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The Great Immoderation: Beware of Money Printers In The Land Of The Bubble Blind, Part 2
By David Stockman. Posted On Thursday, April 20th, 2017
Yesterday we offered Neiman Marcus as a poster boy for the chain of economic deformations and financial mutations which have arisen from Bubble Finance.
Now comes word that the once and former toney emporium of wealthy patrons and conspicuous consumption has been reduced to borrowing money to pay interest on its staggering $5 billion mountain of debt.
Needless to say, in the age before Greenspan, customers of Neiman Marcus were quietly but pointedly advised to put their MasterCard away. Only an American Express card----preferably of the platinum variety---would do at the clerk's desk.
But now its own balance sheet is being PIK'd to death by so-called payment-in-kind bonds. The latter were invented only after the Fed began is long campaign of yield deprivation, thereby driving money managers to reach ever deeper into the eddy pools of financial risk in order to meet their return bogeys.
In the case at hand, that reach is symbolized by the company's 8.75% notes due in 2021 that are now rated CCC and trading at 57 cents on the dollar. Since it didn't have the cash to pay the coupon due last week, the company elected to issue new notes bearing a 9.5% coupon, which is to say, it will implicitly act to double its unpayable debt every 10 years.
The story of how Neiman Marcus ended up in the financial gutter is a lesson in applied Bubble Finance. For a long while the bullish beneficiaries of the Fed's "wealth effects" policies at the top of the economic ladder spent up a storm at its posh emporiums.
This permitted the company to regularly raise prices by 7-9% per year, while expanding it store base and driving its merchandise offerings in an ever more opulent direction. At one point its catalogue even included a small jet plane for $1.5 million.
This did wonders for its margins and EBITDA, bestowing upon the company the aura of a high growth cash flow gusher with an ever rising enterprise value (TEV). That is, it became LBO bait as the spread sheet jockeys of Wall Street modeled endlessly rising prices, permanently expanding margins and double digit cash flow growth as far as the eye could see. No sweat!
And we do not say this facetiously. We were in the private equity business for the better part of two decades and saw time and again the wondrous returns that small upward tweaks to same store sales and margins in a 10-year LBO model could generate.
All you had to do was believe that Ben Bernanke had more or less abolished the business cycle (modest "downside" recession cases were always modeled and usually ignored), and that prices could be raised indefinitely when it came to premium products and services.
At the same time, the lower echelons of the junk bond market boomed owing to a growing desperation for yield among bond fund managers and home gamers piling into high yield mutual funds and ETFs. The suspension of disbelief became especially acute when issuers could claim that they had "pricing power" and were surrounded by competitive moats owing to brand equity or a unique customer franchise.
Accordingly, Neiman Marcus did what no top drawer emporium ever would have done in the pre-Greenspan world. Back then any kind of debt other than a modest mortgage on the building was frowned upon, but in the financial environment of 2005 it was an altogether different story.
Neiman Marcus was LBO'd by Warburg Pincus and TPG for about $5.1 billion, and leveraged to the hilt in order to fund the transaction. In fact, the new owners along with bankers at Credit Suisse, came up with a new version of pay-in-kind (PIK) debt called "toggle bonds".
These instruments not only enabled borrowers to make interest payments by issuing new bonds rather than paying cash in the unlikely event of a downturn, but also upped the leverage ratio available at the get go. As the Wall Street Journal chronicled this chapter of the company's history:
Investors were drawn by a better yield, and PIK toggle bonds became a feature of many of the era’s corporate buyouts. To celebrate their Neiman purchase, the buyout firms hung plaques fitted with replicas of old-fashioned factory switches.
When the financial crisis hit in 2008, and sales fell, Neiman’s owners didn’t want to spook suppliers by drawing on a credit line to make interest payments, said people familiar with the matter. Instead, they issued new debt to cover payments for nine months through October 2009. In Warburg’s New York offices, employees flipped the wall-mounted switches from “cash” to “bonds,” some of these people said,
When Neiman resumed cash payments in mid-2010, Warburg employees celebrated by switching the toggle back, they said.
In any normal world the company's near death experience during the Great Recession would have been warning enough about a financial scheme that should have never been repeated. That was plainly evident from the fact that during about six quarters running in 2008-2009, the company's same store sales nearly vaporized.
