Brooks Brothers’ first week in bankruptcy court, marked by a last-minute switch of debtor-in-possession financing lenders, shows how the retailer may be gearing up for a possible going concern sale.
When the retailer began its proceedings in Delaware last Wednesday, its owner and chief executive officer Claudio Del Vecchio told WWD that although the company had entered the proceedings without a stalking-horse bidder despite exploring a sale of the business for years, it hopes for a relatively quick trip through bankruptcy court that would culminate in a sale.
There are some early indications of how the centuries-old classic men’s wear retailer might pull this off. In its first-day hearing last week, the company revealed it had received an $80 million DIP facility offer from a joint entity of licensing company Authentic Brands Group and mall operator Simon Property Group, to replace the $75 million offer from WHP Global that it had entered the process with.
The DIP by the ABG and Simon entity, which the court has preliminarily approved, establishes swift milestones in the case for a potential sale to be completed within 88 days of Brooks’ Chapter 11 petition. The apparent contest to provide the retailer’s DIP financing, and the involvement of Simon Property at this stage, is notable, bankruptcy experts said.
“It’s an interesting change in retail bankruptcies that the landlord is entering the process very early on by providing the DIP loan, as opposed to waiting until later in the case to assist the company coming out of the bankruptcy,” said Joel Shapiro, partner at Blank Rome LLP, who represents companies in bankruptcy proceedings. Shapiro is not involved in the Brooks Brothers case and spoke generally.
“And it remains to be seen why they’re doing it at this early stage, and we will see that play out during the case,” he said.
Representatives for Brooks Brothers and Simon Property did not respond to a request for comment.
In general, the bankruptcy process gives a company’s lenders some advantages if they’re angling to buy the business. For instance, the ability to credit bid, which is a feature of the bankruptcy code, grants DIP lenders and pre-petition lenders the right to use the amount of their loan to the debtor company as a credit in an eventual auction, if they’re bidding for the assets of the company that they have liens on. That essentially means those lenders could use the claims they own to pay toward a purchase price of those assets, if they successfully bid on them.
“The DIP lenders are in the strong position of being able to buy the company because they can then credit bid their claim,” said Edith Hotchkiss, professor of finance at the Carroll School of Management at Boston College.
Companies filing for bankruptcy over the last decade have also shown a tendency to sell their assets, experts said. Hotchkiss, who researches corporate finance and bankruptcy proceedings, said her examination of 540 large corporate bankruptcies between 2002 and 2017 showed that 18 percent of those cases involved a sale of “substantially all assets” in a going-concern process.
That percentage increased when focusing on just 288 firms that had filed for bankruptcy since 2009, with going-concern sales in about 21 percent of those cases, she said. The figures are part of an ongoing study by Hotchkiss on corporate bankruptcies. An earlier version of the study in 2016, titled “Cashing Out: The Rise of M&A in Bankruptcy,” is available on the social science research network.
The proportion is even higher when looking at companies that sell a portion of their assets as a going concern through the bankruptcy process, Hotchkiss said. In cases where there is a partial sale of assets as a going concern, such as a division of the company, the figure rises to 42 percent of the 540 firms that had filed for bankruptcy between 2002 and 2017, she said.
“It’s very typical behavior at this point for firms to essentially, well, pre-market themselves before filing, and then enter bankruptcy with either the stalking horse in place, or something close to that,” Hotchkiss said.
“To say that roughly one in five Chapter 11 cases for large corporations leads to a sale of substantially all assets as a going concern is a very good approximation.”
Brooks Brothers has indicated it plans to use the bankruptcy proceedings to shrink its footprint — the company plans to reject more than 60 leases, according to its first-day declaration in the case by Stephen Marotta, a senior managing director at Ankura Consulting Group LLC, and the retailer’s chief restructuring officer.
The company has roughly 424 retail and factory outlet stores and some 4,025 employees, and its revenue for the fiscal year ending 2019 was roughly $991 million, according to court filings. The company expects its total cash flow in the first 13 weeks of its bankruptcy to be in the range of negative $35.5 million, as its total operating disbursements exceed its projected income, according to a budget attached to its DIP financing.
A bankruptcy process can accelerate potential sale timelines, as companies sometimes invoke the so-called “melting cube” argument of needing to preserve the business as costs rise and the value depreciates.
“One of the difficulties of sitting in bankruptcy for a longer period…is maybe the negative effect it’s going to have on the business in the meantime,” Hotchkiss said. “The flip-side criticism is, you push through a sale too quickly, not realizing the highest value for the assets.
“But neither a sale or restructuring guarantees the future of the business operating,” Hotchkiss said, speaking generally about the prospects for companies in bankruptcy. “Value could be more in the brand name and not so much in the stores.”
For Brooks Brothers, however, there appear to be signs of interest in preserving the company’s future, some bankruptcy observers said, even amid the ongoing uncertainty about the future of business workwear as many white-collar professionals continue to work remotely during the pandemic for the foreseeable future.
“It shows that everyone believes it’s a strong brand,” said Anthony Lupo, partner at Arent Fox LLP. Lupo is not involved in the Brooks Brothers case and spoke generally. “I think these companies recognize the opportunity there, if they can clean up some of the debt.”