The Rockport Company, Payless Shoesource/Nine West & Enduro Resources
|May 16||Public post|
Curated Disruption News
Midweek Freemium Briefing - 5/16/18
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APR 22: ‼️Pension Crises Abound‼️
News of the Week (3 Reads)
1. “Independent” Directors Are Under Attack (Long Quid Pro Quo)
In June 2017 in “Dividend Recaps Under Attack in Payless Holdings Case,” we wrote,
We're impressed that Reuters and Bloomberg both picked up on something that happens - or at least appears to happen - often in bankruptcy cases: a conflict.
Here's the drill: the official committee of unsecured creditors (UCC) in the Payless Holdings LLC case filed an application seeking to employ…expert consultants. The mandate included providing "expert consulting services and expert testimony regarding the Debtors' estates' claims relating to the pre-petition dividend recapitalizations and leveraged buyout, including solvency and capital surplus analysis." As a quick refresher, Payless' private equity overlords Golden Gate Capital and Blum Capital dividended themselves hundreds of millions of dollars of value via debt incurred - albeit under relatively low interest rates - on the company's balance sheet. The company's debt load - in addition to various other factors characteristic of retail players today - was a major factor in the company's eventual bankruptcy filing.
Payless Holdings LLC - through Munger Tolles & Olson LLP ("MTO") as counsel to "the independent director of the Debtors" - subsequently objected to the UCC's application. The independent director (the "ID") claimed that the application is, at a maximum, duplicative of the services to be rendered by another UCC professional and at a minimum, premature. Why premature? Well, because the ID is conducting, through MTO, his own investigation into the dividend recapitalization claims the company might have against the private equity firms. That investigation is ongoing. Having a simultaneous analysis runs the danger of not only being duplicative and premature but also hindering the Debtors' aggressive proposed timeline for emergence from bankruptcy.
As loyal readers of PETITION know, we're big fans of the (shadiness of the) dividend recap and, as such, we really enjoyed Bloomberg's snark: "That's right, someone close to private equity is investigating private equity firms for doing a very private equity thing." To be clear, separate counsel at the direction of an independent director is investigating the private equity firms. But, close enough.
Let's pull the thread. Payless' main counsel, Kirkland & Ellis LLP, does a ton of private equity work - including, upon information and belief, work for the private equity sponsors implicated here. According to its own retention application, K&E has been representing Payless since 2012 as general corporate counsel. The private equity transaction dates back to 2012. Curious. K&E began representing the Debtors in connection with restructuring matters in November 2016; its engagement letter is dated January 4, 2017.
The ID presumably got his mandate because he has "served as an independent or disinterested director for various companies in financial distress and restructurings." Among his qualifications are four other current director engagements including iHeartMedia Inc. and Energy Future Intermediate Holding Company LLC. Recognizing that the recap might be at issue, the ID hired separate counsel shortly after joining the board in January 2017 - right around the same time that K&E got hot-and-heavy on the restructuring side (if the engagement letter date is any indication).
So, to summarize, K&E and management have been working with the private equity owners for five years. During that time, the dividend recaps occurred. The ID came on board right around the same time that K&E's restructuring team got enmeshed with the company. The same ID has a board portfolio of 5 directorships, 60% of which are for companies that are using K&E as restructuring counsel as we speak. Meanwhile, we have to assume that the ID gets paid tens of thousand of dollars for each board mandate with, perhaps, some equity consideration thrown in for good measure. Defensively, the objection drops a nice little footnote to assure us all that the ID is truly independent:
From the Debtors' Objection to the Shaked Application.
Perhaps the benefit of the doubt ought to be given to the ID and approval of the Shaked application delayed until after the ID completes his investigation. After all, if he comes down against the private equity shops, the application is moot. On the flip side, well, he won't. Notably, the objection already lays the case that the company relied in its business judgment on the opinions of Duff & Phelps, which issued a solvency opinion and presentation at the time of the transaction(s). Naturally, the UCC won't believe it and will push, again, for this engagement. Presumably, the company will jam them with the "train has left the station" defense. The upshot: if we were litigating this on behalf of the UCC we would certainly call into question the actual "independence" of the investigation sooner rather than later and see if the Judge bites. If done tastefully and in a way that doesn't impugn the character of the ID (which we are in no way advocating), it will at least somewhat offset the impression the Debtors are leaving with the Duff & Phelps bit and plant the seed in the Judge's mind for consideration upon the results of the investigation.
Ultimately, the retention was approved, the resultant UCC report filed under seal, and a settlement secured – a small benefit to the creditors in that case but a large injustice to the system. Given that these issues — dividend recaps, fraudulent transfers and the role of the independent director — appear more and more commonplace in the midst of this private equity-induced wave of retail bankruptcy, the bankruptcy bar could have benefitted from some established precedent.
And, indeed, the issue is back. Reorg Research recently highlighted how, in Nine West, Akin Gump Hauer & Strauss LLP deployed some of the same Payless arguments while opposing Nine West’s proposed DIP credit facility. Akin, as Reorg noted,
“…previewed various issues with respect to the debtors’ 2014 leveraged buyout, led by Sycamore Partners, and the related carve-out transactions. [They] noted that the debtors’ RSA does not provide information as to the recovery for any unsecured creditor but does contemplate the complete resolution, settlement and release of causes of action relating to the LBO. He said that these claims, however, may be the only source of recovery for unsecured creditors.
