The Fed Calls it “Collateral Stripping.” These PE Firms Took it to the Next Level and Just Got Away With It

Neiman Marcus newest disclosures – and what the crazy-hot IPO market has to do with it.

Private-equity owned Neiman Marcus disclosed two things on Tuesday: Awful operating results for the quarter ended April 27, and a deal with its beaten-up creditors who, under threat of getting clobbered in bankruptcy court, agreed to not sue over a blatant act of “collateral stripping,” as the Fed calls it, and agreed to kick the can down the road in return for some potential crumbs.

The luxury retailer with 45 Neiman Marcus and Bergdorf Goodman stores and 24 Last Call stores is buckling under $4.9 billion of long-term debt, part of which would have come due in 2020 – hence the urgency.

The debt is mostly a hangover from its leveraged buyouts: It was first acquired in 2005 by PE firms Warburg Pincus and TPG, which sold it in 2013 to the current owners, Ares Management and the Canada Pension Plan Investment Board (CPPIB) for $6 billion. Ares and CPPIB have been using the threat of a bankruptcy filing since early 2017 to beat creditors into submission.

In March 2017, Neiman Marcus hired investment bank Lazard Ltd to help restructure its debt, a clear signal to creditors that a bankruptcy filing is one of the options if they don’t go along.

In April 2017, Neiman Marcus announced that, in order to preserve cash, it would not pay the interest on a $600 million 8.75% bond issue in cash, but “in kind” – meaning, bondholders would not get interest payments in cash, but instead get more of these dubious bonds. The payment-in-kind (PIK) option had been written into the bond covenant. Yield chasing creditors don’t care about these “cov lite” contracts, until they suddenly care.

In September 2018, Neiman Marcus disclosed that it was transferring its online luxury fashion e-commerce site, MyTheresa, to a holding company owned by Ares and the CPPIB. This would move MyTheresa out of reach of Neiman Marcus creditors in case of a bankruptcy filing. Neiman Marcus had acquired the Munich-based business in 2014.

In December 2018, one of the creditors – distressed-debt investor Marble Ridge Capital – delivered a letter to the board of directors of Neiman Marcus, calling this effort to get MyTheresa out of creditors’ reach “corrosive conduct” and a “self-serving enrichment scheme.”

And now Ares and the CPPIB have elevated the art of “collateral stripping” to the next level, and gotten away with it, and have thus set a precedent that will make this tactic of ripping off bondholders and leveraged-loan holders a standard procedure.

Operating results first: Total revenues plunged 9.3% to $1.06 billion in the quarter ended April 27, compared to the same quarter a year ago (filing). The biggest reason for the plunge is that Ares and the CPPIB extracted the MyTheresa operations, which had $98 million in sales in the quarter a year ago, from Neiman Marcus and shifted it out of reach of creditors – said act of collateral stripping. More in a moment.

And the net loss of what is left of Neiman Marcus jumped 57% to $31.1 million, bringing the loss for the first three quarters to $88.4 million.

Sales at its US online operations are languishing, with a growth of just 1%, even as e-commerce for other retailers is booming. But note, even at Neiman Marcus, its US online sales, at $318 million, account for 30% of its total revenues. Quarterly sales at its brick-and-mortar stores dropped to just $731 million in the quarter.

The “definitive agreement” with creditors was also on the announcement menu on Tuesday (filing). Creditors – what other options do they have if they don’t want to get crushed in bankruptcy court? – agreed to a deal that would effectively extend the maturity for various portions of the debt, via an extension agreement and via an exchange of bonds, from 2020 and 2021 to 2023 and 2024.

It would have been nearly impossible to find the financing to pay off the bonds coming due in 2020; and that would have been the bankruptcy date. Now that can has been kicked down the road for three more years.

By now, most of this debt is owned by distressed debt funds, such as above-mentioned Marble Ridge Capital, that acquired it for cents on the dollar. Their hope is to push up the value of this debt, and perhaps sell it, or at least collect the big-fat yield for a while. For example, the new and unrated 8% notes that mature in October 2024 now are going for 45 cents on the dollar, according to Finra, for a theoretical yield of 28.7% — theoretical because there is a risk Neiman Marcus might not be able to make the interest payments and might in the end not be able to pay off the bonds.

