Curated Disruption News
Midweek Freemium Briefing - 5/09/18
Read Time = 4.8 a$$-kicking minutes
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ICYM Sunday’s MEMBER Briefing:
Hey you. Yeah you. Johnny Freeloader. We know that you read us religiously every week. And we know that spin class you took the other day was $35. Yeah, yeah, you might have $347,200 worth of debt, but you can still afford us. So, what are you waiting for? The price to go up? In case you haven’t heard, prices everywhere are going up.
In our Members’-only Sunday briefing “💥Donald Trump is (Still) Great for Bankruptcy💥,” we covered LBI Media, FullBeauty, WeWork, GNC, Toms Shoes and much much more. Did you miss it? Congratulations! Our Members — your competitors — are now officially smarter than you. Good luck on that next pitch.
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News of the Week (2 Reads)
1. Is rue21 Becoming rue22? (Short Liberal Return Policies)
On Mary 15, 2017 - nearly exactly a year ago — rue21 Inc. became the latest in what was a string of specialty fashion retailers to file for bankruptcy; it sought to pursue both an operational and a financial restructuring. The company had 1179 brick-and-mortar locations in various strip centers, regional malls and outlet centers. It also had a capital structure that looked like this:
Much of the leverage emanated out of an Apax Partners LLP-sponsored take-private transaction in 2013. We recently discussed Apax Partners in the context of FullBeauty here, in our recent Members’-only briefing.
Without any real contest, it was clear that the term loan holders constituted the “fulcrum” security and would end up swapping said loans for equity in the reorganized company. And that is precisely what happened. The ABL was covered, the term lenders funded a roll-up DIP credit facility along with new money to finance the pendency of the cases and then converted that DIP into an exit facility. The post-emergence capital structure consists of:
$125 million ABL; and
$50 million term loan (plus accrued interest on the DIP term loan as of the effective date).
General unsecured claimants were provided an equity “kiss” on the petition date and then, after the Official Committee of Unsecured Creditors’ (“UCC”) formed, it extricated additional value in the form of, among other things, (i) a put option to sell its post-reorg equity to one of the reorganized debtors, and (ii) a waiver by the prepetition term lenders of their $200 million deficiency claim. While the UCC did try and go after third-party releases for Apax, Apax ultimately succeeded in obtaining the release pursuant to the bankruptcy court’s September 9 confirmation order on the basis that it…
“…agreed to (i) support the Plan, including by promptly facilitating and participating in prepetition Plan discussions that culminated in the Restructuring Support Agreement and the Plan, notwithstanding that their equity position would likely be eliminated thereunder; and (ii) participate in the financing of the DIP Term Loan Credit Facility.”
In other words, Apax bought its release for $2 million in DIP allocation.
All told, this was a solid deleveraging of roughly $700 million. Moreover, the company closed roughly 400 stores. The company was seemingly well-positioned to effectuate the rest of its proposed restructuring, including (i) revamping its e-commerce strategy, (ii) improving the in-store experience, and (iii) pursuing a long-term business plan under relatively new management in a highly competitive retail atmosphere.
“Seemingly” being the operative word. In January, The Wall Street Journal reported (paywall) that the retailer experienced lackluster sales and tightening trade terms. Then, in February, Reuters reported that the company “is seeking financing after lackluster holiday sales failed to generate the cash it had hoped for….” It noted, further, that the company had engaged Piper Jaffray Companies ($PJC) to raise the funds. Notably, there has been nothing new on this front since. No news is probably not good news when it comes to this situation. Start the sewing machines: a Scarlet 22 tag may be in order and a liquidation on the horizon.
In the meantime, if the company is looking for ways to preserve liquidity, it might want to consider a far less generous return policy:
uhm yeah so this dude right here RODE A HORSE in clothes from rue21 and then tried to return them W/O A RECEIPT OR TAGS and we let him bc my manager is a nice person BUT WTF. perks of living in a small area bc i searched his name and bam, proof of an asshole pic.twitter.com/rHWPe1Uz6wApril 26, 2018
2. Did Talen Energy’s Acquisition of MACH Gen Miss the Mark? (Short Synergy)
Since we’re on the topic of Scarlet 22s, we ought to address MACH Gen LLC. MACH GEN is the owner of a portfolio of natural gas-fired electric generating facilities in New York, Arizona and Massachusetts; it generates its revenue by selling energy, capacity and other services into power markets; it also went through a prepackaged bankruptcy in March of 2014. In bankruptcy, the company addressed its capital structure: $119 million first lien revolver (Beal Bank USA and Beal Bank SSB), $483 million first lien term loan (same), and $1 billion second lien term loan (BONY), deleveraging $1 billion by equitizing the second lien term lenders, eliminating $83 million in annual interest expense and pushing out debt maturities. Beal Bank ended up holding roughly $680 million of exit paper and, upon information and belief, this falls closer to project financing based on perceived asset value than a traditional term loan that is underwritten based on cash flow.
