Forever 21 Bankruptcy

Overview

On Sunday, September 29, one-time apparel retail disruptor Forever 21 filed for chapter 11 bankruptcy and will now seek to beat the odds by restructuring its liabilities, right-sizing operations and emerging as a going-concern post-restructuring.  The company, founded by South Korean immigrants Do Won and Jin Sook Chang in Los Angeles in 1984, fueled its growth by pushing a relentless stream of low-cost but novel merchandise into its stores, effectively turning speed into a competitive advantage while exposing the operational weaknesses of many of its competitors.  In the aftermath of the Great Recession, the combination of a business model in synch with the times (high novelty, low-cost) and eager landlords seeking expansion-minded tenants led to explosive growth.  

Though Forever 21 does not report financial results, industry sources in recent years suggested that growth had slowed, revenue targets were missed, and the company was experiencing cash flow challenges.  The bankruptcy filing stands as confirmation that the combination of increased fixed costs due to expansion, shifting consumer tastes, and the migration of an ever-larger share of apparel spending to ecommerce successfully halted the momentum of what had until recently been a winning model.

Too Big to Fail

No one likes to see a good customer fail, but the specter of Forever 21 failing could be particularly chilling to Simon Property Group, which counts Forever 21 as its sixth-largest tenant, occupying 1.5 million square feet of retail space spread over 99 locations.

With 800 total locations, a major question for Forever 21’s landlords will be what the post-restructuring footprint of the company will look like.  History suggests the pullback could be severe: a report by AlixPartners indicates that of 44 store-based retailers that emerged from bankruptcy in recent years, 24 reduced their store count by 25% or more. 

Landlords are not without options, however.  When Aeropostale exited bankruptcy, it did so with the support of a consortium that included landlords Simon Property Group and General Growth Properties.  Leadership at Simon Property Group has signaled that the Aeropostale investment may not be a one-off, and could represent a model that the company would utilize again.

With 800 total locations, a major question for Forever 21’s landlords will be what the post-restructuring footprint of the company will look like.

Forever 21 Store Breakdown

The Advantages of Bankruptcy

The U.S. bankruptcy code is designed to give companies the opportunity to reorganize.  Company management and advisors take advantage of the automatic stay to gain some breathing room in order to execute their plans.  Reluctant lenders can take comfort in the additional protections afforded to Debtor-in-Possession (DIP) loans; for troubled companies it is often easier to borrow money in bankruptcy.  These advantages provide only temporary respite from market forces, however.  Retail companies seeking to reorganize since 2005 (when the U.S. bankruptcy code was last amended) have an uninspiring track record. The challenge now is for Forever 21 and its advisors to navigate a path to a true going-concern reorganization, avoiding the ignominious fate of liquidation that has befallen many troubled retailers in recent years.

Forever 21 DIP Financing and Top 50 Unsecured Creditors

An Industry in Turmoil

Traditional bricks-and-mortar retail is a high fixed cost business, and the explosive growth of ecommerce has had a devastating effect on many retailers, forcing the restructuring of many one-time industry darlings, and more than a few liquidations.  Perhaps more frightening, with some experts estimating that U.S. retailers are “over stored” by as much as 30%, the current spate of retail restructuring is not yet at an end.

Conclusion

Forever 21 is now in a moment of crisis, but with the right mindset, a crisis can lend an invaluable level of clarity.  The company successfully grew from a single store in 1984 to 800 today, leveraging “fast and cheap” into an industry-shaking competitive advantage.  A reasonable guess would be that the next phase of the company’s story will involve a lower store count, and perhaps a non-traditional ownership structure.  The creativity and out-of-the-box thinking of the company’s leadership, combined with subject matter expertise on the intricacies of a successful restructuring in bankruptcy on the part of its advisory team, may enable the company to reset and set the stage for further triumphs in the years ahead.

About the Author:

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career, David has served as financial advisor and interim executive to dozens of middle market companies.  David can be contacted at: david@abraxasgp.com.

Distressed Retailers Groping for Viability

The challenges that retailers have faced in the past few years have been nearly biblical in size and scope.

