Tuesday, January 08, 2019

Ripped Toughskins

Sears Holdings, which owns Sears and Kmart, announced today that it is closing all its stores.  After 126 years Sears is done.  This CNBC article has a good summary of Sears' decline.  I don't believe Sears' death was inevitable.  It did face tough competition from Walmart and Target and then Amazon, but Target and Walmart have not gone out of business due to Amazon.  Sears did not have the retail management expertise to face its rivals and shifting consumer tastes and buying patterns.  This passage from the CNBC article gets to the heart of what happened to Sears:

(Eddie) Lampert saw opportunity in both (Sears and Kmart). The former Goldman Sachs intern had wowed investors with his ability to turn around the auto parts store . Armed with his hedge fund ESL Investments and the confidence of a man nicknamed “the next Warren Buffet,” Lampert believed he could concoct a similar turnaround in Kmart and Sears. He believed he saw value where others didn’t.
Lampert bought Kmart out of bankruptcy through ESL and ultimately combined it with Sears, to create Sears Holdings Corporation.
But Lampert was battling a national decline in the department store industry, as shoppers abandoned the mall and favored casual over formal wear. Department stores accounted for 14.5 percent of all North American retail purchases in 1985 but only 4.3 percent last year, according to Neil Saunders, managing director of GlobalData Retail. Sears’ peers, like Bon-Ton and Mervyn’s, whittled away, while rivals like and poured money into their businesses to be among the ones left standing.
Walmart and Target proved relentless in their competition. The companies scaled quickly and poured money into private label brands, which were better in quality than those sold at Sears and Kmart.
As Sears’ competitors invested in its stores, Sears took a different approach. Lampert believed that a strong loyalty program and data made investing in stores and advertising optional, people familiar with the situation have said. Then, as Sears’ sales fell and its losses piled up, it no longer had a choice — investment fell out of reach.
Sears shrank its store-base, in a desperate attempt of to regain profitability. The stores that remained were in disarray, with outdated fixtures, dark lighting and piles of unwanted clothes. Sears lost relevancy and its customers’ loyalty.
I am not upset about Sears, but it is another example of private equity buying a retailer and then not having the retail skills to operate the business.  Confidence and access to capital are great, but they are not the same as retail expertise.  If you are a landlord and a private equity firm buys one of your retail tenants you better start reserving for the day that tenant stops paying rent.

Separately, and much cooler than Sears' closure, is this episode of the podcast 99% Invisible about Sears Roebuck selling complete home kits through the mail.  The Sears' homes included everything to build a home, all the way down to light and plumbing fixtures, along with complete instructions.  Sears may soon be gone, but some of its mail order homes and other buildings are still in use.

Monday, January 07, 2019

Energy Embargo

FS Energy and Power Fund announced in an 8-K today that it has decreased the price at which it it issues shares under its distribution reinvestment plan from $6.50 per share to $6.10 per share, or a drop of over 6%.  I view the prices at which business development companies (BDCs) issue shares as part of their distribution reinvestment plans as a proxies for their net asset values.  FS Energy and Power is an energy sector BDC, and is, apparently, facing the same industry-wide problems as other leveraged loan lenders, which I mentioned late last week

Another PE Example

Here is another example of a private equity firm buying, stripping, ruining, and closing a retail firm.  This Washington Post article describes Sun Capital's acquisition and management of Marsh Supermarkets, with a particular emphasis on how Sun Capital used bankruptcy to get out of meeting employee pension obligations.  These stories seem to write themselves: Wall Street bankers start a private equity firm and raise investment capital, buy a business they now nothing about and have no skills to run or improve, sell valuable assets, leverage remaining assets, declare bankruptcy and close business, all the while taking out big fees and salaries.  This is a lopsided ledger, but Sun Capital's investors got their money out, probably at some positive Internal Rate of Return, so Sun Capital can claim its investment in Marsh Supermarket a success to raise more money and inflict its management on another company.

Thursday, January 03, 2019

Financial Times Article

Boy, my last post was in late September and titled Disappearing Sponsors.  I did not also mean disappearing blogger.  Well, I have not gone away yet, although the sales to many alternative investments have gone away.  I will be honest, though, I am thinking of more effective ways to express my thoughts on alternative investments.  This blog will be just one outlet.

The Financial Times does not like links to its website, but it has an article from December 30, 2018, on KKR, Franklin Square, and Blackstone GSO that is worth your time to find and read.  The point of the article is that KKR has initiated big write-downs on some of the loans in the Franklin Square Investment Corp BDC that were originated by Blackstone's GSO.  (This BDC, after its merger with Corporate Capital Trust, re-named itself FS-KKR Capital Corp and trades under the symbol FSK.)  The write-downs is not new news to anyone that watched the falling stock price of FSIC or the lowered NAVs of the FS Investments' non-traded BDCs.  What has caught the attention of analysts is KKR's ballooning of the watch list, which tripled in 2018, and now encompasses 28% of the portfolio.

It looks like the high yield and leveraged loan market is going to be a story in 2019.  The Financial Times has had some good recent articles on the issues facing the high yield market.  In the KKR article noted above, The Financial Times notes that, industry wide, 70% of the leverage loans being issued are "covenant-lite," which means the loans lack the strict controls that would allow creditors to seize assets of under performing loans.  This also means that the underlying business do not have to meet as strict an operating criteria as do loans with stronger covenants.  The saying that "it was all good until it wasn't" could be 2019's leveraged loan market mantra.

