Disruption from the Vantage Point of the Disrupted
Midweek Free Briefing - 8/15/18
Read Time = 9.1 a$$-kicking minutes
⚡️Pub Service Announcement #1⚡️
We are nearing the end of the beta period for PETITION. This newsletter has found success that has surpassed our expectations and we couldn’t be more appreciative of the reception in the market. Still, we want to be bigger and better; we have aspirations.
With that preface, we will be raising our price. Sometime shortly after Labor Day, PETITION will move to a simplified pricing plan of $299/year per subscriber. Tell all your friends, colleagues, and firm resource/research managers (if not your enemies): now is the time to lock down your PETITION subscription at the current rate. And, yes, we do process groups of ten or more. Email us: firstname.lastname@example.org.
If you are already an individual subscriber: thank you! Your early support has helped make PETITION into a strong independent business. You will be locked in at the original price you paid for your first two years. And if your company has a group subscription, the original price you paid will also be guaranteed for two years. This grandfathering deal is also good for anyone who subscribes by Labor Day.
One other thing of note: are you sick of forwarding our a$$-kicking briefing to a friend or colleague? Feeling guilty about it? You can now gift them a subscription. Consider it nuisance alleviation.
In case you're wondering why we are doubling down on subscriptions, you might want to consider the most recent news from the magazine industry...
🗞News of the Week (2 Reads)🗞
1. The Media is Stuck Between a Rock and a Hard Place (Long Recurring Revenue)
The magazine industry puts on a brave face, but data doesn’t lie.
New analysis from the Association of Magazine Media, which unabashedly pushed the power of print magazines as an advertising vehicle, shows an industry still trying to find its place in an instantaneous world while advertising revenue continues to slip away.
Reported magazine ad spending by the 50 biggest advertisers last year fell to $6.1 billion from $6.5 billion in 2016, according to AMM’s annual report. So magazines lost at least $417.5 million in revenue last year, a difference of 6.4 percent, numbers AMM did not make readily available in its report, which was sponsored by magazine printer Freeport Press.
The report notes how top advertisers spent their marketing dollars. Pfizer Inc., Johnson & Johnson, LVMH Moet Hennessy Louis Vuitton, Estee Lauder Cos. Inc., Kering, Chanel, and Amazon were all WAY down, more than offsetting increases from the likes of Proctor & Gamble and L’Oreal. As just one example, Pfizer’s spend decreased by $85mm. That’s a whopping number.
With whopping ramifications. More from the WWD:
With so much money being lost in print advertising, which is largely being diverted to other avenues, like Facebook, Google and influencers, it’s no wonder magazines keep shutting.
A total of 50 magazines with at least a quarterly publication frequency closed last year, despite 134 titles being launched, leaving the number of magazines last year at 7,176. The number of magazines has been a bit up and down over the last decade, but on the whole, down, as there are 207 fewer than in 2008.
Overall, there are very few major magazine brands managing to pull strong through the digital shift. Of the 114 magazine brands tracked by AMM, 56 titles, or 50 percent, have a total audience in decline year-to-date. Print and digital editions are faring even worse, with 74 titles, or 64 percent of magazines, seeing audience on the decline.
Little wonder advertisers are looking elsewhere.
Apropos, a heads up for PETITION readers: you can give the media business a whirl if you masochistically desire. On August 27, the chapter 7 trustee in the case of Interview Inc., the once-famous magazine owned by Peter Brant, is conducting an auction for the sale of the media property. If bankrupted magazines aren’t your jam, there are plenty of other options available — including, most recently, New York Magazine.
Given the decline in advertising, media companies are re-evaluating their business models and many are toggling over to subscriptions. Subscriptions are the “it” thing now. And that obviously includes PETITION (though, to be accurate, we were never dependent on ads). In fact, we now subscribe to so many different resources that our costs are going up meaningfully from month to month. That’s the truth. At a certain point, consumers may get subscription fatigue.
Subscriptions are a great way to draw a steady stream of revenue from readers — unless readers share their login credentials with everyone they know.
As publishers try to grow subscription businesses, they have to figure out how to handle password-sharing, a phenomenon that subscription services like Netflix and Spotify have wrestled with for years.
