Disruption from the Vantage Point of the Disrupted
1/23/19 Read Time = 6.5 a$$-kicking minutes
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1. 👠Marie Kondo is Coming to a First Day Declaration Near You (Long Thrift Shopping)👠
2019 has already been a rough year for retail. Beauty Brands LLC, a Kansas City-based brick-and-mortar retailer with 58 stores in 12 states filed for chapter 11 bankruptcy in the first week of January. Then, last week, both Shopko (367 stores) and Gymboree (~900 stores) filed for chapter 11 bankruptcy — the former hoping to avoid a full liquidation and the latter giving up hope and heading straight into liquidation (it blew its first chance in bankruptcy). And, of course, there’s still Charlotte Russe, Things Remembered, Payless and others to keep an eye on.
All of this has everyone on high alert. Take this piece from The Wall Street Journal. Pertaining to J.C. Penney ($JCP) and Sears Holding Corporation ($SHLDQ), the WSJ notes:
J.C. Penney Co.’s sales are falling, its stores are stuck in malls and the turnaround strategy keeps changing. Now, three months after the embattled retailer hired a new chief executive, a handful of senior positions remain vacant.
The series of events is prompting analysts and other industry experts to question whether Penney can avoid the fate of fellow department-store operator Sears Holdings Corp., which filed for bankruptcy and barely staved off liquidation.
The Plano, Texas-based chain was once the go-to apparel retailer for middle-class families. It and Sears had once dominated American retailing but lost their customers, first to discounters like Walmart , then to fast-fashion retailers and off-price chains like T.J. Maxx. The shift to online shopping hastened their decline.
First, the Sears Holding Corporation ($SHLDQ) drama continues as the company heads towards a contested sale hearing in the beginning of February. To say that it “staved off liquidation” is, at this juncture, factually incorrect. While the company’s prospects have improved along with Mr. Lampert’s purchase offer, it is not a certainty that the company will be able to avoid liquidation. At least not until the Official Committee of Unsecured Creditors’ objection is overruled and the bankruptcy court judge blesses the Lampert deal. The sale hearing is slated for February 4.
Second, we were relieved to FINALLY see an article about retail that didn’t pin the blame solely at the feet of Amazon Inc. ($AMZN). As we’ve been arguing since our inception, the narrative is far more nuanced than just the “Amazon Effect.” To point, Vitaliy Katsenelson recently wrote in Barron’s:
Retail stocks have been annihilated recently, even though retail sales finished 2018 strong. The fundamentals of the retail business look horrible: Sales are stagnating, and profitability is getting worse with every passing quarter.
Jeff Bezos and Amazon.com get most of the blame, but this is only part of the story. Today, online sales represent only 8.5% of total retail sales. Amazon, at about $100 billion in sales, accounts only for 1.6% of total U.S. retail sales, which at the end of 2018 were around $6 trillion. In truth, the confluence of a half-dozen unrelated developments is responsible for weak retail sales.
He goes on to cite a shift in consumer spending to more expensive phones, more expensive phone bills, more expensive student loan bills and more expensive health care costs as contributors to retail’s general malaise (PETITION Note: yes, it appears that lots of things are getting more expensive. Don’t tell the FED.). More money spent there means less discretionary income for the likes of J.C. Penney. Likewise, he highlights the change in consumer habits. He writes:
We may not care about clothes as much as we may have 10 or 20 years ago. After all, our high-tech billionaires wear hoodies and flip-flops to work. Lack of fashion sense did not hinder their success, so why should the rest of us care about the dress code?
Consumer habits have slowly changed, including the advent of rental clothes from companies like Rent the Runway and LeTote.
We’ve previously written extensively about the rental and resale wave. We wrote:
Indeed, per ThredUp, a second-hand apparel website, the resale market is on pace to reach $41 billion by 2022 and 49% of that is in apparel. Moreover, resale is growing 24x more than overall apparel retail. “[O]ne in three women shopped secondhand last year.” 40% of 18-24 year olds shopped retail in 2017. Those stats are bananas. This comment is illustrative of the transformation taking hold today,
“The modern consumer now has a choice between shopping traditional retail or trying new, innovative business models. New apparel experiences and brands are emerging at record rates to replace old ones. Rental, subscription, resale, direct-to-consumer, and more. The closet of the future is going to look very different from the closet of today. When you get that perfectly curated assortment from Stitch Fix, or subscribe to Rent the Runway’s everyday service, or find that killer handbag on thredUP you never could have afforded new, you start realizing how much your preferences and behavior is changing.”
Lots of good charts here to bolster the point.
That wave just got a significant shot of steroids.
Earlier this month Netflix Inc. ($NFLX) debuted “Tidying Up with Marie Kondo,” a show that springs off of Ms. Kondo’s hit 2014 book, “The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organizing.” The news since is not too encouraging for retailers.
Per NPR, “Thrift Stores Say They’re Swamped With Donations After ‘Tidying Up with Marie Kondo’” (audio and audio transcript). Indeed, thrift stores like Goodwill are seeing an uptick in donations across the country (and Canada).
The Wall Street Journal published a full feature predicated upon “throw a lot of sh*t out.”
