Asset-Stripping, Biglaw Inflation, & Internet Trends
|Jun 6||Public post|
Curated Disruption News
Midweek Freemium Briefing - 6/6/18
Read Time = 6.4 a$$-kicking minutes
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ICYM Sunday’s MEMBER Briefing:
We’re now a few months removed from launching our Member model and we couldn’t be more appreciative of your support. Founding Members include Davis Polk & Wardwell LLP, AlixPartners LLC, SierraConstellation Partners, Gavin/Solmonese, GLC Advisors, and others that want to be discreet and have asked not to be highlighted.
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News of the Week (3 Reads)
Internet Trends Part I (Long Disruption)
“Listen” up. You need to understand the trends that are impacting your clients. Tunnel vision is a competitive disadvantage.
Every year Mary Meeker of Kleiner Perkins releases her “Internet Trends” report: this year it was 294 pages long. It contains a tremendous amount of data and is worth you pouring over it with a nice cup of coffee. But, you’ve got hours to bill. So here are some highlights:
Adults are addicted to their phones as much as young pups. Mobile adoption increases YOY and adults are now spending nearly six hours a day on digital media. SIX. HOURS. A. DAY. And a good percentage of that time is spent watching video (what are you doing behind that closed office door, hmm?):
Are you watching Twitch streams of Fortnite?! This is textbook hockey-stick growth up and to the right:
App Annie: By 2022 consumer spending on App Store will reach $75.7 billion, up 80% from 2017. $53.1 billion is expected to be spent in 2018. Games account for 31% of downloads and 75% of spending.May 31, 2018
But what happens as Amazon Echo ($AMZN) and other voice-controlled devices take over. What effect will that have on people’s relationships with their phones? Are your clients thinking about a voice-strategy or will they — like with e-commerce — get caught off guard? Do you even own an Echo? How can you hope to advise your clients if you don’t?
Stick this into your next retail First Day Declaration:
Obviously, Amazon isn’t the whole story (as we’ve been beating to death). We will continue highlighting other relevant trends in Sunday’s Members’-only newsletter. Become a Member:
2. Asset Values Soar: Human Asset Values. (Long Inflation)
Asset values have been soaring off into the stratosphere to the point that even Warren Buffett is complaining about a dearth of reasonably-priced opportunities (hence his short dalliance with Uber?). The FED, meanwhile, is keeping tabs on inflation; perhaps the Fed ought to look no farther than the legal world. It is experiencing two forms of inflation this week.
First, Milbank Tweed Hadley & McCloy announced that it was raising first year associate salaries to $190k and generally all associate salaries between $10k-15k. Choice bit from The American Lawyer:
“Two years have now gone by, and there is cost-of-living increases and inflation,” Edelman said. “We want to signal to the market that we do want the best, and we’re willing to pay for the best, and we think after two years, an additional increase is appropriate.”
Inflation indeed. As one biglaw partner told us a year ago, a clear cut sign of a market top is when biglaw firms raise first year associate salaries. Well, then…let the recession commence!
Indeed, nothing says "good timing" (or income inequality) like a pay raise to know-nothing lawyers at a time when Toys R Us’ fees are front page news and mad-as-hell employees are picketing KKR's offices. Sometimes biglaw can be its own worst enemy. More:
Edelman said the change would not have “a material effect on firm finances,” adding that he didn’t expect partner capital contributions to change.
Right. Because with 500 associates, the extra $5 million in expense will surely be passed on to the clients. Get ready for a fee increase folks. That’s something worth singing about in court even.
Anyway, we’re not hating. After all, Milbank needs to incentivize people to go to law school AND choose them over several other biglaw firms. Why would anyone do that if they can make $40k/month as a social media influencer? Why would anyone do that if they can be “Running a $500,000 Retail Empire by iPhone?” Good and serious question. That is the competition these days.
Second, Weil Gotshal & Manges LLP announced that, in an effort to incentivize lawyers to stay, partnership (and, for some, counsel position) will now be offered to lawyers that have been with the firm for a mere 7.5 years. Per the ABA Journal,
Weil, Gotshal & Manges hopes to improve associate retention by cutting the wait for partnership by two years.
