Hilco Streambank CEO Gabe Fried and Executive Vice President David Peress co-authored the below article that appears in this month's The Secured Lender.
Asset-based lenders have never been more willing to factor the value of a borrower’s intellectual property into a borrowing base. This is especially true for lenders to retailers and consumer products companies. Many of these borrowers have well-established brands and other intangible assets that can be packaged and sold in the event of a liquidation. In the discussion that follows, executives from Hilco Streambank focus on the characteristics of intellectual property most often used as collateral, consider the steps that lenders should take to preserve asset values when a borrower is distressed, and examine available strategies in a recovery transaction. They also include a few recent examples of intellectual property sales by companies whose intellectual property had been used to secure an asset-based loan.
For many companies, their intellectual property assets are their crown jewels. These are assets that are only going to be sold in a change in control tr ansaction or in liquidation. When lenders think about intellectual property, they should think about it as broadly as possible. In the consumer-based economy, trademarks are the most prevalent form of intellectual property assets; however, often bundled around the trademarks are several other key pieces of collateral, including websites and domain names, and customer data. Product designs (which may or may not be patented), specifications and samples are another key category of assets. As a bundle, all of these assets create value. At the inception of any loan secured by intellectual property, it is critical that the lender consider the relationship of these assets to each other and the impact that stripping away one or more of these assets from the bundle will have on recovery values, in general.
Brands have value because of customer awareness and acceptance. We generally think about the relationship of a brand to its customer in terms of engagement. Successful brands maintain engagement with their customers through many channels, including in stores at the point of sale, e-commerce, social media , digital marketing and advertising. A sophisticated marketer understands how to create and maintain engagement with its customer and to engender and enhance customer loyalty. Lenders must understand the basics of this dialogue between the borrower and the borrower’s customers. In addition to monitoring sales and margin, a lender, relying on IP collater al to secure its advances, must also monitor the productivity of its client’s marketing initiatives and consider the impact on value if these initiatives are unsuccessful or unproductive.
When a borrower becomes financially distressed, a lender exposed to IP collateral must go through a checklist to ensure that brands are being supported and customer engagement is being maintained. Sometimes, this can be achieved by a shift in revenue model or distribution model. For example, a brand can be diced into smaller pieces through licensing arrangements that might shift expenses relating to product development and sourcing to a licensee. In addition, brands can be shifted into other channels, for example, from brick and mortar stores to e-commerce distribution. These shifts can often preserve or enhance the recovery value of intellectual property while reducing operating expenses and allowing for the liquidation of working capital assets such as inventory and accounts receivable.
Identifying the key corporate functions that contribute to the maintenance of a brand, and making sure that those functions are being adequately staffed and funded, is crucial. The loss of functions such as digital marketing and database management can have a profoundly negative impact on the preservation of IP value. Other functions may be less visible, but equally important. For example, a company whose brand depends on innovative product design or styling may need to maintain key design personnel in order to maintain brand value. Similarly, a company whose brands depend upon fast turns and fashion-oriented product, may need to invest to keep its supply chain intact during a financial restructuring or workout.
Maintaining these key elements of customer engagement during a workout is usually what differentiates orderly liquidation recoveries from forced liquidation recoveries. If lenders are going to underwrite loans secured by intellectual property assets to orderly liquidation values (OLV), they must be prepared to factor into their workout strategy the cost of maintaining these critical functions. If a lender is not prepared to take these expenses into account, it is best served by underwriting to lower forced liquidation values (FLV). In any consumer brand workout, time is of the essence. Loss of customer engagement almost always leads to a loss in recovery value.
Recent Examples of Distressed Intellectual Property Workouts
Recent examples of distressed intellectual property workouts substantiate these key lessons while validating the underwriting assumptions made at the inception of the loans.
RadioShack: With over 90 years of history, RadioShack was once a brand that stood for innovative solutions for consumer electronics. In 2013, RadioShack received an asset-based loan secured in part by its brand and related intellectual property. A key component of RadioShack’s brand is the promise that its product provides a lower-cost value alternative with similar functionality to higher-priced premium consumer electronics brands. The ability to deliver on this promise has sustained the Radio Shack brand, especially in underserved markets in the United States, where a consumer’s other choices may be limited to big box/mass merchants or the internet, and internationally, where the demand for personal computing and mobility equipment is high, but spending power is low. In addition to its trademarks, critical components of the RadioShack intellectual property bundle are its customer database, franchise and licensing agreements, patents and product design files.
