto, Tony Simion, Cari Turner, Jodi Ehrenhofer, Erin McKeighan, Scott Asplund, and Greg Karpel.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥.
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