High Drama in Retail-Land: Sears and Pier 1.
|Jan 16||Public post|
Disruption from the Vantage Point of the Disrupted
1/13/19 Read Time = 9.1 a$$-kicking minutes
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In Sunday’s Members’-only briefing, “💥A Retail Bloodbath💥,” we took a deep look at the week in retail, the future of mobile, macroeconomic trends, the restaurant industry’s 2018 performance, and more. If you’re not a Member, you missed out. Do something about that here ⬇️⬇️
Over the past few years, the service industry has started hacking worker schedules by outsourcing human duties to machines. Automated experiments include robots that take over bartendingand salad-making duties on cruise ships and in airports, and that deliver food to hotel guests’ rooms. More hotels are offering automated check-in via app or even—in China—via facial recognition. Alexa-enabled speakers in hotel rooms let guests ask for sightseeing tips and order toothbrushes without talking to staff.
Of course, automation is only one technology remaking the industry. More and more, hotel guests opt for food-delivery apps such as Grubhub or Postmates over room service. They’re generally cheaper, and chains sometimes offer coupon codes for guests who decide to order out. But hotel workers have complained that when apps eclipse room service, hotel chains staff fewer room-service workers.
Given these trends, the issue of wages is going to continue to be thorny. And lead to distress. That is, if owners don’t pivot their way out of the issue first.
1. What the Hell Happened with Sears? (Long Stays of Execution)
Apologies to those ardent followers of PETITION on the Twitters: a little of this is going to be a bit duplicative.
Monday was the start of D-Day(s) for Sears Holding Corporation ($SHLD) as the long-awaited auction of the company's assets started at the offices of Weil Gotshal & Manges LLP. In the lead-up to the auction, we really got a master class in messaging by Eddie Lampert and ESL Investments. The sh*t was straight out of Billions…AND IT APPEARS TO HAVE WORKED.
Immediately after the bankruptcy filing, Lampert made it clear with his initial $4.4b offer that HE is the only one that can save 400+ stores and 50k+ jobs: it's either him or the liquidators. Never mind the ten-year slog of financial engineering that got us here. HE'S IT. Of course, he then subsequently revised/upsized his bid, again reiterating that he's the only chance the company has to survive. The media swooned. Liquidation temporarily avoided! Eddie Lampert is ponying up $600mm more for Sears' assets! Eddie Lampert = White Knight for retail employees!
This is the legacy of Toys R Us: nobody wants to be the villain that shut down a massive retailer and cost tens of thousands of people their jobs. Nobody. A hardship fund is the 21st century version of a Scarlet Letter. (PETITION Note: upon information and belief, ESL Investments is basically a family office wrapped in the veneer of a hedge fund. Absent limited partners who can apply the “Lestor Freamon Rule” and follow the money, a hardship fund here is extremely unlikely — in contrast to the private equity funds in Toys R Us that were beholden to state pension funds and the like. Of course, we’ve been wrong on this subject before.)
Anyway. Never mind that in spinning this pro-employee narrative, Lampert is also looking to extract a significant amount of new value in exchange for his new bid. This isn't trivial and it puts the Official Committee of Unsecured Creditors ("UCC") in an awkward position.
Speaking of the UCC, Lampert has conducted his machinations in the face of a combative UCC that consists of 2 massive REITs who have stated, on the record, that they would stand to benefit should Sears just go away. If you want to understand UCC formation a bit more and what transpired in the Sears case, check out “Sears: How the Sausage is Made (Long UCC Shenanigans)” here. Or, TL;DR. Otherwise, note what Simon Property Group CEO David Simon said in the SPG earnings report before the SHLD filing:
Here’s what we wrote about that strange statement by Mr. Simon:
We wrote more about the UCC’s position in “💥Sears = Sh*t Show💥.” Note that ESL wasted no time pointing out the UCC’s conflict. So, this is Mr. Lampert’s first narrative: it’s ESL vs. the big bad liquidation-inclined REITs.
Now, consider the MSM reports from over the weekend. Narrative #2: Sears' professionals are sinking the ship; they cost too much; their absurd run rate is pressuring ESL's ability to bid and cover those expenses (administrative expenses). Per CNBC:
We first wrote about the army of professionals deployed on this case on November 4, 2018 in “🐔A Conflicts Turducken?🐔.” And then we noted Weil’s fees on December 9, 2018 in “🙈Eddie Lampert Makes His Move🙈.”
Which begs an obvious question: so, why, a full month later (in the case of Weil’s fees) is all of this vitriol towards professionals ONLY coming out on the weekend directly before the auction? THIS IS NO COINCIDENCE. Mr. Lampert is clearly trying to sway public opinion to, at most, persuade the company, the UCC and ultimately the Bankruptcy Court to accept his offer or, at least, deflect blame for Sears' downfall and pin it on the evil combination of rich bankruptcy pros and big bad REITs.
