🚴‍♂️Special Edition: Peloton Files its S-1🚴‍♂️

Labor Numbers, More Oil & Gas Bankruptcy, McKinsey/Alix

⚡️Announcement⚡️

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Labor Day! As you embark on whatever it is you have planned — i.e., a last pre-school getaway with the kids, the baseball stadium, the local parade, the swanky Hamptons — be sure to give a moment’s pause to remember what Labor Day is all about. Per History.com:

Labor Day pays tribute to the contributions and achievements of American workers and is traditionally observed on the first Monday in September. It was created by the labor movement in the late 19th century and became a federal holiday in 1894. 

This is an interesting time for the American worker. Per the Bureau of Labor Statistics, the national unemployment rate held steady at 3.7% in July 2019* with approximately 164k jobs created. Professional and technical services, health care, social assistance and finance were just some of the categories enjoying increases. To put the national number in perspective, the unemployment rate was 9.5% in July, 2009 and 6.2% in 2014. It was 3.9% last year.

At the state level, on a month-to-month basis, unemployment rates decreased for 6 states (Alabama, Maine and New Jersey showing the most improvement), increased for 2 (Iowa and Wyoming), and remained stable for the other 42 states and the District of Columbia. Interestingly, year-over-year, the following states exhibited meaningful upticks in unemployment: Hawaii, Michigan, Minnesota, Mississippi, Nebraska, North Carolina, and Washington. Somewhat surprisingly, West Virginia and Wyoming have experienced significant improvements (0.5% each). Detroit and New York City, meanwhile, are heading in the wrong direction.

Marco numbers notwithstanding, we all know that there are folks in coal country, in retail, and in media, among other industries, that are struggling. Please remember that while you sip on your Aperol Spritz this weekend and pour one out for those folks who may be far less fortunate than you.

We wish all of our loyal PETITION readers a safe and fun weekend chock full of sun, barbeque, beach and baseball (or whatever else it is that you’re into). We’ll be off this Sunday but back at you next week. Here is some weekend reading to keep you occupied. Cheers!

*The Bureau will release August ‘19 numbers on September 6, 2019.

🚴‍♂️The Rise of Home Fitness: Peloton Files its S-1 (Long Twitter Fodder)🚴‍♂️

In case you haven’t heard, Peloton Inc. filed its S-1 earlier this week. An S-1 is like a bankruptcy First Day Declaration. It’s an opportunity to sell and control a narrative. In the case of the S-1, the filer wants to appeal to the markets, drum up FOMO, and maximize pricing for a public capital raise (here, $500mm). So, yeah, want to call yourself a technology/media/software/product/experience/fitness/design/retail/apparel/logistics company? Sure, go for it. In an age of WeWork, a la-dee-da-kibbutz-inspired-community-company-that-may-or-may-not-be-valued-like-a-tech-company-despite-being-a-real-estate-company, hell, anything is possible.

Frankly, we’re surprised Peloton didn’t throw in that it’s a “CBD-infused-augmented-reality-company-that-transacts-in-Pelotoncoin-on-the-blockchain company” for good measure. Go big or go home, dudes! PETITION Note: the bankruptcy/First-Day-Declaration equivalent of this absurdity must be every sh*tty retailer on earth claiming to be an “iconic” brand with loyal shoppers who, despite that loyalty, never spend a dollar at said retailers, all while some liquidators are preparing to sell them for parts:

But we digress.

For those who don’t live in Los Angeles or New York and are therefore less likely to know what the hell Peloton is (despite its 74 retail showrooms in the US, Canada and UK and pervasive ad-spend), it is a home fitness company that sells super-expensive hardware ($2,245 for the flagship cycle and $4,295 for the treadmill)* and subscription-based fitness apps ($39/month). It’s helped create the celebrity cycling trainer and aims to capture the aspirational fitness enthusiast. And, by the way, it’s a real company. Here are some numbers:

  • $196mm net loss (boom!) on $915mm of revenue in the fiscal year ended June 30, 2019 ((both figures up from 2018, which were $47.8mm and $435mmmm, respectively, meaning that the loss is over 4x greater (boom!!) while revenue grew by over 2x));

  • Hardware revenues increased over 100%, subscription grew over 100% and “other” revenue, i.e., apparel, grew over 100%;

  • 511,202 subscribers in 2019, up from 245,667 in 2018;

  • 577k products sold, with all but 13k in the US;

  • a TAM that, while not a ludicrous as WeWork’s the-entire-planet-is-an-opportunity-pitch, is nonetheless…uh…aggressive with total capture at approximately 50% of ALL US HOUSEHOLDS

and;

  • $994mm VC raised, $4+b valuation;

A big part of that net loss is attributable to skyrocketing marketing spend. But, Ben Thompson highlights:

Peloton spends a lot on marketing — $324 million for 265,535 incremental Connected Fitness subscribers (a subscriber that owns a Peloton bike or treadmill), for an implied customer acquisition cost (CAC) of $1,220.18 — but that marketing spend is nearly made up by the incremental profit ($1,161.40) on a bike or treadmill. That means that subscription profits are just that: profits.

