💥Do You Lift Bro?💥
24 Hour Fitness, Hertz, Proteus Digital Health, Pyxus International
|Jun 17|| 4|
California-based 24 Hour Fitness Inc. (along with ten affiliates, the “debtors”) filed for chapter 11 bankruptcy in the District of Delaware earlier this week after it became apparent that it’s awfully hard for a business that typically does $1.5b in revenue and $191 in adjusted EBITDA to make money when a pandemic rips through the nation, shelters-in its 3.4mm customers serviced across 445 (leased) US-based locations, and effectively converts the brand to “0 Hour Fitness Inc.” Like, overnight. This, ladies and gentlemen is as pure-play a COVID-19 story as they come these days (outside of Hertz and a couple of airlines).
Now, that’s to not to suggest that everything was copacetic prior to the quarantine. The business had some pimples on it. For instance, the debtors’ CRO highlights how the debtors’ newly-instituted selling/operating model became a drag on financial performance pre-COVID: apparently you actually need humans to walk people through gyms and close sales. Who knew? But the biggest and scariest pimples are the debtors’ balance sheet and lease portfolio. The former includes $1.4b of funded debt; the latter, 445 locations leased across the country, of which 135 have already been deemed unnecessary and are the subject of a first day executory contract rejection motion (PETITION Note: the debtors denote this as “a first wave.”). When revenues stop coming into the coffers, these tremendous amounts become quite an overhang and a liquidity drain.
The filing, among other things, helps solve for the liquidity issue. The debtors have obtained a commitment for a $250mm new-money senior secured DIP facility from an ad hoc group of lenders. While there was no restructuring support agreement in place here at the time of the petition date, the ad hoc group is comprised of 63.3% of the aggregate principal amount outstanding under the prepetition credit facility and approximately 73.9% of the face amount of the $500mm in senior unsecured notes. In other words, there’s a solid amount of support here but not enough yet to command the senior class of debt.
Luckily, the debtors gave themselves a form of pre-DIP. Wait. Huh? What are we referring to?
…the Debtors were obliged to close all of their fitness clubs nationwide on March 16, 2020, in response to this national emergency. As a result, the Debtors were no longer able to generate new sources of revenue (by winning new members) and, on or about April 15, 2020, the Debtors suspended billing on account of monthly membership dues.fn
In the footnote, the debtors note:
To date, litigation has been commenced in connection with the Debtors’ monthly billing on a post-March 16 basis, notwithstanding, among other things, the Debtors’ rights under their various membership agreements. The Debtors reserve all rights, claims, and defenses in this regard.
Uh, apparently, “0 Hour Fitness Inc.” nevertheless equals “30 Days of Payment Inc.” We’ll see whether this short-term liquidity grab created long term customer retention issues.*
Moreover, the fact that they apparently laid off thousands of employees via conference call probably won’t amount to a whole lot of goodwill. Just sayin’.
Now it’s wait and see. The debtors have reopened approximately 20 locations in Texas and hope to have the majority of their other non-rejected clubs open by the end of June. We’ll see if the uptick in COVID cases in certain states throws a wrench in that plan. To combat any COVID-related perception risk, the debtors are instituting some new measures:
…the Debtors have taken an innovative approach to the reopening of their clubs, instituting market-leading strategies to keep their members and employees safe, including an app-based reservation system to ensure that their clubs remain in compliance with applicable social distancing guidelines, a touchless check-in system to limit members’ and employees’ contact with surfaces, and cleaning schedules that ensure that entire clubs are sanitized every hour. (emphasis added)
Gosh. We see sh*t like this and it really makes us wonder: what the bloody hell were these cesspools doing pre-COVID?!?!? Clearly not enough.
And, yet, otherwise, we have some sympathy for these businesses. This is a brand new paradigm. The debtors indicate that they’re implementing a reservation-based system where people are locked into an hour-max workout after which the gym will be closed for 30 minutes for a “deep clean.” That is not exactly a seamless and frictionless user experience. Moreover, what kind of chemicals are going to be dumped all over the facility every 60 minutes? These are tough issues.
As far as social distancing:
…the Debtors are utilizing space in their clubs in creative ways in order to continue to offer members a range of amenities and services. For example, the Debtors are utilizing their basketball courts to hold group exercise classes, including by relocating stationary bike equipment to continue to offer indoor cycling classes, so that members and equipment can be properly spaced to comply with social distancing guidelines.
No offense but is THIS really worth going to the gym for? You can use apps for a fraction of the cost and do this at home…mask-less.
So what now?
Lawyers for 24 Hour said the funding is a crucial first step to stabilizing the business, which has generated virtually no revenue since mid-April because of pandemic-related closures. Investors backing the loan include Sculptor, Cerberus, Cyrus Capital Partners LP and Franklin Advisers Inc., court papers said. The group owns more than 60% of the company’s $930 million in senior debt and more than 70% of $500 million in unsecured bond debt.