Per Reorg, Akin also…
“…asserted that this is “troubling” because the debtors’ counsel Kirkland & Ellis has also been retained by Sycamore on other unrelated matters. [They] pointed out that the debtors’ two independent directors, who are investigating causes of action relating to the LBO, were suggested and put in place by Kirkland. Further troubling, [they] said, is the fact that the UCC is required to finish its investigation of LBO causes of action in three and a half months, even though the debtors’ independent directors have had seven months to investigate those claims and are still not finished.”
“The UCC’s solution for this problem…is to place all of the potential litigation regarding the LBO and the carve-out transactions into a post-confirmation trust. With this solution, fiduciaries “who are not either directly or indirectly conflicted” can prosecute those potential causes of action, which will allow the other parties in the case to work on confirming a plan. [They] also acknowledged that debt from the LBO transaction is still in existence and that there needs to be analysis as to “any vulnerability about that debt and who should be able to participate in recovery.” [They] asserted that the UCC is uniquely qualified to perform that analysis because of the representation of different tranches of creditors on the UCC.”
In other words, Akin Gump is pushing back against the company’s and the directors’ proposed subjugation of its committee responsibility. They are pushing back on directors’ poor and drawn-out management of the process; they are underscoring an inherent conflict; they are highlighting how directors know how their bread is buttered. Put simply: it is awfully hard for a director to call out a private equity shop or a law firm when he/she is dependent on both for the next board seat. For the next paycheck.
Query whether Akin continues to push hard on this. (The hearing on the DIP was adjourned.)
The industry would stand to benefit if they did.
2. The Rockport Company Files for Bankruptcy (Short Footwear)
Back in March we wrote,
The Walking Company. Payless Shoesource. Aerosoles. The bankruptcy court dockets have been replete with third-party sellers of footwear with bursting brick-and-mortar footprints, high leverage, scant consumer data, old stodgy reputations and, realistically speaking, limited brand value.
Add another to the list.
Earlier this week, The Rockport Company LLC, a Massachusetts-based designer, distributor and retailer of comfort footwear filed for bankruptcy — the latest in a string of footwear retailers that found its way into chapter 11.
The company operates in what it dubs a “highly competitive” business where “[a]t various times of the year, department store chains, specialty shops, and online retailers offer brand-name merchandise at substantial markdowns which further intensifies the competitive nature of the industry.” The company has (i) a robust wholesale business (57% of all its global sales), (ii) a direct retail business (eight full-price and 19 outlet stores in the United States and 14 full-price and 19 outlet stores in Canada), (iii) e-commerce, and (iv) an international distribution segment.
The business has suffered from (a) operational challenges (a costly and time consuming separation from the Adidas Networks, with which the company's operations were deeply integrated until late 2017), (b) other negative externalities (i.e., the closure of three supply factories, contract disputes with warehousemen), and (c) the burdens of its brick-and-mortar footprint. The company notes, "[o]ver the last several years the Debtors have faced a highly promotional and competitive retail environment, underscored by a shift in customer preference for online shopping." And it notes further, "[t]he unfavorable performance of the Acquired Stores in the current retail environment has made it difficult for the Debtors to maintain sufficient liquidity and to operate their business outside of Chapter 11." PETITION NOTE: This is like a broken record, already.
In light of this, armed with a $20 million new-money DIP credit facility (exclusive of rollup amounts) extended by its prepetition ABL lenders, the company has filed for bankruptcy to consummate a stalking horse-backed asset purchase agreement with CB Marathon Opco, LLC an affiliate of Charlesbank Equity Fund IX, Limited Partnership for the sale of the company's assets - OTHER THAN its North American assets — for, among other things, $150 million in cash. The buyer has a 25-day option to continue considering whether to purchase the North American assets but the company does "not expect there to be any significant interest in the North American Retail Assets." Read: the stores. The company, therefore, also filed a "store closing motion" so that it can expeditiously move to shutter its brick-and-mortar footprint at the expiration of the option. Ah, retail.
And, ah, footwear. Check out this lineup:
With today's Rockport #bankruptcy, these 12 shoe sellers have gone bankrupt just since 2017:
❌The Walking Company
❌Sports Zone Elite
In addition to those 13 bankrupt shoe sellers, other shoe stores are closing. Among the largest:
❌150 Finish Line stores since '16 $FINL
❌161 Crocs stores since '17 $CROX
❌163 Foot Locker stores since '17 $FL
❌266 Stride Rite and related stores since '16 (412 since '14) $WWW pic.twitter.com/5eFZbltrRL
“Sales at U.S. shoe stores in February 2017 fell 5.2%, the biggest year-over-year tumble since 2009. Online-only players like Allbirds, Jack Erwin, and M.Gemi have gained nearly 15 percentage points of share over five years.”
Yes, the very same Allbirds that is so popular that it is apparently creating wool shortages.