In fact, during the Wall Street meltdown in the final quarter of 2008, same store sales dropped by 28% and that was followed by declines of 25% and 23% in the next two quarters, respectively. Nothing like that was in the LBO models----nor were the crushed margins and cash flows that resulted.
But soon enough, the Fed was back at the game of levitating financial asset prices through it $3.6 trillion bond buying spree. Consequently, the animal spirits returned to the top rungs of the wealth ladder and Neiman Marcus' bout of sinking same store sales quickly reversed direction.
During 2012-2013 sales soared at nearly double digit rates per store, and margins rebounded to prior levels and beyond.
As a result, a company that had been so short on cash that it couldn't scrap up the cash to pay it's coupon began generating enough cash to pay down debt, and as the WSJ further described:
.... the owners plotted their exit. They took nearly $450 million out of the company as a dividend a year before selling it for about $6 billion in 2013 to Ares Capital and the Canada Pension Board (CPPIB). The sellers more than doubled their cash investment in the deal.
Not at all surprisingly, these second gen LBO investors leveraged the company up with even more debt. By 2014, Neiman owed $4.7 billion, up 19X from $250 million in 2005. But alas, not even a tripling of the S&P 500 could keep the good times rolling.
In a word, even Neiman Marcus ran up against a ceiling on its relentless practice of making up for shrinking volumes with increasingly higher prices. During the second half of FY 2014, its same store sales slipped to just 2.2% and 1.6% versus prior year, respectively.
From there the unthinkable happened, at least in so far as the leveraged finance game is concerned. That is, even without a recession same store sales turned negative in FY 2015, and during the last two quarters have sunk by 8.0% and 6.8%.
Needless to say, the company's margins have taken a hard hit, and its cash flowed turned negative to the tune of $400 million during the last two fiscal years.
Once again, it cannot service its towering debt and meet the heavy CapEx requirements that super-luxury emporiums like Neiman Marcus inherently require.
In times gone by it would have been hard to imagine that Neiman Marcus posted a pre-tax loss of $547 million on $4.9 billion of net sales. But that negative 11% margin was exactly the outcome in 2016.
These baleful results also put the kibosh on the company's planned IPO-----and therein lies the real lesson of this story. Three times since the early 1990s, the Fed has bailed out the junk bond markets and generated roaring bull markets in the equity pits.
More often than not, this resulted in a "stick save" of wildly and inappropriately over-leveraged LBOs----exactly as happened with Neiman Marcus after the Great Recession.
Leveraged bank loans got refunded, junk bonds got refinanced for another 7-year term and private equity owners at the bottom of the heap, and who had lost everything on a mark-to-market basis, were able to profitably unload their share in an IPO or to the next gen LBO investor.
It was a giant, long-running profitable game of kick-the-can for Wall Street insiders and private equity firms. And that was exactly the plan for Ares Capital and its Canada pension partner. After two or three years of allegedly "improved" performance, they were to make the second great escape---this time via the public equity market.
But the music stopped too soon, and under a totally different and unexpected circumstance. That is, the Fed is out of dry powder and stranded near the zero bound. So this time there will be no "stick save" owing to a massive reflation of financial asset prices.
And with no prospect of a fourth revival of animal spirits at the top of the wealth ladder, there is no chance of a renewed run of booming same store sales growth, expanding margins and rising TEV capable of shouldering a renewed round of leveraged loan and junk bond financing----even with toggle switches and other Wall Street gimmicks.
To the contrary, Neiman Marcus will struggle to sustain its current results and therein lies the reckoning. During 2016 its EBITDA came in at just $600 million and CapEx requirements were $300 million.
That means that its true enterprise value based on $300 million of free cash flow is less than $2.5 billion ( 8X cash flow) or barely half it current debt.
It also means that all of those LBO profits and juicy junk bond yields that have been extracted from the company over the last decade have essentially been fraudulent conveyances. That is, distributions based on the Ponzi principle of borrowing new money to pay off old investors.
Here's the thing. The US and global economies are virtually bobby-trapped with endless like and similar long-running exercises in Ponzi-finance. But this time there are no more cans to be kicked.