The company projects it will generate about $13 million in total revenue over the next two months compared with roughly $130 million in operating expenses, including about $60 million in rent payments due in August….
There’s a lot of questions hovering over this one. Will those people who paid for a month when the gym was closed come back? Will the news about employee treatment effect the “brand”? Will all of those people who bought home gyms or learned to run need to go to a gym? The re-opening notwithstanding, all of these questions will directly impact valuation. Indeed, how do you value this business with so many massive question marks? Well, luckily, we have the debt to get a sense of what that answer might be. And considering that, at the time of this writing, the term loan is bid in the high 20s and the unsecured notes are bid around 3 — that’s right, 3 — it’s pretty clear who is getting (generally) wiped out in this scenario and where the market thinks the value breaks.
*Honestly, this was a dirty move but from the debtors’ perspective, it also totally makes sense. Have to be sensible about that.
⚡️Update: The Hertz Corporation ($HTZ)⚡️
We’ve previously discussed The Hertz Corporation ($HTZ) here (upon filing), here (upon filing of the controversial equity issuance motion) and here (upon approval of said equity issuance motion by the bankruptcy court). The company subsequently released its “Prospectus Supplement” for an offering of up to $500mm of common stock — a maneuver met with unfettered and uproarious collective laughter and consternation. Vanity Fair’s William D. Cohan said:
It’s easily one of the more cynical financial ploys to come along in a season filled with cynical financial ploys.
Among other bewildering provisions were these two “risk factors”:
Pure poetry. Nothing like the dynamic duo of illiquidity and worthlessness.
Except, the stock, at the time, wasn’t worthless. It was worth $2.83/share — half of what it was just a few days prior — yet nevertheless $2.83/share. That changed a bit on Monday. Bloomberg wrote:
Equity holders will not see a recovery from any bankruptcy plan unless those with more senior claims, including bondholders, are paid in full, Hertz said as it offered as much as $500 million of common stock. That would require “a significant and rapid and currently unanticipated improvement in business conditions,” the company said.
Hertz shares plunged as much as 37% on Monday, though the stock is still well above where it initially traded after the company filed for Chapter 11. A bankruptcy court judge signed off on the equity sale last week after the company pledged to alert buyers about the potential they could be wiped out.
The stock ticked up slightly higher on Tuesday (on 92mm shares of volume, a fraction of its average volume), only to apparently give the move back after-hours:
Regardless of whether you believe all of this strange market activity is attributable to a hoard of rabid day traders regularly swiping through Robinhood (PETITION Note: there are certainly detractors of this theory), there is an element of Robinhood that does gamify trading. In his newsletter “Why is this interesting?,” Noah Brier juxtaposes the Robinhood UX against E*trade’s UX. He wrote:
And so while we’re all trying to unwrap just what is happening in the markets and the role retail investors play, it seems that we should look beyond Davey Day Trader, and r/wallstreetbets, and even just the fact of Robinhood’s existence, and think about the ways design choices can fundamentally alter the mechanics of a game for which many thought they knew the rules.
Who would have thought? But it’s possible that digital design is a part of this bigger story. 🤔
💊 New Chapter 11 Bankruptcy Filing - Proteus Digital Health Inc.💊
In a week chock full of chapter 11 bankruptcy filings, in our opinion, the filing of California-based medtech company Proteus Digital Health Inc. is the most interesting and unique. Sure Extraction Oil & Gas ($XOG) is a publicly-traded oil and gas exploration and production company but, aside from the fact that it (i) operates primarily in Colorado rather than Texas or Oklahoma (ii) was basically toast as soon as its lender bank decided to de-risk and redetermine the borrowing base down, there’s nothing particularly fresh or interesting about it. We get it already: oil and gas is f*cked.
In contrast (and with apologies for the long block quote), when’s the last time you read about a chapter 11 debtor that does this:
The Debtor is a pioneer and leader of the “Digital Medicines” industry. “Digital Medicines” are oral pharmaceuticals formulated with an ingestible sensor aimed at tracking a patient’s adherence to prescribed medication treatments. When patients use Digital Medicines, their mobile devices collect information about medication taken and safely transmit the data via the cloud to the healthcare provider. Care teams are able to see if their patients are properly taking their medication and observe and analyze real-time data regarding the patient’s overall health such as heart rate, activity and rest. Digital Medicines enable care teams to manage larger patient populations and make medical decisions without the need for a patient to physically travel to the doctor’s office. Digital Medicines can help accelerate the trend toward conducting medical consultations over the internet. This opportunity is especially pronounced in rural areas and developing economies both domestically and internationally, particularly in light of challenges posed by the COVID-19 pandemic and resulting social distancing measures.
