Disruption from the Vantage Point of the Disrupted
11/14/18 Read Time = 5.2 a$$-kicking minutes
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1. 💣D-Day is Coming (Short Hedge Funds)💣
November 15 is a big day. In addition to it being the day that marks the expiration of the 30-day grace period for companies that had an October 15 interest payment (and there are several), it also marks D-day, of sorts, for hedge funds. And it couldn’t possibly be worse timing: the industry just had its worst performance in years.
Hedge funds suffered their worst month in October in seven years as equity strategies were hit by a sell-off in technology stocks.
Ah, the old “hedge fund hotel” concept. Which really begs the question: why the hell do people pay hedge funds 2-and-20 when they’ll just take that money and crowd into FAANG stocks? You can buy that sh*t for $4.95/trade on Fidelity or, if you’re millennial-minded, for free on RobinHood. But we digress.
Per Hedge Fund Research (“HFR”), it was a bloodbath of a month for hedge funds. All strategies aggregated down 3%, the worst monthly decline since September 2011. Performance for the year is down 1%.
The worst of it, though, came down to those funds that invest in energy which, after another brutal week, appears to be comfortably nestled into bear market territory. Looks like President Trump is getting his wish: low energy prices. The effect? Most energy stocks got hammered last week. Which is to say nothing of high yield bonds, see., e.g., Parker Drilling and Weatherford International. An HFR index tracking energy-focused hedge funds was down 8%. Savage.
Back to The Financial Times:
Dispersion between the best- and worst-performing hedge funds also widened, with the top tenth returning 6.6 per cent and the bottom 10 per cent falling 13.7 per cent, HFR found. Only a quarter of hedge funds were positive for the month.
So what does November 15 have to do with any of this? November 15 marks the deadline for investors to put hedge fund managers on notice that they want their money back. So far this year, clients have already pulled $11.1b and multiple hedge funds have closed and/or converted over to family offices.
The last time the industry careened toward annual losses was in 2015, when managers were tripped up by events including the unexpected surge in the Swiss franc and the devaluation of the Chinese yuan. The fallout: clients withdrew $77.2 billion between the fourth quarter of that year and the first quarter of 2017 -- the biggest withdrawals since the global financial crisis.
That doesn’t portend well for hedge funds. That is, unless they can convince investors that — in a world where index funds are virtually free — active management will be necessary to navigate the complexities of an ever volatile world marked by political risk and a slowdown of global macroeconomic growth.
Source: Moody’s Investors Service.
So what do you do if you’re a hedge fund operating in a bull equity market devoid of high yield-wielding opportunities? You reintroduce collateralized debt obligations (“CDOs”), of course. Lord have mercy.
2.⚡️Update: Sears Holding Corp. (Short Evil REITs)⚡️
We’re already sick of Sears Holding Corp. ($SHLD) and you likely are too and so we’re going to provide a very short summary of what transpired yesterday in this case so that you’re at least up to date. And we’re going to pat ourselves on the back in the process: it’s clear that PETITION’s writing influenced the papers. Here’s what happened:
First, the Debtors filed a reply to the UCC objection to its proposed global bidding procedures (see “💥Sears = Sh*t Show💥”) that essentially says “you don’t know sh*t, guys” Like, almost literally. They wrote:
Committee seeks to substitute its judgment—formed after less than a mere 20 days after being appointed—for that of the Debtors. Quite remarkably, at the infancy of these cases and contrary to fundamental principles of chapter 11 to promote reorganizations and maximize value, the Committee appears to have concluded that the Debtors should liquidate their enterprise and not even consider a possibility of saving tens of thousands of jobs. Worse yet, in support of its demand to liquidate the enterprise, the Committee’s objection is filled with baseless allegations and statements that are inconsistent with the voluminous information that has been provided by the Debtors and their advisors to the Committee and its advisors. Hardly any of the Committee’s objections actually addresses the relief sought by the Motion. The Committee’s litigation tactics are unfortunate and a waste of estate resources.
Second, back on October 28, we highlighted how Simon Property Group ($SPG) may be…shall we say… a wee bit tainted in its approach to its fiduciary responsibilities as a member of the UCC. After all, as we pointed out, David Simon EXPLICITLY STATED that he’s okay with and in fact would be better off if Sears simply disappeared.