Still, the UCC and the company have an obligation to ensure that the bid will ensure that parties in interest will get more than they otherwise would get in a liquidation scenario. This is federal law folks. And so none of this is to say that the MSM pieces are wrong: bankruptcy DOES cost too damn much. But this is a billionaire leveraging the media to the utmost. Will it have any effect on the results of the auction?
Let’s discuss bankruptcy auctions for a second. Much of what we’ve witnessed leading up to this week relates to the bid procedures that the debtors sought approval of and the requirements for what constituted qualified bids. In the first instance, Mr. Lampert’s bid fell short of a “qualified” designation. This was the significance of his revised bid and the result of the recent status conference before Judge Drain: it paved the path for Mr. Lampert to see another day and participate in the auction.
Mitch Nolen Retail@mitchnolenNo news yet on today's #bankruptcy auction to decide Sears' fate: "Sources told WWD the auction was ongoing as of late afternoon." $shld https://t.co/DcsrtqTkeA
Mitch Nolen Retail@mitchnolen@petition The Aéropostale auction started on a Monday and didn't end until late Thursday.
Fine, not catered food. Pizza. We extend heartfelt apologies for the error.
Negotiators initially didn’t embrace Lampert’s revised rescue plan for the bankrupt retailer, but they were concentrating on his proposal rather than competing bids from liquidators, according to people with knowledge of the discussions. Sticking points still include whether he should be insulated from lawsuits over his previous turnaround deals, said the people, who weren’t authorized to speak publicly.
Why was this? First, liquidator proposals are far less nuanced than Mr. Lampert’s complex bid. Liquidators typically work off of a small handful of general fee structures and given that their bids center upon a complete liquidation of the enterprise, they should be fairly easy to compare on an apples to apples basis. There’s also no controversial “credit bid” component. Mr. Lampert’s proposal, on the other hand, focuses on pockets of value, leaving certain assets and liabilities behind and, significantly, a release of any and all liability on his part (if any); it also subsumes a credit bid of his secured debt — which the UCC argues may not be viable (they’re not alone, see, e.g., this). To fully evaluate his proposal and juxtapose it, the UCC has to be confident in their claims against Mr. Lampert, offset the probability of success by litigation cost and risk, and conclude that its constituency will be better off in the liquidation + attack-Lampert scenario than in Lampert’s going-concern + release-of-liability scenario. That requires extensive on-site analysis, which is why, among other reasons, there are likely dozens of lawyers and bankers sitting in those conference rooms eating crumby firm-cafeteria-produced chocolate chip cookies and NYC’s finest pizza. If Lampert, et. al., were concerned over fees before, wait until they see the vast quantity of hours billed by those sitting in that conference room. That is gonna be one EXPENSIVE hootenanny. But we digress.
Anyway, there’s also this (again, from Bloomberg):
Lampert has repeatedly pointed to the number of jobs at stake in seeking support for his plan, making some lenders wary of being blamed for the collapse of the iconic chain if they refuse to provide funds.
It seems Lampert’s messaging has had its desired effect.
That said, the auction process worked. The whole point of the process is to extract the “highest or best” offer the company can. This enlarges the company’s bankruptcy “estate” and potentially increases recoveries for parties-in-interest. Tuesday morning Bloomberg reported that Lampert was showing some flex:
Eddie Lampert presented a new bid for Sears on Tuesday that included some concessions as talks to save the bankrupt retailer from liquidation continue, according to people with knowledge of the discussions.
The new offer includes terms that are more favorable to the department store chain and its creditors, including more cash, said the people, who asked not to be named as the negotiations are confidential. The overall value of Lampert’s offer is still pegged at over $5 billion, one of the people said.
The question late on Tuesday night, however, suddenly became whether Judge Drain would. Per Reuters, he encouraged the parties to have a resolution by the end of the night. The nudge apparently worked. Mr. Lampert’s final bid reportedly came in at $5.2mm worth of total consideration — an $800mm increase from the initial offer. Per The Wall Street Journal:
Mr. Lampert, a hedge fund manager who steered Sears into bankruptcy, prevailed by sweetening his roughly $5 billion offer over several days of negotiations with Sears’s board and creditors, the person said.
His last-ditch rescue plan would keep roughly 400 stores open. The offer beat out a bid, which was supported by most Sears creditors and landlords, by Abacus Advisory Group LLC to close all the stores and sell the inventory.
Lampert’s bid, boosted from an earlier $5 billion offer, prevailed after weeks of back-and-forth deliberations that culminated in a days-long bankruptcy auction held behind closed doors. The billionaire’s proposal, made through his hedge fund ESL Investments Inc, will save up to 45,000 jobs and keep 425 stores open across the United States.
