FINAL FREE SUNDAY Briefing - 3/4/18
Read Time = 8.7 a$$-kicking minutes
Channeling Alanis Morissette: In the Same Week that Spotify Marches Towards Public Listing, iHeartMedia Marches Towards Bankruptcy
In anticipation of its inevitable direct listing, we’d previously written about Spotify’s effect on the music industry. We now have more information about Spotify itself as the company finally filed papers to go public - an event that could happen within the month. Interestingly, the offering won’t provide fresh capital to the company; it will merely allow existing shareholders to liquidate holdings (Tencent, exempted, as it remains subject to a lockup). Here’s a TL;DR summary:
And here’s a more robust summary with some significant numbers:
Revenue: Up 39% to €4.1 billion ($4.9 billion) in ‘17, ~€3 billion in ‘16 and €1.9 billion in ‘15. Gross margins are up to 21% from 16% in 2014 - and this is, in large part, thanks to renegotiated contracts with the three biggest music labels. Instead of paying 88 cents on every dollar of revenue, the company now only pays 79 cents. Only.
Free Cash Flow: €109 million ($133 million) in ‘17 compared to €73 million in ‘16.
Profit: 0. Net loss of €1.2 billion in ‘17, €539 million in ‘16, and €230 in ‘15.
Funding: $1b in equity funding from Sony Music (5.7% stake), TCV (5.4%), Tiger Global (6.9%) and Tencent (7.5%). Notably, Tencent’s holdings emanate out of a transaction that converted venture debt held by TPG and Dragoneer into equity - debt which was a ticking time bomb. Presumably, those two shops still hold some equity as Spotify reports that it has no debt outstanding.
Subscribership. 159 million MAUs and 71 million premium (read: paid) subscribers as of year end - purportedly double that of Apple Music. Services 61 countries.
Available Cash. €1.5 billion
Valuation. Maybe $6 billion? Maybe $23.4 billion? Who the eff knows.
For the chart junkies among you, ReCode aggregates some Spotify-provided data. And this Pitchfork piece sums up the ramifications for music fans and speculates on various additional revenue streams for the company, including hardware (to level the playing field with Apple ($AAPL) and Amazon ($AMZN)…right, good luck with that), data sales, and an independent Netflix-inspired record label. After all, original content eliminates those 79 cent royalties.
Spotify for a long time was a great product and a terrible business. Now thanks to its friends and antagonists in the music industry, Spotify's business looks not-terrible enough to be a viable public company.
Zing! While this assessment may be true on the financials, the aggregation of 71 million premium members and 159 million MAUs is impressive on its face - as is the subscription and ad-based revenue stemming therefrom. Imagine the disruptive potential! Those users had to come from somewhere. Those ad-dollars too.
Enter iHeartMedia Inc. ($IHRT), owner of 850 radio stations and the legacy billboard business of Clear Channel Communications. In 2008, two private equity firms, Bain Capital and Thomas H. Lee Partners, closed a $24 billion leveraged buyout of iHeartMedia, saddling the company with $20 billion of debt. Now its capital structure is a morass of different holders with allocations of term loans, asset-backed loans, and notes. The company skipped interest payments on three of those tranches recently. While investors aren’t getting paid, management is: the CEO, COO and GC just secured key employee incentive bonuses. Ah, distress, we love you. All of which will assuredly amount to prolonged drama in bankruptcy court. Wait? bankruptcy court? You betcha. This week, The Wall Street Journal and every other media outlet on the planet reported that the company is (FINALLY) preparing for bankruptcy. And maybe just in time to lend some solid publicity to the DJ Khaled-hosted 2018 iHeartRadio Music Awards on March 11.
For those outside of the restructuring space, we’ll spare you the details of a situation that has been marinating for longer than we can remember and boil this situation down to its simplest form: there’s a f*ck ton of debt. There are term lenders who will end up owning the majority of the company; there are unsecured lenders alleging that they should be on equal footing with said term lenders who, if unsuccessful in that argument, will own a small sliver of equity in the reorganized post-bankruptcy company; and then there is Bain Capital and Thomas H. Lee Partners who are holding out to preserve some of their original equity. Toss in a strategic partner like billionaire John Malone’s Liberty Media ($BATRA) - owner of SiriusXM Holdings ($SIRI), the largest satellite radio provider - and things can get even more interesting. Lots of big institutions fighting over percentage points that equate to millions upon millions of dollars. Not trivial. Would classifying this tale as anything other than a private equity + debt story be disingenuous? Not entirely.