The company also claims very low churn** — 0.70%, 0.64%, and 0.65% in 2017, 2018 and 2019, respectively — though this thread ⬇️ points out some obfuscation in the filing and questions the numbers (worth a click through):

Ben Thompson hits on churn too, noting that major company promotions haven’t rolled off yet:

Only the 12 month prepaid plans have rolled off; the 24 and 39 month plans are still subscribers whether or not they are using their equipment (and given the 0% financing offer, I wouldn’t be surprised if there were a lot of them). 

Surely roadshow attendees will have questions on this point and then, market froth being market froth, totally disregard whatever the answers are. 😜

The company also highlights some tailwinds: (a) an increasing focus on health and fitness, especially at the employer level given rising healthcare costs and a general desire to offset them;** (b) the rise of all-things-streaming; (c) the desire for community; and (d) significantly, the demand for convenience. We all work more, weather sucks, the kids wake up early, etc., etc.: it’s a lot easier to work out at home. This thread ⬇️ sure captured it (click through, it’s hilarious):

Which is not to say that the company doesn’t have its issues.*** It appears that like most other fitness products, there’s seasonality. People buy Pelotons around the holidays, after making New Year’s resolutions they undoubtedly won’t keep. There are also some lawsuits around music use. As we noted above, the marketing spend is through the roof ($324mm, more than double last year) and SG&A is also rising at a healthy clip. Many also question whether Peloton’s cult-like status will fizzle like many of its fitness predecessors. And, of course, there’s that cost. Lots or people — ourselves included — have questioned whether this business can survive a downturn.

Indeed, among a TON of risk factors, the company notes:

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates.

And:

To date, our business has operated almost exclusively in a relatively strong economic environment and, therefore, we cannot be sure the extent to which we may be affected by recessionary conditions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services could have an adverse effect on our business, financial condition, and operating results. (emphasis added)

Now ain’t that the truth. This will be an interesting one to watch play out.

*****

Questions about the company’s stickiness in a downturn notwithstanding, we ought to take a second and admire what they’ve done here. Take a look ⬇️

Sure, sure, it’s a ridiculous metric in an SEC filing but…but…look at the total number of workouts. Look at the average monthly. Unless Peloton is truly expanding the category, those workouts are coming out of someone else’s revenue stream. Remember: SoulCycle did pull its own IPO some time ago.

In a recent piece about the rise of home fitness and the threat it poses to conventional gyms and studios, the Wall Street Journal noted:

U.S. gym membership hit an all-time high in 2018, but the rate of growth cooled to 2% after a 6% rise the year before, according to the International Health, Racquet & Sportsclub Association. Much of the decade’s growth has been fueled by boutique studios like CrossFit, Orangetheory and SoulCycle, whose ability to turn fitness into a communal experience has sparked fierce loyalty to their brands. IHRSA says it’s too early to tell whether streaming classes will reduce club visits. CrossFit, SoulCycle and Orangetheory say they don’t see at-home streaming fitness programs as a threat.

We find that incredibly hard to believe. Is there correlation between the slowdown and growth and Peloton’s 128% and 108% growth from ‘17-’18-’19? Peloton may be more disruptive than the naysayers give it credit for.

Back to Ben Thompson:

Like everyone else, Peloton claims to be a tech company; the S-1 opens like this:

We believe physical activity is fundamental to a healthy and happy life. Our ambition is to empower people to improve their lives through fitness. We are a technology company that meshes the physical and digital worlds to create a completely new, immersive, and connected fitness experience.

I actually think that Peloton has a strong claim, particularly in the context of disruption. Clay Christensen’s Innovator’s Dilemma states:

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

It may seem strange to call a Peloton cheap, but compared to Soul Cycle, which costs $34 a class, Peloton is not only cheap but it gets cheaper the more you use it, because its costs are fixed while its availability is only limited by the hours in the day. Sure, a monitor “underperforms” the feeling of being in the same room as an instructor and fellow cyclists, but being able to exercise in your home is massively more convenient, in addition to being cheaper.

Moreover, this advantage scales perfectly: one Peloton class can be accessed by any of its members, not only live but also on-demand. That means that Peloton is not only more convenient and cheaper than a spinning class, it also has a big advantage as far as variety goes.

