Disruption from the Vantage Point of the Disrupted
12/19/18 Read Time = 10.1 a$$-kicking minutes
Hey PETITIONERS -
Just some housekeeping here before we say “so long” to 2018. First, we want to thank you all again for your support of PETITION over the year. We are overwhelmed by the widespread acceptance of PETITION and look forward to bigger and badder things in 2019. Thank you for your subscription! 👊👍
A heads up: this special edition will be the last briefing of 2018. It’s the holidays and so many of you will be traveling that we don’t want to write and distribute masterpieces only for them to go unseen, lost in the ether. We may post/send Members’-only content if/when necessary, depending on what happens out there between now and year’s end. Follow us on the Twitters and check back on our website often. 🎄🕎
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⚡️End of the Year Followup⚡️
Many of you have provided us with positive feedback over the year about our “Notice of Appearance” segment. And so we followed-up with many of our previous participants (as well as some other loyal readers) and asked them to share, now that the year is over, some end-of-the-year thoughts (some edited for length and/or clarity):
PETITION: With the benefit of 20/20 hindsight, what surprised you most about 2018?
The durability of the markets, even under increasing pressure. Certainly the massive amounts of undeployed capital help, but the momentum of the past decade remains surprising. - Richard Chesley and Rachel Albanese, Partners at DLA Piper (US) LLP
Oil and Gas is STILL a thing! I remember well first learning about E&P capital structures after the oil price dive about this time in 2014, and since then I have worked on significantly more than a dozen oil/gas restructurings for creditors. I have become a regular at the Four Seasons in Houston (check out the “Top Golf” booths, they are great for blowing off steam after court), and I have learned far more than I ever expected I would know about a fascinating industry, filled with super smart (and colorful) characters. The fact that four full years in we would still be discussing so many energy companies was very surprising to me. - Damian Schaible, Partner at Davis Polk & Wardwell LLP
As to restructuring surprises in 2018, for the upper market it’s definitely the brazen asset stripping that borrowers have gotten away with – mind boggling! For the mid to lower markets that we play in, it’s the continued credit bubble. We’re still able to refinance companies out of trouble. Most of these companies don’t self correct and will squander their second chance on life. Another surprise this past year was how busy we have been with distressed multi generational family businesses and PE portfolio companies. - J. Scott Victor, Managing Director at SSG Capital Advisors LLC
PETITION shrugs off the buzz around distressed health care, and I had the same impression going into the year, but I think the buzz ended up being real in 2018 and will continue. But according to the Polsinelli - TrBK Distress Indices, the Health Care Services Distress Research Index was 405 for the third quarter of 2018, which was a 65 point increase from the previous quarter, 82% increase year-over-year, and 305% increase from 2010 (www.distressedindex.com). While many of these cases are not the mega cases with the mega fees that receive a lot of attention, the distressed health care bankruptcies are the core of national, regional and, local bankruptcy practices in 2018. I am a convert. The hype is real. - Chris Ward, Partner at Polsinelli P.C.
I was surprised at the amount of general market gyrations associated with interest rate hikes. Many folks were caught off guard by the ripple effects - this was telegraphed and should have been understood. I’m surprised the market reacted the way it did. - Navin Nagrani, Executive VP and Principal at Hilco Global
The biggest surprise is the crazy availability of capital available for questionable credits. It feels very toppy. Similar to 2006/2007 era. Covenant light or covenant free is clearly there. I suppose I shouldn’t be surprised, but I am. The thing that’s most interesting about it is that it seems “in on the joke.” Restructuring firms like mine are staffing up or getting acquired. Law firms are making moves for big restructuring talent in advance of a cycle. Yet while everyone clearly sees a cycle coming, rescues and refis are more prevalent than any time I can remember. - Lawrence Perkins, Partner at SierraConstellation
That although Agricultural bankruptcies are up, I was surprised we didn’t have more larger middle market Ag company distressed activity. - Dan Dooley, Principal and CEO at MorrisAnderson
PETITION: What growing (and under-appreciated) trend will have a marked impact on 2019 (or beyond) as we approach what could be a down cycle?
