An Active Week for Bankruptcy Filings: GCX, Sienna & More.
|Sep 18, 2019|| 2|
🤔A GameStop Turnaround Story? (Long Skepticism)🤔
PETITION is generally about disruption and one notable retail business is clearly in the midst of a secular sea change*…
On September 10, GameStop Corp. ($GME) reported Q2 ‘19 earnings. They were, to put it kindly, dogsh*t. The results reflected a sharp decline in sales -14.3% from $1,501mm in Q2 ‘18 to $1,286mm, driven by a 41% drop in console sales and 18% reduction in pre-owned sales. Comparable same stores sales declined 11.6%. To make matters worse, GameStop gave investors lower guidance than expected. On last Tuesday’s earnings call management noted:
We are approaching the end of the current console cycle with nice generation consoles slated to be available in late 2020, and as such we expect our year-over-year sales to be down over the next three or four quarters, reflecting the end of that cycle.
Such confidence and enthusiasm!! The shift to digital video games is clearly cutting GameStop out as the middleman, and increased competition is eating up its market share: the business is becoming increasingly cyclical.**
On the earnings call, Ben Schachter, equity analyst at Macquarie Group, had some questions for management about the shift to digital in the video game industry and how $GME is going to adapt:
Can we talk about high-level -- the shift to digital, and then how it impacted the business? So a few questions on that. One, when you think about the next cycle, what percentage of total game, do you think are going to be sold physically versus digital? And what your share might look like in that? Two, how do you expect to participate in digital? How will that evolve for you guys versus what it is today? And then three, around the used business, what does that look like as we move more to digital?
Our assumption is that, they'll launch in both formats with the new cycle just as they do now. And our assumption is that, we'll have a piece of both businesses. Obviously, we have a very, very significant share when it comes to physical games. Physical games are still a significant portion of the overall gaming industry today.
I think it's fair to say that, historically, we probably had a preference for physical games versus digital games and we've been clear to say both internally and externally that we’re going to be agnostic and it has to be the customer's choice, as to which may we sell.
So we will focus on making the digital sales process easier, more streamlined, more embedded, and we'll push to make sure that we have that approach.
This wasn’t exactly a confidence-inspiring reply — especially when you take a deeper dive into the industry trends. Per Statista:
It’s hard to be agnostic about such a stark trend.
Who are some of these digital competitors that are disrupting the (physical) video game space?
In June of this year, Alphabet ($GOOG) announced its new digital gaming platform, Stadia. In an article about Stadia, Android Authority notes:
Stadia is reportedly more powerful than any gaming console on the market right now, and has the advantage of being easier to upgrade.
Google Stadia is launching in November in the U.S., Canada, the U.K., and 11 countries in Europe. Pricing will be $9.99 a month in the U.S. for the Stadia Pro service, which will offer access to roughly a game a month (starting with Destiny 2). Google is also selling a limited “Founder’s Edition” version that includes a Night Blue color controller, a Chromecast Ultra dongle, three months of Stadia Pro, a buddy pass for three months of Stadia Pro to give to a friend, and first access to claim your Stadia name. It will cost $129 in the U.S and is available to pre-order now.
But they’re not the only ones disrupting the industry. Microsoft’s ($MFST) Xbox is offering services called “Xbox Game Pass” and “Xbox Play Anywhere.” And Sony ($SNE) is offering a service called “Playstation Now”. Per Project Disrupt:
Video games have been transitioning towards the digital model for some time now and gaming services such as Playstation Now and Microsoft’s Xbox Game Pass and Xbox Play Anywhere (the next step being Project xCloud) are allowing people to play their games, previously only on physical discs accessible only with their consoles, on multiple compatible devices and platforms.
Oh, and in case you missed it, a small Cupertino-based company had a product announcement this past week that might also affect things: Apple Inc. ($AAPL) announced “Apple Arcade,” a new game subscription service that, at $4.99/month, will become available shortly in more than 150 countries. Right out of the gate, Apple users will be able to play over 100 new and exclusive games across their Apple devices.
GameStop counters that demand for physical copies of video games will persist because gamers will want to be able to bring games over to their friends’ houses. To which we be like:
Um, sure, okay. We’re prettttty pretttttty sure that kids are bringing that powerful mini-computer they carry everywhere in their pockets over to their friends’ houses too. Call us crazy.