It seems that Weil Gotshal & Manges LLP has been reading. They wrote:
…the Committee has instead chosen to make the determination in one of the first public pleadings in these cases that, after being involved in these cases for a mere 20 days since the Committee was formed, that they are “unconvinced” the Debtors should continue as a going concern. As an initial matter, the Debtors are sure of one thing: there is no way that the Committee could make this determination in three weeks’ time for the Debtors—one of the largest retailers in the world that span multiple, independent business units, tens of thousands of employees, as well as a highly complex and siloed capital structure. The scope of the Debtors’ operations is massive and complex by any standard. The Committee’s predisposed position, which largely appears consistent with the Debtors’ landlords even though the Committee’s constituency includes tens of thousands of employees in all fifty states and internationally, and thousands of vendors, foreshadows the Committee’s position (including apparently surprise declarations for this procedural motion) on the Company’s junior DIP financing motion. (emphasis added)
Second, there’s no doubt that Eddie Lampert’s counsel, Cleary Gottlieb Steen & Hamilton LLP, noticed. In their response to the UCC objection, they wrote:
How can it be that liquidation is advocated so quickly by the UCC, which has a fiduciary duty to all unsecured creditors, including retirees and the tens of thousands of Sears employees who would lose their jobs in a liquidation? It appears that the explanation may be that two of the UCC’s members, Simon Property Group (“Simon”) and Brixmor Property Group (“Brixmor” and together with Simon, the "Landlords”), are landlords of many Sears stores, both of which have a vested interest in seeing Sears liquidate without regard to the interests of Sears’ other stakeholders. Indeed, the Landlords have stated publicly in recent days that their profitability will be enhanced by a Sears liquidation. For example, David Simon, Simon’s Chairman and Chief Executive Officer, made his views clear in Simon’s October 25, 2018 earnings call, when he said, “we are going to be able to make money on [Sears’ bankruptcy],” “Sears will no longer exist in 2019,” that Simon is “putting Sears in its rearview mirror.” He also states that Simon intends that Sears stores will be “torn down, redeveloped, [and] re-leased.” Indeed, Sears’ liquidation will be a “unique opportunity” to improve Simon’s bottom line. (emphasis added)
Similarly, James M. Taylor, Chief Executive Officer of UCC member Brixmor Property, in Brixmor’s October 30, 2018 earnings call, addressed the Sears bankruptcy. Taylor stated that Brixmor Property intended to “capitalize quickly on this opportunity” created by Sears’ bankruptcy to evict Sears and “meaningfully upgrade our centers.”3 There has been no nuance from either Brixmor or Simon – they want Sears to liquidate and to do so quickly. In stark contrast, there has been no public statement from any other UCC member calling for Sears’ liquidation.
You’re welcome, Cleary. That bit took us about 12 minutes to read and write which, at current rates, means that ESL owes us $320. Our address is PETITION, Buffalo, Wyoming. Don’t worry: the USPS will find us.
And, finally, not to be left out of the fee generation, Paul Weiss chimed in with a 24-page response to the UCC’s objection to Evercore’s (allegedly duplicative) retention, saying that an investment bank is necessary for the “Restructuring Sub-Committee” to evaluate the 19 shady-as-sh*t transactions that took place in the years leading up to the bankruptcy. We’ll be shocked if this retention doesn’t get approved.
3.⛽️ New Chapter 11 Bankruptcy Filing - All American Oil & Gas Inc.⛽️
San Antonio-based independent oil company All American Oil & Gas Inc. (“AAOG”) and its two affiliated companies, Western Power & Steam Inc. (“WPS”) and Kern River Holding Inc. (“KRH”) filed for bankruptcy earlier this week in the Western District of Texas. WPS is a power company that sells power to the likes of Pacific Gas & Electric — a company that, as we’ve previously noted, is having problems of its own (which only appear to be getting worse) — and provides electricity and steam to KRH to aid KRH’s efforts to extract oil.
The enterprise is reportedly cash flow positive, with approximately $25mm in EBITDA in 217 and higher EBITDA projected for 2018. So what gives?
The debtors accuse their successor lender, Kern Cal Oil 7 LLC (“KCO7”), which acquired the company’s secured debt from Alliance-Bernstein, of “not act[ing] as a typical lender,” instead “implement[ing] a predatory ‘loan to own’ strategy.” The debtors note:
Unlike many E&P cases, this bankruptcy filing is not the result of the Company’s poor operational performance, illiquidity, debt maturities or lack of underlying value. Rather, it was precipitated by KCO7’s efforts to exploit its rights under the Credit Agreements to obtain the Debtors’ assets ‘on the cheap,’ and thereby to destroy tens of millions in equity value.
In a dramatic twist, Kern Cal Oil 7 LLC is, according to the debtors, run by two former investment bankers “who were fired allegedly for cause from AAOG’s and KRH’s former investment banker and financial advisor Cappello Capital Corporation” and have an SEC claim filed against them for “breach of fiduciary duty, misappropriation of confidential information, and fraud, among other allegations.” Salacious.
