Curated Disruption News
Midweek Freemium Briefing - 6/27/18
Read Time = 4.8 a$$-kicking minutes
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News of the Week (2 Reads)
1. Optimism Remains in Toys R Us Situation
You’d think that every person on the planet would be sufficiently jaded by anything Toys R Us at this point. Apparently not everyone. And, oddly, the optimism seems to come from someone typically critical/skeptical of private equity…
Yesterday Axios’ Dan Primack’s lead piece asked, “Should the former private equity owners of Toys "R" Us pay around $70 million in severance to the company's 33,000 laid-off employees?” The question seems to stem from reports that limited partners (i.e., pension funds) are questioning what took place with the Toys investment. We noted this on Sunday:
🔥Elsewhere in private equity, maybe there’ll be backlash emanating out of Toys R Us?? The Minnesota State Board of Investment voted to halt investments in KKR pending a review of the bigbox toy retailer. 🔥
With this as background, Primack wrote:
This is not an academic question. It's become the subject of some public pension investment committee meetings, prompted by a lobbying campaign by left-leaning nonprofit advocacy groups, and has gotten the private equity industry's attention.
The basic argument: Bain Capital, KKR and Vornado killed Toys "R" Us by saddling it with too much debt, while taking out fees along the way. It's only fair that they help folks who are without work because of private equity's mismanagement, particularly when PE firms are so rich and many of the employees were living paycheck-to-paycheck.
The legal argument: There is none. The private equity firms no longer own Toys "R" Us, and a bankruptcy court judge threw out the severance package because employees weren't high enough in the creditor stack.
We’re old enough to remember when mass shootings got private equity’s attention too. They promised to divest. They didn’t. And then Vegas happened. And then Florida happened. And then Bank of America ($BAC) swore off lending to gun companies only to, uh, lend to Remington Outdoor Company.
We’re old enough to remember people like Warren Buffett say that they should pay more in taxes. That his secretary has a higher effective tax rate than he does. But, to our knowledge, he didn’t exactly voluntarily write a billion dollar check to the U.S. Treasury.
Likewise, neither will KKR write a severance check to employees. No frikken way in hell. Why? Because there is no compulsion to do so. The legal argument? He’s right, “[t]here is none.” So, yeah, good luck with that.
And so the above is really where the piece should stop. A nice little moral high ground piece about how employees and vendors got effed, it is what is, now on to tariffs, Petsmart’s asset stripping “mystery,” Harley Davidson’s ($HOG) war with President Trump or Moviepass owner Helios & Matheson’s ($HMNY) stock hitting a record low.
But Primack also points out,
Finally, the pro-severance folks are a bit liberal (no pun intended) with their math. They argue the PE firms took out $464 million, by adding up advisory fees ($185m), expenses ($8m), transaction fees ($128m) and interest on debt held by the sponsors ($143m). Yes, we were first to point out how the general partners may have gotten back more than they put in. But some of those fees were shared with LPs — including the now-aghast public pensions — while the interest was held in CLOs that had their own investors. In other words, PE "profit" was much smaller than claimed (although, on the flip side, you could argue the firms collected management fees on Toys-related capital that ended up being set on fire... again, it's complicated). (emphasis added)
Right. We’re sure the Minnesota State Board of Investment is cutting a check as we speak.
Sadly Primack didn’t stop there; he continued,
PE firms do have moral obligations to portfolio company employees. You break it, you own it (even if you technically broke it while owning it, which caused someone else to own it).
Um, ok, sure.
Bottom line: The PE firms should pay at least some of the severance, or figure out some other form of compensation. And I have a sense that they might. Not because of preening public pension staffers or legal obligations, but because it's the right thing to do. Sometimes it's just that simple.
LOL. Riiiiiiight. In the absence of Mr. Primack having an inside track at KKR, it’s just that fantastic (def = “imaginative or fanciful; remote from reality.”).
2. #Scarlet22 = Geokinetics Inc.
Just when we thought companies had mysteriously figured out how to stay out of bankruptcy court, alas, a filing!
And just when we thought oil and gas-related distress had ridden off into the proverbial Texan sunset, in walks Houston-based geophysical services provider Geokinetics Inc. into the Southern District of Texas with a plan to sell substantially all of its assets to (one-time bankruptcy candidate) SAE Exploration Inc. for $20mm. Looks like the oil and gas downturn still has some appetite for prey. And it must be tasty prey: this is the second time in four years that this company is in bankruptcy. #Scarlet22. Indeed, this company is so good at bankruptcy that, the first time, it emerged from chapter 11 a full year before it even confirmed its plan!! From paragraph 24 of the First Day Declaration:
"On March 10, 2014, GOK and certain affiliated subsidiaries confirmed a prepackaged chapter 11 plan of reorganization in the District of Delaware. Pursuant to the Plan, GOK equitized over $300 million of debt and paid off its revolving credit facility. On May 10, 2013, GOK and certain affiliated subsidiaries emerged from chapter 11."
And we thought HBO’s Westworld had mind-bending timelines. Whoops.
The company blames the prolonged downturn and certain discreet "operational difficulties" that resulted in “uncollectable receivables” for its bankruptcy. Wanting to jump ship as the iceberg approached, Wells Fargo ($WFC) sought to minimize its exposure but the company and its bankers, Moelis & Company ($MO), weren't able to find a suitable secured loan facility to refinance its revolving loan. So Moelis toggled to "strategic alternatives" mode which, seemingly, included dumping this turd on unsuspecting public equity investors as the company -- under the guidance of Fried Frank Harris Shriver & Jacobson -- filed a confidential S-1 under the JOBS Act. Sounds a lot like Domo Inc. Or Tintri Inc., for that matter. #HailMary
Obviously the company didn't IPO. Instead, it continued to bleed cash. Ascribe Capital replaced Wells Fargo and funded bridge loans for some time until they were no longer willing to perform triage. The company and its advisors stepped on the gas, lined up the stalking horse bidder, and secured interest in a $15mm DIP credit facility -- from Whitebox Advisors and Highbridge Capital, two funds that are stakeholders in the stalking horse bidder -- and filed for bankruptcy. The proceeds of the DIP will be used, in part, to pay off Ascribe's bridge loans.
Meanwhile, remember that IPO? It seems the company thought that that was a gigantic waste of time: among the top creditors are Fried Frank and Moelis.
We have compiled a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. You can find it here. We recently added four new books on our “to-read” list: (1) “When the Wolves Bite” by Scott Wapner (about the Carl Icahn/Bill Ackman Herbalife battle), (2) “I Love Capitalism!: An American Story” by Ken Langone, (3) “Factfulness” by Hans Rosling (recommended recently by Bill Gates) and (4) “Enlightenment Now” by Steven Pinker (recommended recently by Warren Buffett). We’ve added “Bad Blood: Secrets and Lies in a Silicon Valley Startup” by John Carreyrou. He tells the story of Theranos’ Elizabeth Holmes’ epic deception. We are definitely adding this to our list of beach reads.