Except, those "partners" will be non-share partners making “fixed income” rather than receiving partner distributions. And, except, further,
Lawyers in the niche counsel category for specialty practices can remain there as long as they stay at the firm. Lawyers in the other category get, at most, three years in the position. During that time, they may be promoted to partner. Those who don’t make it will be transitioned out of the firm.
Hahaha. C’mon. So you’ll basically have 10.5 years to prove that you merit equity partner before they unceremoniously toss you out into the wilderness…uh, sorry…”transitioned.” You know, rather than 9.5 years. But that new title though!! Title inflation!!
Query: where did Weil get that idea from? (Cough, Kirkland & Ellis). What's that saying: imitation is the sincerest form of flattery? We guess they’re waiting 7.5 years before labeling someone a “partner” rather than 6 years so, uh, there’s that. Just what biglaw needs: more lawyers running around with an inflated sense of self.
3. Don’t. Mess. With. Daisy. Chapter 4. (Petsmart: Long Asset-Stripping Shenanigans)
Man this dog series (and John Wick referencing) is fun. With regard to Petsmart Inc., we previously we wrote:
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 Partners, GIC, Longview Asset Management, Caisse de dépôt et placement du Québec and StepStone Group, helped by writing a $1.35 billion new equity check.
That capital structure refresher is important…
Taking a page out of J.Crew’s asset-stripping, litigation-inducing, bird-flip-to-senior-lenders-activating playbook, Petsmart this week announced that it moved a 16.5% stake in Chewy.com (a/k/a the savior) to an unrestricted subsidiary — unironically using a sponsor dividend mechanic for the transaction; it also dividended 20% of the equity in Chewy.com to its parent company, Argos Holdings, an entity controlled by private equity firm BC Partners. Consequently, Chewy.com is no longer a wholly-owned subsidiary of Petsmart. Moreover, per The Financial Times,
“Chewy will no longer guarantee PetSmart's debt, according to Xtract Research, though the remaining 63.5 per cent of the shares will still be pledged to secure term loans and senior bonds.”
We love financial shenanigans that weaken lender collateral packages to the apparent benefit of junior creditors and private equity sponsors. Particularly when they’re done so quickly after the original transaction!
it is with a heavy heart that i must announce that the borrowers are at it again
(PetSmart basically gifted 20% of Chewy's shares to its PE owners)https://t.co/kIwd2pnGNY
PetSmart’s bonds rallied as the move of the online vendor’s assets was seen as less aggressive than what bondholders had originally priced in, according to the people, who said the initial buyers of the notes have unloaded the positions. Investors sold PetSmart’s debt last year on fears it would sell or spin off as much as 100 percent of the Chewy equity to the private equity owner, removing it from the pool of assets they have recourse to as bondholders.
Haha, right. So instead of getting potentially 100% effed, bondholders only got 33% effed. Can you say: Credit positive!? This is what makes the distressed world just so unmistakably poetic and nasty at the same time: everything is largely a function of…well…you guessed it: asset price and asset value. With the par guys out and buyers at distressed levels in, “credit positive” is entirely relative.
Anyway, more from Bloomberg,
The company’s management said that said they will continue to actively monitor the capital structure and potentially pursue additional strategic opportunities to extend debt maturities, reduce overall leverage and invest in the business, according to the people. Management didn’t have a question and answer portion at the end of the call.
Of course not. Why would they? The first question would be “By ‘reduce overall leverage’ does that mean issuing new bonds secured by the newly siphoned off equity of (valuable?) IP in exchange for the cov-lite unsecured notes?” Even Eli Manning couldn’t so obviously telegraph his next move (The Financial Times, citing Covenant Review, cites some other options here).
This bit is great:
Petsmart’s transfer of assets to an unrestricted subsidiary was not surprising given what J. Crew was able to do with its transfer of intellectual property under its loan documents, James Wallick of Xtract Research said in an interview. The move is “symptomatic” of the current market for loans and bonds, where agreements “are so flexible that you can do a transaction such as this.”