We will see more small and mid-size companies using non-bankruptcy code solutions like in the “olden days” before the 1978 code changes. Article 9 sales, assignment for the benefit of creditors, state court liquidations and other mechanisms. The current bankruptcy models are too expensive and are not timely enough…. - Ted Stenger, Managing Director at AlixPartners
The credit bubble is beginning to burst on the cash flow side and it can’t be too much longer that the ABL side gets tighter. All lenders- Cash Flow, ABL, Term, Second Lien, Split Lien, Mezz … and their PE backed borrowers have far more trouble in their respective portfolios than they would like to admit. It’s only going to get worse in 2019 as credit tightens! - J. Scott Victor, Managing Director at SSG Capital Advisors LLC
The underlying growth assumptions in many businesses have changed. When you couple this with increasing costs of capital - the M&A market is going to be more challenged. We will see more “scratch and dent” type setups and more Corp. bankruptcies. - Navin Nagrani, Executive VP and Principal at Hilco Global
The rapidly growing lending by BDCs and other non-traditional lenders which has been accelerated as commercial banks were forced out of leveraged lending by the bank regulators. Ironically the BDCs still have the leveraged lending exposure as they are all financed by commercial banks. So banks still have the same leveraged loan risk; only they have less control of the risk. A totally stupid edict by the regulators. Alternative lenders are relatively new to the market and generally have minimal back office credit functions as who needs this cost when defaults are low. So it will be interesting how alternative lenders manage thru the next downturn. I would imagine some of this new group won’t survive and be sold or liquidated.
Bonus Comment- my firm recently did a $40M refinancing project. Like many distressed deals it was a “quick response from lenders required” type of deal. This was a deal a commercial bank could have done with debt leverage about 3.5x. Terms sheets received from alternative lenders in 3 weeks = 9. From commercial banks = 0. Two banks did issue term sheets 2 or 3 weeks late. In my view customer responsiveness is a big deal in a service business and commercial banks are getting slaughtered on this key metric by alternative lenders. Commercial banks are ripe for your byline — Disruption. - Dan Dooley, Principal and CEO at MorrisAnderson
We will see a continued utilization of prepackaged bankruptcies and combined liquidating plans and disclosures statements. Lenders, distressed companies, and just about everyone else in the country is tired of hearing about, and paying for, professional fees. Bankruptcy is a necessary, and expensive, tool, that needs to be used in some instances. We have seen a plethora of Restructuring Support Agreements implemented through a pre-negotiated or pre-packaged chapter 11 bankruptcy. I believe that trend will continue. However, not every deal is big enough for an RSA, and those deals are accomplished through lighting quick 363 bankruptcy sales, which sell the company’s assets at liquidation values to a third party or to a credit bid to the secured lender and leave behind a no-asset estate for a chapter 7 trustee to deal with. Most courts have soured on this, especially in Delaware, and prefer that a combined liquidating plan and disclosure statement be used to wind down the estate and provide a minimal benefit to creditors. I think this will be an increasing trend in 2019. - Chris Ward, Partner at Polsinelli P.C.
The combination of reduced housing starts and significant mortgage interest hikes portend potential trouble in the largest driver of the US economy. - Richard Chesley and Rachel Albanese, Partners at DLA Piper (US) LLP
First, asset stripping. This in not necessarily new, but there’s a broad enough play-book out there on how to do it now, that it will trickle down market to the middle market world.
Second, the tech bubble is set to have a big shakeout too. We’ve seen some distress there and some big money has chased some direct-to-consumer brands that are more product than company. History would suggest that that’s not a good way to scale a business. I love the direct-to-consumer trend; I think it is truly disruptive; I hope these companies make it; but I just don’t see how the investors get a return on these deals. Not every company can disrupt every industry…. - Lawrence Perkins, Partner at SierraConstellation
Creditor groups organizing early and often. Loose documents and the dispersed nature of holders has permitted and led to coercive exchange offers and consent solicitations, drop-downs and general value leakage. Having been burned time and again, investors are recognizing that early and consistent coordination among creditors is often their best protection. As a result, groups are forming long before any real signs of distress or likely engagement by the borrowers/issuers or their sponsors. This is a challenge and an opportunity for advisors who are forced to look further into the future in order to add value for their clients but also often get the opportunity to spend time with holders long before crises develop. - Damian Schaible, Partner at Davis Polk & Wardwell LLP
PETITION: Which person and firm do you think had an outsized impact on the restructuring industry in 2018 (you cannot nominate yourself or your firm)?