• The unstoppable rise of ecommerce, driven by voracious competitor Amazon, has siphoned revenue growth from competitors great and small, and forced every retailer to reassess their vulnerabilities and contingency plans.
• Shifts in consumer tastes have left retailers struggling to reposition store footprints that are increasingly at odds with where and how their customers prefer to shop.
• Business model innovations, particularly among apparel retailers have forced legacy retailers to rethink historic approaches to sourcing that maximized volume procurement over speed and flexibility.
• And for private equity backed retailers, debt burdened capital structures have increasingly come to seem less like savvy aspects of financial engineering than millstones around the necks of companies robbed of the ability to pivot.

Perhaps most challenging: during this industry’s (most recent) hundred-year flood, the ominous specter of an emerging consensus has hung like a pall over executives, investors, vendors, and advisors: bankruptcy had become a death sentence for retail, a roach motel with straightforward entrance but no viable way out (at least as a going concern).

Recently, the clouds have lifted somewhat. Retailers Toys “R” Us, Payless, and Gymboree are each on a path to successfully emerge from a chapter 11 bankruptcy filing with a substantial percentage of their pre-bankruptcy store count intact.

Enlightened self-interest has driven retail stakeholders to reassess their approaches to the challenges inherent in supporting a distressed retailer and better align their tactics with the twin goals of minimizing losses and repositioning struggling retailers for long-term success. As a result, following years of disappointing retail restructurings, stakeholders are more actively supporting a purposeful restructuring process as the best option for a distressed retailer, holding the prospect of considerably higher recoveries than a fire-sale liquidation.

The structural challenges facing retail are likely to persist, but with renewed signs of aligned interests among stakeholders, it now appears likely that struggling retailers can navigate a restructuring without the process devolving into a value-destroying liquidation.

About the Author

David Johnson, founder and managing partner of Abraxas Group, has a 20-year track record of driving organizational change. David has served as interim executive or financial advisor to dozens of middle market companies in turnaround and restructuring situations.

Mt. Gox Bankruptcy

It has long been an axiom of mine that the little things are infinitely the most important.

― Arthur Conan Doyle

Bitcoin exchange Mt. Gox filed for bankruptcy under Japanese law less than a week after revealing that the company had lost over $450 million in its own and its customers’ Bitcoin holdings.  While revelations of the loss of customer funds was the death blow for the company, prior allegations as well as increasing pressure from prosecutors had eroded faith in the exchange.

CEO Mark Karpless, who purchased Mt. Gox from founder Jeb McCabe in 2011, had enjoyed success as one of the foremost proponents of virtual currencies, and he led Mt. Gox to a dominant position, with the company at one point accounting for 80 percent of all Bitcoin transactions.

The broader Bitcoin community seems remarkably unshaken by the Mt. Gox situation. The price of Bitcoin stabilized shortly after revelations of the most recent fraud, and many fans of the currency are hopeful both existing bitcoin companies and new entrants to the market will take more aggressive security measures to improve the safety and reliability of the currency.

coindesk-bpi-chart

In many ways, the overriding challenge of this development for Bitcoin and other virtual currencies may be that it highlights fundamental challenges for their broader adoption.  Virtual currencies, bitcoin chief among them, have been promoted by many as friction-free mediums of exchange, superior in many ways to the currency most people rely on.  Yet the undetected theft of $450 million in bitcoin by exploiting a flaw in the currency’s code suggests that there remain considerable drawbacks to unregulated currencies supported by minimal infrastructure.  Additionally, the practice of relying on a currency’s inherent structure, as opposed to the controls built around it, has shown itself to be insufficient.

Virtual currencies are shaking things up.  Many economists scratch their heads at the phenomenon.  Law enforcement, in particular Preet Bharara, the U.S. attorney in Manhattan, continues to view mediums of exchange that simplify elicit transactions with distrust.  But despite their detractors, virtual currencies have numerous enthusiasts, and may well continue to play a role in the global economy.  For that role to grow, serious thought will need to be given toward building in additional protections for users of the currency.  For most potential users, lower transaction costs and an elegant structure are insufficient inducements to use a currency that can disappear in the blink of an eye.

