😬We Have Our Answer😬

Destination Maternity Finally Files, CBL & Private Credit

New Chapter 11 Bankruptcy Filing - Destination Maternity Inc. ($DEST)

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Back on September 25th, we asked “🤔Is it a "Destination" if Nobody Goes?🤔.” The question presupposed an answer because, like virtually everyone on the planet, we had strong suspicions that Destination Maternity Inc. ($DEST) was going to, in very short order, find itself in the bankruptcy bin. What tipped us off? Well, it might have been some combination of, in no particular order, the #retailapocalypse, low fertility rates,* repeated piss poor earnings reports, regular downgrades, a revolving door C-Suite, awful earnings call performances, this homeboy popping up on the board of directors, and its penny stock status. Alas, here we are. This sucker finally arrived at its rightful destination: bankruptcy court.**

So, what’s the plan? The company initiated a marketing process pre-petition and, it says, ran out of liquidity before that process could run its course. As we previously said, there was no way a sale was getting done outside of bankruptcy anyway. So now, pursuant to its agreement with pre-petition lender, Wells Fargo Bank NA ($WFC), the company has the consent to use Wells’ cash collateral but with some strings attached. Wells is requiring a fairly aggressive time line that includes:

  • “No fewer” than 175 store locations to commence closing sales by October 28;

  • “No fewer” than 35 more store locations to commence closing sales by November 1;

  • Bids for the business due by December 5 and an auction on December 9; and

  • Payment in full by year end.

Wells clearly wants this sucker off its books in 2019. The company will have a dramatically reduced footprint come early November;*** it currently has 436 locations (excluding 423 leased departments in Macy’s, buybuyBABY and Boscov’s). It will at least halve that. There’s no guarantee that this business will survive: with limited time and cash to run a process — nor any stalking horse bidder — there is no guarantee that anyone will come forward and buy this business. Given that the company spends $62mm in annual rent and leases 253,671 total square feet for their retail stores, all of this has to be a super-welcome development for the mall landlords heading into Xmas time. Ho ho ho, suckers.****

*Indeed, May 2018, we wrote:
Consumer Products (Short the Declining Birth Rate). The U.S. fertility rate fell to a record low for a second straight year and consumer products companies are feeling the pain. This might also explain Destination Maternity’s troubles.
In its bankruptcy papers, the company, indeed, noted:
The significant disruption to the brick-and-mortar retail industry generally and a downward trend in birth rates have compounded difficulties caused by the overly complex structure of the Debtors’ businesses, above-market rent across their store fleet, and high leadership turnover.
Perhaps fewer billable hours and more sexy time people.
**Our snarky commentary aside, this is the quintessential entrepreneur’s story. The founder identified a personal problem — a lack of quality fashionable maternity apparel — and went out and solved it. She started the company in ‘82, had 40 stores by ‘90 and IPO’d in ‘92. After years of tack-on acquisitions, she eventually achieved 20% of market share by revenue.
***The usual suspects have made notices of appearance: Brookfield Property REIT Inc., Taubman Company ($TCO), Washington Prime Group Inc. ($WPG), and Simon Property Group Inc. ($SPG). CBL & Associates Properties Inc. ($CBL) has not, at the time of this writing, made a notice of appearance but they are littered all over the company’s filed creditor matrix. More on this below.
****Speaking of suckers, there’s also the state of New Jersey. Through its Grow New Jersey Assistance Program, the Board of the New Jersey Economic Development Authority enticed the company to leave Philadelphia and relocate its corporate headquarters and distribution operations to southern New Jersey. The incentive package consisted of $40mm, paid $4mm/year over 10 years. In turn, the company committed to creating “certain levels of annual jobs” in the state lest it be disqualified from receiving the benefits. Interestingly, the annual benefit exceeded the company’s annual income tax liability to the state. Why? Obvi, because the company performed like dogsh*t. You can’t pay income tax if you don’t actually show a net profit. Therefore, “[t]o maximize the realizable value of the incentive package, as allowed under the Grow NJ Award, the Debtors enter[ed] into agreements with various third parties to sell up to 100 percent of the annual income tax credits awarded to the Debtors.” Who knew there was a market for state-issued incentive credits? Gotta love America.

