🚧The Ghost of Toys R Us Past Still Haunts🚧

Hasbro Inc., Sears, Moelis & Welded Construction

Disruption from the Vantage Point of the Disrupted
Freemium Briefing - 10/24/18
Read Time = 7.2 a$$-kicking minutes
Twitter: @petition
Website: petition.substack.com

🗞News of the Week (3 Reads)🗞

1. Hasbro Continues to Reel (Long the Aftershocks of Toys R Us).

You have to hand it to Hasbro Inc. ($HAS). They didn’t try to sugarcoat anything. They launched straight into their slide deck with an immediate mention of Toys R Us and the continued effect that Toys’ demise has had on its business. Here is the start of the conference call:

Good morning, everyone. And thank you for joining us today. The global Hasbro team is effectively working through a disruptive year. Our third quarter results reflect last [sic] Toys“R”Us revenues in the US, Europe and Asia Pacific,…

Strong to the hoop. They might as well milk the Toys story for as long as they can, right?

On Sunday we noted that, in the case of VF Corp. ($VFC), we may already be seeing the effects of Sears Holding Corp’s ($SHLD) bankruptcy filing. Indeed, VFC hasn’t recovered from its earnings call and its stock remains nearly 11% down. Of course, Sears had been on the precipice of bankruptcy for years whereas Toys was a relatively unexpected freefall into bankruptcy and so suppliers of the former have had years to contingency plan; the suppliers of Toys didn’t have that luxury. And, as a result, Hasbro, as just one example, continues to reel (and likely will continue to through the end of Q4). Time will tell how long the aftershocks affect Sears suppliers. In Hasbro’s case, not much at all. The company noted:

In the third quarter of last year, we recorded $18 million of bad debt expense associated with Toys“R”Us. Retail continues to change and last week Sears filed for bankruptcy. Sears represented less than 1% of overall Hasbro revenue last year and our bad debt exposure is immaterial as we have closely managed the account for some time.

Like we said: plenty of lead time to contingency plan. Not so much re: Toys R Us.

And so the numbers were bad. Hasbro reported $1.57b in net revenues, down 12% YOY. US and Canada were down 7%. International was down a jaw-dropping 24%. Operating profit was down by $47mm. Net earnings and earnings per share also were, given all of the foregoing, down. Obvi.

Looking at the last nine months, the picture is even bleaker:

Check out the impact of the Toys R Us closure on Hasbro’s international segment:

Total. Effing. Bloodbath.

The company stated:

Just over one year ago, Toys“R”Us filed for Chapter 11 bankruptcy and put into motion a process which ultimately resulted in the rapid closing of most of their stores, including all stores in the US, UK and Australia, and transitioning to new owners in select markets. In certain markets, this transition is ongoing. We continue to believe this is a near-term retail disruption that will last for the next few quarters.

In the meantime, the company is responding. It is forming relationships with an array of new retailers (10k over the last year); it is establishing supply chain efficiencies to deal with differentiated shipping requirements; it is adding a new warehouse in the Midwest to shorten delivery time and reduce trucking mileage. All of this accounts for Hasbro’s new retail reality. Without the bigbox option presented by Toys, it is cobbling together retailers in disparate geographies in order to recapture Toys revenue.

But all of this will take time and will continue to be somewhat dependent on external forces (e.g., the ownership dispute revolving around Toys R Us Asia).

Bankruptcy can be brutal. Especially the unexpected ones. Consider that as you continue to read about covenant-lite paper that is currently pervasive in our capital markets. In the future, filings may end up more like Toys R Us and less like Sears.

2. Moelis & Co. Reports Earnings; Stock Gets Hammered

To be fair, the entire market got hammered yesterday and volatility is surging — a factor that could reasonably hinder M&A activity. And so this overshadowed what was otherwise a pretty strong earnings report. The company had $208mm of quarterly revenue — a 22% YOY increase — bringing revenue for the year to an impressive $648mm.

We view bankers as leading indicators in the restructuring business. They’ll often sell capital markets solutions to stressed and distressed clients before everyone drops the charade and recognizes reality, i.e., that the business is larger sh*tpile than everyone felt inclined to acknowledge and needs a real fix. And so when they talk — particularly in SEC-regulated fashion — we listen. Relating to the overall investment banking environment, the firm’s co-founder and co-President Navid Mahmoodzadegan stated:

Overall the key drivers of the deal activity…remained very much intact in our view.