Elon Musk who proves that insolvent companies can thrive with the right amount of hype and equity market support. Eddie Lampert who has made the Sears situation an exercise in smoke and mirrors and sullied the reputation of the investor community. - Ted Stenger, Managing Director at AlixPartners
Kirkland, all of them. Kirkland is the 800 lbs. gorilla in the restructuring industry, and deservedly so. They fall into the category of there is no such things as bad press. Despite the constant attack on their fees, and recent attacks on mandatory arbitration clauses, Boards of Directors of most prominent Fortune 500 Company and beyond in distress or financial difficulty considers Kirkland for engagement. And who can blame them. They get results. This past year they not only continued their stranglehold on the restructuring industry, but also saw recognition for some of their younger attorneys, namely Chad Husnick who was an honoree in the American Bankruptcy Institute’s second annual 40 Under 40 class. - Chris Ward, Partner at Polsinelli P.C.
Donald Trump. While the markets are choppy enough, the uncertainty surrounding the President’s words and actions had an outsized impact in 2018, and almost certainly will have far greater impact as the markets weaken. - Richard Chesley and Rachel Albanese, Partners at DLA Piper (US) LLP
Jamie Sprayragen and Kirkland! Jamie took a solid but not extraordinary restructuring practice and turned it into a market making behemoth on the company side. They have impacted directly the venues where cases are filed (Houston, St. Louis, Richmond), the ways they are filed (prepacks with RSAs that are sometimes not quite what they seem) and the terms of restructurings (professional fee carveouts, broad releases for sponsors and management and the risk of cram up for secured lenders). - Anonymous
Jamie Sprayregen — an absolute machine - Dan Dooley, Principal and CEO at MorrisAnderson
I would nominate the PETITION Editorial Staff. Not trying to garner favor, but its been a consistent topic of conversation within my firm, and people at other firms have mentioned it. - Lawrence Perkins, Partner at SierraConstellation
PETITION Note: As flattered as we are by the recognition (thank you - btw, we’ll still highlight it if you or your firm effs something up and it’s of interest!), we think there are others who deserve recognition for their impact. And, so, without further ado, PETITION’s first annual awards:
Law Firm of the Year (tie): Kirkland & Ellis LLP & Weil Gotshal & Manges LLP. The two firms have dominated company-side debtor work in a manner that is public/private, geographically, and industry agnostic. Kirkland handled ATD, VER, Parker Drilling, Westmoreland, EV Energy, Nine West, iHeartMedia, Cenveo, Exco and Aegean Marine. Weil managed Tops Holding, The NORDAM Group, Waypoint Leasing, Sears Holding Corporation, Fieldwood Energy, Southeastern Grocers, Claire’s Stores and Catalina Marketing. We expect this (share of) volume to continue in 2019.
Runners-up: Akin Gump Strauss Hauer & Feld LLP & Latham & Watkins LLP. The former solidified itself as the go-to bulldog for committees (with a sizable company-side mandate in FirstEnergy to boot) and the latter, with (a) new personnel moves, (b) a renewed focus on company-side work and (c) a strong platform, looks primed to take on this year’s winners in 2019.
Local Counsel of the Year: Young Conaway Stargatt & Taylor LLP. The data doesn’t lie. This firm is involved, in one way or another, in virtually every case to file in the District of Delaware. Runner-up: Jackson Walker LLP (for the same reason in the Southern District in Texas).
