Distressed Value Investing

Faris Saah
Senior Lecturer
IE Business School
Tel +1 203.832.5790
[email protected]
Group Assignment – J Crew Case

Team 1 Team 4
ANZOLA KUSTERMANN
MARTÍNEZ PEREZ JIMENEZ
TELHADO MARTÍNEZ GARCÍA-GASCO
CHALON YANCHEVA
PALUCH

Team 2 Team 5
CESARI DE BENITO CARRERAS
TEJERA ECENARRO SERRADOR
KOBRIN THACKAR
CARDOSO LESSA BORGES DE CASTRO BENANT

Team 3 Team 6
MOTA PINHO ROCCAVILLA
MADEIRA PEREIRA BATTAGLIA
JADHAV KALOUST
SZALAI OJEDA FERRER
Distressed Value Investing Class – Course Timetable

Sessions Date Time (CET) Topic Room #

1–2 Mar 25 16:00 – 18:50 • Introduction to Distressed Investing V-202

• Corporate Distress and Restructuring

3–4 Mar 26 12:00 – 14:50 • Valuing the Investment Opportunity V-202

• Valuing the Investment Opportunity (Cont.)

5–6 Mar 27 12:00 – 14:50 • J Crew Case - Private Equity Ruins Retailing V-202
• Restructuring and the Key Players

7–8 Mar 29 12:00 – 14:50 • Restructuring and the Key Players (Cont.) V-202
• The Workout Process/Final Exam
Silicon Valley Bank: Bargain Buy or a Bankrupt?
SVB
• On March 8, 2023, investors were shocked to hear of Silicon Valley Bank’s
(SVB) USD 1.8 billion losses on the sale of its bond investments.
• That same day, SVB also announced an offer to raise capital for USD 1.75
billion.
• The bond loss was expected to immediately negatively affect the share
price of SVD’s parent company, SVB Financial Group’s (SVBFG).
SVB
• SVB was the 16th largest bank in the United States, with Forbes ranking it as
one of America’s best banks for 2023.
• Many investors believed that SVB’s core fundamentals were still sound. So,
they wanted to invest in SVB shares at the current market price of USD 267—
or lower if the prices fell further.
SVB
• A fund manager’s clients sought his quick advice on whether SVB was still a
good investment at the current valuation or was doomed to a bigger collapse.
• SVBFG had some non-bank-operating units, including SVB Capital, an
investment firm, and SVB Securities, a brokerage firm.
SVB
• To answer his clients’ queries, the fund manager decided to identify the
reasons behind SVB’s financial crisis and examine SVBFG’s financial
statements to estimate any signs of financial distress.
 USD in hundreds (‘00) (SVB)

0
100
200
300
400
500
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700
800
1/6/2022
1/12/2022
1/19/2022
1/25/2022
1/31/2022
2/4/2022
2/10/2022
2/16/2022
2/23/2022
3/1/2022
3/7/2022
3/11/2022
3/17/2022
3/23/2022
3/29/2022
4/4/2022
4/8/2022
4/14/2022
4/21/2022
4/27/2022
5/3/2022
5/9/2022
5/13/2022
5/19/2022
5/25/2022
6/1/2022
6/7/2022
6/13/2022
6/17/2022
6/24/2022
(JANUARY 1, 2022, TO MARCH 8, 2023)

6/30/2022
7/7/2022
7/13/2022
7/19/2022
7/25/2022
7/29/2022

SVB
8/4/2022
8/10/2022
8/16/2022
8/22/2022

NASDAQ
8/26/2022
9/1/2022
9/8/2022
9/14/2022
9/20/2022
9/26/2022
9/30/2022
10/6/2022
10/12/2022
10/18/2022
10/24/2022
10/28/2022
11/3/2022
11/9/2022
11/15/2022
11/21/2022
11/28/2022
12/2/2022
12/8/2022
12/14/2022
12/20/2022
12/27/2022
SVB FINANCIAL GROUP AND NASDAQ COMPOSITE INDEX

1/3/2023
1/9/2023
1/13/2023
1/20/2023
1/26/2023
2/1/2023
2/7/2023
2/13/2023
2/17/2023
2/24/2023
3/2/2023
3/8/2023
0
2000
4000
6000
8000
10000
14000
16000
18000

12000

USD in thousands ('000) (NASDAQ)