Netflix and Spotify can absorb this danger. But smaller media outlets either struggling to survive or looking to grow don’t have that luxury. Every time someone shares media that lives off of the subscription model, he/she is effectively siphoning off revenue from them and pushing them one step closer to insolvency. Sadly, only a very select few of you will make fees in that scenario. The rest of you will lose out on quality content you’ve come to love and enjoy. Now wouldn’t that be a shame?
⚡️Pub Service Announcement #2⚡️
We may be “snarky,” “irreverent,” or some other adjective that you might choose to describe us but we aren’t heartless. We love seeing the restructuring community wield its mighty influence for good causes. On September 24, 2018 from 6-9:30pm, the community will gather to support the Citizens Committee of New York City at an Evening on the Lake at the Central Park Boathouse honoring Holly Etlin, Managing Director of AlixPartners. The organization’s mission is simple: “to help New Yorkers—especially those in low-income areas—come together and improve the quality of life in their neighborhoods.”
SIX lucky PETITION subscribers will be eligible to receive complimentary tickets to the event ($195 value) simply by filling out this a$$-kicking survey by August 24. Even if you cannot attend the event, we’d appreciate you filling out the a$$-kicking survey anyway. It will help us ensure that PETITION keeps living up to the community’s lofty standards. Cheers!
2. Assignment for the Benefit of Creditors (Long Private Markets as Public Markets)
⚡️🤓Nerd alert: we need to lay a little foundation in this one with some legal mumbo-jumbo. Consider yourself warned. Solid payoff though. Stick with it.🤓⚡️
Allow us to apologize in advance. It’s summer time and yet we’ve been nerding out more often than usual: on Sunday, we dove into net-debt short activism, for goodness sake! We know: you want to just sit on the beach and read about how Petsmart implicates John Wick. We get it. Bear with us, though, because there is a business development aspect to this bit that you may want to heed. So attention all restructuring professionals (and, peripherally, start-up founders and venture capitalists)!
Recently the Turnaround Management Association published this piece by Andrew De Camara of Sherwood Partners Inc, describing a process called an “assignment for the benefit of creditors” (aka “ABC”). It outlines in systematic fashion the pros and cons of an ABC, generally, and relative to a formal chapter 11 filing. When the bubble bursts in tech and venture capital, we fear a number of you will, sadly, become intimately familiar with the concept. But there’ll be formal bankruptcies as well. ABCs won’t cut it for a lot of these companies at this stage in the cycle.
Let’s take a step back. What is the concept? Per Mr. De Camara:
An ABC is a business liquidation device governed by state law that is available to an insolvent debtor. The ABC procedure has long existed in law and is sometimes addressed in state statutes. In an ABC, a company, referred to as the assignor, transfers all of its rights, title, and interest in its assets to an independent fiduciary known as the assignee, who liquidates the assets and distributes the net proceeds to the company’s creditors. The assignee in an ABC serves in a capacity analogous to a bankruptcy trustee in a Chapter 7 or a liquidating trustee in a Chapter 11.
He goes on to state some characteristics of an ABC:
Board and shareholder consent is typically required. “If a company is venture-backed, it may be required to seek specific consent from both preferred and common shareholders. It is possible to enter publicly traded companies into an ABC; however, the shareholder proxy process increases the difficulty of effectuating the ABC and results in a much longer pre-ABC planning process.”
There is no discharge in an ABC.
Key factors necessitating an ABC include (a) negative cash burn + no access to debt or equity financing, (b) lender wariness, (c) Board-level risk as a lack of liquidity threatens the ability to pay accrued payroll and taxes, and (d) diminished product viability.
And some benefits of an ABC:
ABC assignees have a wealth of experience conducting liquidation processes;
The assignee manages the sale/liquidation process — not the Board or company officers — which, as a practical matter, tends to insulate the assignee from any potential attack relating to the process or sale terms;
Lower admin costs;
Lower visibility to an ABC than a bankruptcy filing;
Secured creditors general support the process due to its time and cost efficiency, not to mention distribution of proceeds; and
Given all of the above, the process should result in higher distributions to general unsecured creditors than, say, a bankruptcy liquidation.
Asleep yet? 😴
Great. Sleep is important. Yes or no, stick with us.
ABCs also have limitations:
Secured creditor consent is needed for use of cash collateral.
Buyers cannot assume secured debt without the consent of the secured creditor nor is there any possibility for cramdown like there is in chapter 11.