The Change Agents We Need

The leader of men in warfare can show himself to his followers only through a mask, a mask that he must make for himself, but a mask made in such form as will mark him to men of his time and place as the leader they want and need.

― John Keegan

The middle market has seen considerable change in recent years, and these changes have led to an evolving shift in how capital providers view distressed situations among their portfolio companies. Increasingly, capital providers (including banks, commercial finance companies, subordinated debt lenders, private equity firms and fundless sponsors) are seeking out versatile professionals able to serve as Chief Restructuring Officers in order to manage a distress situation from the inside, and steer a troubled company to an optimal outcome.  In many middle market companies a CRO will often find him/herself to be the lone advisor on-site, and as such these professionals must embrace the role of change agent.

The emerging generation of CROs will need to possess the following traits:

1) Focus on Substance over Form.  Too often distressed situations devolve as a result of an overly restrictive view of form success will take.  An experienced CRO will recognize that a sale of the company, refinancing, or balance sheet restructuring are all likely to generate superior value to a liquidation, and as a result will pursue a flexible strategy to position stakeholders for the highest value outcomes while not excluding the possibility of lower-value (but still viable) solutions.

2) Strong Communication Skills.  A distressed situation is always a tenuous balancing act, with multiple constituencies angling for position.  Skilled CROs understand the need for clear and consistent communication to all stakeholders, both within the company and without.  Inevitably certain constituencies will receive more or less information, but the messaging should be clear and the focus should be on executing toward an identified goal.

3) Comfort with both Strategy and Tactics.  In the middle market the day of the armchair CRO is coming to an end.  Small and midsize companies experiencing distress can no longer afford to have turnaround advisors dictate broad strategy while the company internally struggles with execution issues.  Today’s distressed situations call for advisors able and willing to first develop a viable strategy and then take a central tactical role (i.e. leading the charge) in executing that strategy.

The role of Chief Restructuring Officer is becoming increasingly central in driving distressed situations to a successful conclusion.  However, changes in the capital provider universe as well as an increase in the general tempo of distressed situations has given rise to a need for a more versatile, independent type of CRO than those who previously served the market.  Increasingly stakeholders must look not only for a CRO, but for a CRO with the right mix of skills, in order to steer a distressed company to a successful outcome.

Fisker Automotive: A Beautiful Mess

This article originally appeared in Business Insider

How can anybody learn anything from an artwork when the piece of art only reflects the vanity of the artist and not reality?

― Lou Reed

Fisker Automotive recently filed for chapter 11 bankruptcy protection and announced plans to sell itself to recently formed holding company Hybrid Technology, following that company’s purchase of a defaulted Fisker loan from the U.S. Energy Department.  Of the startup automakers granted loans by the Energy Department, Fisker Automotive was approved for the largest amount ($529 million).  Tesla Automotive has repaid the $465 million in loans it received.  Though it received approval for a $529 million loan, Fisker received only $192 million (the company repaid only $53 million of that total).

Co-founded by Ashton Martin designer Henrik Fisker, Fisker Automotive set out to create something beautiful and lucrative.  By all accounts the company was wildly successful at the former, and shockingly unsuccessful at the latter. Fisker Atlantic

The Fisker Atlantic

Privco Chief Executive Sam Hamadeh summed up the challenges of an aesthetically driven company with too much capital and too little discipline when he noted the Fisker was at one point spending $900,000 per vehicle produced, and then selling those vehicles for $70,000.

Hamadeh went on to note:

Fisker Automotive may well go down as the most tragic venture capital-backed debacle in recent history,” Hamadeh said in a statement. “The sheer scale of investment capital and government loan money — over $1.3 billion in all — was squandered so rapidly and with so little to show for it that the wreckage is breathtaking. Bankruptcy will be the end of Fisker, but for the taxpayers, venture capital firms, individual investors, and Fisker’s suppliers, it will all be too little too late.

The writing has been on the wall for some time regarding Fisker.  The company laid off 75% of its staff in April as it sought to preserve its dwindling cash and assess its options.  At the time of its announcement, Fisker, which had raised an estimated $1.3 billion from investors, had cash on hand of less than $30 million.