Lampert boosted his bid by adding more cash and assuming more liabilities, the sources said. The auction, held at the Manhattan offices of Weil, Gotshal & Manges LLP, the law firm representing Sears, concluded in the early morning hours of Wednesday.
Reuters also noted that while Mr. Lampert “prevail[ed],” there are still obstacles to surmount: he (and the debtor) needs to (i) overcome lingering creditor opposition, (ii) get the deal papered, and (iii) convince the Bankruptcy Court that the transaction is sensible. Chances are that there are some bankers and lawyers curled up in fetal position on the floor of a Weil Gotshal & Manges LLP conference room at the very moment you read this.
There is a strange yet-tragic undercurrent here in that the future of Sears hangs in the balance during the very same week that Gymboree is rumored to file for bankruptcy again and speculation abounds vis-a-vis the fate of Payless. As retail Chapter 22s* proliferate all around us — and given Lampert’s not-so-sparkly track record running Sears to date — are we really to come away from all of this believing that ~50,000 jobs will be “saved”? Or is this really just a “stay of execution”? What purpose does Sears serve in today’s retail environment? If Lampert closes this transaction, we suppose we’ll soon find out. For the sake of those 50,000 employees who have been on an emotional and existential roller-coaster, we truly hope that this time Lampert has a viable plan. We’re skeptical. And employees ought to be, too; they ought to plan accordingly.
*For the uninitiated: there is no such thing as Chapter 22 under the bankruptcy code. The tag is a popular way to note a repeat chapter 11 filer. That is, first chapter 11 bankruptcy + second chapter 11 bankruptcy = chapter 22).
2. Is Pier 1 on the Ropes? (Short “Iconic” Brands).
Back in October in “☠️R.I.P. Sears (Finally)?☠️,” we discussed the imminent bankruptcy filing of Sears Holding Corp. ($SHLD) and, more significantly, what that might mean for malls. REIT operators are smart business people and when they say they stand to gain from a Sears liquidation and replacement tenants who pay multiples more in rent than Sears was on the hook for, well, we certainly believe them.
The problem is: vacancy rates in the lifestyle and mall segment of commercial real estate are on the rise. And mall rents are in decline. As we discussed in October, closures of Sears and Bon-Ton Stores stores factored heavily into those figures. We wrote:
What sparked the vacancy jump? Bankrupted Bon-Ton Stores closing and, gulp, Sears closures too. Which, obviously, could get a hell of a lot worse. Indeed, Cowen and Company recently concluded that “we are only in the ‘early innings’ of mass store closures.” As noted in Business Insider:
"Retail square footage per capita in the United States has been widely sourced and cited as being far above most developed countries — more than double Australia and over four times that of the United Kingdom," Cowen analysts wrote in a 50-page report on the state of the retail industry. The data "suggests that the sector remains in the early innings of reduction in unproductive physical retail."
On point, one category that had largely remained (relatively) unscathed in the last 2 years of retail carnage is the home goods space. But, now, companies like Pier 1 Imports Inc.($PIR) and Bed Bath & Beyond Inc. ($BBBY) appear to be in horrific shape. Bloomberg’s Sarah Halzack writes:
Two major companies in this category, Bed Bath & Beyond Inc. and Pier 1 Imports Inc., are mired in problems that look increasingly unsolvable. Bed Bath & Beyond saw its shares tumble 21 percent on Thursday after it reported declining comparable sales for the ninth time in 10 quarters. And Pier 1’s stock fell nearly 20 percent in a single day last week after it saw an even ghastlier plunge in same-store sales and discontinued its full-year guidance.
The struggles of those two retailers ought to compound problems in the overall retail environment. Pier 1 has 1000 stores. Bed Bath & Beyond has 1024 stores.
At the time, Bed Bath & Beyond Inc. $BBBY was trading at $13.62/share and Pier 1 Imports Inc. ($PIR) was trading at $1.50/share. Here is BBBY now:
Bed Bath & Beyond swam against the retail tide last week as the company’s stock showed huge gains after it said that it is ahead of its long-term plan and that it is successfully slowing down declines in operating profit and net earnings per share. Which is interesting because, putting forward guidance aside, the ACTUAL numbers weren’t all that great. In fact, the company’s trend of disappointing same-store sales continues unabated (negative 1.8%, worse than forecast). EPS and revenue numbers were slightly better and slightly worse, respectively, than expected. Which means that to drive the higher EPS, the company must be taking costs out of the business. We have no crystal ball and this is in now way meant to be construed as investment advice, but we’re not seeing justification for a massive stock price increase (up 15% from when we wrote about it and 30% from its December 24 low).