The key breakthrough in all of these disruptive products is the digitization of something physical.

In the case of Peloton, they digitized both space and time: you don’t need to go to a gym, and you don’t have to follow a set schedule. Sure, the company does not sell software, nor does it have software margins, but then neither does Netflix. Both are, though, fundamentally enabled by technology.

If Thompson is right about that value proposition, is it possible that, in a downturn, Peloton can win? At $40/class, it would take 57 classes to break even on the hardware and then you’re getting a monthly subscription for the cost of one class. Will people come around to the value proposition because of the downturn?****🤔

Before then, we’ll find out whether the market values this company like a tech hardware company or a SaaS product. And the company can use the IPO proceeds to market, market, market and try and lock-in new customers before any downturn happens. Then we’ll really test whether those churn numbers hold up.

*The company doesn’t break out the success of the two other than to say that the majority of hardware revenue stems from the bike. We would reckon a guess that the treadmill is losing gobs of money.
**It stands to reason that the company would have strong retention rates given the high fixed/sunk cost nature of its product.
***One risk factor is curiously missing so we took the initiative to write it for them:
We sell big bulky products that appeal more to coastal elites.
Unfortunately, given the insanity if housing prices and spatial constraints, a lot of our potential customers in Los Angeles, San Francisco and New York simply may not have room for our sh*t.
****Unrelated but WeWork’s Adam Neumann insists that WeWork presents an interesting value proposition in a downturn: viable office space without the long-term locked in capital commitment. It’s not the craziest thing we’ve heard the man say.

⛽️Oil & Gas Continues to Feed Bankruptcy Court Dockets. New Chapter 11 Filing - EPIC Companies LLC⛽️

Another day, another oil-related bankruptcy filing. Houston-based Epic Companies LLC and six affiliated companies filed for chapter 11 on August 26, 2019 in the Southern District of Texas (Judge Jones presiding) to effectuate a sale to their pre-petition and post-petition lender, White Oak Global Advisors LLC.* White Oak intends to credit bid $48.9mm and assume $40mm of the debtors’ debt. It then hopes to flip the assets — that’s right, flip the assets — to a secondary buyer, Alliance Energy Services LLC, for $40mm and the assumption of $35mm of debt. The debtors hope to consummate the transaction within 65 days. This is bankruptcy today folks: super speedy cases tied to aggressive DIP milestones. Why? In large part, because bankruptcy is too frikken inefficient and expensive to go about a sale transaction otherwise. This is why it’s imperative to have a robust pre-petition marketing process. Here, there’s the added element of the secondary sale.

Formed in Q1 2018, the debtors service the oil and gas industry through heavy lift, diving and marine, specialty cutting and well-plugging and abandonment services. Said another way, these guys work with oil and gas companies at the end of the well lifecycle.

Speaking of the end of lifecycles, the company has been in trouble from the get-go. After spending a year acquiring assets, the debtors already had to start divesting by April of 2019. White Oak foreclosed on equity interests in three entities in July 2019. The company still owns three heavy lift and diving vessels, other equipment, IP, and real property. They owe $106.9mm under a senior loan** and $124.8mm under a junior loan. Unsecured trade debt is $30mm. Other liabilities include litigations against the debtors’ vessels.

Why is this company in bankruptcy? They’re very to the point:

Like many in their industry, the downturn in oil and natural gas prices and other industry-related challenges negatively impacted the Debtors' liquidity position.

Consequently, White Oak called a default and has been driving the bus ever since: in July, White Oak informed management that it was done sinking money into this morass. Five days later, the debtors terminated 400 employees. 28 employees remain. Sadly, their future is decidedly more uncertain today than it was even two months ago.

*Prior to the voluntary filing, one of the debtors was involuntaried in Louisiana.
**Once White Oak exercised remedies, it then restated the debtors’ senior debt into three separate facilities. Acqua Liana, as junior lender, followed suit vis-a-vis the junior loan.

⛽️Uneconomical Contracts & Angry Clients Force Bankruptcy. New Chapter 11 Filing - KP Engineering LP⛽️

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Texas-based KP Engineering LP and an affiliated debtor filed for bankruptcy in the Southern District of Texas (Judge Jones). The debtors are “in the business of designing and executing customized engineering, procurement, and construction (“EPC”) projects for the refining, midstream, and chemical industries.” Said another way, the debtors serve as a general contractor for their clients, functioning as project manager overseeing subcontractors during the development and completion of facilities for clients. One thing about this kind of business: particularly when you have over $68mm of debt, your contracts have to be economical and your clients have to like you. It seems that the debtors fail on both counts.