"It is telling when companies like Spotify hit the markets while more traditional players retrench. Like we've seen in retail, disruption is real and if you stand still and don't adapt, you'll be in trouble. It gets harder to compete when new entrants are delivering a great product at low cost." - Perry Mandarino, Head of Restructuring, B. Riley FBR.
Indeed, there is a disruption angle here too, of course. Private equity shops - though it may seem like it of late - don’t intentionally run companies into the ground. They hope that synergies and growth will allow a company to sustain its capital structure and position a company for a refinancing when debt matures. That all assumes, however, revenue to service the interest on the debt. On that point, back to Spotify’s F-1 filing:
When we launched our Service in 2008, music industry revenues had been in decline, with total global recorded music industry revenues falling from $23.8 billion in 1999 to $16.9 billion in 2008. Growth in piracy and digital distribution were disrupting the industry. People were listening to plenty of music, but the market needed a better way for artists to monetize their music and consumers needed a legal and simpler way to listen. We set out to reimagine the music industry and to provide a better way for both artists and consumers to benefit from the digital transformation of the music industry. Spotify was founded on the belief that music is universal and that streaming is a more robust and seamless access model that benefits both artists and music fans.
2008. The same year as the LBO. Guessing the private equity shops didn’t assume the rise of Spotify - and the $517 million of ad revenue it took in last year alone, up 40% from 2016 - into their models. Indeed, the millennial cohort - early adopters of streaming music - seem to be abandoning radio. From Nielsen:
Finally, Pop CHR is one of America’s largest formats. It ranks No. 1 nationwide in terms of total weekly listeners (69.8 million listeners aged 12+) and third in total audience share (7.6% for listeners 12+), behind only Country and News/Talk. In the PPM markets it leads all other formats in audience share among both Millennial listeners (18-to-34) and 25-54 year-olds. However, tune-in during the opening month of 2018 was the lowest on record for Pop CHR in PPM measurement, following the trends set in 2017, the lowest overall year for Pop CHR, particularly among Millennials. While CHR still has a substantial lead with Millennials (Country ranked second in January with 8.4%), it will be interesting to track the fortunes of Pop CHR as the year goes on, and music cycles and audience tastes continue to shift.
This is the hit radio audience share trend in pop contemporary:
And, consequently, radio ad revenues have essentially flattened. And if Spotify has its way, the “flattening” will veer downward:
With our Ad-Supported Service, we believe there is a large opportunity to grow Users and gain market share from traditional terrestrial radio. In the United States alone, traditional terrestrial radio is a $14 billion market, according to BIA/Kelsey. The total global radio advertising market is approximately $28 billion in revenue, according to Magna Global. With a more robust offering, more on-demand capabilities, and access to personalized playlists, we believe Spotify offers Users a significantly better alternative to linear broadcasting.
One company’s disruptive revenue-siphoning is another company’s bankruptcy. Now THAT’s “savage.”
News of the Week (6 Reads) - Sponsored by B. Riley FBR
1. Ad Agencies Get Hammered (Short Don Draper)
Draper never would’ve made it in the age of #MeToo anyway.
This week, Proctor & Gamble ($PG) announced that it cut its digital ad spending by approximately $200mm, a shot across the bow of certain undisclosed big ad players (cough, Google) and a major blow to the middlemen ad agencies that seem to be caught in a maelstrom of disruption. Back to that in a sec. More on P&G,
P&G, however, has not cut overall media spending. Funds have been reinvested to increase media reach, including in areas such as TV, audio and ecommerce media, a company spokeswoman told Reuters.
Not yet, anyway. P&G intends to cut an additional $400mm in agency and production costs over the next 3 years. In so doing, they’re also going back to the old school after realizing that the 1.7 seconds of eyeball view time doesn’t necessarily translate into sales. Podcast producers take note.