Thursday, September 20, 2018

Disappearing Sponsors

Last summer I watched And Then There Were None, a televised version of Agatha Christie's famous novel of the same name, where guests on a weekend stay at a desolate island mansion end up murdered, one by one.  Yesterday's news that Steadfast is exiting the non-traded REIT and credit business adds to the list of sponsors that are pulling their offerings.  I feel like I am watching a non-murderous version of And Then There Were None. 

Last year Steadfast tried to rebrand as Sitra Capital Markets, but the made-up name did not resonate and Steadfast made the decision to shuttered its Apartment REIT III and its Sitra Alcentra Global Credit Fund.  The REIT raised $197 million over two-and-a-half years and the credit fund raised just $36 million in about fifteen months. 

CNL is not stopping syndication, but did announce last week that it was not extending the offering for Healthcare Properties II, which only raised about $45 million since its inception in March 2016.  Like CNL, Griffin Capital is not stopping syndication but announced in mid-August the close of its Essential REIT II offering.  According to filings, the REIT has formed a special committee to review a potential strategic alternative.  Essential Asset II started its latest offering in September 2017, but only raised $7.3 million in 2018. 

Sponsors continue to suspend their offerings and/or exit the syndication business one-by-one.  Based on industry sales, there are so many candidates that I don't even want to start to guess what sponsor will be the next to yank its slow selling program. 

Tuesday, September 18, 2018

Ten Years On

I just re-read a bunch of my posts from 2008 as the financial world collapsed.  I sure posted a lot in 2008, several posts a day.  I noted Lehman's collapse, now seen as the pivotal point in the financial crisis, with a "WOW!" But it was just one of two big deals that September weekend, and it happened alongside with the implosion and Government bailout of AIG, action which was spurred by the market's negative reaction to the non-bailout of Lehman. 

I don't want to relive that trauma.  I remember turning on Bloomberg TV late at night that fall, after everyone in house had gone to bed, and watching the Asian markets to see what dread Europe and the US could expect the following day.  Not that my fears and news addiction would have any impact, but I had to know. 

It is hard to see inflection points as significant as they happen, especially if they occur amidst other events that appear major.  But Lehman's demise was different.  It showed that the Fed and Government had to step in to save the financial system from a complete collapse, especially as much larger firms than Lehman teetered towards financial ruin.

What scares me today is that I know the lessons of 2008 have not been learned, or if learned are not being heeded.  The housing market is inflated in many parts of the country, lending standards are down, and regulations enacted after 2008 to protect the financial system have been relaxed or eliminated.   It is important to note, too, that some areas devastated in 2008, like Southern California's Victor Valley, have been slow to recover, even after ten years. These communities need a stable banking system to continue their recovery. 

I am also frightened to think that any future financial crisis will be met with much stiffer resistance to Government bailouts of banks. This thinking is wrong because letting banks fail is going to wipe out retirement accounts and the housing market, including million's of peoples' equity in their homes.  Argue your political ideas on Twitter, not with the equity I have built over many years with a conservative mortgage. 

Wednesday, August 22, 2018

Colony and RXR: Make Investors Whole

Dear Colony and RXR,

Your non-traded REIT, NorthStar/RXR New York Metro Income, Inc., at around $38 million in investor capital, is just a speck in both your commercial real estate investment empires.  It is unfortunate that this REIT did not catch on with financial advisors, especially given the quality of the RXR management team and its long-term successful track record.  It's an ugly reality that sometimes financial advisors and their clients find investment funds that pay unsustainable 8% distributions and acquire dubious assets preferable to lower initial distributions and the potential for real long-term value appreciation.

As you know, New York Metro Income has two investments and a net asset value of $8.49 per share.  I read your filing yesterday, August 21, 2018, about your plan to liquidate the REIT's assets through a series of asset sales and internal transactions, and your generous offer to forfeit your shares to increase distributable cash to investors.  I did not, however, after reading the filing several times, note any mention of an intent to return investor capital in full.  I figure, based on a $10.00 per share offer price and the $8.49 NAV per share, that Colony and RXR would need to contribute $5.7 million, or about $2.9 million each to fully return investor capital.  I know that $3 million is not nothing, but it is a small amount to pay for firms of your size, and the goodwill you'd accrue with investors, financial advisors, and the broker dealers that invested with you would be far greater than $3 million.


Rational Realist

Tuesday, August 07, 2018

Bad Lenders

This Bruce Kelly article in InvestmentNews on two failed lenders raises some important issues.  The lenders are being investigated for loan fraud. I am not sure if the fraud is from the securities the two lenders sold to investors or the loans they made to small businesses.  For investors that likely lost their entire investment, it does not really matter.  One red-light-flashing issue to me is proper return for appropriate risk. Any investment that is paying 10% for a less than one-year hold period is risky; probably much riskier than the 10% potential return.  Assuming there is no fraud involved, I wonder how many investors would sign up if they were told that there is a better than 50% chance they could lose all their money to get 10%?  Not many. 

The second issue, and again assuming no fraud, is that lending and credit analysis is hard.  It is hard even for the biggest banks, which work in a strict regulatory environment with its own lending guidelines, and which have spent decades honing their credit analysis.  These banks are still far from perfect and they are considered the best.  Big private equity firms and their debt-focused divisions or competitors*, while outside of much of the regulatory environment facing banks, have established their own credit criteria and safeguards, but again these big non-bank money lenders are far from perfect.  Then you get down to firms like the fraudsters in the InvestmentNews article.  I can't imagine these outfits having credit expertise and procedures that approach even the smallest community bank.  Investors had no chance.

*Non-bank banks continue to grow and are an important part of the credit industry.  According to a recent Baron's article, private debt fund managers raised $107 billion in 2017.