Does the rising tide (in home goods) lift all boats? Here is where PIR currently trades:
In other words, it’s been diced in half since we last wrote about it and that’s AFTER the stock rose a bit last week (not that that lasted long). Consequently, the company received a notification of non-compliance by the New York Stock Exchange on January 11. Ruh roh. Let’s dig a bit deeper.
Texas-based Pier 1 is an omnichannel retailer (with approximately 987 stores) specializing in imported home furnishings and decor, particularly furniture, table-top items, decorative accessories and seasonal decor. It has been in business since 1962. A month ago, the company lost its CEO, Alasdair James, a former KMart executive (seriously?), who was replaced by interim CEO Cheryl Bachelder and her $1.25mm salary, a current board member. Mr. James had been pursuing a “New Day” strategic plan that, as the last earnings report reflected, didn’t appear to right the ship. Rather, the company reported a 11.9% decrease in YOY net sales and a $50.4mm net loss. What happened? In a nutshell, the words of the now-CEO:
It’s become clear that we are not giving our Pier 1 customer the style, the value, the selection that she wants to find in our stores and online. The sector is performing well. So, we know the opportunity is there for Pier 1. We just have to capture it.
Mmmm hmmm. She also called Pier 1 an “iconic brand” — a statement that’s downright laughable. Anyway, let’s look closer at the numbers…because they’re effing terrible. Net sales were down 11.9% and comp sales declined 10.5% — and those numbers are adjusted on account of “the shift of certain selling days between quarters.” Sheesh. But, wait there’s more: gross profit declined by $46mm and gross margin dipped 20% from 37.7% to 31.6%. To sell inventory, the company admittedly had to resort to higher promotional discounts. Yup, that sure sounds like the tactics of an “iconic brand.”
To round out the horror show, the Q3 net loss totaled $50mm ($0.62/share) and EBITDA registered a negative $17mm.
On the costs side, the company took capex down by $20mm and SG&A down $3mm and seeks to continue taking costs out of the business. Per the company CFO:
…we have been working with a highly regarded procurement firm, and together we have already identified and captured approximately $20 million of annualized savings for fiscal 2020. We view this as a solid starting point and expect to ultimately realize upwards of $35 million in annualized savings for the next fiscal year.
Is “procurement firm” the latest technological innovation in euphemisms? Is that code for restructuring advisor? Color us intrigued. (Jokes aside, sources do tell us that a large restructuring advisory firm is embedded with the company).
Apropos to our introductory note above and our discussion on Sunday, we found certain other company comments intriguing. Like, for instance:
We are beginning to drive further automation at our newly configured Columbus fulfillment center, which is expected to improve customer experience and generate labor efficiencies over time.
The combination of “drive further automation” and “generate labor efficiencies” sounds like more polish to us.
Turning now to sourcing, supply chain and distribution, our sourcing team has been focused on consolidating our vendor base, developing new partnerships and driving cost savings. Thus far in fiscal 2019, we have negotiated cost savings in excess of our $18 million target, which is expected to flow through the P&L in fiscal years 2020 and 2021.
In other words, the company is hosing vendors. Notably, the company reported Q3 accounts payable of $172.7mm, a marked uptick from last quarter’s $71.2mm that can possibly be justified by a seasonally-warranted uptick. Year-over-year, however, the juxtaposition remains stark: at the end of fiscal Q3 2017, the company reported $94.2mm of accounts payable. In addition to getting deals renegotiated, it sure looks like vendors are getting stretched too. Indeed, in its Q, the company notes: “The increase in accounts payable from fiscal 2018 year end primarily resulted from changes in trade terms with certain vendors and timing of merchandise purchases.” We bet it did. Back to this shortly.
Surprisingly, the company’s balance sheet isn’t an atrocious monstrosity the likes of other retail horror shows of late. The company has access to a virtually untapped $350mm revolver due June 2022 and recently closed a $50mm FILO tranche ($15mm FILO, $35mm TL) provided by Bank of America and Pathlight Capital maturing in June 2022. The company also has a $191.5mm senior secured covenant-lite term loan, the fair value of which sits around $140mm — a meaningful discount to par and at distressed levels, sure, but not entirely down in the dumpster. The company also has $71mm of cash and equivalents.
So, ample liquidity for the short-term and no near-term maturities combine to beg the question: why the hell are we writing about it? Well, everything in retail these days has to come back to Toys “R” Us and Sears Holding Corporation. Given this company’s cash burn and the volume of stretched vendors, you have to wonder at what point “administrative expense” begins to lose its meaning and the company’s lifeline gets shorter. If Eddie Lampert’s approach to the Sears auction is one legacy of Toys “R” Us, vendor skittishness is certainly another. Let’s dub this, “The Toys R Us Effect.” Eventually that will tip another retailer into bankruptcy. Will that be the “iconic” Pier 1? 🤔
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