These creditors also agreed to a deal over MyTheresa. If Ares and CPPIB are able to sell the site, creditors would get the first $450 million of the proceeds. In return, creditors agreed not to sue over the transfer of MyTheresa to Ares and CPPIB, thus conceding to the transfer of the collateral represented by MyTheresa, rather than trying to have a court put an end to this form of “collateral stripping.”

The hope for these creditors is that today’s steamy-crazy white-hot IPO market would allow MyTheresa, which is just a small-ish online retailer, to be sold to the public for a mind-boggling premium so that they could collect their $450 million.

Ares and CPPIB have now taken collateral stripping to the next level, from a more limited version pioneered by the owners of J.Crew – TPG Capital and Leonard Green & Partners, which had acquired the retailer in 2011 via a leveraged buyout.

By 2016, as J.Crew was on the verge of bankruptcy, the owners extracted the intellectual property behind the brand name from the collateral pledged to existing creditors. Then in 2017, they offered this intellectual property as collateral to new creditors and by doing so, were able to borrow again – thus kicking bankruptcy down the road. Alas, in March 2019, bankruptcy once again showed up on the agenda as J.Crew once again started discussions on restructuring its debt.

BC Partners in London, the PE firms that owns teetering PetSmart, is doing a similar thing when it transferred a stake in Chewy.com, which PetSmart had bought for $3.4 billion, to a special subsidiary that would be hard to reach for bondholders in case of a bankruptcy, and transferred another stake in Chewy.com to the parent holding company, where it would be even more difficult to reach. Now it’s getting ready to sell Chewy.com via an IPO, and it might throw stiffed creditors a few crumbs to entice them to go along.

And throughout these processes, PE firms are turning the idea of “collateral” into a mirage that can just vanish.

It’s happening one frustrated retail customer at a time. But I doubt there are other options. Read…  Here’s How I think E-Commerce Is Wiping Out Brick & Mortar

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  56 comments for “The Fed Calls it “Collateral Stripping.” These PE Firms Took it to the Next Level and Just Got Away With It

  1. Timothy J McLean
    Jun 12, 2019 at 4:09 pm

    Great information Wolf! This provides further evidence to support the thesis when the junk and almost junk bond market crashes, it will make most of these securities worth close to zero.

    • Jun 13, 2019 at 11:02 am

      Or it proves how resilient the junk bond market really is

  2. Adam Silber
    Jun 12, 2019 at 4:11 pm

    Neiman Marcus has engaged in shadey behavior for years..this is no suprise

    • Charles
      Jun 14, 2019 at 4:12 pm

      Plus the company is in court again for their data breach..millions they dont have will be needed to finally settle that one

  3. IslandTeal
    Jun 12, 2019 at 4:18 pm

    Good article.. Thanks. Just read the IPO pricing announcement for Chewy. Range of $19-21. Only lost $268M on $3.5B of revenue. What a joke…

    • qt
      Jun 12, 2019 at 5:09 pm

      Don’t forget CrowdStrike too

    • Jun 12, 2019 at 5:34 pm

      Have they learned nothing from Pets.com?

      • Jun 12, 2019 at 11:56 pm

        I think what they learned from pets.com is to IPO quick when the market’s hot. Then it’s someone else’s problem.

      • Morty Mc Mort
        Jun 13, 2019 at 8:56 am

        YES!! – They have learned that they can Rape, Pillage, and Steal. The SHEEP LOVE it!!!!

  4. kitten lopez
    Jun 12, 2019 at 4:20 pm

    astounding report… almost makes you wanna go back to reading troll comments before bed, eh?

    (smile)

    • HowNow
      Jun 12, 2019 at 6:30 pm

      Astounding, yes. I hope this makes the laissez faire, “free marketers”, wince because financial plundering is just unregulated capitalism; and it’s legal. There has to be someone in Congress with ia brass pair to put an end to this. Or at the least, not allow pension funds and similar to get within 5 miles of ownership of these entities.
      “Nero fiddled as Rome burned.”