Financial Advisor of the Year: FTI Consulting Inc. The firm dominated the grocery space and the healthcare space, among others, and has quietly transformed into a shop that can handle company-side and creditor-side mandates alike. And, strangely, the market doesn’t really appear to have noticed. Notable mandates include Synergy Pharmaceuticals, Southeastern Grocers, Petroquest Energy Inc., Promise Healthcare, Waypoint Leasing, and Catalina Marketing.
Investment Bank of the Year: Houlihan Lokey. We have to agree with the folks at International Financing Review. Between company side engagements, e.g., Shopko Stores Operating Co. LLC (not in court…yet), Guitar Genter Holdings Inc. (avoided court), All American Oil & Gas, Promise Healthcare, Waypoint Leasing and creditor engagements, Nine West, Sears, Toys R Us, Neiman Marcus, Mission Coal, Claire’s, the firm is on fire.
Administrative Agent of the Year: Prime Clerk LLC. Of the categories, this one — just looking at the data — was the most obvious. It continues to be a “monopoly of a duopoly,” which, in turn, appears to — for the large-size cases anyway — be creating the closest thing the restructuring community has to a monopoly, generally. Whether that is actually good for the end-user clients, at the end of the day, is another matter.
M&A Transaction of the Year: Reorg Research. Kudos to the fine folks at Reorg for creating a product that people like, use, and depend upon. Due to this, they’ve been rewarded with a premium purchase price by Warburg Pincus (rumored to be an eye-popping 20x revenue). Keep up the good work, y’all.
CONTINUE READING BELOW FOR OUR RESTRUCTURING DEAL OF THE YEAR…
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥.
Last year, Damian Schaible of Davis Polk & Wardwell LLP shared with us some truly extraordinary gift ideas that we felt compelled to ask him what he has up his sleeve this year. First, he’s back with the ridiculous sweaters. Here’s his:
You can check out some others here. And, apparently, the ugly sweater thing has captured Hanukkah, too, so you can stash this ridiculously absurd sweater for next year if revelry is your jam (sorry we were a bit late to the Hanukkah party this year).
Damian also suggested two other great gift ideas:
The Gaiam Evolve Balance Board for the Standing Desk. He says, “We all work too much and exercise too little. Work on your core while yelling at your counterparties by taking calls while standing on this.” (PETITION Note: this is awesome. We’re going to work on our cores while irreverently commenting on restructuring matters!).
The Segway Minipro and the Ninebot Gokart attachment. He says, “You control the newest Segway with your knees. It’s smaller, lighter and super fast — a ton of family fun.” PETITION Note: he sent us a video of his “6 year old bombing around our house while [his] wife was traveling!” and it looks FRIKKEN BADA$$. Safe driving all.
🏆Deal of the Year🏆
We anguished over this because this year has been such a treasure trove of action. We, of course, considered both Sears Holding Corporation and Toys “R” Us because, naturally, both just seem like gifts that keep on giving. We also looked at Exco Resources, a January filing that continues to languish in bankruptcy court but ultimately decided against it. Oil and gas is so…2016. Given that 2018 was supposedly the year of healthcare, we briefly considered 4 West Holdings LLC, which we covered in “😷Healthcare Volume < Healthcare Drama😷”. Ultimately, however, the decision became abundantly obvious…
Introducing the 2018 Deal of the Year….
🍾🎆NINE WEST HOLDINGS INC.🎆🍾
If you’re shocked at this call, you haven’t been paying attention. We first wrote about Nine West back in March in “👞UGGs & E-Comm Trample Birkenstock👞,” amidst a discussion of “the Brand-Based DTC Megatrend.” Shortly thereafter, in April, the company filed for bankruptcy and we wrote about the factors that contributed to its fall — including its $1.578b capital structure — and its restructuring support agreement (hahahaha!) in “✌🏾Peace Out Nine West✌🏾.” Therein we wrote:
Chinese Manufacturing Part II. If President Trump really wants to flick off China, perhaps he should reconsider his (de minimus) carried interest restrictions and let US private equity firms continue to run rampant all over the shoe industry. If the recent track record is any indication, that will lead to significantly over-levered balance sheets borne out of leveraged buyouts, inevitable bankruptcy, and a top 50 creditor list chock full of Chinese manufacturing firms. Behind $1.6 billion of debt and with a mere $200 million of sale proceeds, there’s no shot in hell they’d see much recovery on their receivables and BOOM! Trade deficit minimized!!