At the time of filing, the company noted the following — in addition to company-specific ails — among the causes of bankruptcy:
Energy margins in New England, New York, and the Desert Southwest for natural gas combined cycles have generally contracted since 2008 due to shrinking power demand stemming from the economic recession and loss of an industrial base, lower gas prices due to surge in gas supply from unconventional sources, and an increase in supply of zero marginal cost renewable wind and solar power particularly in Arizona. In addition to energy margins, New York generators in 2011 and 2012 experienced lower and more volatile capacity prices due to a surge in demand side management resources and imports from other regions. The lower energy and capacity margins in the spot market also drove down the forward energy markets making hedging margins forward less attractive than in past years. With lower spot markets and lower forward markets, the value of generation assets have declined since prerecession levels.
Milbank Tweed Hadley & McCloy LLP and Moelis & Co. ($MO) represented the company in the restructuring while White & Case LLP represented Beal Bank and Kirkland & Ellis LLP represented the consenting second lienholders. Angelo Gordon & Co. and Solus Alternative Asset Management ended up with representatives on the reorganized Board of Directors.
Subsequently, in November 2015, Talen Energy Corporation acquired MACH Gen for $1.175 billion (inclusive of debt). As outlined in this presentation describing the transaction, Talen’s strategic objectives were to diversify its fuel mix by adding more natural gas-fired capacity and, in turn, diminishing its percentage of coal-based capacity (#MAGA!!). It also provided Talen with geographical diversity by opening up exposure to New York and New England.
In June 2016, Talen Energy and Riverstone Holdings LLC announced a merger that was subsequently closed in December 2016. Talen’s stock ceased trading on the NYSE at that time. Kirkland & Ellis LLP served as Talen Energy's legal advisor. Goldman, Sachs & Co. and RBC Capital Markets served as financial advisors to Riverstone. Wachtell, Lipton, Rosen & Katz and Vinson & Elkins LLP served as Riverstone's legal advisors for the transaction.
Here is where natural gas prices were (i) in April 2014 around the time of the bankruptcy filing (5.97), (ii) in November 2015 (2.08) at the time of the Talen acquisition, (iii) in June 2016 (2.57) at the time of the announced Riverstone transaction, (iv) in December 2016 at the time the transaction closed (3.58) and (v) where they stand now (~2.69):
In addition to natural gas continuing to price at distressed levels, competition from alternative energies in AZ shows no sign of abating. Power demand remains low. The future of the NY assets may be dictated by regulatory pressures that will affect future cash flow generation. Because the loans are purportedly predicated upon asset value rather than cash flows, the question becomes whether — given the uneconomical maintenance structure — true asset value comports with the construction and maintenance costs. And to the extent that the assets do have value, undoubtedly a buyer will want to cleanse an asset sale through Chapter 11 and preserve tax attributes. In consideration of all of this, the company has purportedly advisored up. Is a transaction (and/or Chapter 22) on the horizon? Is there more distress to come in the beleaguered power space? Time will tell.
⚡️Ponder This ⚡️
In recent years, ABI Presidents have pursued lengthy agendas, including the ABI Chapter 11 Commission, launching an ethics task force, and creating the Consumer Bankruptcy Commission – all worthy projects deserving our respect. I have a tough act to follow as the incoming president.
Last month, I was pleased to announce the formation of the ABI Task Force on Veterans Affairs. Led by members and U.S. veterans John Ames, John Penn and Jack Williams, the group is comprised of individuals who are committed to changing veterans’ lives in a meaningful way. The Task Force will examine how the bankruptcy system treats veterans differently, and unfortunately— less favorably. Recommendations and corrective steps will be proposed to Congress or the Rules Committee in the coming year to improve bankruptcy outcomes for all veterans.
Consider what it’s like for vets to return home with any one of the many issues our brave warriors experience after serving their country. And then add to that the financial burden imposed by their service— a burden exacerbated by the cost of transitioning to civilian life; the medical fees associated with caring for injuries; transportation expense to healthcare professionals located at inconveniently-located VA hospitals; and lost income each time they have to see a VA doctor.
Then imagine as the crushing burden of medical or consumer debt mounts, you may be treated in an unfavorable way under the current Bankruptcy Code— especially if you’re a disabled vet.
When a civilian qualifies for and receives social security disability payments, those payments are based on their past income, and in the event of a bankruptcy filing, are not counted as income under the means test. When a disabled veteran files a bankruptcy petition, their disability payments are counted as income under the means test. The effect of this disparity is that someone on veteran disability has a lower likelihood of being able to avail themselves of the complete discharge offered by chapter 7 than a debtor who receives social security disability payments. This is but one of the ways in which the Code fails to work for veterans and service members.
I look at this problem, and I am reminded that ABI’s membership has shown, time and time again, that when its talents are utilized and focused, we can literally redefine our field. And I ask, what solutions to this problem might be unlocked by the brainpower of our members? I know that we haven’t done enough to change the things we can for veterans.
For an organization that many associate with corporate mega-bankruptcies, we’ve achieved quite a lot to improve outcomes for individuals whose lives are impacted by bankruptcies – either their own, their employer’s, or the companies they have built that have fallen on hard times. And now, we’re going to make bankruptcy function better for those who have served our country.
On Sunday, we mistakenly stated that Michael Kramer has joined UBS from Greenhill & Co. Inc. It is Andrew Kramer who made the move. Michael Kramer remains at the helm of Ducera Partners. Apologies to all involved.
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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