The Great Immoderation: Beware of Money Printers In The Land Of The Bubble Blind, Part 2
By David Stockman. Posted On Thursday, April 20th, 2017
Yesterday we offered Neiman Marcus as a poster boy for the chain of economic deformations and financial mutations which have arisen from Bubble Finance.
Now comes word that the once and former toney emporium of wealthy patrons and conspicuous consumption has been reduced to borrowing money to pay interest on its staggering $5 billion mountain of debt.
Needless to say, in the age before Greenspan, customers of Neiman Marcus were quietly but pointedly advised to put their MasterCard away. Only an American Express card----preferably of the platinum variety---would do at the clerk's desk.
But now its own balance sheet is being PIK'd to death by so-called payment-in-kind bonds. The latter were invented only after the Fed began is long campaign of yield deprivation, thereby driving money managers to reach ever deeper into the eddy pools of financial risk in order to meet their return bogeys.
In the case at hand, that reach is symbolized by the company's 8.75% notes due in 2021 that are now rated CCC and trading at 57 cents on the dollar. Since it didn't have the cash to pay the coupon due last week, the company elected to issue new notes bearing a 9.5% coupon, which is to say, it will implicitly act to double its unpayable debt every 10 years.
The story of how Neiman Marcus ended up in the financial gutter is a lesson in applied Bubble Finance. For a long while the bullish beneficiaries of the Fed's "wealth effects" policies at the top of the economic ladder spent up a storm at its posh emporiums.
This permitted the company to regularly raise prices by 7-9% per year, while expanding it store base and driving its merchandise offerings in an ever more opulent direction. At one point its catalogue even included a small jet plane for $1.5 million.
This did wonders for its margins and EBITDA, bestowing upon the company the aura of a high growth cash flow gusher with an ever rising enterprise value (TEV). That is, it became LBO bait as the spread sheet jockeys of Wall Street modeled endlessly rising prices, permanently expanding margins and double digit cash flow growth as far as the eye could see. No sweat!
And we do not say this facetiously. We were in the private equity business for the better part of two decades and saw time and again the wondrous returns that small upward tweaks to same store sales and margins in a 10-year LBO model could generate.
All you had to do was believe that Ben Bernanke had more or less abolished the business cycle (modest "downside" recession cases were always modeled and usually ignored), and that prices could be raised indefinitely when it came to premium products and services.
At the same time, the lower echelons of the junk bond market boomed owing to a growing desperation for yield among bond fund managers and home gamers piling into high yield mutual funds and ETFs. The suspension of disbelief became especially acute when issuers could claim that they had "pricing power" and were surrounded by competitive moats owing to brand equity or a unique customer franchise.
Accordingly, Neiman Marcus did what no top drawer emporium ever would have done in the pre-Greenspan world. Back then any kind of debt other than a modest mortgage on the building was frowned upon, but in the financial environment of 2005 it was an altogether different story.
Neiman Marcus was LBO'd by Warburg Pincus and TPG for about $5.1 billion, and leveraged to the hilt in order to fund the transaction. In fact, the new owners along with bankers at Credit Suisse, came up with a new version of pay-in-kind (PIK) debt called "toggle bonds".
These instruments not only enabled borrowers to make interest payments by issuing new bonds rather than paying cash in the unlikely event of a downturn, but also upped the leverage ratio available at the get go. As the Wall Street Journal chronicled this chapter of the company's history:
Investors were drawn by a better yield, and PIK toggle bonds became a feature of many of the era’s corporate buyouts. To celebrate their Neiman purchase, the buyout firms hung plaques fitted with replicas of old-fashioned factory switches.
When the financial crisis hit in 2008, and sales fell, Neiman’s owners didn’t want to spook suppliers by drawing on a credit line to make interest payments, said people familiar with the matter. Instead, they issued new debt to cover payments for nine months through October 2009. In Warburg’s New York offices, employees flipped the wall-mounted switches from “cash” to “bonds,” some of these people said,
When Neiman resumed cash payments in mid-2010, Warburg employees celebrated by switching the toggle back, they said.
In any normal world the company's near death experience during the Great Recession would have been warning enough about a financial scheme that should have never been repeated. That was plainly evident from the fact that during about six quarters running in 2008-2009, the company's same store sales nearly vaporized.