In the end, the company failed to produce the most beautiful of all outcomes for investors: a return.

Municipal Distress

This article originally appeared in Business Insider

Eventually we all have to accept full and total responsibility for our actions, everything we have done, and have not done.

― Hubert Selby Jr., Requiem for a Dream

A noteworthy facet of the evolving municipal distress story in the U.S. has been the slow moving, inexorable nature of the challenge.  Sadly, when a crisis of the magnitude that we are facing develops along these lines it is difficult to appreciate the true scope of the challenge.  This is doubly so when the inevitable change that is coming will upset so many entrenched interests.  And of course the opaque nature of municipal finance has not helped matters.

Stepping back to review the lessons learned in recent years, a few themes become evident:

1)      The Story We Told Ourselves Was Flawed

We may very well look back on the smug claims that “local governments have taxing authority and so can always raise more revenue” and “XYZ bond issue is backed by a dedicated revenue stream, which makes it safer” as we now look at Wall Street’s over-reliance on structured finance to mitigate risk, and the simple yet profoundly wrong thesis that was spread in the middle of the last decade that real estate prices could never go down nationwide.  The simple fact is that for a great many municipalities, and for a troubling number of states and territories as well, the cost of honoring liabilities is severely restricting the ability of local governments to govern effectively (i.e. provide services).

2)      Municipal Risk Has Been Mispriced

The dirty secret of the municipal finance world is that risk has been massively underpriced for too long.  But at the right yield investors will take on the risk of lending to a local government that has gone through a restructuring, and it may not be very long before forward-thinking creditors start to wonder if those local governments who acknowledged their problems and acted accordingly might not in fact offer a superior risk profile, having addressed their issues.

Highlighting the fact, which we have often repeated, that governments do not exist solely to service their debts, Moody’s has indicated that prior recovery rate assumptions for distressed municipal issues were flawed, and is therefore lowering its recovery rate assumptions for these issues going forward.

3)      The Market is Forgiving

When the conversation around municipal distress first attracted wide attention in 2011, many commentators argued that local governments would do everything in their power to avoid a chapter 9 bankruptcy filing or related restructuring in order to stay in the good graces of the capital markets.  It appears that the markets are actually far more understanding than the commentators, with Vallejo, CA, which filed for chapter 9 bankruptcy protection in 2008 having recently sold $19 million in water-revenue bonds.

4)      Delaying the Inevitable Will Only Force More Pain

  • Puerto Rico is facing a financial catastrophe, and the longer it seeks to paper over its challenges with additional borrowings from enabling lenders, the more distract the ultimate remedy will have to be.
  • The approval of the Jefferson County, AL plan of adjustment highlights the scope of losses that are possible going forward.  The revised plan will impose a 47 percent haircut on the holders of $3.1 billion in sewer bonds.
  • Vallejo, CA is facing the prospect of a slow slide to another bankruptcy filing due to an overly aggressive set of assumptions underlying its first emergence.

Conclusion

We are still in the early stages of a seismic shift in the municipal finance sector.  Liabilities have grown to such a point that they will not be paid in full.  This is a painful reality for all stakeholders, but that pain makes it no less true.  Hopefully the lessons of our first tentative steps toward comprehensive municipal restructuring will enable us all to act with clearer eyes and firmer convictions as we seek to position local governments to meet the needs of citizens in the years to come.

Blockbuster Stores’ Stunning Reversal

This post originally appeared in Business Insider

Video rental chain Blockbuster, owned by Dish Network, announced yesterday that it will shutter its 300 remaining U.S. stores.  This closure puts an end to what must rank as one of the most precipitous falls from dominance to irrelevance that has been seen in some time.

In 2004, as it prepared for a spin-off from owner Viacom, Blockbuster was a juggernaut with 9,000 locations.  By 2010 competition from Netflix and others had forced it into bankruptcy (and an ugly, challenging bankruptcy at that).  Now, less than 10 years from the date of its spin-off, the company that defined the U.S. video rental market in the 90s will be gone, with the name living on in a few assorted Dish offerings only.

