Curated Disruption News
Midweek Freemium Briefing - 3/28/18
Read Time = 6.74 a$$-kicking minutes
ICYM Sunday’s MEMBER Briefing:
In our Members’-only Sunday briefing “💰Crowdsourcing Sears' Survival Here 💰,” we discussed half-baked crowd-sourcing efforts to salvage zombie companies like Toys R Us, Catalina Marketing, Catalyst Capital, Airbnb, offshore oil & gas drilling and more. Did you miss it? Become a member by clicking on that little blue button below.
Speaking of members, we’d like to welcome groups from Alvarez & Marsal LLC and Province Inc. to the Membership. If you have five or more interested folks at your firm, email us for a group quote: email@example.com.
Other recent awesome content:
The Fallacy of "There Must be One" Theory (Members’ Only)
News of the Week (3 Reads)
1. Busted Narratives: Fast Fashion Falters (Short H&M)
We’re old enough to remember when fast fashion was allegedly decimating retail and every apparel retailer under the sun was rejiggering its supply chain to fight fire with fire. Well, yesterday, fast fashion retailer Hennes & Mauritz HB — better known in the U.S. as H&M —reported earnings and to say that they were dogsh*t would be an understatement. Here is the stock as of yesterday:
Man that chart is ugly: that’s a 50% drop in the last year. This takes the company all the way down to 2005 levels. What is going on?
For starters, operating profit fell 62% in the three months through February from 3.2 billion SEK to 1.3 billion SEK. And more problematic: the company has $4.3 billion of unsold inventory. This is the stock-in-trade picture as of yesterday:
Y’zikes. Analysts are freaking out.
“While the assortment is appreciated by our customers, we have not improved fast enough. In addition to this, we made some mistakes in the assortment mix in the second half of 2017 that affected the top line. And now, we're working hard to ensure improvements, including fashion improvements and to improve value for money further as well as, of course, and also to have the right balance and assortment mix with the right products in the right -- at the right time, in the right amount to the right channels.”
Clearly. So, after dropping this steaming pile of bad news, Persson does what all good retail CEOs do these days: drop buzzwords and hot catch phrases like they’re hot. In trying to assuage analyst concerns after this buzzsaw of an earnings report, Persson goes all in with '“new store concepts", “optimize the store portfolio,” “image recognition,” “personalized product feeds,” “automated warehouses,” “advanced analytics and artificial intelligence,” “cloud, APIs and microservices,” and “RFID and 3D.” Did you catch all of that? Don’t know about you, but we’re impressed. These guys really threw the whole kitchen sink at us with this pixie cloud of meaninglessness. Take note: if you’re a restructuring advisor or performance improvement specialist seeking a company-side retail mandate, you have our permission to cut and paste this paragraph into your deck. Perhaps you can win over an executive team too-embarrassed to ask you what the hell any of it actually means.
2. Southeastern Grocers = Latest Bankrupt Grocer (Long Amazon/Walmart)
Another day, another bankrupt grocer.
Yesterday, March 27 2018, Southeastern Grocers LLC, the Jacksonville Florida-based parent company of grocery chains like Bi-Lo and Winn-Dixie, filed a prepackaged bankruptcy in the District of Delaware. This filing comes mere weeks after Tops Holding II Corporation, another grocer, filed for bankruptcy in the Southern District of New York. Brutal.
In its filing papers, Southeastern noted that, as part of the chapter 11 filing, it intends to "close 94 underperforming stores," "emerge from this process likely within the next 90 days," and "continue to thrive with 582 successful stores in operation." Just goes to show what you can do when you aren’t burdened by collective bargaining agreements. In contrast to Tops.
Also unlike Tops, this case appears to be fully consensual. It appears that all relevant parties in interest have agreed that the company will (i) de-lever its balance sheet by nearly $600 million in funded liability (subject to increase to a committed $1.125 billion and exclusive of the junior secured debt described below), (ii) cut its annual interest expense by approximately $40 million, and (iii) swap the unsecured noteholders' debt for equity. The private equity sponsor, Lone Star Funds, will see its existing equity interests cancelled but will maintain upside in the form of five-year warrants that, upon exercise, would amount to 5% of the company.
Financially, the company wasn’t a total hot mess. For the year ended December 2017, the company reflected total revenues of approximately $9,875 million and a net loss of $139 million. Presumably the $40 million cut in interest expense and the shedding of the 94 underperforming stores will help the company return to break-even, if not profitability. If not - and, frankly, in this environment, it very well may be a big "if" - we may be seeing this trifecta of professionals (Weil, Evercore, FTI Consulting) administering another Chapter 22. You know: just like A&P. To help avoid this fate, the company has secured favorable in-bankruptcy terms from its largest creditor, C&S Wholesale Grocers, which obviates the need for a DIP credit facility. C&S has also committed to provide post-chapter 11 credit up to $125 million on a junior secured basis. Other large creditors include Coca-Cola ($KO) and Pepsi-Cola ($PEP).