So with all of this disruption cascading through the gaming market and steamrolling GameStop’s numbers, what is management’s strategy to survive? They have a four-pronged plan.
First, they intend to drive more efficiency in their business. They’re going to reduce overhead (read: sh*tcan people — SG&A was up $17mm on one-time hits including severance), optimize inventory management (i.e., steamline SKUs), exit unprofitable businesses, focus on high-margin product categories, and further rationalize their brick-and-mortar footprint (of which, management says, 95% of stores are EBITDA positive). Regarding collectibles, the company’s CEO notes:
…we see further opportunity in expanding our double-digit growth collectibles category, creating more exclusive packages with our vendors, expanding our PC gaming offerings, and evolving our private label business by leveraging our significant scale and retail expertise.
Second, they hope to make GameStop locations a social and cultural hub for gamers. To this end, the company is testing “experiential offerings” in Tulsa Oklahoma. No doubt esports will factor into this initiative. The company also intends to leverage its existing rewards program (and a new Salesforce integration) to drive more customer interaction.
Third, the company is bolstering its omni-channel capabilities, including the recent launch of its redesigned website — which, we have to say, actually looks pretty good.
Finally, management intends to squeeze console manufacturers and other vendors for more favorable economics.
Skepticism within the investment community abounds. And management knows it. They noted:
We recognize that there was a need to rebuild credibility with the investment community and some of our stakeholders. We plan to accomplish this by quickly establishing a track record of delivering on our promises and executing plans for the business that will support improved financial performance and fuel future growth over the long-term.
Uh huh. Whatevs, bro. Per Fortune, analysts continue to be unimpressed:
Mike Hickey of Benchmark Company reduced his price target for the company nearly in half to $3 after the earnings call, comparing the company to ‘a Chernobyl experience.’
‘The new management team appears detached from emerging digital trends, and the idea that GameStop will emerge as a social/cultural gaming hub is a bit of a stretch, in our view,’ he said in a note to investors. ‘We believe the days of GameStop’s channel dominance/relevance will not return, and a strategic effort to gain market share on PC against Steam and Epic is unconvincing at best.’
“At first glance, GameStop’s F2Q 2019 results were much worse than consensus expectations and provide further evidence the new management team has a difficult task ahead as it attempts to turn the company around in our opinion,” writes Loop Capital Markets’ Anthony Chukumba. “We were particularly discouraged by the continued weakness in pre-owned and value video game products sales (which dropped by a high-teens percentage despite a YoY gross margin decline) and management’s worse-than-expected F2019 diluted EPS guidance.”
The market is signaling its agreement:
The company’s stock couldn’t even rebound a little on National Video Games Day:
Yet, while sales continue to sink and this is, in some respects, an operational restructuring story, this is, by no means, a near-term bankruptcy story. Long-term debt is only $419.1mm (‘21 6.75% senior unsecured notes, last trading at 99, rated non-investment grade speculative BB- by S&P), a marked decrease of $404mm of debt from the year prior.*** Indeed, it’s the balance sheet that appeals to the likes of Michael Burry.
On Monday, his firm, Scion Asset Management, revealed it had sent a letter to the board of GameStop (ticker: GME) urging the company to fully execute the $237.6 million remaining on its current $300 million share-buyback authorization.
Dr. Burry noted his interest in $GME’s strong balance sheet (Leverage <1x TTM EBITDA), but didn’t say anything about $GME beating out the competition or addressing the overall trend of digitization of video games. If anything, his desired acceleration of the share-buyback program may only heighten the company’s potential demise. On the flip side, earnings were such a dumpster fire that the shares can now be purchased much more cheaply than they could have a week ago. 😜
Putting aside the benefits of GameStop’s lease reduction program to GameStop, it certainly isn’t great news for retail landlords and retail REITs alike. ARS Technica notes in a recent article:
GameStop says it will be closing "between 180 and 200 underperforming stores" in the next six months. That statement comes following 195 store closures in the last 12 months and what the company says it expects will be "a much larger tranche of closures over the coming 12 months to 24 months.”
For every GameStop in the world, there are 2 other GameStops within 5 miles, on average, and there are 6.2 other GameStops within 10 miles. In other words, gamers who want to head to a real-world GameStop have options within a ten- to twenty-minute drive.