      • MD
        Jun 13, 2019 at 2:35 am

        Yes this is what ‘libertarians’ fail to understand (or willfully fail to acknowledge) – the unregulated world of capitalism isn’t a promised land of wealth and prosperity for all, it’s a land of corporate anarchy, a land in which the wealthy gain more and more political access and wealth/income gaps accelerate as they use that access to gain favor.

        In short – it’s the way to what we refer to as the ‘third world’. Those countries aren’t ‘poor’ per se, it’s just that all their wealth is appropriated by their plundering elites, who cut the place up for themselves, their families and their friends.

        • Jack
          Jun 13, 2019 at 9:07 am

          No MD you’re as Individuals ( living in the US ) in full ownership of this blasphemy that you call ( free market)!

          The answer is in your hands one by one and each one of you, and it’s called VOTE.

          So in the Next election get off your collective Big backsides and vote ( for decency and honor first) and the rest of your problems will be easy to solve.

          So don’t blame Russia’s hackers,
          Or the Chinese underhandedness, the blame is fairly and squarely in your court.

          You as collective have chosen to ignore the continued crimes that your political and business leadership have committed and continue to commit and the Turkeys are coming home to roost.

          The Values that gets all decent humans together are one and have no replicas.

          Vote for a correction or keep bending over whilst you getting er…..( plundered)!!!

        • Wander
          Jun 13, 2019 at 9:45 am

          Respectfully – I don’t think you know any libertarians.

          I am one and work in private equity (mainly more toward the private credit side) and could not disagree more with the approach of these large LBO transactions and the wild west asset stripping of businesses.

          I think they give they give the industry as a whole a really negative image where there are tons of firms actually focused on creating value for their investors vs egregious financial engineering their way to a return.

      • Saltcreep
        Jun 13, 2019 at 6:38 am

        The selection processes for achieving high office in various walks of life tend to favour sociopathy and corruption, and therefore are mostly quite effective at weeding out people with strong ethics along the way. I suppose one or two slip through now and then, but I guess they get identified, sidelined and put into things like working groups or subcommittees on stationary procurement regulations or something.

      • polecat
        Jun 13, 2019 at 10:40 am

        Ahhh .. the klasping of hands, and the nashing of Ferengi teeth, as those fine, standup PE folks in their crisp, taylored snooty suits acquire their ‘acquisitions’ ….

        These people need to be sent ‘off planet’ .. for the greater good.

  5. 2banana
    Jun 12, 2019 at 4:46 pm

    The massive amounts of money of the eight years of QE and ZIRP needs to find a place to die.

    Cheap and easy money (debt) always bubbles up in these insane deals.

  6. Petunia
    Jun 12, 2019 at 5:08 pm

    The luxury websites don’t provide a luxury shopping experience but still charge full retail. I don’t get it. I might buy something if I considered it a bargain, but otherwise I would wait to get to NM. Buying luxury online is like buying perfume by having someone describe it.

  7. timbers
    Jun 12, 2019 at 5:13 pm

    Asset stripping Hmmm…I’m confident the Fed is an expert on that subject.

    They just call it different names like QE, ZIRP, Operation Twist, Balance Sheet, Easing, Patient…

  8. HR01
    Jun 12, 2019 at 5:33 pm

    Wolf,

    I remember well the Neiman LBO 2.0 in 2013 (LBO 1.0 was in 2005).

    Commentary on the second deal raised lots of eyebrows as it was the first deal since the GFC to include a PIK toggle. If not mistaken, may have been Neiman LBO 1.0 that first introduced this feature.

    When the 2013 LBO was announced, leverage in the deal was estimated at 7.3 times earnings. In other words, doomed from the start.

    Remember reading some comments (not sure if it was in Reuters or Bloomberg) from a banker prior to the 2013 deal being finalized:

    “It’s a great asset…but we don’t want to be the bank that gets caught out if the market turns…”

    • Harrold
      Jun 12, 2019 at 5:41 pm

      Neiman’s just doesn’t seem like a big enough retailer to ever pay back all that debt.