There is, generally, no automatic stay. This bit is critical: “While the ABC transfers the assets out of the assignor and therefore post-ABC judgments may have no practical value or impact, litigation can continue against the assignor, and the assignee typically has neither the funding nor the economic motivation to defend the assignor against any litigation. In addition, hostile creditors may decide to shift their focus to other stakeholders (i.e., board members or officers in their capacity as guarantors or fiduciaries) if they believe there will likely be no return for them from the ABC estate.”
Assignees have no right to assign executory contracts, diminishing the potential value of market-favorable agreements.
No free-and-clear sale orders. Instead you get a “bill of sale.” Choice quote: “A bill of sale, particularly from an assignee who is a well-known and well-regarded fiduciary, is a very powerful document from the perspective of creditor protection, successor liability, etc., but it does not have the same force and effect as a free-and-clear sale order from a bankruptcy court.”
This is a golden age for venture capital and the startup ecosystem, as illustrated by PitchBook's latest PitchBook NVCA-Venture Monitor. So far this year, $57.5 billion has been invested in US VC-backed companies. That's higher than in six of the past 10 full years and is on pace to surpass $100 billion in deal value for the first time since the dot-com bubble.
Fundraising continues at breakneck speed. Unicorns are no longer rare, and deal value in companies with a $1 billion valuation or more is headed for a new record. The size of VC rounds keeps swelling. Deep-pocketed private equity players are wading in.
Signs of success (or is it excess?) are everywhere you look. On the surface, delivering a resounding verdict that the Silicon Valley startup model not only works, it works well and should be emulated and celebrated.
But what if that's all wrong? What if this is another mere bubble and the VC industry is in fact storing up pain…?
That's the question posited by Martin Kenney and John Zysman—of the University of California, Davis, and the University of California, Berkeley, respectively—in a recent working paper titled "Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance?"
Instead of spending millions, or billions, in the pursuit of unicorns that could emulate the "winner-takes-all" technology platform near-monopolies of Apple and Facebook and the massive capital gains that resulted, VC investors and their LP backers could instead be buying a bunch of fat Cheshire cats. Bloated by overvaluation, and likely to disappear, leaving just a smile and big losses, since many software-focused tech startups have no tangible assets.
They then ask whether there’s more here than meets the eye. More from Pitchbook:
The problem is that this cycle has been marked by easy capital and a fetishization of the early-to-middle parts of the tech startup lifecycle. Lots of incubators and accelerators. "Shark Tank" on television. "Silicon Valley" on HBO. Never before has it been this easy and cheap to start or expand a venture.
Yet on the other end of the lifecycle, exit times have lengthened, as late-series deal sizes swell, reducing the impetus to IPO (in search of public market capital) or sell before growth capital runs out.
So, what’s the problem?
…in the view of Kenney and Zysman, the VC industry lacks discipline, seeking disruption and market share dominance without a clear path to profitability. You see, VC-fueled startups aren't held to the same standard as existing publicly traded competitors who must answer to investors worried about cash flows and operating earnings every three months. Or of past VC cycles where money was tighter, and thus, time to exit shorter.
We’ll come back to the public company standard in a second.
The interesting thing about the private markets becoming the new public markets (with funding galore) is that when the crazy frenzy around funding (PETITION NOTE: read the link) eventually stops, the markets will just be the markets. And all hell will break lose. The question then becomes whether a company has enough liquidity to stem the tide. What happens if it doesn’t?
Excellent piece from @eringriffith on the state of play in the today's "free money" world. One caveat to below, I believe that "cash burn rate" is still the best proxy we have for defining risk. Currently, "risk" is very high, but masked & encouraged by the low cost of capital. https://t.co/3uGJdy07ZsAugust 15, 2018
This is a great point. With capital “near free” perhaps “months of cash” is better metric than burn. I would say you want 18 minimum, and 36 to breathe easy. https://t.co/TRHBAOXxIHAugust 15, 2018
All of which is to say that “the bigger they come, the harder they fall.” When the music stops — and, no, we will NOT be making any predictions there, but it WILL stop — sure, there will be a boatload of ABCs keeping (mostly West Coast) professionals busy. But there will also be a lot of tech-based bankruptcies of companies that have raised tens of millions of dollars. That have valuable intellectual property. That have a non-residential real property lease that it’ll want to assign in San Francisco’s heated real estate market. That have a potential buyer who wants the comfort of a “free and clear” judicial order. That have shareholders, directors and venture capital funds who will want once-controversial-and-now-very-commonplace third-party releases from potential litigation and a discharge.