These include; one, technological disruption, which requires companies of all sizes to assess their strategic positioning and asset mix in a rapidly changing competitive landscape. Two, shareholder activism where M&A is often a key element for real or potential activist campaigns. Three, record amounts of capital that have been raised and are being actively deployed at private equity firms, sovereign wealth funds and other institutions. And four, positive economic growth and equity market performance especially in the United States, both of which have historically been positively correlated to overall deal activity.

I do think it's fair to point out though that there are some countervailing factors that are impacting the pace of deal making in the near-term. Risk around global trade, certain geopolitical events and regulatory uncertainties are impacting some deals on the margin, especially with respect to the larger cross-border transactions. But as I said before, we don't see these risks threatening the fundamental strength of the overall M&A market at this point in time.

Mr. Mahmoodzadegan was, in fact, asked about equity market volatility and its affect on deals. He said:

Look, you’re 100% right, if we have a prolong period of volatility that will have some impact. When you’re having relative value conversations or companies are using their equities, if there’s just a lot of movement kind of in those values it does kind of impact how people are thinking about deals. And then volatility generally impacts CEO and Board level confidence, which has its own set of impacts on deal making.

But I think it’s still a more recent phenomenon, A; but B, the more important point is the macro drivers that I mentioned before are still very much intact. The technological disruption that’s kind of ripping through every industry isn’t going to stop. The need for scale, the need for companies to be as well positioned as they can possibly be to deal with this disruption or to take advantage of the disruption isn’t going away. And so near-term volatility could have some modest impact, but we still see those fundamental drivers still very much of kind of carrying the M&A market for a period of time.

Regarding restructuring, he adds:

…default rates are still low, it would be interesting to see what happens with the default rates as interest rates tick up, but we haven't seen kind of a flurry of new restructuring activity recently in terms of really moving the numbers on the default rates.

Interestingly, one analyst who has apparently been living in a hole for a few years and doesn’t have any understanding of macroeconomics inquired as to why “we haven’t seen any material wave in restructuring.” Mr. Mahmoodzadegan, impressive with his patience and restraint, answered:

Well, we have a very strong global economy. We have very strong financing environments. And when you have both of those things happening, when you have -- again not all sectors of the economy are strong. We obviously saw a wave of activity in oil and gas few years ago, we've seen some activity in retail. So there is definitely pockets of activity and there's certainly specific companies that have legacy issues dating back to the financial crisis and the pre-financial crisis.

But, you haven’t seen this widespread pickup in default rates and widespread restructuring activity, because the economy has been really good and because there seems to be a form of financing somewhere for a lot of companies to kind of buy them some more time and you tend to see that when rates have been relatively low, when there’s lot of forms of alternative capital and lots of problem solvers in terms of funds and credit funds and folks, we’re prepared to lend money, hedge funds to give the company some more time.

But, as I said when the economic cycle turns, some of those elements will no longer be there and you’ll see an inevitable pickup in default rates.

As Howard Marks said, “too much cash chasing too few deals.” And as we constantly say, “yield baby yield.” These trends are likely to continue to dampen restructuring activity for the near future.

3. New Chapter 11 Bankruptcy Filing - Welded Construction L.P.

Though there will continue to be discreet instances of fee generation. Woo hoo!

Amidst concerns of nationwide pipeline shortages and, strangely, corresponding fears over too much pipeline capacity, it seems even more strange that a pipeline construction company would file for bankruptcy. Alas, on Monday, Welded Construction L.P., a Perrysburg Ohio-based pipeline construction contractor filed for bankruptcy in the district of Delaware despite slightly more than $1b in consolidated gross revenue in the twelve months ended 9/30/18.

We have to hand the company and its professionals some credit: they appear to be paying attention to what PETITION has been saying about the need for more efficiency in the restructuring profession as this case features one of the shortest First Day Declarations we’ve seen in recent memory (16 pages). They cut right to it. No surplus. Which seems only right: surplus is definitely not something a pipeline construction contractor wants.

Sadly, that is apparently what it appears to have. Just not surplus liquidity, unfortunately. Rather they are alleged by some of their clients to have a surplus of cost overruns. And by alleged we don’t mean threatening emails or letters. We mean litigation. And that litigation has cooled the market for Welded and fed into liquidity issues.

The company is currently working on five pipeline construction projects for its various customers, a list that includes the likes of Sunoco (as affiliates of Energy Transfer Partners LP or “ETP”), Consumers Energy Company, and Williams Companies. The latter, upon completion of Welded’s construction work, is alleged to have withheld $23.5mm from a payment owed to the company and filed a lawsuit against the company alleging breach of contract. According to the company, this “created acute liquidity issues for the Debtors and concerns in the market about their viability as a going concern.” When there is a ton of pipeline construction business to be won, this timing couldn’t possibly be any worse.