Hahaha. Man people love to gripe about the capital markets these days. Said another way,
$PETM Chewy maneuver marks "... yet another unfortunate turn for the US leveraged loan market, where lender protections have already been heavily eroded by waves of demand for floating-rate investments." https://t.co/0777BGPtGMJune 5, 2018
⚖Notice of Appearance⚖
PETITION: What is the best piece of advice that you’ve been given in your career?
TS: I’ve been doing this for over 35 years and have received a lot of advice. Sifting through the years the advice, what sticks out the most was the line, “Successful people are prepared to be lucky.” There is an enormous amount of wisdom packed into those seven words, starting with the word “prepared.”
PETITION: What is the best book you’ve read that’s helped guide you in your career?
TS: I am not a fan of business books as I think they are largely written by people who simply re-package common sense and put a fancy name on it, like ‘transformative leadership.’ Having said that, early in my career I read “Getting to Yes: Negotiating Agreement Without Giving In” by Roger Fisher and William L. Ury, which, as a young professional, I found very instructive as it focused, in part, on what motivates people on personal and emotive levels in negotiations.
PETITION: What is one notable trend you expect to see in the second half of ‘18 that not enough people are talking about?
TS: The bankruptcy and restructuring process has become very costly, especially in light of the fact that so many Chapter 11s today are almost exclusively focused only on the debt stack with little attention paid to fixing the operations of a debtor which often requires more time although it is where enterprise value is created. The profession needs to get more efficient, demonstrate better case management skills and therefore drive up the value equation. A soon-to-become-classic line from the 2017 movie, “Molly’s Game” sums it up. After Molly’s father, a psychologist, delivers very deep and meaningful insights to her, he says, “It is amazing what you can can accomplish in three minutes when you are not billing by the hour.” Nuff said.
PETITION: What is the most under-appreciated service restructuring professionals can provide a distressed client?
TS: Helping management redefine success, both for the organization and, perhaps just as importantly, at the personal level for the company leader. While restructurings and bankruptcies don’t have the “taint” of 30 years ago, they are still for most individuals and organizations seen, initially at least, as a failure. Many if not most clients have not been through real corporate trauma. There is fear and shame permeating the organization and its leadership. Restructuring professionals sometimes don’t fully appreciate this as we have already “seen the movie” many times. Therefore, helping re-define success as early in the process as possible can be a key element of a successful reorganization.
PETITION What is the biggest disservice that restructuring professionals are doing to clients? Don’t pull any punches.
TS: Clients need to understand what will happen in the beginning, middle and end of the restructuring, and understand it from several vantage points. Restructuring pros sometimes fall short on that front. The most obvious one is what is the legal and court process. Second, is fully explaining what the likely obstacles to a deal and what should be expected as to the behaviors of various constituents. Third, what are the implications to operations, employees and customers and how and when can they be addressed? All these are sometimes not done well by restructuring professionals, resulting in less efficient and effective restructurings. Or, in some instances, these things are done once, but not repeated enough. Or, in other situations, the professionals cannot explain all three, as they haven’t done their own homework and simply aren’t knowledgeable enough.
PETITION NOTE: Yikes. Sure sounds like clients are getting a ton of bang for that $1,750/hour buck.
Father’s Day is coming.
We have compiled a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption for those in your family who like geeking out about that kind of stuff. You can find it here. We recently added four new books on our “to-read” list: (1) “When the Wolves Bite” by Scott Wapner (about the Carl Icahn/Bill Ackman Herbalife battle), (2) “I Love Capitalism!: An American Story” by Ken Langone, (3) “Factfulness” by Hans Rosling (recommended recently by Bill Gates) and (4) “Enlightenment Now” by Steven Pinker (recommended recently by Warren Buffett). We’ve also added “Bad Blood: Secrets and Lies in a Silicon Valley Startup” by John Carreyrou. He tells the story of Theranos’ Elizabeth Holmes’ epic deception. We are definitely adding this to our list of beach reads.
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