That’s like some scifi-type sh*t right there. Founded in 2002, the debtor has spent the better part of two decades developing its tech, testing its tech, commencing clinical trials, obtaining FDA approval of its drug-device combination product, entering into a marketing and distribution relationship with Otsuka Phamaceutical Co. Ltd. ($OTSKY)(which it later expanded the scope of), and agreeing to a multi-year outcomes-based initiative with the State of Tennessee’s Medicaid program with a focus on hepatitis C treatment of underserved populations. The company currently “…has a panel of more than 20 Digital Medicines that treat cardiovascular and metabolic diseases including hypertension and diabetes being prescribed to patients in the United States.” Its patent portfolio is 400 strong.
On the flip side, the company is currently “pre-revenue.” And as you can imagine, accomplishing all of the above required a significant amount of upfront capital. There’s a reason why this company raised venture capital all the way through a Series H round: $461.5mm, actually, according to Angelist, with the last round of $50mm taking place in April 2016. The company’s valuation reached as high as $1.5b — conferring full on “unicorn” status to the company. The company’s cap table includes, among many others, The Carlyle Group ($CG)(Series B & C rounds), Medtronic PLC ($MDT)(Series D round), Novartis Pharma AG ($NVS)(Series E & F rounds), and PepsiCo Inc. ($PEP)(Series G round). The company also has a $9.5mm pre-petition credit facility.
In late 2019, the company experienced a severe liquidity crisis due, in part, to complications arising out of the expanded collaboration agreement with Otsuka. The debtor nearly wiggled its way out of trouble; it negotiated a synchronized deal with Otsuka and its prepetition lender that would coordinate (a) payments in from Otsuka and (b) payments out to the lender and (c) let the company get back to business as usual and buy it some time to source additional financing. But then COVID-19 struck and the company again found itself in a position where it wouldn’t be possible to live up to its obligations — in this case, a $7.75mm repayment to its pre-petition lender on or before April 30. This thing is like whack-a-mole.
The company spent April and May trying to negotiate itself out of its quagmire and hired Raymond James & Associates Inc. ($RJF) as investment banker to pursue a marketing and sale process. The company entered into a series of agreements with Otsuka and its lender to stem the tide but, ultimately, the shot clock ran out:
In light of all of these circumstances, and after having explored multiple options and carefully considering the alternatives, the Board, in consultation with managements and the Debtor’s advisors, made the difficult decision to file for chapter 11 protection in order to preserve the Debtor’s assets and conduct a sale process or other transaction, all in an effort to maintain continuity of business operations (including the Debtor's TennCare initiative) and maximize going concern value for the benefit of the Debtor’s creditors and equity stakeholders. The Debtor anticipates that it will seek approval of appropriate bidding and sale procedures in the early weeks of the Chapter 11 Case.
The pre-petition lender has consented to the use of its cash collateral to fund the case. Now we’ll see if there are any buyers out there who are as impressed with the premise of Digital Medicines as we are.*
*Full disclosure, we’re going purely off of what the debtor describes and have no medical knowledge whatsoever to opine on the efficacy of such initiatives. Sure sounds cool AF though.
💥Sponsored Content: When It Comes to Sources We Look Up To...💥
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💥Tweet of the Week💥
Okay, it was last week but it should have gotten far more play than it did given that this is a leading indicator of bankruptcies to come:
🚬 New Chapter 11 Bankruptcy Filing - Pyxus International Inc. 🚬
North-Carolina based Pyxus International Inc. (and four affiliates, the “debtors”) filed for chapter 11 bankruptcy in the District of Delaware — the culmination of a fairly rapid descent into distressed territory that we previously discussed here. Of course, it could be worse: these are fully-consensual prepackaged cases that will equitize $636mm of second lien notes, provide the debtors with $260mm in new liquidity, and otherwise leave all employees, vendors and customers unimpaired. As for equity? Well, if equityholders don’t opt-out and/or reject the proposed plan, they’ll get their pro rata share of a $1mm pool. With approximately 9.18mm shares outstanding (per CNBC), that’s about a ~$0.11/share recovery (assuming everyone plays ball). See, sometimes equity can actually get a recovery (see also Extraction Oil & Gas).
Pursuant to the proposed DIP Order, the plan must be consummated within 75 days.
📉Charts of the Week📈
Nothing to see here:
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. We’ve added “No Filter: The Inside Story of Instagram,” which is next up on our “To-Read” list.
Ajay Bijoor (Managing Director) joined DC Advisory from Guggenheim Securities LLC.
George Howard (Partner) joined Vinson & Elkins LLP from Skadden Arps Slate Meagher & Flom LLP.
Josh Baker (Associate) joined Alvarez & Marsal LLC from Tottola Advisors LLC.
Nevin Shetty (Managing Director) joined SierraConstellation Partners after serving as Chief Partnerships Officer at David’s Bridal.
Rina Joshi (Managing Director) joined Apollo Global Management Inc. from PointState Capital LP.
Vince Roldan (Partner) joined Mandelbaum Salsburg PC from Ballon Stoll Bader & Nadler PC.
Balbec Capital on raising its 4th distressed fund, InSolve Global Credit Fund IV, a $1.2b fund focused on non-performing distressed loans.
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