It's likely that the deepest location closures will take place in urban areas where GameStop store density is already high. In New York City, for instance, there are as many as 7 GameStop stores within 1 mile of one another and 35 stores within 5 miles.
That’s right: the company’s largest concentration is in New York which, in case you didn’t know, isn’t exactly the city with the cheapest rent.
…GameStop is competing with itself in a shrinking brick-and-mortar videogame marketplace. Among the most-crowded areas, Astoria, Queens ranks at the top with an average of 32.5 GameStops 5 miles from one another followed by Woodside, Queens with 32. The top-10 most-crowded GameStop areas are all in the New York Area.
With that large of a footprint, it sounds like it won’t just be loss-making stores that are on the chopping block. Per the CEO:
The inorganic or acquisition growth of this business created opportunities in certain markets where we have quite a dance footprint and where we have -- stores within -- in overlapping trade areas or that overlapping within a trade area. That de-densification gives us the opportunity for transferability, regardless of whether or not we are loss making, one of those two stores for example might be loss making.
And so, that's really how we're approaching it. That's the analytic that we're applying. That's why we think about it not as a binary function of loss making versus non-loss making stores. But more importantly, in total, as we rationalize the chain, how can it fully be accretive to -- for bottom line performance.
Clearly, there’s no relief in sight for retail landlords.
*Industry-wide, gaming is in a bit of a state of upheaval. According to industry-tracking firm The NPD Group, and as reported in Venturebeat, consumer spending on video games in the US was down large in August:
**To counteract this, GameStop is increasingly relying upon its collectibles business. That business posted a 21% YOY increase and 15 consecutive growth quarters, with 14 of 15 in double digits. Maybe this is a thing. We’re not sure. We are sure, however, that we’ve seen this movie before: it was called Tower Records. The strategy of being all things “movie/music nerd” didn’t play well for them. Perhaps things will be different for a strategy of all things gamer nerd?
***The company used cash on hand to redeem $350mm of ‘19 5.5% senior notes due in October. The company also repurchased $53.6mm of its ‘21 senior notes between 99% and 101.5% of par value. Finally, the company also has a $420mm ABL of which $283mm remains available.
🙈Take a Break from Oil & Gas Part 1: New Chapter 11 Bankruptcy Filing - GCX Limited🙈
GCX Limited and 15 affiliated debtors filed a prepackaged bankruptcy this week in pursuit of a dual-track restructuring that will, either through a debt-for-equity swap or a sale, extinguish over $150mm of debt. In the swap scenario, the company will hand the keys over to senior secured noteholders; in the sale scenario, the noteholders will gladly take their cash payout and get the f*ck out of dodge. Either way, the company will be under new ownership with a significantly deleveraged capital structure. Certain consenting senior secured noteholders will provide $54.5mm in DIP financing.
The debtors are a global data communications provider; they operate one of the world’s largest fiber networks (PETITION Note: we’re old enough to remember when fiber was the future!). They provide undersea and terrestrial cables and landing stations and provide managed network services all across the globe. In English, this means they help power, among other things, major telecom companies and streaming media.
Unfortunately, the debtors have declining revenues. Among other reasons for that sad state of affairs, the debtors cite (i) newly developed and planned cable systems along the debtors’ existing and planned network routes, (ii) financial distress at the parent level, (iii) ongoing disputes with banks that have applied setoff rights against the debtors’ cash, and (iv) high fixed costs and less certain recurring revenue due to clients newfound refusal to enter into long-term arrangements. For all of these reasons, the debtors have been unable to refinance their senior secured notes and the notes matured on July 31. Obviously — considering this thing is now in bankruptcy court — the debtors’ issues prevented them from paying off the debt as it became due. Instead, the debtors have operated under a forbearance agreement since July, during which time it formulated its go-forward plan and solicited the support, via a restructuring support agreement, of a meaningful amount of senior unsecured noteholders. The forbearance expired on the filing date.
Now the bankers, Lazard & Co., will have their work cut out for them. The debtors hope to run an expedited sales process (though, in the bankers’ favor is the fact that the pool of interested parties for assets like these is likely limited) and conduct an auction within 42 days of the filing. Absent that, the debtors will proceed with the debt-for-equity swap with an eye towards confirmation within 75 days and going effective before the end of the year (subject to requisite regulatory approvals, i.e., FCC and CFIUS).