So what about those middlemen? Judging by WPP’s 10% stock price plummet this week ($WPP), investors are bearish. WPP is a British multinational advertising and public relations company besieged by the ease with which advertisers can publish directly on Facebook ($FB) and Google ($GOOGL) and, in an instant, receive performance metrics. Ad agencies, therefore, are no longer needed as much to connect brands with end users. Per the Wall Street Journal:
For their part, big ad agency companies that have traditionally bought advertising space on behalf of marketing clients are under pressure to reinvent themselves to remain relevant as the industry changes. Advertisers are demanding that their agency partners be more transparent about media-buying, so it is clear that agencies are getting the best possible deal for the clients and aren’t receiving rebates from sellers.
Disrupting kickbacks too? Rough.
2. Busted Tech (All Hail Uber & Lyft)
Late on Friday, the co-founders of Fasten, a ride-hailing company that proudly boasts of over 5 million rides completed, sent around a note to users that it has been acquired by Vezet Group. If you’ve never lived or worked in Austin or Boston, you probably don’t give a damn about this so you can move on. But, if you did, you’re aware of Fasten - particularly since it was the only real viable ride-hailing option in Austin during a period of time (2016) when Uber and Lyft fought with regulators. That fight was resolved, however, and Uber and Lyft returned to the city less than a year ago. Now Fasten is done for: this acquisition is an IP-sale. Operations in the US will be shut and 35 employees let go. In the dog eat dog world of ride-hailing, it is telling that the winners like Uber are those who survive - regardless of a cash burn in the billions of dollars annually. Move fast(est), burn cash, and break things.
3. Commercial Real Estate (Is New York City F*cked? Part IV).
We’ve been asking whether New York City is effed in a series of posts on our OG petition11.com website; we have also cast shade on Vornado Realty Trust ($VNO) on a number of occasions.
The scene unfolding on the cobblestones of one of New York’s trendiest shopping areas shows the increasingly fraught negotiations between tenants and landlords as vacancies soar and retail rents plunge. Similar scenarios are playing out along Madison Avenue to the north and along other thoroughfares in the city that have long been a draw for those shopping for designer clothing and other luxury goods. Property owners are confronting demands once unheard of in Manhattan, from rent reductions to short-term leases.
Ruh roh. Part of the problem is that property owners modeled incomes based on post-Great Recession rental rates and income projections. After holding out for months-if-not-years with the hope of maintaining rates that comport with those projections, those same property owners are now acquiescing to lower rents and shorter terms:
In Soho, Hermes is negotiating a deal at 63 Greene St. that gives the retailer the option to leave after one year, while a few blocks over at 375 West Broadway, Gucci signed a lease that allows it to vacate the space if sales don’t meet expectations after two years, according to people familiar with the deals, who asked not to be identified because terms are private.
But, wait there’s more:
Downtown landlords aren’t the only ones caving. On a tony corridor of Madison Avenue on the Upper East Side, an 18,000-square-foot (1,670-square meter) stretch of luxury retail is facing vacancies. Landlord Vornado Realty Trust doesn’t expect tenants including Gucci and Cartier to sign long-term renewals to leases that expire in September given market conditions, according to mortgage documents tied to the property. It’s offering short-term agreements at lower rates to keep the space occupied, the documents show. As of last month, no deals had been struck.
Vornado, which recently paid off its mortgage at the property, declined to comment.
Of course it did. Vornado of course has held firm in its assertion that New York City is largely impervious to these overall market trends. Maybe that’s true for properties it no longer has mortgages on. Generally, though, Howard Schultz of Starbucks ($SBUX) appears to beg to differ in a leaked memo this week:
“We are at a major inflection point as landlords across the country will be forced (sooner than later) to permanently lower rent rates to adjust to the ‘new norm’ as a result of the acute shift (consumer behavior) away from brick and mortar retailing to e-commerce….”
“Landlords will be faced with having to answer two questions: Do they maintain their current rent expectations while their storefronts remain unoccupied? Do they begin to significantly lower the rent?,” Schultz wrote, adding, “Trust me, rents are coming down!”
