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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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He 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 (@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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

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.

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.

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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

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.

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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

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.

The Least Bad Outcome

This article originally appeared in Business Insider

The range of options available for addressing a problem is directly correlated to the amount of time available.  As the amount of time available to address a problem shrinks, so does the universe of options.  Eventually, the options all start to look painful.  Followers of Eastman Kodak are currently learning this lesson in corporate turnaround dynamics.

News that Kodak is looking to shop a portfolio of 1,100 patents (with the help of Lazard) had excited investors.  The $2.4 – $3 billion an IP sale would fetch would be a welcome cash infusion for a company with cumulative operating losses of $1.2 billion over the last three years.

But the market is fickle, and when Kodak drew down its $160 million revolving line of credit earlier this week, sentiment turned strongly negative.  Moody’s downgraded the company’s bond ratings to Caa2 from Caa1 (way to be ahead of the curve, guys).  Alarmed at Kodak’s cash burn, Scott Dinsdale of KDP Investment Advisors noted: “They could run out of cash in early 2012”.

Taking a look at Kodak’s financials, I think that analysis is fair.  It does not take much of a leap, given a continuation of the company’s recent poor performance, to see Kodak having burned through its current cash balance of $957 million by this time next year, if not sooner.

Given this situation, Bloomberg notes that Kodak may need to file a chapter 11 bankruptcy in order to ensure that bidders for its intellectual property are not liable for a fraudulent conveyance claim.  With the patents now for sale expected to yield several times the current market cap of the company, and additional patents that may offer further opportunities to reap some return on years of R&D (Kodak holds a total of 7,600 patents), any roadblocks to the sale of intellectual property clearly must be dealt with.

This is a sad development for a company that has seen change coming for a long time, but has been unable to make the necessary adjustments.  A 1995 Fortune article highlighted issues facing Kodak that are depressingly familiar today: managing a mature business in decline, building a business around digital imaging, right-sizing the cost structure.  The difference is that in 1995 Kodak had many more options than it does today.  After spending so much time searching for the optimal strategy, it may be that Kodak will have to settle for the least bad option of a chapter 11 filing and the sale of IP that it was never able to fully utilize.

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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

When Failure is the Best Option

This article originally appeared in Business Insider

The fate of Borders Group appears to be sealed.  The final bidder is a group composed of liquidators Gordon Brothers Group and Hilco.  The stalking horse bid of Najafi Companies fell apart when vendors balked at the resumption of normal terms (imposing an enormous liquidity need to manage the company as a going concern) and other lesser indications of interest from various parties came to nothing.

With 399 remaining stores and 11,000 employees, the economic and human costs Border’s failure are significant.  But this is also a moment to take heart: value maximization has won out, and despite the sinking feeling that I am sure many parties to this liquidation may experience as they dismantle what was once a category-killer, the fact that creditors focused on the numbers in black and white and made the decision that maximized value is a net positive for the U.S. business community and U.S. society at large.

As a turnaround and restructuring professional I have been on the ground at many companies that have been in deep distress.  Lenders furious, trade creditors threatening to stop shipments, talent fleeing for the lifeboats, gallows humor among the executive staff distress.  Skilled turnaround professionals can and have done wonders in these situations.  I have seen (and played a part in) my share of corporate turnarounds, with companies that were seemingly dead revitalized after the trial by fire of deep distress.

But I have also seen the opposite, the value destroyer that is a failure to acknowledge that a company is dead.  With stories buzzing about the latest astronomical social media company valuation or the newest M&A coup, we sometimes forget that companies can, and do, die.  It is not always obvious that a company is dead; revenue continues to flow, meetings continue to be held, but slowly the underlying economics turn, the capital structure becomes untenable, and finally a catalyst (in this case, yet another weak holiday season) reveals that the situation is no longer redeemable.

Yes, the liquidation call (see article, pg 3) is a difficult one to make.  But for a company that is the least bad option.

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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

Bowing to the Inevitable

This article originally appeared in Business Insider and TMA Midwest Blog

Eastman Kodak (EK), once among the preeminent companies in the U.S., is reportedly preparing to file for chapter 11 bankruptcy.  This is a sad but not entirely unexpected development.  In October I wrote on the evolving situation at Eastman Kodak, noting that in distressed situations there are no optimal outcomes.  Rather, a distressed situation is brought to a successful conclusion when the least bad outcome is pursued and achieved.

It seems that the least bad outcome has been settled on.  With its $900 million of cash being quickly eroded by persistent operating losses, Kodak must sell its prized intellectual property (IP) in order to maximize value.  The prospect of utilizing this IP in order to reinvent its business is gone.  Lazard has been managing the sale of 1,100 patents, and it appears that one of the drivers of the likely bankruptcy filing will be the need to complete that sale with the protections of the U.S. bankruptcy court.

In addition to facilitating asset sales, another benefit of a bankruptcy filing is the increased availability of financing.  For those unfamiliar with the world of restructuring, it may seem counter-intuitive that a bankruptcy filing could result in Kodak having easier access to financing.  However, given the priority assigned to debtor-in-possession loans, it makes sense that lenders would feel more comfortable providing Kodak financing to complete the sale of its most valuable IP.

Things did not need to be this way.  Eastman Chemical, once viewed as the stodgy spin-off to the more dynamic Kodak, is now thriving.  The key difference, unsurprisingly, between success and failure for these two corporate offspring of entrepreneur George Eastman was the willingness of Eastman Chemical to embrace change.

There is some poetry to the art of restructuring and turnaround, and at a moment like this, with one of the “must own” companies of the 70s reduced to contemplating a chapter 11 filing in order to sell off intellectual property that it was never able to sufficiently capitalize on, the bleak words of Shelley’s “Ozymandias” come to mind.  We should all take a moment to look on this wreckage and despair.

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 is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.