Disruption from the Vantage Point of the Disrupted
Freemium Briefing - 10/17/18
Read Time = 6.1 a$$-kicking minutes
We promised on Wednesday we’d dive deeper into the Sears Holding Corp bankruptcy filing but considering (a) we wrote about it here and here (Members’-only) and (b) it has been covered to absolute death since Sunday, we felt compelled to cover other subjects. Carry on and enjoy…
🗞News of the Week (2 Reads)🗞
1. You Know It’s Hard Out Here for a…Retailer (Short Mom & Pop)
We take sh*t from a lot of you for not covering smaller events as much as the mega cases. So, here goes nothing: we decided to write about a small retailer trying to make it in today’s tough brick-and-mortar environment…
Herb Philipson’s Army and Navy Stores Inc., a New York-based outdoor apparel and sporting goods retailer since 1951, filed for bankruptcy on October 8 in the Northern District of New York.
The company carries various brands like Carhartt, Columbia Sportswear, Levi, lee, Under Armour, Dickies, Timberland and The North Face in its stores (most of which are now the company’s largest unsecured creditors) and also serves as the exclusive retailer for the Utica Comets Hockey Team and the new Utica City Football Club. It has 9 locations, none of which are in or on company-owned structures or real property. The company had revenues of $43.5mm and $39.8mm in 2016 and 2017, respectively. Through nine months of 2018, the company experienced a dramatic decline in business with revenues of just $15.6mm.
What caused such a stark decline in business? The company notes:
“The decline of the Debtor’s business is directly attributable to a confluence of operational and liquidity factors. Starting in 2015, the Company began to suffer from decreased sales — largely attributable to HP’s inventory mix failing to appeal to the tastes of the market and the rise of e-commerce, which allowed the Debtor’s customers to purchase from on-line retailers the same or similar good being offered by the Company.”
Moreover, the company lost access to its line of credit, necessitating sales of new inventory to finance operations and leaving the company unable to order fresh inventory in Q1 2018.
What followed is a textbook tale of a small brick-and-mortar business trying to make it in a world dominated by upstart DTC brands, Amazon, and bigbox retail. It involved renegotiations of leases. Headcount reductions. An intensified focus on inventory selection and management. A scramble for new credit which, here, new ownership was able to lock down.
Clearly, however, the terms of the new credit line were either too onerous or too unrealistic as, unfortunately for the company, the new credit facility merely helped expedite the company’s spiral into bankruptcy court. Indeed, roughly a month after entering into the new lending facility, the lender, Second Avenue Capital, notified the company that it was in default under the facility. The relief afforded the company by the cash infusion was, clearly, short-lived.
Consequently, the company filed for bankruptcy so that the “automatic stay” protections of the Bankruptcy Code (section 362) could be leveraged to prevent Second Avenue Capital from exercising its rights and remedies under the credit facility and provide the company with a “breathing spell” within which to attend to “properly restructure and reorganize its affairs and propose a chapter 11 plan that would provide…creditors with meaningful recoveries.”
As is often the case in bankruptcy, there are two sides to every story. In this case, the company’s secured lender, Second Avenue Capital, argued late last week that the company “demonstrated a shocking inability to accurately project the operating performance of the business” leading to “material deviations” to the underwriting-dependent budget. Second Avenue argues, among other things, that (i) the debtor missed its own sales projections by 33.1%, (ii) comparable store sales are projected in the company’s latest budget to be negative 30% and 37% (vs. the underwritten projected positive 5% and 10%) for the months of November and December 2018; and (iii) the company has already missed its own inventory projection by approximately 17.9%. In other words, Second Avenue — while objecting to the company’s motion to use cash collateral — is asserting that they are undercollateralized and that the company is providing inadequate adequate protection.
Notably, Second Avenue doesn’t expressly say that the company was fraudulent in providing the budget upon which Second Avenue underwrote the loan; it does say, however, that “[a]s a consequence of the Debtor’s financial performance…and not any nefarious conduct by the Lender…the Debtor was in substantial and material default” under the credit agreement. Not exactly mincing words. Which only means one of three things: (1) the company was wildly inept in putting together its projections/budget; (2) the company was hopelessly optimistic and otherworldly unrealistic about its projections/budget; (3) the macro conditions for a small brick-and-mortar retailer in today’s day are coming at owners so fast and so furious that projections and budgets, more than usual, are anyone’s guess. We’ll leave it to a court to decide but it sure looks like there may be a contested fight here over the use of cash collateral with the fate of the company in the balance.*
It’s hard out there for a small brick-and-mortar retailer.