To point, retail rents have declined as much as 17% in certain parts of Manhattan. Which presents additional problems beyond the so-called #retailapocalypse. More from Bloomberg,
Property owners with outstanding mortgages face a more difficult task when it comes to offering sweeteners, said Richard Hodos, a vice chairman at brokerage CBRE Group Inc. They may not be able to put in a tenant that’s paying less than what they had budgeted for when they took out a loan, he said.
“Landlords that have a lot of debt are hamstrung in some ways,” Hodos said.
So far, low borrowing costs have helped cushion the blow for retail landlords by making it easier to refinance debt and make loan payments. That could be about to change as interest rates climb.
Property owners are conferring with lenders behind the scenes, buying time to find elusive tenants when the income from their buildings falls short, according to Jones Lang LaSalle’s Smith.
Most lenders “play ball with the owner to get the space leased,” Smith said. “When you have a market where the conditions are uncertain, the idea of taking a property back is not the best scenario.”
And that right there illustrates a bigger piece of the problem. Mortgaged landlords don’t necessarily have the flexibility to lower rents. Peak purchases at now-unrealistic projections can’t be rented out lower or refinancing upon maturity will be difficult. Hence the deluge of vacancies.
Indeed, $4 billion worth of retail acquisitions were consummated in SoHo alone in the last six years and, as of October, at least, nearly 25% of that remained vacant. Said another way, there are several hundred millions of dollars worth of retail vacancies all situated within a few blocks from one another.
All of which begs the question: what happens when interest rates go up on these mortgaged properties and tenants remain elusive? Mmmmm Hmmmm.
4. Retail Roundup (Some Surprising Results; More Closures)
Macy’s ($M) reported earnings earlier this week and surprised to the upside - particularly with the news that its sales grew in the latest quarter (after 2.75 years of consistent decline). Most of the upside came from cost control measures (and the expansion of its off-price offering, Backstage). Likewise, Dillard’s.
Toys R Us entered administration in the UK.
Charlotte Russe earned itself what we would deem a “tentative” upgrade after consummating an out-of-court exchange transaction that delevered its balance sheet. S&P Global cautioned that it expects “liquidity to be tight” over the next 12 months.
Chico’s FAS Inc. ($CHS) reported same store comp sales down 5.2% and indicated that it closed 41 net stores in 2017, including 14 net stores in Q4. Net income and EPS was higher.
Foot Locker ($FL) intends to close net 70 stores in 2018 after closing net 53 stores in 2017.
JCPenney ($JCP) announced that it is cutting full-time employees and increasing use of part-time employees instead. Total sales rose 1.8% but missed estimates. Comparable sales rose 2.6% and net income, ex-tax reform benefits, was down 6.6%.
Office Depot ($ODP) reported comp store sales declines of 4% and total sales down 7%. It closed 63 stores, including 26 in Q4. Note that we’re not reporting net closures: the company didn’t open any stores.
5. Subway (The Restaurant, Not the NYC Transportation System, But Short Them Both).
Both, frankly, sound like they could use the help of an operational advisor. This piece discusses Subway’s plans to reinvigorate and/or rightsize its 26,000 location footprint. Some critical info:
Subway is coming off a difficult stretch in which it lost two key players: its founder, Greco’s brother Fred DeLuca, to cancer, and its longtime spokesman Jared Fogle to prison. But its broader problem has been what Greco calls “a slow erosion of customers.”
Subway’s traffic has fallen 25% since 2012, a decline that put a brake on that uninterrupted growth.
Last year, according to Technomic's Top 500 Chain Restaurant Advance Report, Subway’s system sales in the U.S. declined 4.4% to $10.8 billion—its lowest level since 2010. Its unit count declined by 3.1%, to 25,908. It was the second straight unit count decline after more than 20 years of increases. The chain has closed 1,200 locations over the past two years.
Yes, that’s yet another 1200 locations that probably aren’t being accounted for in retail closure tallys.
Notably - and particularly interesting in light of the 25% traffic decline - you can order Subway on, among other platforms, Doordash, the on-demand delivery platform that announced this week that it has secured $535 million of Series D funding from the likes of Sequoia Capital, GIC and Wellcome Trust. From the press release:
As part of its merchant-first approach, the company plans to double-down on DoorDash Drive, the platform that enables a merchant to offer delivery to customers that have placed orders directly with the restaurant. The Drive platform has grown 1,300 percent year-over-year.
