Toys R Us Update, Steak N Shake, Luby's, and NYC CRE
Curated Disruption News
Midweek Freemium Briefing - 7/18/18
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Late last night Toys R Us filed a motion seeking approval of a “global settlement” in its chapter 11 cases. A consensual deal to move the cases forward in a way that maximizes what remains of the estate — without the value leakage that would result from protracted litigation — is undoubtedly a good thing for all parties in interest.
Still, we’d be remiss if we didn’t note the following considering recent noise in the market:
Toys R Us has filed a motion detailing a global settlement and we’ve given it a cursory read. In what should be a shock to absolutely nobody, there is nothing in there about severance to employees. Cc @danprimack @PitchBook.July 18, 2018
There is, however, a waiver of claims for management and advisory fees - written in "woe is me" fashion surely to indicate that $KKR, Bain and @vornado didn't get the full benefit of their bargain. pic.twitter.com/JrcujTYNTZJuly 18, 2018
News of the Week (2 Reads)
1. Casual Dining Distress Continues to Rise (Short Soggy Mac N’ Cheese)
We’ve previously covered this topic in “🍟Casual Dining is a Hot Mess🍟” and “More Pain in Casual Dining (Short Soggy Mozzarella Sticks).” Recall that, back in April, Bertucci’s Holdings Inc. filed for bankruptcy and said the following in its First Day Declaration:
"With the rise in popularity of quick-casual restaurants and oversaturation of the restaurant industry as a whole, Bertucci’s – and the casual family dining sector in general – has been affected by a prolonged negative operating trend in an ever increasing competitive price environment. Consumers have more options than ever for spending discretionary income, and their preferences continue to shift towards cheaper, faster alternatives. Since 2011, Bertucci’s has experienced a year-over-year decline in sales and revenue."
Unfortunately for those in the space, those themes persist.
On Monday, Luby’s Inc. ($LUB) — the owner and operator of 160 restaurants (86 Luby’s Cafeteria, 67 Fuddruckers and 7 Cheeseburger in Paradise) reported Q3 earnings and they were totally on trend. While the company reported positive same-store sales at Luby’s Cafeteria — its largest brand — the company’s financial results nevertheless cratered on account of increased costs (in food, labor and operating expense) without a corresponding acceleration in sales (via either increased prices or guest traffic). The company’s overall same store sales decreased 0.9%, its total sales decreased 3.1%.
The company noted:
“…the current competitive restaurant environment is making it difficult for our brand and the mature brands of many others to gain significant traction. We've been faced with the environment for quite some time, which has been a large drag on our financial results and our company valuation.
The challenge of rising costs, flattish-to-down sales, and a sustained debt balance are restricting the company's overall financial performance.”
Like many other chains, therefore, Luby’s is rationalizing its store count. The company previously committed to shedding at least 14 of its owned locations to the tune of an estimated $25mm in proceeds; it is accelerating its efforts in an attempt to generate an additional $20mm in proceeds. The use of proceeds is to pay down the company’s $44.2mm of debt. The company also announced that it hired Cowen ($COWN) to assist it with a potential restructuring of its Wells Fargo-agented ($WFC) credit facility. That hire was a requirement to a July 12-dated financial covenant default waiver (expiration August 10) provided by the company’s lenders.
This company does have one advantage over several distressed competitors: it owns a lot of its locations (in addition to its franchise business; a separate licensee operates an additional 36 Fuddruckers locations). The question therefore becomes whether the company’s lenders will provide the company with enough latitude (via continued waivers or otherwise) to sell enough locations to generate proceeds to pay down or “reduce [its] outstanding debt to near zero.” If patience wears thin or buyers balk at purchasing locations that later may become subject to a fraudulent conveyance attack, this may be yet another casual dining chain to find itself in bankruptcy. The stock, which has been range-bound for about a year, trades as follows:
Likewise, Steak ‘n Shake is also beginning to look stressed — at least as far as its senior secured term loan goes. The casual dining restaurant company has somewhere between 580 and 616 locations, approximately 2/3 of which are company-owned. According to Reorg Research, it also has a group of lenders who are agitating given (i) under-budget revenues, (ii) liquidity concerns, and (iii) lower loan trading levels. Per Reorg:
The lenders’ move to organize comes as Steak ‘n Shake has shifted its focus from company-owned locations to franchise opportunities in the face of declining revenue, same-store sales and customer traffic as well as increased costs. A wholly owned subsidiary of Biglari Holdings, Steak ‘n Shake is a casual restaurant chain primarily located primarily in the Midwest and South United States; the chain is known for its steak burgers and milkshakes. Biglari says that unlike company-operated locations, franchises have “continued to progress profitably.” “Franchising is a business that not only produces cash instead of consuming it, but concomitantly reduces operating risk,” the 2017 chairman’s letter says.