In January 2017, the debtors entered into an EPC contract with Targa Pipeline Mid-Continent WestTex LLC (a subsidiary of Targa Resources Corp. ($TRGP)) to design, procure equipment for and construct a 200mm cubic feet per day gas cryogenic processing plant. The plant is complete and now operational. Unfortunately for the debtors, however, they “sustained a significant economic loss.” Solid job, guys! At least it helped them get additional work from Targa…

…that Targa then fired them from and are now suing over.

In August 2017, the debtors entered into an EPC for a second plant with Targa but prior to full completion, Targa allegedly stopped paying which had the cascading effect of limiting the debtors’ ability to pay its subcontractors. Earlier this month, Targa terminated the EPC agreement and booted the debtors from the job site. Now subcontractors and Targa are suing the debtors for, among other things, lack of payment. The debtors indicate that the litigation forced the debtors into bankruptcy.

So, what now? It’s unclear. The debtors have a $4mm DIP commitment but the papers don’t make it clear where the debtors intend to go from here. Curiously, the debtors provide this hanging explanation for why they’re in chapter 11:

The Debtors face a number of risks to their business. The landscape surrounding the EPC contractor market is competitive, highly technical, and fast-changing. The Debtors face risks related to a changing environment in which technological advancement is altering their core business. An inability to innovate could be detrimental to the future of the Debtors. However, the Debtors’ present innovation has been the cornerstone of its success to date.

We get some of this. We suppose the first plant was uneconomical because fierce competition affected bidding. But what is the rest of this trying to say? What tech advancement are the debtors referring to? What innovation? Are there competitors founded by Jeff Bezos? We mean, WTF? It’s almost like management here forgot for a second that the debtors aren’t a public company and, therefore, there’s no need to throw out buzzwords.

Whatever. Good luck with bankruptcy, you crazy cowboys.


⛓Notable: What We're Reading (6 Reads)⛓

1. More Retail BK to Come (Long Retail Job Loss). Speaking of employment numbers and Mississippi, there’s this story about Fred’s Inc. ($FRED), the discount retail and pharmacy chain that is shuttering stores and inching closer to bankruptcy. The first ever Fred’s was located in Mississippi. Choice bit:

“The reduction in stores now is so drastic it’s hard to see a path forward for this company to survive,” said Harris Raynor, a union official who represents workers at the Memphis distribution center. “I expect the bankruptcy filing any time,” Raynor said.

So do we.

2. McKinsey & Jay Alix (Short Damages). A federal judge in Manhattan dismissed Mr. Alix’s RICO charge against McKinsey, noting, per Reuters, “In sum, the link between McKinsey’s allegedly unlawful conduct and AlixPartners’ alleged injury is too remote, contingent, and indirect to sustain a RICO claim.” It was good entertainment while it lasted. Speaking of lasting, aside from helping cause a $15mm penalty for McKinsey, the soul legacy of all of this drama is a now-neverending chops-busting by the United States Trustee of every professional filing a retention application in every case anytime and anywhere. Not that that is necessarily a bad thing.

3. Infrastructure (Long Disruption): Now this is an interesting second order effect resulting from, among other things, Lyft Inc. ($LYFT) and Uber Inc. ($UBER).

Choice bit:

Data provided by [Denver International Airport] shows that overall, the nearly 4.7 million vehicles stashed in its public lots last year were down nearly 87,000 from 2016, the last time parking peaked.

In 2018, parking revenue accounted for 18.5% of total airport revenue. Sounds like DIA authorities may want to budget for what happens when that number decreases.

4. Coal Country (Long the Need for Solutions). This:

Hot. Mess.

5. Retail (Long Experimentation, Long Growing Pains). As more and more retailers like Macy’s Inc. ($M), J.C Penney Inc. ($JPC) and others dive into rental and/or resale options, it will be interesting to see which, if any, will be able to translate experimentation into revenue.

6. Baseball (Short Umpires, Long Robots). This is a fascinating look at errors calling balls and strikes and the future of baseball. Choice bit:

None of this is sustainable, by the way. I’ve made this point again and again about instant replay — even though, as most of you know, I don’t like it: Once there is an obvious gap between what we see at home and what is called on the field, technology will fill that gap. You can bet on it. It might take a year or several years or even longer, but you can’t have balls consistently called strikes or strikes consistently called balls anymore than you can have fumbles missed or touchdowns called when the player stepped out of bounds. It’s a matter of credibility.


📈Chart of the Week📈

Nothing to see here. We’re super stoked for the low interest 100-year bond!!


📤Notice📤

Louis Chiapetta (Partner) joined Mayer Brown LLP from Skadden Arps Slate Meagher & Flom LLP.


Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.