Compounding matters is the fact that the company has sizable potential surety bond obligations to its insurers. The insurers, in turn, were granted security interests in the company’s assets but…uh…maybe didn’t perfect them? Whoops. Popping popcorn for this inevitable fight. There is no secured debt here other than some potential equipment financing.

Bored yet? Yeah, us too. But there is a lesson here about managing litigation risk. The lawsuit by Williams spooked other potential customers and enhanced the company’s already pressing liquidity concerns. The company states:

The Debtors vigorously dispute the allegations contained in the Williams Complaint. Since the filing of the Williams Complaint, the Debtors have engaged in dialogue with Williams and its other Customers in an attempt to consensually resolve the dispute and avert the need for the filing of these chapter 11 cases. However, the filing of the Williams Complaint was quickly made public to the market and Customers became increasingly concerned about how the payment of receivables would be utilized by the Debtors. In particular, Customers sought assurance that any new payables would be solely deployed toward expenses related to their particular Projects. As such, these discussions were unsuccessful, depriving the Debtors of the necessary liquidity to sustain their business operations outside of chapter 11 and absent negotiated arrangements with their Customers….

Subsequently, and just a few days ago, ETP sent a letter to the company purporting to terminate the company’s engagement on the ETP project. Crikey! The dominoes are falling.

That last bit of the above quote is key here. Armed with a $20mm DIP credit facility, the company intends to use the “breathing spell” afforded by the chapter 11 automatic stay to:

…negotiate arrangements to finalize the Debtors’ ongoing Projects with [customers], all with the overarching goal of maximizing the value of the Debtors’ estates for the benefit of the Debtors’ creditors and other stakeholders.

Sounds like the next few weeks are going to be riddled with intense negotiations. Sure sounds like the company’s survival depends upon it.

🤓Notice of Appearance🤓

This week we welcome a Notice of Appearance by Jonathan Tibus, a Managing Director at Alvarez & Marsal North America LLC in the firm’s Atlanta office. We edited the dialogue lightly for content and length. Enjoy.

PETITION: You have a lot of experience in the distressed restaurant space (e.g., Ignite Restaurant Group, Real Mex). What do you foresee in the near future in the space and what is one factor that not enough people are considering?

It’s a consolidating industry, so in the near future I just see a lot more consolidation - obviously in casual dining but spreading to fast casual after that.  In the last decade, the number of dining establishments in the US has grown at twice the rate of the population, while traffic has been either eroded (no one needs to go to a sports bar to get their game anymore) or siphoned off by grocery stores, c-stores, and meal-delivery services (the restaurant versions of “blame the millennials” and the “Amazon effect”). This has led to lower unit volumes and higher fixed-cost hurdles. On top of that, there’s pressure from every single cost driver: Minimum wages are up, suppliers are consolidating and increasing prices, and compliance requirements keep expanding (ACA, ADA, PCI, NRLB “joint employer” rule, TIPA, local wage and hour rules – it’s a lot). Oil prices are inching up, too, which leads to higher corn prices, which leads to higher feed prices, which leads to higher chicken, pork, and beef prices. Also, for the MAGA! reference, steel tariffs are pushing up keg prices.

Those are the known-knowns, but they’re also collectively the one factor people in our industry often miss: True restaurant turnarounds are a grind at best – can you name one that worked? They require a long time, significant capital, a good team, and then good luck. I’m in meetings all the time where lenders or sponsors start in on “let’s do a 2-for-1 coupon!” or “let’s sub in Tilapia for Cod!” I always think “what are we doing here guys?” There’s no easy button - either commit to invest in a long-term rebuilding plan with a team that you trust, or just sell it to someone else who will.   Save yourself the wasted effort in the meantime. Your old, tired store isn’t coming back to life because you put out artisanal boneless chicken wings. It’s all about hiring well, running good shifts, and taking care of your customers so they’ll want to come back.

PETITION Note: It doesn’t look like labor pressures will be letting up anytime soon, whether in terms of quality of hires or cost.

PETITION: A&M appears to be making a greater push -- in this sound economic environment -- to provide "performance improvement" work to diversify away from just pure restructuring advisory work. Is this accurate and to what degree is the approach to PI different than restructuring work?  