We stand by that point.
Anyway, we also, indirectly, foreshadowed the drama to come when we wrote:
Sycamore Partners & Transparency in Bankruptcy. Callback to this effusive Wall Street Journal piece about the private equity firm: it was published just a few weeks ago. Reconcile it with this statement from the company, “After several years of declines in the Nine West Group business, part of the investment hypothesis behind the 2014 Transaction was that the Nine West® brand could be grown and strong earnings would result.” But “Nine West Group net sales have declined 36.9 percent since fiscal year 2015—from approximately $647.1 million to approximately $408 million in the most recent fiscal year.” This is where bankruptcy can be truly frustrating. In Payless Shoesource, there was considerable drama relating to dividend recapitalizations that the private equity sponsors — Golden Gate Capital Inc. and Blum Capital Advisors — benefited from prior to the company’s bankruptcy. The lawsuit and accompanying expert report against those shops, however, were filed under seal, keeping the public blind as to the tomfoolery that private equity shops undertake in pursuit of an “investment hypothesis.” Here, it appears that Sycamore gave up after two years of declining performance. In the company’s words, “Thus, by late 2016 the Debtors were at a crossroads: they could either make a substantial investment in the Nine West Group business in an effort to turn around declining sales or they could divest from the footwear and handbag business and focus on their historically strong, stable, and profitable business lines.” But don’t worry: of course Sycamore is covered by a proposed release of liability. Classic.
Timing. The company is proposing to have this case out of bankruptcy in five months.
This will be a fun five months.
A QUICK DIGRESSION:
PETITION: With the benefit of 20/20 hindsight, what surprised you most about 2018?
That the folks behind Nine West thought it would be done in five months - PETITION.
Then in May, in “⚡️“Independent” Directors Under Attack⚡️,” we noted how Akin Gump Strauss Hauer & Feld LLP, which had been retained to represent the official committee of unsecured creditors, started homing its sights on Nine West, its directors, and its legal counsel. We wrote:
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.
And they sure have!
But at first we were a wee bit discouraged. In “💩The Fiction that is Transparency in Bankruptcy💩 ,” we expressed some annoyance with the fact that the UCC’s opening jabs were filed under seal. We wrote:
We suppose one can surmise what that was about and walk away with the gist. Sycamore made a ton of money and the question is whether it was a constructive fraudulent conveyance. Still, it would be great to see the meat on the bones.
Want to know whether there are grounds to disqualify an “independent” director and his investigation into potentially fraudulent pre-filing activity? Good luck. In Payless Holdings LLC, the Official Committee of Unsecured Creditors filed a report delineating its findings with respect to the multiple dividend recapitalization transactions that transpired in that case. It would have been a great playbook for attacking such transactions — pervasive as they now may seem — and the “independent” directors who purport to investigate them (PETITION Note: just once we’d love to see a judge call out this sham, enjoin such an investigation immediately (to save fees), and let the committee proceed without having its role subjugated by the alleged “independent” and his lawyers/FAs). Alas, the report was filed under seal and the issue swept under the rug via settlement. We would’ve liked to have seen this litigated in the light of day. Instead it was settled under a veil of secrecy: the report remained under seal and so the market could not judge the merits of the arguments for future reference. The only clear takeaway was that a PE firm could pre-orchestrate an LBO with immediately-following-dividend-recaps and only suffer the indignity of a few MSM headlines, a settlement at a fraction of the potential liability, AND still have its playbook left intact. Brilliant.
In October’s “💰All Hail Private Equity💰,” we continued to express annoyance with the lack of transparency, noting that the UCC filed yet another motion under seal and that we still knew bupkis about how its potential claims were proceeding — other than, well, the amount of money they were spending to investigate those claims.