In addition to its over-levered capital structure, the company has a curious explanation for why it ended up in bankruptcy:
"The food retail industry, including within the Company’s market areas in the southeastern United States, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national, and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company’s primary competitors include Publix Supermarkets, Inc., Walmart, Inc., Food Lion, LLC, Ingles Markets Inc., Kroger Co., and Amazon."
"Adding to this pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."
Sound familiar? Here is what Tops said when it filed for bankruptcy:
"The supermarket industry, including within the Company’s market areas in Upstate New York, Northern Pennsylvania, and Vermont, is highly competitive. The Company faces stiff competition across multiple market segments, including from local, regional, national and international supermarket retailers, convenience stores, retail drug chains, national general merchandisers and discount retailers, membership clubs, warehouse stores and “big box” retailers, and independent and specialty grocers. The Company’s in-store delicatessens and prepared food offerings face competition from restaurants and fast food chains. The Company also faces intense competition from online retail giants such as Amazon."
"Adding to this competitive pressure is the recent growth in consumer demand for a “gourmet” shopping experience, complete with offerings of natural, organic, and gluten-free foods. Some of the Debtors’ competitors have expanded aggressively in marketing a range of natural and organic foods, prepared foods, and quality specialty grocery items. The Debtors have been at a competitive disadvantage to companies that have the financial flexibility to devote greater resources to sourcing, promoting, and selling the most in-demand products."
At least Weil is consistent: we wonder whether they pitch clients now on cost efficiencies they derive from just copying and pasting verbiage from one company's papers into another...? We also wonder whether the billable hours spent drafting the First Day Declaration here are less than they were in Tops. What's your guess?
Anyway, there's more. No "First Day Declaration" is complete without a reference to Amazon ($AMZN). Here, though, the company also notes other competitive threats — including Walmart ($WMT). In "Tops, Toys, Amazon & Owning the Robots," we said the following,
In Bentonville, Arkansas some Walmart Inc. ($WMT) employee is sitting there thinking, “Why does Amazon always get the credit and free publicity? WTF.”
Looks like Weil and the company noticed. And Walmart got their (destructive) credit. Go $WMT!
Other causes for the company's chapter 11 include food deflation of approximately 1.3% ("a drastic difference from the twenty-year average of 2.2% inflation"), and reductions in the Supplemental Nutrition Assistance Program (aka food stamps). And Trump wasn’t even in office yet.
Finally, in addition to the store closures, the company proposes to sell 33 stores pursuant to certain lease sale agreements it executed prior to the bankruptcy filing.
Will this mark the end of grocery bankruptcies for the near term or are there others laying in wait? Email us: firstname.lastname@example.org.
3. Eddie Lampert Speaks (Short Sears, Long Principled Kidnappers)
This week William Cohan and Vanity Fair released a once-in-fifteen-years piece with the infamous Sears Holding ($SHLD) investor, Eddie Lampert. It’s a whopper and worth a read.
The mess that is Sears is quantified here:
“But today those triumphs are largely obscured by his worst mistake: the 2005 merging of Sears, the iconic retailer whose doorstop mail-order catalogue was once a fixture in nearly every American home, with the downmarket Kmart chain, which he had brought out of bankruptcy in 2003. Twelve years on, this blundering into retail has made him a poster boy for what some people think is wrong with Wall Street and, in particular, hedge funds. Under his management the number of Sears and Kmart stores nationwide has shrunk to 1,207 from 5,670 at its peak, in the 2000s, and at least 200,000 Sears and Kmart employees have been thrown out of work. The pension fund, for retired Sears employees, is underfunded by around $1.6 billion, and both Lampert and Sears are being sued for investing employees’ retirement money in Sears stock, when the top brass allegedly knew it was a terrible investment.”
To put this in perspective, people are in an uproar about the liquidation of Toys R Us which has 33,000 employees. Sears, while still in business, has had attrition of 6x that. But wait. That’s just on the human capital side. What about the actual capital side:
“In 2013, Lampert, who was chairman of the board, had himself named C.E.O. of Sears Holdings, as the combined company is known. He’s had a rough four years since then. The company has suffered some $10.4 billion in losses and a revenue decline of 47 percent, to $22 billion.”