Of course, all of this decluttering is an opportunity. Anna Silman writes in The Cut:
Well, congrats to all the people who have committed to the KonMari life and ridded themselves of the burden of their unwanted possessions, and who now have to waste 15 minutes a day folding their underwear into tiny rectangles. But also, good for us! Imagine how many bad choices people are liable to make in a feverish post New Year’s Kondo-inspired purge? Mistakes will be made. Purgers are going to see that lavish fur cape they never wore and deem it impractical; come Game of Thrones finale cosplay time, they’re going to rue their hastiness. Conscientious closet cleaners will dispose of the low-rise jeans they haven’t worn since the mid-aughts, but the joke’s on them, because low-rise jeans are coming back, bitches!
So, my fellow anti-Kondoers, if you’re in a post-holiday shopping mood, get thee to thy nearest second-hand clothing store Beacon’s (or Goodwill, or Buffalo Exchange, or Crossroads, or the internet) and get started on building your 2019 wardrobe. And if you arrive at your nearest resale outlet and see a long line, don’t worry: Those people are there to sell. Those aren’t your people. Forget them. Focus on the racks — those sweet, newly stocked, overflowing racks, where so much joy awaits.
It’s just like the old adage: One woman’s trash is another woman’s treasure, especially because most of it was never trash to begin with.
Likewise, Lia Beck writes in Bustle, “…get out there and find some things that spark joy for you.”
And reseller The RealReal is signaling that resale is so big that it’s ready to IPO. Talk about opportunistic. No better time to do this than during Kondo-mania. The company has raised $115mm in venture capital from Perella Weinberg Partners, Sandbridge Capital and Great Hill Partners, most recently at a $745mm valuation.
None of this is a positive for the likes of J.C. Penney. They need consumers to consume and clutter. Not declutter. Not go resale shopping. We can’t wait to see who is first to mention Marie Kondo as a headwind in a quarterly earnings report. Similarly, we wonder how long until we see a Marie Kondo mention in a chapter 11 “First Day Declaration.” 🤔
2. New Chapter 11 Bankruptcy Filing - Maremont Corporation (Long PG&E Foreshadowing).
Michigan-based Maremont Corporation, a subsidiary of publicly-traded non-debtor automobile component manufacturer Meritor Inc. ($MTOR), filed for bankruptcy on January 22, 2019 along with three affiliates in the District of Delaware. The company was a manufacturer, distributor and seller of aftermarket auto products — many of which contained asbestos; currently, it has no ongoing operations and its only assets are an intercompany receivable, a rent-producing commercial property with Dollar General as a tenant, a few bank accounts, and some insurance assets. In contrast, the company has significant liabilities — notably asbestos-related liabilities including defense and other costs associated with defending 13k pending personal injury and wrongful death claims.
The company, in consultation with its parent and committees of Future Claimants and current Asbestos Claimants, arrived at a prepackaged plan under section 524(g) of the Bankruptcy Code. The plan envisions a personal injury trust to be funded, in large part, by Meritor (via the repayment of a remaining receivable, a contribution of intercompany payables and a $28mm settlement payment) and a channeling injunction that protects the company (and Meritor) from future suit and liability arising out of the company’s asbestos legacy. Instead, any and all asbestos-related personal injury claims may only be pursued against, and paid from, the personal injury trust.
Meritor, like most of the stock market, got beaten up yesterday. There’s no telling whether the multi-million dollar payout here had anything to do with that.
For the uninitiated, this (horrifically boring) bankruptcy filing presents us with a good opportunity to highlight a potential structure (and its limitations) for any imminent Pacific Gas & Electric Company (“PG&E”) chapter 11 bankruptcy filing. PG&E’s issues — as have, by this point, been extensively documented — largely emanate out of (i) some oppressive California state liability laws (inverse-condemnation — definitely), (ii) man-made global warming and resultant mudslides and wildfires (probably), and (iii) at least a glint of negligence (probably). While the company has $18.4b of (mostly unsecured) debt, the catalyst to bankruptcy may be its multi-billion dollar liability from the aforementioned CA-state laws and years of environmental disaster.
Similar to Maremont, PG&E is likely to end up with some kind of plan of reorganization that features a litigation trust (for affected claimants) and a channeling injunction. Except, as John Rapisardi and Daniel Shamah of O’Melveny & Myers point out, there are limitations to that structure. They write:
There is one significant obstacle to any PG&E bankruptcy: the likely inability to discharge liabilities associated with wildfires that have not yet occurred. There have been numerous mass tort bankruptcies in the past that have been resolved through the formation of a litigation trust and channeling injunction, forcing litigants into a single forum where claims are satisfied through trust assets. See, e.g., 11 U.S.C. §524(g) (channeling injunction for asbestos debtors); In re TK Holdings, Doc. No. 2120, Case No. 17-11375 (Bankr D. Del.) (confirmation order with channeling injunction for debtor that manufactured airbags with defective components). But that structure only works for claims based on prior conduct or acts. PG&E, in contrast, faces perennial liability associated with wildfires and inverse condemnation. It may be challenging to discharge the inverse-condemnation liabilities associated with a post-petition wildfire. See 28 U.S.C. §959(a) (debtors-in-possession may be sued “with respect to any of their acts or transactions in carrying on business connected with such property.”).