There are few better illustrations of just how fleeting strategic advantage truly is in a dynamic market.  Blockbuster’s day in the sun was long, but the company was blinded by its success and failed to see the ways in which Netflix and other competitors cut at the very heart of its value proposition.  By the time Blockbuster management recognized their error, it was too late.

And now a brand that rose to prominence by giving consumers more control over their viewing options has been put to rest, killed in part by a failure to see that the video rental store itself was at best an intermediate step toward our current on-demand offerings.  Blockbuster had the resources and the brand to make the leap, but not the vision.  There is a lesson in Blockbuster’s failing for us all.

New Paradigm of Government Distress

This article originally appeared in Business Insider

July 7, 2011

A Slow-Moving Disaster

The state of Illinois is broke, and if it were a company it would at this moment be in the midst of a chapter 11 bankruptcy process.  A recent Bloomberg Businessweek article highlights just how bad things are in the Land of Lincoln:

  • The state is $4 billion behind on bills to 8,000 businesses, charities and state agencies.  Of that number, 114 are owed over $1 million.
  • This mountain of overdue bills exceeds the entire annual budget of the state of Delaware and is more than 10 percent of Illinois’ general budget for the upcoming year.
  • Banks are refusing to lend against these receivables, a sure sign that a state default is no longer a fringe idea.
  • Tax increases raised $7 billion for the state, which was insufficient to cover a $13 billion deficit.  The partisan fight over more borrowing continues.

State budget cuts are getting progressively deeper, and municipalities, faced with an end to federal stimulus money, the financial struggles of states, and declining property tax assessments, are being pressed to find new and ingenious methods to keep expenses down.

Painful Changes Needed

Sadly, cost reduction is not an area of expertise in most governments.  In the turnaround and restructuring community a shakeout is viewed as inevitable.  At the most basic level a restructuring of state and municipal debt as well as pension and healthcare obligations is essential.  Shared services and joint purchasing proposals will need to be moved from the drawing board to implementation.  We can expect vicious fighting between bondholders, government employees (current and former), voters and the unlucky politicians caught in the middle.

The policy implications of an age of local government financial distress must be considered as well.  California’s Proposition 13 was enacted in opposition to rising property taxes at a time (1978) when only half of the Baby Boomer generation was in the midst of their childbearing years.  We are a very different society with different demographic and social trends now, and more property tax fights might be expected, with long-term impacts on the resources placed at the disposal of local governments.

Meredith Whitney Was Right

When Meredith Whitney mad her bearish call predicting a wave of municipal defaults, scorn was heaped upon her.  In a follow up research report looking at the state finances, Whitney reiterated her bearish call, pointing out that the health of state finances is even more precarious than is generally acknowledged.  While many fixed income investors have argued technical points of her analysis, I believe that by taking a step back it is clear that Whitney is making the directionally correct call and those opposing her analyses are propounding a type of exceptionalism that has traditionally led to significant losses for investors.

True believers are difficult people.  Often the very traits that allow them to be ahead of the curve on issues make them poor proponents of those issues to the broader public.  This is exactly the problem with Whitney.  She is media savvy and, since her Citigroup call, seems to be hooked on making big predictions.  As another Business Insider piece pointed out, she could learn a great deal from economist Nouriel Roubini, whose firm also has a bearish view on the U.S. municipal bond market, but has been politic enough to couch their prediction in the soothing tones of economist-speak.

A New Paradigm

We are living in an exciting time, during which the role of state and local governments will be reshaped, with luck for the better.  The old paradigm had something for everyone: nearly risk-free returns for creditors, job security for government employees, pension and healthcare benefits that were both very generous (for employees) and underfunded (for taxpayers).  It was an imperfect system but it worked for a long time.  That time is now at an end.  Stakeholders can fight all they want (and they will), but change has come, and we expect that this change will be contentious but ultimately for the best.

The Demise of a Bad Deal

This post originally appeared in Business Insider

Victory has a thousand fathers, but defeat is an orphan.

– John F. Kennedy

Things seemed so simple in 2007. Energy company TXU looked like a sure-thing. Demand for energy was climbing. The company’s robust profitability suggested an ability to service a substantial debt burden. Throw in some operational efficiencies and TXU had the appearance of a golden opportunity for some of the biggest PE firms in the U.S. to ride increasing energy demands to riches.