And on the financial side:
“…Sears Holdings stock price has slumped to $2 a share, down considerably from the high of $134 per share some 11 years ago. Sears Holdings now has a market value of around $250 million, making Lampert’s nearly 60 percent stake worth $150 million.”
How. The. Eff. Is. This. Business. Still. Alive. Well, this:
“The vultures are circling, waiting for Lampert to throw in the towel so they can try to make money by buying Sears’s discounted debt. But Lampert continues to claim that’s not going to happen if he can help it.”
Gotta give the guy credit for perseverance.
For those who may be too young or too weathered to remember, KMart was actually a successful turnaround for the first few years after Lampert converted his (acquired) debt position into equity. Operating profit was $1.3 billion in 2004 and 2005. But then he decided to combine KMart and Sears. Thereafter, the big issues began.
Interestingly, the piece suggests that Lampert was “ahead of his time” by de-emphasizing investment in the in-store experience and focusing on e-commerce. But shoppers didn’t buy online. Cohan writes,
“At the time they were just not comfortable enough with the technology to do so. Whatever the reason, Sears’s Web site never remotely rivaled the sales in the stores. Or on Amazon.”
Maybe because, even today, the website is a cluttered mess that will give even those with the most robust heart arrhythmia. In that respect, the online experience mirrors the offline experience. And this runs afoul of current theories of retail. Jeremy Liew of Litespeed Venture Partners writes about new “omnichannel” retailers like Bonobos, Allbirds, Away, Modcloth and Glossier and the new “customer acquisition channel”:
“All retailers need to be wherever their customers are. And for all retailers, their best customers are in every channel. This is just as true for DNVBs. For Bonobos for example, customers who buy first in store spend 2x more and have half the return rate. But more importantly, they spend 30% more online over the next 12 months.
But these DNVBs think about physical retail in a very different way than incumbent retailers. They are not measured purely on “four wall profitability” or $/sq foot, some of the traditional metrics in retail. Many of the stores are showrooms, they don’t carry full inventory. Most support iPads or other ways to browse the online catalogue.
These brands understand the importance of experiential marketing, and they see their physical spaces as a platform to engage deeply with their customers. In short, they see physical retail as customer acquisition channels for their online business. In some cases, a contribution positive customer acquisition channel. In others, a customer acquisition channel whose costs you can compare to Facebook, Instagram, Google or other customer acquisition channels. But always the online business grows.”
For this to work, Everlane’s Michael Preysman says you “must make it look good.” If only Lampert bought in to this premise. Instead, Sears’ online experience mirrors the offline experience: horrible user experience + dilapidated stores = a wholesale contravention of, as Liew points out, everything that successful retailers are doing today. It’s the customer rejection channel. Hence the suspicions from outsiders — which Lampert vehemently denies — that he’s treating Sears like a private company, milking the company for his own benefit, and slowly liquidating it to the point of bankruptcy. Once in bankruptcy, Lampert will allegedly be able to leverage his place in the capital structure to own the company on the backend. It would be a leaner version of Sears — free of debt, onerous leases and pension obligations. Why invest in customer or employee experience now if this is a possibility later? Good question.
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Notice of Appearance
This week PETITION welcomes a notice of appearance by Rachel Albanese, a restructuring partner in the New York office of DLA Piper LLP.
PETITION: What is the best piece of advice that you’ve been given in your career?
"Trust your instincts." I first heard this advice as a kid and even as recently as this past week from a mentor. It applies to every stage of life, but it's especially helpful to navigate the substantive, interpersonal and ethical issues lawyers face all the time.
PETITION: What is the best book you’ve read that’s helped guide you in your career?
“Debt's Dominion” by Penn Professor (and Puerto Rico Oversight Board Member) David Skeel. Not as lofty as all that, but it's an eminently readable history of bankruptcy law in the US. Recommended reading for sure.
PETITION: What is the one product that helps make you a more efficient or relaxed pro?
PETITION NOTE: We legit had to look up what that even is. But we dig the old school. But, Rachel, check it…BLACKBERRY LIVES!:
PETITION: What is one notable trend you expect to see in ’18 that not enough people are talking about?
Large companies outsourcing legal services to legal vendors, like GE recently did with UnitedLex. Talk about law firm disruption...
PETITION NOTE: Someone is thematically on point.
Hey. Yeah you. Want to get smarter about disruption? We’ve aggregated a list of resources on the topics of restructuring, tech, finance, and disruption. This is for you…you know, so that you can be smarter in the marketplace. You can find it here. This will be a growing list: if there are any resources that you think should be included, please let us know below. We have updated it to include Rachel’s recommendation above.
Due to the Easter/Passover holiday, there will be no Sunday briefing this week. Happy holidays all and thank you for your continued support.