Venture capitalists tend to like ABCs for private companies because, as noted above, they’re “lower visibility.” They like to move fast and break things. Until things actually break. Then they move fast to scrub the logos off their websites. What’s worse? Visibility or potential liability?
And then there are the public markets.
A month ago, we discussed Tintri Inc., a California-based flash and hybrid storage system provider, that recently filed for bankruptcy. Therein we cautioned against IPOs of companies with “massive burn rates.” We then went on to highlight the recent IPO of Domo Inc. ($DOMO) and noted it’s significant cash burn and dubious reasons for tapping the public markets, transferring risk to Moms and Pops in the process. The stock was trading at $19.89/share then. Here is where it stands now:
In the same vein, on Monday, in response to Sunday’s Members’-only piece entitled “😴Mattress Firm's Nightmare😴,” one reader asked what impact a potential Mattress Firm bankruptcy filing could have on Purple Innovation, Inc. ($PRPL), the publicly-traded manufacturer and distributor of Purple bed-in-a-box product. Our response:
Not investment advice obviously...
Depends, in many respects, on what happens to the 142 Mattress Firm locations #PRPL is currently experimenting with. Do they survive a BK and setback wholesale ambitions? If reports are correct and MF prepacks, trade will likely be paid in full
The business has bigger problems. Negative EBITDA, "high return dollars," large inventory on the books, decreased margins, and higher CACs (which they note are increasing due to digital crowding... $FB's gain, $PRPL's loss). Also no CEO.August 13, 2018
And then yesterday, Bloomberg’s Shira Ovide (who is excellent by the way) reported that “Cash Wildfire Spreads Among Young Tech Companies.” She wrote:
It’s time to get real about the financial fragility of young technology companies. Far too many are living beyond their means, flirting with disaster and putting their investors at risk.
Bloomberg Opinion examined 150 U.S. technology companies that had gone public since the beginning of 2010 and were still operating independently as of Aug. 10. About 37 percent had negative cash from operations in the prior 12 months, meaning their cash costs exceeded the cash their businesses had generated.
A handful of the companies, including online auto dealer Carvana Co., the mattress e-commerce company Purple Innovation Inc. and health-care software firm NantHealth Inc., were on pace to burn through their cash in less than a year, based on their current pace of cash from operations and reserves in their most recent financial statements.
In addition to Purple Innovation, Ms. Ovide points out that the following companies might have less than 12 months of cash cushion: ShiftPixy Inc. ($PIXY), RumbleON Inc. ($RMBL), RMG Networks Holding Corp. ($RMGN), NantHealth Inc. ($NH), Carvana Co. ($CVNA), and LiveXLive Media Inc. ($LIVX).
The big takeaway for me: Young technology companies in aggregate are becoming more brittle during one of the longest bull markets ever for U.S. stocks. This trend is not healthy. Companies that persistently take in less cash than they need to run their businesses risk losing control of their own destinies. They need continual supplies of fresh cash, which could hurt their investors, and the companies may be in a precarious position if they can’t access more capital in the event of deteriorating market or business conditions.
It’s not unusual for young companies, especially fast-growing tech firms, to burn cash as they grow. But the scope of the companies with negative cash from operations, and the persistence of some of those cash-burning companies for years, was a notable finding from the Bloomberg Opinion analysis.
Notable, indeed. There will be tech-based ABCs AND bankruptcies galore in the next cycle. Are you ready? Are you laying the foundation? Are you spending too much time skating to where the puck is rather than where it will be?
*We’ll take this opportunity to state what should be obvious: you should follow us on Twitter.
But, seriously, and more importantly, we know we tout the disruptive effects of the direct-to-consumer model. But make no mistake: we are WELL aware that a number of these upstarts are going to fail. Make no mistake about that.
We have compiled a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. You can find it here. A lot of our nerdy finance friends are checking out “Crashed: How a Decade of Financial Crises Changed the World” by Adam Tooze. It just came out on August 7 so we haven’t had a chance to check it out yet.
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