Given all of that, would you want Rockport’s brick-and-mortar business?
3. Enduro Files for Bankruptcy (Long Continued Oil Distress)
Two weeks ago in “⛽️Oil & Gas is...Back? Baby.⛽️,” we wrote,
As concerns grow about Iranian and Venezuelan production levels, oil and gas is now hovering around $67-68, and there are headlines like this: “Is Big Oil Back?” You’d think, therefore, there’d be a bit less talk about distressed oil and gas companies. After all, distressed oil and gas is so 2015.
Actually, it’s apparently so May 2018.
Late yesterday, Enduro Natural Resources LLC, an oil and natural gas producer with properties in North Dakota, Wyoming, Texas, Louisiana and New Mexico, has filed for bankruptcy to effectuate a three-package asset sale to three separate stalking horse bidders. The company notes in an endearingly self-aware way,
"Like many other upstream energy companies, the Debtors did not anticipate in the early part of this decade that they would eventually succumb to the demands of repaying the capital they borrowed to invest in their exploration and production activities. But the prices of crude oil and natural gas declined dramatically beginning mid-year 2014, as a result of robust nonOrganization of the Petroleum Exporting Countries' ("OPEC") supply growth led by unconventional production in the United States, weakening demand in emerging markets, and OPEC's decision to continue to produce at high levels."
While the company took a variety of measures to combat the effects of these externalities -- including operational fixes and a prior out-of-court restructuring transaction -- its leverage remained too high in relation to asset value. Indeed, in the aggregate, the combined offers for the three packages of assets equates to $77.5 million which doesn't even clear the first lien debt.
Finally, the beauty of a huge wave of same-industry chapter 11 filings is that you start seeing the same players over and over again. Among Enduro’s top creditors are some other oil and gas companies with plenty of experience in bankruptcy court, i.e., Exco Operating Company and Basic Energy Services (and, soon, Pioneer Natural Resources?).
The bottom line: despite higher oil prices, pain continues to roll through the upstream exploration and production space.
💥Notice of Appearance💥
PETITION: What is the best piece of advice that you’ve been given in your career?
LP: Making a quick and good decision with bad information is much better than a slow and perfect decision with perfect information. In our business sometimes its better to make a pretty good quick decision rather than waiting too long and the decision being made for us. This was taught to me by one of my mentors 15 years ago and has stuck with me.
PETITION: What is the best book you’ve read that’s helped guide you in your career?
LP: As cliché as it may sound, both Fountainhead and Atlas Shrugged by Ayn Rand have had a huge impact on my life. I think the focus on independence, objective thinking, and having a philosophical spine (regardless of whether you agree with it) have turned me into a better practitioner and leader. I also think there is a big emphasis on non-conformist thinking which is, in my opinion, the essence of creative thinking and solution making.
PETITION: What is one notable trend you expect to see in the second half of ‘18 that not enough people are talking about?
LP: More of the same. I think people are expecting things to change, but I don’t see it. There is a lot of talk about a restructuring bubble building, maturities rising, a new real estate bubble, and other themes like this that I’ve heard throughout my career. I’d expect that things will basically stay as they are right now until something absurd or otherwise totally unexpected comes and punches us all in the mouth.
PETITION NOTE: This is a fair point. Everyone gets in the business of prognosticating but the last several cycles started due to wholly unforeseeable exogenous events.
PETITION: What is the most under-appreciated service restructuring professionals can provide a distressed client?
LP: Emotional support of clients and principals. We work primarily with middle market companies — including family-owned businesses. Compassion and empathy are underrated skill sets. We could callously conclude “this is just business,” but, ultimately, we’re dealing with emotional beings caught in an insanely stressful situation. People find themselves retaining us because something bad usually happened, and its very rare that those bad decisions that led to our retention were intentional or otherwise nefarious. I go into situations without preconceived judgement and with the objective of understanding a situation rather than rashly concluding that a person is dumb or unsophisticated. It’s rarely the case that someone is those things, and it’s dangerous as a practitioner to assume so.
PETITION: What is the biggest disservice that restructuring professionals are doing to clients?
LP: Restructuring — particularly formal restructurings — have devolved into a very litigious, expensive, and inefficient way to work out complex situations. A big part of this is the e-mail “thuggery” that is prevalent in these situations: it is more focused on getting a “gotcha” rather than a solution. If people really were trying to get to the right answer, I’d expect that there would be a whole lot more phone calls and face-to-face meetings, rather than 30 person CC lists and 27 versions of documents. If we take the approach that we’re trying to solve the problem, park aside the anger and posturing that comes with the process, and try to work towards a solution knowing that everyone is being impacted, we’ll collectively provide more value to our clients.
We have compiled a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. You can find it here. We recently added four new books on our “to-read” list: (1) “When the Wolves Bite” by Scott Wapner (about the Carl Icahn/Bill Ackman Herbalife battle), (2) “I Love Capitalism!: An American Story” by Ken Langone, (3) “Factfulness” by Hans Rosling (recommended this week by none only than Bill Gates) and (4) “Enlightenment Now” by Steven Pinker (recommended this week by Warren Buffett).
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