*Strangely, the first day hearing was scheduled for October 15 but no orders have hit the docket at the time of this writing.
2. Trouble Continues to Brew in Coal Country (Short #MAGA!?)
Back in April in “🌑Trouble Brews in Coal Country🌑,” we wrote about FirstEnergy Solutions Corp. (bankrupt), Murray Energy Corp. (somehow not bankrupt) and Westmoreland Coal Company (now bankrupt) and discussed to what degree President Trump would leverage obscure federal regulations and special plans to carry through with his campaign promises to save coal. We got some indication this week.
On Monday, Politico reported the following:
One of the Trump administration’s major efforts to prop up ailing coal companies has run aground in the White House, a setback to an industry that had hoped for a major resurgence after Donald Trump won the presidency.
Energy Secretary Rick Perry has spent more than a year pushing various plans that would invoke national security to force power companies to keep their economically struggling coal plants running — a goal in line with Trump’s frequent pledges to revive what he calls “beautiful, clean coal.”
But the White House has shelved the plan amid opposition from the president’s own advisers on the National Security Council and National Economic Council, according to four people with knowledge of the discussions.
Relating to efforts by the Department of Energy to formulate and justify a go-forward coal plan, Politico added:
The stalled plan marks DOE’s third attempt to save coal plants since Trump took office. A grid study intended to highlight the benefits of coal and nuclear power found, inconveniently, that most of those units were shutting down because of competition from cheap natural gas rather than onerous regulations. A subsequent proposal that Perry submitted to FERC was struck down unanimously by the five commissioners — four of whom Trump had appointed.
We wonder if recent troubles in coal country will revitalize efforts to come up with a viable plan. What recent troubles, you ask?
Well, the filing of Mission Coal Co. LLC, for instance. On Monday, Mission Coal marked the second coal company (and Kirkland & Ellis LLP client) to file for bankruptcy in a week. The Tennessee-based (primarily) metallurgical coal (think “steel”) producer has two deep mines, one located in West Virginia and another in Alabama. Its bankruptcy comes less than a year after its formation. Yup. Less. Than. A. Year.
Wait, huh?? How does that happen?
Mission was formed in early 2018 by combining and consolidating the operations of Seneca Coal Resources LLC and Seminole Coal Resources LLC, both consisting of assets acquired by ERP Environmental Fund Inc in distressed asset buys in 2015 and 2016. The company amassed the cheap mines from what is now Cleveland-Cliffs Inc. as it exited the U.S. coal sector and acquired assets from Walter Energy Inc. for no consideration other than assuming the liabilities associated with those mines as Walter went through a bankruptcy process that would result in the more streamlined Warrior Met Coal Inc.
And that amalgamation has required investment. The company notes:
As of the Commencement Date, the Debtors have spent approximately $28 million upgrading these mining complexes, and despite favorable market forces and commodity pricing, internal and external factors have prevented the Debtors from maximizing the value of their mining operations. Although Mission Coal’s executives previously targeted a total of 6.5 million short tons in production in 2018, adverse mining conditions, combined with rail and port disruptions, forced the Debtors to revise their annual target to 4.5 million short tons, with only approximately 2.1 million short tons produced as of September 2018. This diminished production and sales volume has severely limited the Debtors’ liquidity and has prevented them from implementing their operational upgrade program, including fully performing the necessary maintenance on their mining operations. (emphasis added)
A short digression. When Westmoreland filed we posted this on Twitter:
Yes, we’re cheeky SOBs. Which is probably why we got this response:
And @Ellerbe420’s response is definitely not right in the case of Mission Coal. As recently as August, the Debtors binned 360 employees at its Pinnacle Mining Complex in West Virginia. And cheekiness and #MAGA sarcasm aside, it may, unfortunately, get worse. Per the company:
As of the Commencement Date, a final date for Pinnacle’s closure had not yet been decided, although the Debtors intend to make a final decision prior to October 19, 2018. The Debtors expect to reduce their workforce further in the event that they close this mine, and would likely reduce further in late November 2018 upon the downsizing of the preparation plant on the property.