      • Petunia
        Jun 12, 2019 at 5:54 pm

        At every price point, they all sell the same things. There is no exclusivity, no reason to buy now. Most of the stuff eventually lands up at the discounters.

        • panatomic-x
          Jun 13, 2019 at 2:56 am

          they don’t call them needless markup for nothing.

  9. Mike Earussi
    Jun 12, 2019 at 6:05 pm

    This kind of asset stripping has been going on for decades and is pretty SOP. And since this behavior is very well known (and expected) by everybody the investors who are stupid enough to help fund a leveraged buyout get exactly what they deserve–and NO sympathy.

    • Old Engineer
      Jun 12, 2019 at 8:42 pm

      In other words: A fool and his many are soon parted.

      That was the first thought that crossed my mind.

    • RepubAnon
      Jun 12, 2019 at 11:16 pm

      I wonder what happens when nobody buys the bonds any more… if you know you’re buying paper that isn’t even 2-ply, soft, and pleasantly scented, why buy it?

      As I recall, the stock market took a long time to recover after the South Sea Bubble. I expect once these leveraged buyouts start crashing one after the other, the markets will dry up (only so many fools have enough money to part with to keep these schemes flying.) . At that point, I suppose they’ll invent a new scam.

      • Nat
        Jun 13, 2019 at 5:00 am

        One would think there would be a limited supply of greater fools, but it seems like the world is somehow just starved for financial assets to invest in. Argentine defaults five times in the 20th century, and then issues 100 year bonds – based on history those should would be defaulted on five times over (if that were possible) before the principle payment would be made, and yet buyers lined up to snag them. In short there are already far worse deals then PE leveraged buy-out bonds and these even worse deals still get people to line up in droves every time. The PE bonds may someday cease to get bidders, but that likely won’t be until long after the even worse deals do.

    • GSW
      Jun 13, 2019 at 9:20 am

      Exactly, it’s all part of the game. Carl Icahn was doing this to TWA in the 80s; only difference is instead of overseas routes and Heathrow landing slots, they’re stripping IP and subsidiaries.

      Same dance. The lenders signed up to these provisions. So they can’t play dumb or the victim card here.

      The worst loans are made in the best of times.

      • MC01
        Jun 13, 2019 at 2:12 pm

        What Carl Icahn did to TWA was actually different than the typical M&A in the retail sector financed py PE money.
        When Icahn effectively bought TWA in 1985, the airline was losing money. A lot of money to be honest: TWA had somehow adapted to deregulation but its aging aircraft fleet was getting expensive to operate and domestic US operations were not doing well. Icahn told TWA employees, creditors and shareholders what they wanted to hear: he’d use his financial acumen to make the company profitable again. Very profitable. In 1988, the year TWA reached its high water mark by carrying close to 50%(!) of the North Atlantic traffic, Icahn effectively killed the company by taking it private. Icahn made a killing (rumored to be well north of the $250 million mark in 1988 dollars, after taxes) while TWA was saddled with a further $540 million debts in 1988 dollars, debt it could not afford to take on at a time when the company desperately needed to replace its Boeing 727 with something more efficient and start thinking about a replacement for the aging 747-100 and Lockheed L1011.
        Everything else Icahn did was just gravy (for him): his master plan had been to take the company private to make a killing all along and he succeeded pretty much without any opposition. After all under his watch TWA made a big $110 million profit in 1987 and was beating the competition into a pulp on the Transatlantic market. Icahn was the financial wizard who had turned TWA around in just two years.
        It was diabolically cunning.

        By contrast modern PE takeovers show no subtlety. They are the equivalent of using dynamite to get to the bank safe: as Arsène Lupin (interpretated by the great Georges Descrières) once said everybody can do that.

  10. David Hall
    Jun 12, 2019 at 6:17 pm

    It’s only when the tide goes out that you learn who has been swimming naked.

  11. Auld Kodjer
    Jun 12, 2019 at 6:24 pm

    The blatant greed / theft by the PE firms like Warburg Pincus, TPG, and Ares is pretty much a given nowadays. Endless case studies here and elsewhere.

