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

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Wolf Richter,

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, 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 to the parent holding company, where it would be even more difficult to reach. Now it’s getting ready to sell 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.


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