Prior conduct or acts, huh? A discontinued product that happened to contain asbestos fits that bill. Likewise, a remedied airbag (the TK Holdings referenced above refers to Takata Airbags). Sadly — especially for Californians, there is nothing prior about environmental issues. Those are very much a present and future thing.
In Sunday’s Members’-only edition entitled “⚡️Why is Gymboree an Unmitigated Disaster?⚡️,” we discussed how recent Chapter 22s are making a mockery of feasibility in bankruptcy. We concluded:
Given that we now have conflicts counsel to conflicts counsel and everyone in the universe has their own set of advisors, perhaps we’ve arrived at the point in bankruptcy proceedings where the bankruptcy court, itself, ought to hire professionals to verify or challenge the evidence presented to it. We could see it now: Judge Nebraska hiring Banker EFF&D to serve as her banker to determine whether the feasibility proffer is a total clusterf*ck like the one here. Why has this not happened yet? Don’t even tell us it’s fee sensitivity.
One astute reader north of the border wrote us:
I am a trustee in insolvency in Canada (the equivalent does not exist in the US – the role is a hybrid of an FA/US trustee/Restructuring banker) and under our Chapter 11 equivalent, Companies' Creditors Arrangement Act (CCAA), a Monitor (usually a Big 4 accounting firm) is in fact appointed to act as the advisor to the court. Thought it could be of interest to you guys.
⚡️Notice of Appearance⚡️
For those who are new to us, our “Notice of Appearance” feature provides an opportunity for a professional in the field of restructuring to provide us all with some perspective about the markets generally, the industry, and professionalism. This week, we dialogued with Ted Gavin, Managing Director & Founding Partner at Gavin/Solmonese.
PETITION: There are a number of chapter 22s on the horizon. We've been poking fun at the "successful retail chapter 11" designation but, really, it is tragic and the process is failing. What do you think this is attributable to and what can be done by all involved -- lawyers, advisors, bankers, investors -- to avoid them in the future?
These are all unforced errors born of greed disguised as impatience in the form of short timelines that are driven by the immovable post of restrictive budgets. All of these chapter 22s have the common trait of having used the first filing to strip off debt, but the efforts to actually fix the underlying company were either insufficient (in some cases) or outright absent. If the company couldn’t meet its operating nut, stripping off some debt just gets you back to the same place eventually. If you’re not taking the time provided by the bankruptcy to fix the damn company, you’re just spending money for what will, in all likelihood, turn out to be a broken investment.
PETITION: The Creditors' Committee pitch process is becoming an inside game. UCC Lawyers are hiding behind UCC FAs and company-side FAs are sharing advance peaks with UCC FAs to give them a first-mover advantage. What gives?
A lot of this can be blamed on Lawyers’ Rule of Professional Conduct 7.3 (the prohibition against solicitation) and how it hasn’t scaled to deal with modern practice. The other issue is the inconsistency in practice within the U.S. Trustee Program – not only from Region to Region, but from office to office and, in some cases, from staff attorney to staff attorney. What is commonplace in one jurisdiction is impossible to accomplish in another because of this. Are there lawyers with undisclosed pecuniary interests tied to FA firms? Of course there are. Do some FAs shill for law firms while acting as attorney-in-fact for creditors without disclosing some other financial interest in the outcome of that efforts? Of course they do. So do lawyers. It happens. It’s indefensible.
Want it to stop? Change Rule 7.3 so it reflects the committee organization process or form all committees by mail and do away with the “in the room” beauty contests so proxies are no longer necessary and having a hand-holder in the room to move the process in the way they want becomes a moot exercise. Easier said than done, but still doable if the practice decides to get serious about it.
PETITION: There seems to be new independent director candidates popping up every day. Is this good, bad, or neutral?
It depends. When an independent director is really independent and is there to oversee the process with unfettered autonomy and no fear of reprisals, it’s fine – good, even. When the independent director’s future business depends on finding that nothing untoward happened, and the same individual keeps getting dropped in by the same law firm, it’s a problem. Independent directors should be viewed the same way we view expert witnesses – if you keep showing up for the same law firm, you’re not independent.
PETITION: Restructuring advisory shops seem to be proliferating. What can a financial advisor do in today's crowded market place to separate herself/himself from the crowd?
Be easy to work with. Be about the work. Be proactive. Be generous with your experiences and knowledge. Make your referrals look like effing geniuses for having referred you. Know more than the next shop and be able to do something with it that gives your side an edge. There’s a reason I went to law school, and it wasn’t the scintillating debate and the excitement of reading the Blue Book.
PETITION: What book has helped prepare you to be the best professional you can be?
Hue 1968 by Mark Bowden. It’s an incredibly compelling analysis of prolifically bad decision-making that became the turning point of America’s involvement in Vietnam. It’s a walk-through, from the ground, of the event that changed our national dialog about our purpose in the war and, when it was over, America would never again fully trust its leaders.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥.
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Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.