    But the Canada Pension Plan Investment Board joining in this behaviour? Wow. The moral compass of the corporate world really has collapsed.

    • KPL
      Jun 12, 2019 at 9:46 pm

      “The moral compass of the corporate world really has collapsed.”

      Yup! My bigger grouse about it is that capital being wasted.

      By stopping such practices of daylight robbery, the capital will find a home where it could be put to good use and probably benefit people. But then when enriching oneself through devious means without any roadblocks whatsoever what can one say of that society. Sad indeed.

      • Iamafan
        Jun 13, 2019 at 7:22 am

        Yes indeed. Capital is wasted because it’s too cheap. A good sign that interest rates are too low.

        As an example, the yield on the 10Y Treasury (actually 9-Year 11-Month Note) auctioned yesterday at only 2.13% was even lower than those in 2017.

        I am afraid that they are striping the country and old people out of INCOME and not just collateral.

      • lenert
        Jun 13, 2019 at 7:50 am

        Aw come on – this capital is finding a nice home in the Hamptons. It’ll be fine.

    • MD
      Jun 13, 2019 at 2:41 am

      They will argue of course that they are forced to behave in this way to get the returns their customers need – and they are right to a certain extent, as the days of steady 5% PA returns on low-risk annuities etc. slowly building a nice pension pot appear to be permanently over.

      We are ALL it seems now expected to become financial speculators in order to provide for our future – and more fool us if we don’t, that’s just ‘survival of the fittest’.

      I have a feeling in two-three decades’ time the societal effects of this way of thinking will be profound.

  12. GSW
    Jun 12, 2019 at 6:41 pm

    You have to know the deal you’re signing up for as a lender. 80% of these deals are covi-lite (compared to 10% in 2008) and the terms have gotten ridiculous in larger cap deals. But enough people are saying yes to get the financing done. They now have a “J Crew blocker” provision to try to close these loopholes in new deals but credit agreements have so many holes, EBITDA addbacks and baskets the sponsor can drive a truck through them currently; all because money is chasing yield.

    I do think this calls to mind how much unregulated money is chasing yield in these asset classes. The banks have been largely shut out since the last crisis but all this risk is now in levered funds, shadow banks, CLOs, etc. They have leveraged loan ETFs now, I assure you most mom and pop investors have no idea what they’re signing up for. Caveat emptor. I’m fine with pushing the risk out of depositors hands so long as we let the ones that get caught naked fail. I assure you there will be sob stories about some pensions or retail investors who were “duped” into chasing yield in this asset class.

  13. Chadwick
    Jun 12, 2019 at 7:05 pm

    It amazes me that anyone is willing to lend these companies any money whatsoever. Better to leave capital rolling over in 28 day T Bills than chasing loans with no collateral.

    • Old Engineer
      Jun 12, 2019 at 8:49 pm

      You mean: “..chasing loans with no collateral” to tanking companies whose business model is in decline. If New York legalizes the sex trade you’d have a better chance getting your money back if you loaned it to ladies of the night to buy lipstick and mini-skirts! (I’m sorry, this whole issue is just a joke. Do any of these tanking retailer LBOs succeed?)

  14. Javert Chip
    Jun 12, 2019 at 8:33 pm

    As far as I can see, the right people are sitting on both side of the table (other than the painful fact some are playing with OPM). This is like a bunch of cannibals sitting around wondering who they should invite for dinner tomorrow night.

    Maybe if our politicians ever got tired of Russian collusion, they could pass some laws against this blatantly unethical law-of-the-jungle behavior.

    • HowNow
      Jun 13, 2019 at 4:10 am

      Javert, I’d like to get a better understanding of what you mean by “ethical”. Ethical for stakeholders, for society, or both? If the only reason for a business to exist is to earn profits for stakeholders, the only ethic is earning that money within the legal framework, however narrowly they can cut it. No?
      So, by “jungle” do you mean barbaric, primitive, lawless?? Can you elaborate? These PE exploits are technically “legal”.