In 2015, RadioShack commenced a Chapter 11 bankruptcy case. During the process to generate a recovery on its intellectual property, management and its lenders took several steps to maintain the critical components of intellectual property value. These steps included maintenance of its franchisee relationship management team, maintaining in place its global sourcing management and infrastructure and maintaining its customer database management, e-commerce business and digital marketing activities. Ultimately, a robust auction for the RadioShack intellectual property ensued which generated over $40 million in aggregate proceeds. This recovery represented a recovery of approximately 160% of the projected OLV recovery at the inception of the loan.
Mexx: Mexx is a fashion apparel brand based in The Netherlands. In 2012, Mexx was acquired from Liz Claiborne by a private equity firm, which financed the acquisition in part through an asset-based loan secured by its intellectual property. Mexx operated retail stores in Canada and Europe, and had wholesale distribution to department stores and specialty retailers. The Mexx brand is a contemporary lifestyle brand that fills a niche between lower-priced fast fashion and higher-priced premium fashion brands. In 2014, the Mexx brand was under pressure because of the economic challenges in Canada and the Eurozone, as well as lack of product differentiation from lowerpriced offerings. Its financial sponsor made the decision to close its Canadian operations and to stop funding its operations in Europe. A receiver was appointed in The Netherlands to liquidate the company.
During the liquidation process, the company’s lender worked with the receiver to organize a sale of the intellectual property while the Mexx retail stores were being liquidated. A critical component of the brand’s value was its acceptance in markets in Eastern Europe, where it faced less competition from established European brands and where its contemporary urban style aesthetic meshed well with consumer tastes. Ultimately, the intellectual property was acquired by Turkish textile and retail company Eroglu Holding for €21 million in January 2015. For Eroglu, the Mexx brand represents a bridge between its retail holdings in the UK and its holdings to the East. This recovery reflected a recovery approximately at the mid-point between the projected FLV recovery for the European intellectual property and the projected OLV.
Coldwater Creek: For many women, Coldwater Creek was the go-to brand for warm, colorful apparel that could be worn to the office, to a school function, or on a casual night out . Following the Great Recession, Coldwater Creek’s designs started to become edgier, more urban and contemporary in aesthetic; its core middle-market customer became disenchanted with its offerings. In 2014, it commenced a Chapter 11 bankruptcy case and soon thereafter began to liquidate its inventory and other assets, including its brand and customer database. Ultimately, the intellectual property was acquired by another recognized "Middle America" traditional retail brand, Talbots (owned by Sycamore Partners), generating a recovery consistent with the projected liquidation value. Sycamore understood that it wasn’t the customer that had abandoned Coldwater Creek, but a brand that had abandoned its customer. Today Coldwater Creek is available online and through its catalogs. It leverages the Talbots platform by opening additional channels of distribution to a broader customer base.
As the foregoing discussion demonstrates, consumer brands and related intellectual property collateral can provide a predictable source of recovery for asset-based lenders. Careful underwriting requires an understanding of channels of distribution and how a brand can be purposed or repurposed during and following a distressed sale. When done correctly with appropriate guidance at the front end and during the recovery process, intellectual property assets will generate recoveries well within predicted ranges.
David Peress is executive vice president of Hilco Streambank, a specialist in the monetization and valuation of intangible assets including trademarks, patents and domain names. He has 20 years of experience working in the corporate restructuring and distressed investing industry as both an advisor and investment professional. Until 2000, he was a partner in the bankruptcy department of Wilmington, Delaware’s Young Conaway Stargatt & Taylor, LLP. He later served as managing director and general counsel of The Ozer Group LLC, an asset disposition firm, and the chief operating officer of Ozer’s Real Estate Services Company. Following the sale of The Ozer Group, he led the special situations investing business for Crystal Capital, a multistrategy private investment fund. At Crystal Capital, Peress structured and managed debt and equity investments in several retailers and consumer products companies including Tower Records, The Sharper Image, Polartec, Cranium, Tommy Armour Golf and Bob’s Stores.
Hilco Streambank’s CEO Gabe Fried began liquidating intangibles in 2000 when he was retained to dispose of his employer’s intangible assets. During this initial assignment he learned several valuable lessons. First of all, the market needs intangible asset disposition expertise. Secondly, the principles of sales and marketing apply in each case, but cannot be effectively executed without a deep understanding of the assets. And lastly, a highly publicized auction is not always the best disposition strategy. Over the course of the next seven years Fried wore virtually every hat in the distressed intangibles world, including liquidator, auctioneer, investor, buyer’s broker, consultant, expert witness, and appraiser. Fried’s industry experience includes automotive, consumer durables, health care, retail, franchise, apparel and footwear, chemical, telecommunications, software, and more. Prior to founding Hilco Streambank, Fried was a managing director at XRoads Solutions Group, consultant to CONSOR and Gordon Brothers Group, and cofounder of IP Recovery.
By: Gabe Fried and David Peress