Shortly thereafter, we noted how Nine West had an effect on Sears Holding Corp. We wrote:
Look, Sears is a bit of a special case. It has been a slow moving train wreck for years. Everyone has known that it was coming. This presents the perfect opportunity to set yourself up both in terms of relationships and quals/performance. And so when you’re down to two firms and you know that there are significant pockets of value that are subject to attack in ways that could potentially enhance unsecured creditor recoveries, do you choose the firm that talked a big game about alleged independent directors and div recaps only to settle (Payless Shoesource) or do you choose the firm that is digging in its heals and is bulldogging through a case against a powerful PE firm, it’s powerful lawyers and its pervasive directors (Nine West)? Sh*******t. Nine West is the undercard. Sears is the main event.
And so Akin Gump Strauss Hauer & Feld LLP has nailed down the UCC legal role.
Eddie Lampert can send Sycamore Partners a “thank you” note for having Akin unleashed on him.
Anyway, where are we now? A little over a week ago, the company filed a motion (Docket 923) seeking an additional $22mm in DIP financing. Law360 reported:
Nine West Holdings Inc. has asked a New York bankruptcy court to approve an additional $22 million in debtor-in-possession financing, saying it now expects to exit its contentious Chapter 11 at least a month later than it originally planned and needs the additional cash.
PETITION Note: “A month later?” Memories are short. Reminder: this was supposed to be a five month case.
It gets better:
In a Tuesday motion, Nine West said creditor objections have pushed its anticipated exit from Chapter 11 from February to at least March, leaving it in need of an amended DIP term facility in order to continue to pay its professionals.
“The debtors also need additional liquidity to cover seasonal working capital needs. ... The debtors historically build working capital from January to March of each year to maintain adequate inventory to operate through the spring season,” it said.
We had to double-check the motion and, as Law360 reported, there is paragraph after paragraph about fee generation and then this cavalier statement that the additional funding is also necessary for…like…the ACTUAL EFFING BUSINESS. Might as well have dropped that in a footnote. This bit in the motion is precious:
…that amount will be necessary to pay professional fees for a period longer than originally contemplated when the Debtors and DIP lenders sized the DIP Facilities prior to the commencement of these cases. Professional fees for estate paid professionals have been accruing at approximately $9 million per month since the petition date but are expected to increase by an additional $3–4 million per month (driven by ongoing discovery and litigation in parallel to ongoing negotiations), for a total expected run rate of $12–13 million per month.
Of course, this extension conveniently takes us into the new year when, “in accordance with ordinary practice,” firm rates increase. Indeed, on December 14, Kirkland & Ellis LLP filed a supplemental declaration (Docket 973):
We remember when the race to a $1 trillion market cap between Apple Inc. ($AAPL) and Amazon Inc. ($AMZN) was a thing. Frankly, we think the race to the $2,000/hour billable is much more compelling.
Anyway, as foreshadowed by the DIP extension motion, there’ll be “ongoing discovery and litigation in parallel to ongoing negotiations” for us all to get excited about. Make sure you leave room at the holiday dinner table for some popcorn in 2019. We’re popping some. And leaving open the admittedly remote possibility that Nine West is a repeat champion in 2019.
So, what is the prize?
As you can see, Amazon wasn’t particularly helpful. It’s probably best. We’re not sure they’d be able to offer the option to set it on fire and then have it delivered anyway. So, we leave you, sadly, with only this gif:
See you all in 2019.
Jefferies’ Restructuring & Recapitalization Group is actively looking for experienced Associates and Vice Presidents for our New York office.
The Group provides a full array of advisory and financing solutions to increase financial flexibility for corporate and investor clients. Services include debtor and creditor advisory, liability management / debt exchanges, private capital raising (“rescue”, DIP, exit, and other bespoke financings), and special situations M&A (stressed/distressed, 363 sales, post-reorg), both in bankruptcy and on an out-of-court basis.
Applicants MUST have 2-10+ years of restructuring experience at another investment bank, law firm, consultancy / FA, or as a distressed investor.
If you meet this requirement, please submit your resume to: firstname.lastname@example.org.
If your firm has job opportunities, please email us at email@example.com.
Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.