⚡️Update: CBL & Associates Properties Inc.⚡️

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In our recent newsletter, “🇺🇸Forever 21: Living the (American) Dream🇺🇸,” we highlighted the exposure that landlords have to Forever21:

The company currently spends $450mm in annual rent, spread across 12.2mm total square feet. The company will close 178 stores in the US and 350 in total.

We highlighted how the company noted the impact this plan will have on large mall landlords, the company said:

Forever 21’s management team and its advisors worked with its largest landlords to right size its geographic footprint. Four landlords hold almost 50 percent of its lease portfolio. To date, Forever 21 and its landlords have engaged in productive negotiations but have not yet reached a resolution.

Two of those landlords were the largest unsecured creditors, Simon Property Group ($SPG) and Brookfield Property Partners ($BPY). But another, CBL & Associates Properties Inc. ($CBL), also has exposure. In “Thanos Snaps, Retail Disappears,” we discussed CBL’s issues: bankruptcy-related store closures are something that CBL is very familiar with. Management said last February that things were going to turn around but, instead, things just keep getting worse as more and more retailers go out of business.

Forever 21 is one of CBL’s top tenants, occupying 19 stores (plus 1 store in “redevelopment phase”). Per CBL’s FY 2018 10-K, Forever 21 accounts for roughly 1.2% of CBL’s revenue or $10 million.

Of those 20 stores, 7 are subsumed by a motion by Forever 21 to enter into a consulting agreement to close stores (see bankruptcy docket (#81 Exhibit A):

On October 14, 2019, partly due Forever 21’s bankruptcy, Moody’s downgraded CBL’s corporate family rating to B2 from Baa3 and revised its outlook to negative. Moody’s explained:

CBL's cushion on its bond covenant compliance is modest, particularly the debt service test, which requires consolidated income to debt service to annual debt service charge to be greater than 1.50x. The ratio has declined from 2.46x at year-end 2018 to 2.27x at Q1 2019, and 2.25x at Q2 2019 due principally to declining operating income during these periods. CBL's same-center NOI growth was -5.3% for Q2 2019 YTD and CBL projected same-center NOI growth to be between -7.75% and -6.25% for 2019, which means that the debt service test will likely weaken further.

The chart below reflects the company’s capital structure and debt prices. It is not doing well. In fact, the term loan and the unsecured notes have priced down considerably since March:

Here is the company's stock performance:

The last thing CBL needed — on the heals of the downgrade — was near-instantaneous bad news. It got it this week.

Yesterday, the bankruptcy court granted interim approval authorizing Destination Maternity Corporation ($DEST) to assume a consulting agreement with Gordon Brothers Retail Partners LLC. Gordon Brothers will be tasked with multiple phases of store closures. Among those implicated? CBL, of course:

CBL is landlord to DEST on 16 properties that are slated for rejection. Considering that DEST cops to being party to above-market leases, this ought to result in a real economic hit to CBL as (a) it will lose a high-paying tenant, (b) it will take time to replace those boxes, and (c) it is highly unlikely to obtain tenants at as favorable rents.

Let’s pour one out for CBL, folks. The hits just keep on coming.


🤪Lending, Lending, Lending🤪

Sunday’s looooooong special report, “💥CLO NO!?!?💥,” about Deluxe Entertainment, collateralized loan obligations (and their limitations), leveraged lending, EBITDA add-backs and other fun lending stuff sparked A LOT of interest. If you’re not a Member, you missed out and now thousands of people you’re competing with for business are officially smarter than you. Go you!

One thing we didn’t have time (or, given the length, space) to note is how private credit lenders take exception to being lumped in with the syndicated leveraged loan market and, by extension, CLOs. Indeed, “leveraged loans” are a rather broad category and there are differences between lenders that ought to be acknowledged: private credit vs. public BDCs vs. private BDCs vs. syndicating banks, etc., etc.

Regardless of distinctions, however, there’s clearly a ton of green out there looking for some action. To point, back in September, Bloomberg noted:

Globally, private credit, which includes distressed debt and venture financing, has ballooned from $42.4 billion in 2000 to $776.9 billion in 2018. By one estimate, the total is likely to top $1 trillion in 2020.