In October, Kern Oil 7 LLC, under the auspices of attending a constructive meeting relating to potential M&A involving Kern Oil and the debtors, issued a notice of default on the basis of insufficient hedging, a move the debtors claim “was a transparent attempt to intimidate AAOG into handing over the Company to KCO7 for little or no value to its shareholders.” Suffice it to say that there is other dramatic stuff here including the debtors’ inability to put hedges in place, purportedly due to the notice of default, incomplete documentation relating to the change from Alliance-Bernstein to KCO7, and more. KCO7 notified the debtors that default interest now applied and on November 8, the debtors had a scheduled interest payment to make which, given these circumstances, the debtors opted not to make. In turn, the debtors filed for bankruptcy to “protect its going concern enterprise value and to restructure its secured debt.”
To fund their cases, the debtors seek authority to use their pre-petition lenders’ (read: KCO7) cash collateral. That ought to be a fun first day hearing.
4. 🍟Previously on PETITION: Luby’s Restaurants🍟
On July 18 in “Casual Dining Distress Continues to Rise (Short Soggy Mac N’ Cheese),” we wrote about Luby’s Inc. ($LUB), which, at the time, was the owner and operator of 160 restaurants (86 Luby’s Cafeteria, 67 Fuddruckers and 7 Cheeseburger in Paradise). We noted that the company (i) had been shutting stores and using the proceeds to pay down its $44.2mm in debt (ii) hired Cowen ($COWN) to assist it with the potential restructuring of its Wells Fargo-agented credit facility, and (iii) was suffering from a fairly range bound stock price of around $2.45/share. So, what’s the latest?
For the fiscal year, total sales were down, same-store sales were down, the loss from continued operations increased, and adjusted EBITDA decreased. Said another way, it was a rough year (aside from its foodservice management business for other entities, which appears to be on the rise).
The company sold 10-owned properties during the fiscal year and closed 21 underperforming locations. The company’s debt decreased to $39.3mm on account of debt pay down from asset sales. The footprint now looks as follows:
We previously wrote:
This company does have one advantage over several distressed competitors: it owns a lot of its 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.
So far, the lenders appear to be doing just that. Had there been any analysts on the call, we would know for sure how that dynamic is playing out.
Relating to our bit about the 10th anniversary of the chapter 11 bankruptcy filing of Circuit City Stores Inc., Jason Binford, a partner at Foley & Lardner LLP wrote:
A relatively early example of BAPCPA making things difficult for national big box retail Chapter 11 reorganizations. 503(b)(9) expense and the pressing 365(d)(4) 210-day clock. Lots of similar Chapter 11 reorg gravestones since then.
PETITION Note: “Lots” is a bit of an underwhelming descriptor, considering.
Regarding “The Tax Man Cometh for Bankruptcy Professionals (Long Fees),“ the proposed Puerto Rico tax on professionals, one reader wrote:
Thoroughly enjoyed yesterday’s piece on PR. Had no idea a professional’s tax was being considered. Huge issue.
Let the lobbyist games begin!
Lastly, another wrote:
11/11/18 issue gets my vote for issue of the year! Congratulations, the publication continues to provide a "must read" pithy recap of events.
Circuit City reminded me of The Wiz - Nobody Beats the Wiz. As year end approaches consider developing the Whizzy Award - an award that recognizes excellence in disruption. You have a considerable field of contenders from which to choose in 2018.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥.
Meanwhile, Guggenheim Securities’ Jim Millstein recently spoke with Barry Ritholtzof Ritholtz Asset Management (audio) about the financial crisis, a coming wave of bankruptcies on the horizon, sovereign and municipal debt (where he says there’ll be a reckoning thanks in large part to pensions…right, pensions) and more. Therein, he recommended several books: “Can Capitalism Survive?,” “Crashed: How a Decade of Financial Crises Changed the World,” “Capitalizing on Crisis: The Political Origins of the Rise of Finance,” and “Sapiens: A Brief History of Humankind” (which really appears to be one of the ‘it’ books of the moment). With the holidays coming up, all of the resources included on our list would make a great gift for the finance/law geek close to you.
Carl Marks Advisors, a nationally recognized investment bank providing operational and financial advisory services, seeks professionals with 4+ years of transferable restructuring and turnaround and experience. These individuals will work in an integrated team environment on a diverse range of engagements in restructuring, turnaround, bankruptcy, valuation analysis and financial performance assessments. Key attributes include strong accounting & financial modeling skills, independent judgment, resourcefulness, and creativity. NYC based position with substantial travel. Interested candidates should click here https://carlmarksadvisors.com/jobs/ to submit their CV and cover note.
Evercore (EVR) is a leading global independent investment banking advisory firm. Evercore advises a diverse set of investment banking clients on a wide range of transactions and issues and provides institutional investors with high quality equity research, sales and trading execution that is free of the conflicts created by proprietary activities. Evercore seeks to hire the following for its NY office:
Associate with relevant experience. For requirements and other specifications, please click here.
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Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.