No, no typo explains that number. Doordash is going after the “last mile” hard and now has a treasure trove full of $535 million of benjamins to do so.
In 2017, DoorDash more than doubled delivery volume, while growing gross profits six fold year-over-year. This fast and sustainable growth played a role in the investors' enthusiasm for the company. DoorDash's growth rate has accelerated further in 2018, and this year the company is expected to triple its geographic footprint from 600 to 1,600 cities and hire more than 250 people across its corporate offices.
Right. Why leave your home if the “last mile” is otherwise covered? Subway might want to speed up its footprint evaluation. After all, delivery isn’t going anywhere.
6. The Weinstein Company (Long SeeSaws)
On. Off. On. Off. On. We have whiplash.
The ink on The New York TImes’ piece explaining “How a Deal to Sell the Weinstein Company Fell Apart” was barely dry before it came out on Thursday that the much-ballyhooed Ron Burkle-backed $500 million deal was back. And, significantly, New York Attorney General Eric Schneiderman is on board. A victims fund will be established, jobs preserved, and Maria Contreras-Sweet will, along with a slate of female directors, lead the efforts to rehabilitate the company 100% under a different corporate name.
The buyers, which include Lantern Asset Management, will assume $225 million in debt and place $275 million in equity, a large portion of which will be set aside for a victims’ fund. Existing equity - including that of the Weinsteins, Goldman Sachs ($GS) and WPP (rough week for those dudes) - will be wiped out.
Disruption comes in various forms; it can come slowly and gradually; or it can come in a sudden bathrobe-draped freefall horror. It seems, however, like this is a step in the right direction for the innocent parties (e.g., employees) affected by the actions of one megalomaniac.
Final note: have you considered what the creditor matrix would have looked like in a bankruptcy filing? Ashley Judd, Salma Hayek, Uma Thurman, Rose McGowan, et. al. It would have been a stalker’s paradise.
Chart of the Week
It was clear from our survey results that people are hungry for a$$-kicking resources on the topics of restructuring, tech, finance, and disruption. We started compiling a "reading list," of sorts for your benefit. You can find it here. The list is expanding regularly. Our latest addition is “Conspiracy: Peter Thiel, Hulk Hogan, Gawker, and the Anatomy of Intrigue.”
For those of you who missed the Wharton Restructuring conference last Friday, a kind Redditer posted a summary of a good portion of the content - including thoughts from Jamie Dinan (York Capital), Marc Lasry (Avenue Capital), and Bruce Richards (Marathon Asset Management).
ABI Battleground West, 3/6, Los Angeles
Orrick Breakfast Briefing: Business and Bankruptcy Issues at the Supreme Court, 3/7, NYC
Notable: What We're Reading (4 Reads)
Apple (New Numbers). Looking at the business ($AAPL) through the lens of active devices.
DNVBs (Clicks to Bricks). Casper opened its first standalone store in New York this week and it’s not just a showroom; it’ll actually carry inventory. This comes on the heels on a recent partnership with (and investment from) Target. Elsewhere, Harry’s is electing not to renew the lease of its New York based “Corner Shop”.
Dieting (Long Oprah Winfrey). We’re old enough to remember when Weight Watchers International Inc. ($WTW) was on distressed watchlists. Not anymore: the company’s stock was gangbusters in 2017 and is off to the races again in 2018 (despite a recent pullback off the highs - along with the rest of the market). The company’s boost is largely attributable to new programs and international expansion - both of which have benefitted significantly from the advocacy of Oprah Winfrey. Apparently her business track record includes keeping companies out of bankruptcy.
Sunpower Inc. ($SPWR) (Short Tariffs). The American solar company is laying off 10% of its workforce to cut costs - in part to address new headwinds emanating out of solar tariffs.
Stephens Inc. has purchased Blackhill Partners. And now Stephens’ U.S. restructuring advisory practice launches with 14 former Blackhill professionals including managing directors Lance Gurley, Jeff Jones, Eric Scroggins, and Joe Stone.