(PETITION Note: yes, we’re aware that read boring AF, but you try making a telecom company sound interesting.)
💊Take a Break from Oil & Gas Part 2: New Chapter 11 Bankruptcy Filing - Sienna Pharmaceuticals Inc.💊
If you’re tired of distressed retail and oil & gas companies, the good news is that the biopharma space has been mixing things up. Yesterday, Sienna Pharmaceuticals Inc. ($SNNA), a California-based clinical-stage biopharma and medical device company filed for bankruptcy in the District of Delaware. It develops multiple products aimed at chronic inflammatory skin diseases (e.g., psoriasis) and aesthetic conditions (e.g., unwanted hair and acne). Like most other biopharma companies that wind their way into bankruptcy court, the company is at the stage in its lifecycle that those in the tech world would designate “pre-revenue.”
And that is precisely the problem. Much like distressed oil and gas companies, distressed biopharma companies are capital intensive (a $184.1mm accumulated deficit) and tend to succumb to the weight of their long-duration development cycle. In this case, the company “has relied on equity issuances, debt offerings, and term loans” to fund development and operations. It has also leveraged its equity as a currency, engaging in strategic acquisitions that enhance its product portfolio; it, for instance, entered into a share purchase agreement in late ‘16 with Creabilis plc. This added one more product that, at this juncture, the company cannot advance due to liquidity issues. Womp womp.
The company has, over the course of time, been indebted to its pre-petition secured lender, Silicon Valley Bank, in the range of $10-30mm. On September 15th, for instance, the company owed SVB over $30mm. In exchange, however, for the use consensual use of cash collateral, the company made a $21.3mm payment to SVB on September 16th, the day before the bankruptcy filing. That’s what you call influence, folks. SVB’s loan is secured by a laundry list of debtor assets though it is technically not secured by the company’s extensive trove of intellectual property (~250 patents). That IP, however, is subject to what’s called a “negative pledge,” a provision that prevents the company from pledging the IP on account of the fact that SVB’s security interest includes “rights to payment and proceeds from the sale, licensing, or disposition of all or any part of the Intellectual Property.” It’s a wee bit hard to enforce a security interest in IP if someone else has a right to the payment streams emanating therefrom (not that this company has any revenue streams, but you get the idea).
Why bankruptcy? For starters, the company is subject to a “minimum cash covenant” under its SVB facility and liquidity dipped below the minimum. Due to the company’s declining stock price, the company lost access to the equity market. Finally, the company has lingering financial commitments from the Creabilis deal. For all of these reasons, the company simply doesn’t have the liquidity needed to fund the next stages of product development which, in turn, would get the company closer to revenue generation. Chicken. Meet egg.
As is the overwhelming norm these days, the company now seeks to use the bankruptcy process to pursue a sale. As of the filing, no stalking horse purchaser is teed up but the company is “confident” that its banker, Cowen & Co. ($COWN), will locate one that will enable the company to emerge from bankruptcy as a going concern. No pressure, Cowen.
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 recently added “Super Pumped: The Battle for Uber” by Mike Isaac, which we blew through rather quickly. Next up on our list: “What it Takes: Lessons in the Pursuit of Excellence” by Stephen A. Schwarzman, “The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company” by Bob Iger, and “That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea,” by Netflix co-founder Marc Randolph.
⚡️Notice of Appearance: Ted Gavin of Gavin/Solmonese⚡️
PETITION: You represented the UCC in the Videology Inc. chapter 11 case that filed back in May 2018. Videology is an adtech company that had received a significant amount of venture money and, later on, venture debt. What did you learn about the adtech business, the impact of venture debt on upstart companies, and how might these lessons be applied to bankruptcies in the future?