  15. Old-school
    Jun 12, 2019 at 8:38 pm

    The world is upside down on valuation. I made a large for me investment in the space Chewy is going after. The company ticker PETS is online pharmacy but sells food and accessories as well. No debt, tons of cash and great dividend. How does market reward it? 1.2xsales and a 9 PE. Chewy is going to market at around 2xsales, no chance of earnings for a few years and tons of debt. Its all about leveraging up to grow the top line with tons of debt. It’s definitely not the Ben Graham way (Intelligent Investor author).

    • HowNow
      Jun 13, 2019 at 11:07 am

      Have you seen the amount of the float for PETS that is shorted?

  16. nofreelunch
    Jun 12, 2019 at 9:57 pm

    Part of my job is evaluating assets of public and privately traded companies. There is no comparison. If public companies overvalue assets, bad things can happen, even SEC violations with criminal penalties, or shorts driving equity prices to zero. Private companies can say whatever they want, and as a result their assets are consistently valued way too high. Stay away from PE holdings. They are living in a fantasy land.

  17. Bill from Australia
    Jun 12, 2019 at 11:53 pm

    Perhaps its time to name, and shame, with photos just who these criminals are .

    • HowNow
      Jun 13, 2019 at 4:14 am

      Do you mean the U.S. Congress? Their photos are readily available.

      • mark
        Jun 13, 2019 at 7:09 am

        Yep The US Congress. The War Party Of The Rich

  18. Old-school
    Jun 13, 2019 at 4:59 am

    The other thing that seems screwy is that on the Chewy IPO it appears to me that by releasing a small sliver and having the rights as stayed in SEC documents to either buy or sell additional shares they are falsely pegging market price in a public company.

  19. truthalwayswinsout
    Jun 13, 2019 at 5:10 am

    The mob invented the asset stripping business plan.

    The mob didn’t perfect it and really make it work like Wall Street has done.

    • Petunia
      Jun 13, 2019 at 10:14 am

      Who do you think works on WS?

      • Jun 13, 2019 at 2:55 pm

        My nature channel analogy is the vulture, recycling a lot of monetary carrion. There is a whole lot of malinvestment, circa 2008, and the carnage has yet to run its course, and you will wonder where are the vultures?

  20. Tang
    Jun 13, 2019 at 9:58 am

    Ha Grigory Potemkin.
    The modern Potemkin village or villages now, the e-commerce site, the dot com valued at billions by stake holders and dumb dumbs are all build in the clouds.
    Admired also by many who click click all day.
    There are always parallels in history.

  21. c smith
    Jun 13, 2019 at 10:20 am

    ALL of it aided and abetted by central banks. PE now “owns” over 1/3 of the U.S. economy. What would this fraction be if QE/ZIRP had never happened?

  22. Jun 13, 2019 at 11:11 am

    PIK is right out of Bob Prechter’s doomsday predictions. He suggests sovereigns who buy corporate debt will use that to unwind their mistakes (deferred assets). USG is the firewall between insolvency, bankruptcy and corporate debt. It would be ironic should the courts undo that, and these are cases which I suspect cannot be laid on SCOTUS doorstep for a hockey stick reversal. Just listened to Paul Tudor explain how 80% of the tax cut went to shareholders. We know where the bread is buttered and which side it lands on when it hits the floor.

  23. CreditGB
    Jun 13, 2019 at 11:48 am

    Any value is long gone. See “Sears” Wash, rinse, repeat.

  24. robt
    Jun 13, 2019 at 7:43 pm

    Hudson’s Bay Co., founded 1670, aims to go private, conditional on the sale of retail assets in Germany for 1.5 billion dollars. They have lots of valuable property in Canada. The owners did an IPO in late 2012 at 17 for 365 million dollars for 20% of the company, shares went to about 30, latest price 6, the announcement is to buy the shares outstanding for 9.45.
    Bye Bye HBC.

    • d
      Jun 14, 2019 at 11:28 am

      Why Bye bye, take it private, later High-price IPO of profit making company, share price drop Take it private, rinse repeat.

      DEll is playing that game.

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