Why is all of this happening? What internal and external factors was the company referring to? Well, aside from the aforementioned production issues, similar to Westmoreland, the company is party to collective bargaining agreements with attendant pension obligations and has other post-employment benefit obligations due and outstanding (e.g., $61.1mm of retiree medical obligations). It has environmental and regulatory liabilities and asset retirement obligations. And, despite a relatively paltry balance sheet relative to Westmoreland, it has too much debt, with $175mm on its balance sheet. While the macro environment for met coal has improved, the costs associated with regulatory compliance impose meaningful direct costs on coal companies generally, and this company specifically.
Sadly, vendors have also been burned by too many bankruptcies across coal country. And they’ve smartened up. They now impose stringent terms on the company; or they have declined credit entirely. It’s a dog eat dog world out there in coal country.
So what now?
The company has received Bankruptcy Court approval to draw $25mm in DIP monies on an interim basis out of a proposed $201mm DIP (of which $54.5mm constitutes new money: the “roll-up” — once a rarity — seems to be firmly embedded as commonplace practice these days). The company will use that capital to pursue a sale process. Despite all of the problems delineated in the respective bankruptcy filings of Westmoreland and now here, someone, presumably, still wants to be in the coal business. God bless them.
Postscript: Mission Coal wasn’t the only coal-related company to file for bankruptcy early this week. Tonawanda Coke Corporation, a producer of “high-quality foundry coke,” also descended into bankruptcy.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. Two books we’re excited to add to the list include Bethany McLean’s “Saudi America” and Gary Shteyngart’s “Lake Success.” The former is about the U.S. as a world oil superpower and the latter is apparently about how hedge funders are d-bags.
😎Notice of Appearance😎
PETITION: You have a lot of experience in the distressed shipping space. That space, however, has been fairly quiet of late with some exceptions (e.g., Toisa, Emas Chiyoda). Danaos Corporation ($DAC) got an out of court deal done. What do you foresee in the near future in the space and what is one factor that not enough people are considering?
The macro risk is the large amount of tonnage still on the Chinese and Korean order books. A lot of that will come on line in the next two years or so. Reaching capacity equilibrium will continue to be a challenge given the building boom that led to the downfall to begin with. If rates tick up for a stretch, the order books will start to fill. If they tick down, then there is too much tonnage chasing too little freight. From a micro perspective, the instability in the Middle East is always a risk, but a lot of the players in that space have shored up their balance sheets, so they should be able to weather such storms (maritime pun intended, of course).
PETITION: With Venezuela struggling and Iran under sanctions, oil has been surging in price. What does this mean for the oil and gas exploration and production industry? Is it completely out of the woods or will there continue to be pockets of distress there over the next year? If the latter, some examples would be appreciated.
With WTI in the $60-$70 range for the last three months, and the tightening supply due to the cluster-(insert NSFW word here) in Venezuela and Iran, I think the E&P space is largely out of the woods from an industry perspective. A lot of the companies that came out of restructuring had post-reorg projections with oil in the $55 to $60 range. There are still one-offs that are candidates for workout, but that will always be the case. I plead the Fifth on what companies might have a future in Delaware or Houston, but I think they are out there.
PETITION: Years ago it seemed like a few large firms dominated all of the company side deals. Then the market share seemed to spread out a bit as firms like Bracewell, Akin Gump and Milbank started filing debtor cases. It now feels like massive concentration is back. In your view, what are the most significant macro trends affecting the industry and are they for better or for worse?
I am not sure the massive concentration ever ceased to be the case. From the Bracewell perspective, a lot of our debtor work was for existing clients, although we did get called in to a few cases due to conflicts or because of our specific expertise in both the shipping and E&P spaces. Shameless plug: one thing that has been helpful to us in positioning in debtor cases is our ability to put very senior and experienced partners on the day-to-day deal team. I had one client whose board of directors insisted she use a ... ahhhh … Big Name Firm. I told her she would probably be working with a partner who wasn’t even in law school back when I was doing mega-cases. She called me many times to lament that I was spot on.
PETITION: What is the best book you've read that's helped guide you in your career?
Is this where I am supposed to say Sun Tzu’s Art of War so I look learned and cultured? Sorry to disappoint, but I’ve never read it. I really think Robert Caro’s three-tome biography on LBJ was one of the most influential. Say what you want about LBJ and his cronies, but they were a very strategic, tactical (and conniving) group of thinkers. I was reading Caro’s books when I was a younger lad and they really shaped my ability to be a strategic, creative thinker (ouch, hurt my arm with that pat on my back).
PETITION Note: No worries, Bob, we pat ourselves on the back all of the time!
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