Public pension funds, insurance companies and family offices are some of the biggest investors putting money to work in private credit. Private equity firms themselves have also flooded into the space, forming their own credit arms or raising cash for private credit vehicles, along with private equity funds of funds from these investors. The frenzy has turned some lending start ups into heavyweights almost overnight. Owl Rock Capital Partners — a New York firm founded by BlackstoneKKR and Goldman Sachs veterans — has amassed $13.4 billion of assets since it started in 2016.

Bloomberg continued:

An influx of new lenders and fresh cash in the space has contributed to cutthroat competition and looser covenants -- terms lenders impose on borrowers to help protect their investments -- in addition to thinner returns. Regulators in Europe have taken note of private credit’s boom, saying its growth has been accompanied by signs of increased risk-takingUBS credit strategists have called private credit “ground zero” for concerns due to the increased leverage on direct loans. Covenants can also be undermined when borrowers goose their earnings by, for instance, claiming savings from ambitious cost-cutting programs that may never come to pass. Jamie Dimon, CEO of JPMorgan, has also said some non-bank lenders may not survive an economic slump because they’re holding lower-quality loans -- and their disappearance could leave some borrowers “stranded.”

Hmmm. It sure sounds like the aforementioned distinctions may be without a difference given the market dynamics.

In response, the private credit guys — and, yes, they’re overwhelmingly dudes — love to say that they’re not necessarily overrun by the supply/demand imbalance that generally exists elsewhere in credit. “We have proprietary credit analysis techniques,” they’ll say, thumping their vested chests in the process. “We have specialization in category XYZ,” they’ll argue in an attempt to de-commoditize themselves. Boasts notwithstanding, any actual or alleged competitive differentiation hasn’t, in fact, insulated most lenders from macro market trends where sponsors have the power and lenders capitulate on the regular. No doubt, private equity sponsors are playing competing BDCs and private credit providers against one another to get deals done with favorable terms. Otherwise, we wouldn’t be reading about EBITDA add-backs, and cov-lite or cov-loose, etc.

Still, they’re combative. “Credit quality is more important than documentation,” they’ll say, highlighting how they loan with the intent to satisfy the life cycle of the paper rather than dole it out or ditch it. Management. Industry. Financials. No cyclicality. The documentation is less relevant when these things line up, they’ll say. Do that right and they won’t have to worry about what happens when the thing goes sideways. Counterpoint: restructurings wouldn’t exist if underwriting was 100% bullet-proof. 🤔

Alternatively they’ll deploy the Trump defense. “Sure, sure, our docs suck. But the worst private credit doc is better than the best syndicated loan doc.” Or they’ll argue that they’re able to get favorable pricing in exchange for the lax nature of the docs. Maybe. We suppose we’ll also see in due time if that pricing properly compensates lenders for the risks they’re taking.

Look, we get that the type of loans that now constitute “private credit” fared relatively well in the last cycle. We also understand priority and acknowledge that top-of-the-capital-structure loans ought to be, from a recovery perspective, fine places to play. But to cavalierly play it like there isn’t reason for concern is disingenuous.

Apropos, Golub Capital just hired new Workout Counsel. He — and his ilk — may be busier than these private credit lenders care to admit.


📚Resources📚

We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. We previously indicated excitement for Stephen A. Schwarzman’s “What it Takes: Lessons in the Pursuit of Excellence,” thinking that there’d be gems about historic deals, pearls for aspiring private equity investors, etc. We’re about 2/3 through the book and we have to say: it’s garbage. Save your money: we honestly haven’t learned a thing.

On the flip side, Ronan Farrow’s “Catch and Kill” is a sprawling story about cover-up, complicity and corruption. PETITION is about disruption and this book has the potential to disrupt the media industry (as if it needs help). How? It discusses the morally and ethically bankrupt means that NBC brass, certain lawyers (Lisa Bloom), and Harvey Weinstein deployed to keep a critical story in the shadows. It’s an important book at an important time. And it reads like a spy thriller. We highly recommend it.👍


💰New Opportunities💰

Force Ten Partners, an advisory firm specializing in corporate restructuring, challenged businesses, litigation, and other special situations, is growing. They seek Associates and Directors with 5-10 years of bankruptcy and restructuring experience. If you are interested, please visit 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.