“Yes, there was venture money, and yes there was venture debt. And sure, maybe that venture debt was more venture money than debt. Here’s the thing about adtech in general and Videology in particular: the value of these businesses is wrapped up in their intellectual property, which generally comes in two forms: a proprietary engine, and the customer lists. If an adtech company isn’t running a proprietary engine, then it’s just a service bureau with aspirations. And customer lists (and, for that matter, the proprietary engine technology) are incredibly portable. This makes for blurred lines with respect to what corporate family member actually “owns” the assets. You can move the IP from company to company, and that can be done for legitimate purposes (if we’re calling the creation of a middleman to create opportunities to upcharge customers by intermediating them from the sale side of the business “legitimate”) or it can be done to frustrate creditors, please noteholders, or any other suspicious or quasi-nefarious purposes. While Videology came to command decent value in a sale, it took a lot of investment to get there. Those proprietary engines cost money to create, develop and prove out – yet they’re still nothing without turning that into a revenue-producing customer list. Someone’s got to foot that bill and, if it’s done with debt, the company will not likely survive long enough to realize a return on the investment because of over-leverage (think of it as a tech company version of the Revel Hotel & Casino – sure, you’ve over-invested in startup, but put it through bankruptcy a couple times to strip off that debt and pretty soon you’ve got yourself a good business!). Generating enough cash to fund ongoing operations and also be able to pay back the cost of development is gonna take a minute. Videology, which commanded a respectable sale value (at least in relation to its stalking horse bid), couldn’t do it.”
PETITION: You also represent the debtor in the Consolidated Infrastructure Group case. This one has some hair on it: breach of contract allegations, de minimis asset value, etc. Was chapter 11 a suitable option for dealing with this company's issues or do you think this case could've been avoided with agreements outside of court?
“Chapter 11 was the only suitable option. Reasonable people can see the same facts differently. Reasonable people can try and fail to find common ground. But parties who aren’t talking to each other never will find the basis for resolving their issues. If the destruction of the other party is what each party is fighting for, then it’s a war of attrition. And that was the story of CIG. This case wasn’t ever going to find an equitable and consensual resolution outside of a court-supervised process. The exigencies of the case required neutral oversight and a transparent process, and there were years of history to support the premise that it was never going to happen outside of bankruptcy. Once that process was in place, there was a platform for the various parties’ grievances to be heard, and for an open sale process to be run. A sale process in which all the parties are involved can be a de-escalating force once it’s done.”
PETITION: You and the G/S team play a lot in the small to middle market. A lot of the noise these days has been emanating out of big retail and energy: the small and middle markets don't get as much media love. What are you seeing there that is notable as we inch closer to Q4 '19?
“Lordy – in the last 15 years across the restructuring spectrum we’ve gone from restructurings, to cleaning up the balance sheet with a quick sale, to “screw it we’re just going to liquidate because retail”. Where do we even start? With small and middle-market companies, there exists the opportunity to actually accomplish something that resembles an actual turnaround and reorganization. Sure, the companies are running on fumes, but so are large company cases because they’ve waiting too long to file. So, with smaller companies, you need less capital to get past the “running on fumes” stage. Smaller cases often present with less of a foregone conclusion, which means there can be more creative solutions. I’ve seen small-market debtor plans that look almost indistinguishable from chapter 13 plans. And, like chapter 13, small-company chapter 11 work can be an interesting and unfamiliar neighborhood.”
PETITION: Cases these days appear to be veering more towards chapter 11 363 sales with liquidating plans. You do a lot of liquidating trust work: what are some things about liquidating trusts that you think need changing? Are there tech solutions out there that can make liquidating plan processes much more efficient to the benefit of creditors?
“Liquidating Trusts are a mixed bag: what appears to be simple can become burdensome and expensive, particularly when there is protracted motion practice to resolve claims. On the other hand, what looks like it will be lengthy and complex can often be made simple by understanding reserves and pushing money out sooner rather than later. But the one constant seems to be the complete lack of transparency and oversight over how the Liquidating Trusts come to be. If a bankruptcy plan is akin to a law, a Liquidating Trust agreement and the subsequent oversight is more like an executive order – it just sort of happens. And Liquidating Trustee work can get unwieldy and complex – particularly with recent case law narrowing what types of claims a Liquidating Trustee can bring, and who can bring claims that a Liquidating Trust will later inherit. As for the one thing that would improve Liquidating Trusts, I say transparency. Constituents should know why their Liquidating Trustee should be their Liquidating Trustee and they should be aware of the whole of the business or pecuniary relationship between the Liquidating Trustee and any other parties in the case. Those relationships aren’t fatal, but they should be disclosed like any other connection in a bankruptcy case.
There are plenty of tech solutions that streamline Liquidating Trustee work. I use one at the moment, and I’ve used most of the others. There are plenty out there; but the bottom line is that if a Liquidating Trustee isn’t using a consolidated claims management and banking platform, they are wasting time and resources on a process they could be having done for free.”
PETITION: Thanks Ted.
Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.