It has not worked out quite that way. Following its purchase in 2007 in a $48 billion buyout, the company, now renamed Energy Future Holdings had its profitability crushed by the unset of large scale fracking and the accompanying collapse in natural gas prices. Arguably good management and savvy financial engineering are the only reasons that the day of reckoning has been put off as long as it has. Natural gas hedges minimized the pain in the early years after the buyout. And on the balance sheet side there have been several distressed exchanges and refinancings in specific tranches of the company’s $43.6 billion debt structure. But there is only so much that good management and creative financial engineering can do when faced with an investment thesis that has been proven false, and market expectations are that a bankruptcy filing is imminent.

Losses happen in investing, but it is interesting to see in this case the maneuverings of savvy investors on all sides.
• PE firms KKR and TPG Capital contributed $3.5 billion in equity to the original deal
• Goldman Sachs Capital Partners contributed $1.5 billion in equity
• $3.3 billion of equity was contributed by clients of KKR, TPG and Goldman, as well as Lehman Brothers, Citigroup and Morgan Stanley
• Investor Apollo Management Group, Oaktree Capital Group and Centerbridge Partners have taken considerable stakes in various tranches of the company’s debt, positioning themselves for an eventual ownership stake following a restructuring

Recent news suggests that that $8.3 billion equity commitment may, post-restructuring, shrink to an ownership stake of less than 3 percent. The pain is not limited to the equity in this deal, though. Moody’s recently reported that due to the sheer size and complexity of Energy Future Holdings’ restructuring, it would likely result in lowered recoveries across the capital structure.

With $270 million in interest payments due November 1, one of the largest non-financial bankruptcies in U.S. history is likely about to be filed. A successful chapter 11 reorganization will allow a way forward for the over-indebted company, but will be a black eye for investors floored by the punch they did not see coming.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. He can be reached at 312-505-7238 or at david@acm-partners.com.

Eike Batista

This article originally appeared in Business Insider

How flattering to the pride of man to think that the stars on their courses watch over him, and typify, by their movements and aspects, the joys or the sorrows that await him! He, in less proportion to the universe than the all-but invisible insects that feed in myriads on a summer’s leaf are to this great globe itself, fondly imagines that eternal worlds were chiefly created to prognosticate his fate.

–          Extraordinary Popular Delusions and the Madness of Crowds

Eike Battista is not having a good year.  In fact, it might be fair to say that the Brazilian entrepreneur is having perhaps one of the most horrendous years of wealth destruction on record.  In little more than a year Batista’s fortune has plummeted by over $30 billion, his support among Brazilian politicians has evaporated, and his creditors have gone from enthusiastically backing his endeavors to nervously eyeing their collateral.

For those unfamiliar with the new poster boy for emerging markets euphoria gone horribly wrong, look no further than the recent Bloomberg Businessweek article by authors Juan Pablo Spinetto, Peter Millard, and Ken Wells.  Their reporting details all the usual elements in these situations, with a few interesting wrinkles:

  • The Batista empire benefited from a compelling story that investors desperately wanted to believe.  With a network of companies focused on natural resources and based in Brazil, Batista had a need for capital at exactly the point in time when institutional investors were looking for investment opportunities emerging markets.
  • OGX, an energy exploration and production company founded by Batista in 2007, bid aggressively (in some cases offering bids double that of its competitors) for offshore oil leases.
  • Batitsa had the dangerous combination of being a famously hands-off manager who was nevertheless relentlessly optimistic about his ventures.  Over time his direct reports came to avoid bringing him bad news, which may have only speeded the decline of Batista’s empire.

The focus of Eike Batista these days is on preserving some value, as he struggles to restructure the debt of his various companies.  News that mining company MMX had reached an agreement to sell a controlling stake in a Brazilian iron-ore port sent the stock up 8 percent for the day, though investors have still suffered a 76 percent decline in 2013.  This marks only the latest in a series of transactions aimed at preserving something of the Batista empire, though the heavy debt burden of these companies suggests that preserving any equity value may be a lost cause (see articles here and here).

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.