In fact, during the Wall Street meltdown in the final quarter of 2008, same store sales dropped by 28% and that was followed by declines of 25% and 23% in the next two quarters, respectively. Nothing like that was in the LBO models----nor were the crushed margins and cash flows that resulted.
But soon enough, the Fed was back at the game of levitating financial asset prices through it $3.6 trillion bond buying spree. Consequently, the animal spirits returned to the top rungs of the wealth ladder and Neiman Marcus' bout of sinking same store sales quickly reversed direction.
During 2012-2013 sales soared at nearly double digit rates per store, and margins rebounded to prior levels and beyond.
As a result, a company that had been so short on cash that it couldn't scrap up the cash to pay it's coupon began generating enough cash to pay down debt, and as the WSJ further described:
.... the owners plotted their exit. They took nearly $450 million out of the company as a dividend a year before selling it for about $6 billion in 2013 to Ares Capital and the Canada Pension Board (CPPIB). The sellers more than doubled their cash investment in the deal.
Not at all surprisingly, these second gen LBO investors leveraged the company up with even more debt. By 2014, Neiman owed $4.7 billion, up 19X from $250 million in 2005. But alas, not even a tripling of the S&P 500 could keep the good times rolling.
In a word, even Neiman Marcus ran up against a ceiling on its relentless practice of making up for shrinking volumes with increasingly higher prices. During the second half of FY 2014, its same store sales slipped to just 2.2% and 1.6% versus prior year, respectively.
From there the unthinkable happened, at least in so far as the leveraged finance game is concerned. That is, even without a recession same store sales turned negative in FY 2015, and during the last two quarters have sunk by 8.0% and 6.8%.
Needless to say, the company's margins have taken a hard hit, and its cash flowed turned negative to the tune of $400 million during the last two fiscal years.
Once again, it cannot service its towering debt and meet the heavy CapEx requirements that super-luxury emporiums like Neiman Marcus inherently require.
In times gone by it would have been hard to imagine that Neiman Marcus posted a pre-tax loss of $547 million on $4.9 billion of net sales. But that negative 11% margin was exactly the outcome in 2016.
These baleful results also put the kibosh on the company's planned IPO-----and therein lies the real lesson of this story. Three times since the early 1990s, the Fed has bailed out the junk bond markets and generated roaring bull markets in the equity pits.
More often than not, this resulted in a "stick save" of wildly and inappropriately over-leveraged LBOs----exactly as happened with Neiman Marcus after the Great Recession.
Leveraged bank loans got refunded, junk bonds got refinanced for another 7-year term and private equity owners at the bottom of the heap, and who had lost everything on a mark-to-market basis, were able to profitably unload their share in an IPO or to the next gen LBO investor.
It was a giant, long-running profitable game of kick-the-can for Wall Street insiders and private equity firms. And that was exactly the plan for Ares Capital and its Canada pension partner. After two or three years of allegedly "improved" performance, they were to make the second great escape---this time via the public equity market.
But the music stopped too soon, and under a totally different and unexpected circumstance. That is, the Fed is out of dry powder and stranded near the zero bound. So this time there will be no "stick save" owing to a massive reflation of financial asset prices.
And with no prospect of a fourth revival of animal spirits at the top of the wealth ladder, there is no chance of a renewed run of booming same store sales growth, expanding margins and rising TEV capable of shouldering a renewed round of leveraged loan and junk bond financing----even with toggle switches and other Wall Street gimmicks.
To the contrary, Neiman Marcus will struggle to sustain its current results and therein lies the reckoning. During 2016 its EBITDA came in at just $600 million and CapEx requirements were $300 million.
That means that its true enterprise value based on $300 million of free cash flow is less than $2.5 billion ( 8X cash flow) or barely half it current debt.
It also means that all of those LBO profits and juicy junk bond yields that have been extracted from the company over the last decade have essentially been fraudulent conveyances. That is, distributions based on the Ponzi principle of borrowing new money to pay off old investors.
Here's the thing. The US and global economies are virtually bobby-trapped with endless like and similar long-running exercises in Ponzi-finance. But this time there are no more cans to be kicked.