[O]ur push into PI creates two important opportunities: First, a presence at a different place in the corporate life-cycle than restructuring. For a non-distressed restaurant, for example, we have resources in strategy, real estate, supply chain, marketing, and human resources. Targeting those areas for improvement while the client is still healthy, has engaged management, and ample liquidity means the death spiral may never begin. Second, PI work gives us the opportunity to approach companies directly, as opposed to relying on lenders, sponsors, and law firms for referrals. This will be of great importance as we continue to grow the firm. And, of course, we believe that we have a natural edge in the space given our operational heritage and restructuring DNA – we like being in the field or at the plant making changes rather than in the office making slide decks.    

PETITION: You work in the Southeast. What trends do you see in that region of the country that may lead to geographically specific restructuring activity? 

I definitely cut my teeth on southern-specific industries … like farming, textiles, and poultry processing, and those do seem to be back on our radar. Farm credit has been drying up as the major lenders scale back or get out and the remaining lenders hike up fees and interest. Tobacco is increasingly challenged in North Carolina as competition from other countries is pricing our farmers out of the market (again, millennials – earlier generations favored Carolina tobaccos for their flavor, consumers today don’t really care about origin). And of course, Hurricane Michael just drowned everyone’s crops, and killed a bunch of hogs and turkeys and chickens. Could be time for all the guys who geared up for the Ch. 9 wave a few years back to start studying up on Ch. 12.

PETITION: There has been a proliferation of restructuring advisory firms in recent years. How does that affect your approach to business development and do you consider industry consolidation (Alix/Zolfo) to be a long-term positive or negative for A&M? 

Interesting question in that it addresses consolidation and proliferation at once, and I think one is definitely driving the other.

As a firm grows or consolidates, the professionals naturally become more narrowly and deeply focused, leading to a depth of resources that a smaller firm can’t compete against.  Need a guy who knows the shipping business in Argentina?  We’re going to have that.  California wage and hour laws?  Got it.  There’s comfort in that for a lot of clients, so we highlight that whenever we can.  Second, the firm starts to get a lot of controls and infrastructure to help manage the business.  These are necessary at some point, but for some people this feels like bureaucracy and politics.  The people I’ve known who started their own shops are energetic, ambitious guys who are just happier not dealing with that part of the business, wanted to remain generalists, and didn’t want to feel like part of a machine.  I don’t see it necessary as a positive or a negative for A&M – we’re going to win when we compete for clients who value our depth, breadth, capabilities, and brand.  The smaller shops can’t do every job, but they can also go deeper into the middle market to find the right roles.  I do think that we – the bigger firms – have a natural advantage in the most difficult part of the business right now:  hiring good people with 4-7 years of experience.  At that level, we can sell candidates on our stability and breadth and also offer a brand-name for their resume while they’re building their early careers. 

PETITION: What is the best book you've read that's helped guide you in your career?

I’m trying as hard as I can to answer this with “A Confederacy of Dunces,” which is my favorite book.  It’s hard to call it a business book or a career book, though, so I’ll go with “The Goal” by Eliyahu Goldratt instead. For a guy with a degree in English, it was a digestible introduction to operations analysis and management, and it showed how thinking about problems analytically can actually lead to solutions. It’s rooted in manufacturing, but the lessons apply to us, too: Turnaround people have an instinct to roll out lots of initiatives at once. Thinking about system-wide capacity and constraints with our clients can help control that instinct, forcing us to do smart stuff, not just lots of stuff. As the book says, activating a resource is not the same as utilizing a resource. Plus, it has Herbie the fat cub scout as an important character, and he reminds me of a young Ignatius P. Reilly from “Confederacy”. Everyone should read both.


We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. Another book we’re excited to add to the list and check out is Barbara Kahn’s “The Shopping Revolution: How Successful Retailers Win Customers in an Era of Endless Disruption.”

💰New Opportunities💰

Carl Marks Advisors, a nationally recognized investment bank providing operational and financial advisory services, seeks professionals with 4+ years of transferable restructuring and turnaround and experience.  These individuals will work in an integrated team environment on a diverse range of engagements in restructuring, turnaround, bankruptcy, valuation analysis and financial performance assessments. Key attributes include strong accounting & financial modeling skills, independent judgment, resourcefulness, and creativity. NYC based position with substantial travel. Interested candidates should submit their CV and cover letter to careers@carlmarks.com

Evercore (EVR) is a leading global independent investment banking advisory firm. Evercore advises a diverse set of investment banking clients on a wide range of transactions and issues and provides institutional investors with high quality equity research, sales and trading execution that is free of the conflicts created by proprietary activities. Evercore seeks to hire the following for its NY office:

  • Associate with relevant experience. For requirements and other specifications, please click here.

  • Analyst with relevant experience. For requirements and other specifications, please click here.

If your firm has job opportunities, please email us at petition@petition11.com.

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