Even so, 415 of the total 616 Steak ‘n Shake locations are company-operated and creditors are pushing the company to bring in operational advisors, sources say. The company’s $220 million term loan due in 2019, which according to the Biglari 10-Q had $185.3 million outstanding as of March 31, has dipped to the 86/88 context, according to a trading desk. The term loan, which matures March 19, 2021, is secured by first-priority security interests in substantially all the assets of Steak ‘n Shake, although is not guaranteed by Biglari Holdings.
Same-store sales fell 0.4% in 2016 and another 1.8% in 2017. Traffic last year fell 4.4%.
The decline in traffic wiped out the chain’s profits. Operating earnings per location declined from $83,300 in 2016 to just $1,000 in 2017.
Part of the issue may be the company’s geography-agnostic “consistent pricing strategy” which keeps prices static across the board — regardless of whether a location is in a higher cost region. This strategy has franchisees in an uproar which, obviously, could curtail efforts to switch from an owner-owned model to a franchisee model. Indeed, a franchisee is suing. Per Restaurant Business:
For franchisees that operate 173 of the 585 U.S. locations and have to pay for royalties on top of other costs, the traffic declines risk sending many locations into financial losses. In addition, rising minimum wages in many markets, along with competition for labor, could put further pressure on that profitability.
Steaks of Virginia, the franchisee that filed the lawsuit last week, claimed it was losing money at all nine of its locations.
Curious. Apparently the company’s reliance on higher traffic to generate profits didn’t come to fruition. Insert lawsuit here. Insert lender agitation here. Insert questionable business model shift here.
In a February shareholder letter, Biglari Holdings Chairman Sardar Biglari channeled his inner-Adam Neumann (of WeWork), stating:
We do not just sell burgers and shakes; we also sell an experience.
Given all of the above and the perfect storm that has clouded the casual dining space (i.e., too many restaurants, the rise of food delivery and meal kit services, the popularity of prepared foods at grocers), lender activity at this early stage seems prudent.
2. New York City CRE (Long the Changing Retail Landscape)
Is anything available in New York City for less than $5? Some of you are about to find out.
Yesterday, Bloomberg noted the following:
Retail rents are tumbling in Manhattan, especially in the toniest neighborhoods.
In the area around the Plaza Hotel on Fifth Avenue, home to the borough’s priciest retail real estate, rents fell 13.5 percent in the second quarter from the previous three months, the largest decline among the 16 neighborhoods tracked by brokerage CBRE Group Inc. The drop was due in part to a single space that had its price cut from $3,500 a square foot to $2,500, CBRE said in a report Tuesday.
Tenants have the upper hand in New York as landlords contend with a record number of empty storefronts. Across Manhattan, 143 retail slots have sat vacant for the past year, and rents have been reduced on more than half of those spaces, CBRE said. Property owners are increasingly willing to negotiate flexible terms in an effort to get tenants to commit to leases, according to the report.
Apparently a number of commercial real estate brokers didn’t get the memo. Brokers reportedly lashed out last week upon news that General Growth Properties ($GGP) leased out a large space to Five Below, a discount consumer products chain, at 530 Fifth Avenue. Per Commercial Observer:
Some brokers expressed disappointment with the tenant selection.
“It’s not a Fifth Avenue-type tenant. Everyone is pissed,” one broker said of the deal because of the nature of the tenant on a prized part of Fifth Avenue. He added: “There goes the neighborhood.” A more suitable location, the broker said, would have been south of 42nd Street.
“Not sure this was the tenant surrounding landlords with available space were hoping for,” said Jeffrey Roseman, a vice chairman at Newmark Knight Frank Retail, who was not involved in the deal.
Wait. What? Currently, there’s literally a JPMorgan Chase Bank, a Walgreens and a Kaffe 1668 right there there. Who among that lot can rightfully object?
What these brokers don’t appear to grasp is that the brick-and-mortar landscape has dramatically changed. There aren’t very many tenant options for landlords — at least not for 10,800 square foot spaces (which is what this is). And there’s no benefit to any of the other retailers in the vicinity of the space for it to remain vacant. Apropos, as noted in Commercial Observer, one broker appears to get it:
“Five Below is the updated variety store or five-and-dime store of our day—something for everyone,” said Faith Hope Consolo, the chairman of the retail leasing and sales division at Douglas Elliman. “As for the character or image of the street, that is not really affected or important. The key is that a big space was absorbed and this type of tenant will generate traffic.”
Our thoughts exactly. Those adhering to a New York City of yesteryear clearly haven’t noticed the influx of coffee shops, pharmacies and banks on every corner. Who else would take such a large space? Toys R Us?
What? Too soon?
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