SVB
The fund manager asked the following questions:
• Were there any red flags that signalled this downfall?
• Did SVB miss any risk management aspects? If yes, what were they?
• Did SVB miss any warning signs of its financial distress?
SVB
To answer investors’ queries and concerns, the fund manager decided to
analyze SVB on the following two fronts:
• subjective analysis of the operational aspects and their loopholes in risk
management and internal controls
• objective analysis of its financial statements to ascertain if this distress was
evident, leading to solvency issues using the probability of financial distress
model (PFD)
The Analysis
1. Learning Objectives
1. Risks prominent in banks
• asset-liability mismatch risk
• interest rate risk
• liquidity risk
• funding risk
• market risk
2. Risks SVB faced
• Interest rate risk – To generate higher yields, SVB's balance sheet was highly
skewed towards longer-term investments, with 75 per cent of its investments in
US Treasury bonds and mortgage-backed securities.
• Asset-liability mismatch risk – SVB’s deposits (mostly short duration) had grown
enormously. For higher yields, SVB mistakenly invested these short-term
deposits in longer-term mortgage securities that had a maturity of more than
ten years.
SVB Analysis
• Funding risk
a) Since most of SVB deposits were excess money from venture capitalists,
private equity firms, start-ups, and other emerging companies, they were
invested for much less time—sometimes for only a few months.
b) Owing to their short-term nature, these funds could be demanded back
by the depositors anytime, posing considerable funding risk to the bank.
Risks
• Liquidity risk – Asset-liability mismatch coupled with SVB’s failure to identify
funding risk led to considerable liquidity risk.
• Concentration risk – SVB failed to diversify its customer base beyond the
high-risk technology and venture capital sector. on the asset side, SVB failed
to diversify its asset portfolio beyond US government bonds and mortgage-
backed securities.
Failures
• Regulatory failure risk – SVB’s fallout can be partially attributable
to regulatory failures in the banking sector. Due to concessions
under the Dodd-Frank Act , small- and medium-sized banks with
assets under USD 250 billion faced less stringent capital, liquidity,
and stress testing requirements. SVB fell under this category of
banks. The absence of preventive measures enhanced the risk on
SVB’s portfolio considerably.
Failures
• Governance failure risk – For most of 2022, SVB did not have a full-time
chief risk officer. A good quality chief risk officer would have supervised
the overall risk management functions giving periodic performance
reports and ensuring that risk was within acceptable limits.
What Happened
• The fund manager found multiple issues in SVB and identified various risks
related to interest rate, asset-liability mismatch, funding, liquidity, and
concentration of portfolio in addition to governance and regulatory failure.
• Based on the current financials of SVB, the PFD value as calculated indicated
a high likelihood of bankruptcy in the next twelve months.
• Hence, the fund manager cautioned the investors not to invest in SVB and
suggested that they pause their investments until any positive
developments/news emerged about the company.
SVB – What Happened
• SVB’s shares lost 60 per cent of their value on March 9.
• To investors’ surprise, SVB collapsed on March 10, 2024, within two days
of booking losses and disclosing its plan to raise funds.
• Taking cognizance of the bank’s inability to meet the withdrawal demand
and protect depositors, SVB was shut down by regulators and put under
the control of the US Federal Deposit Insurance Corporation.
J Crew Case A – PE Ruins Retailing
▪ On May 5, 2020, Chinos Holdings, Inc, et al (more commonly known as J. Crew)—once the
purveyor of preppy fashion basics—filed for court protection while restructuring its debts.
▪ It was the first retailer to file for bankruptcy during the COVID-19 pandemic of 2020, but
was certainly not the first retailer potentially to disappear from the retailing industry.
▪ Indeed, J. Crew was soon followed into bankruptcy court by Neiman Marcus and J.C.
Penney.
▪ The preliminary filing pertaining to J. Crew’s restructuring indicated that its private equity
owners, TPG Capital and Leonard Green & Partners, had arranged for lenders to convert
$1.65 billion of debt into equity. 22

▪ In its bankruptcy filing, J. Crew’s parent company, Chinos Holdings, Inc., indicated that J.
Crew owed claims totaling between $1 billion and $10 billion to more than 25,000 creditors.
▪ J. Crew estimated the value of its assets to be $1 billion to $10 billion—depending upon
how trademarks that had been used as loan collateral were valued following J. Crew’s 2017
restructuring.
J Crew Case A – PE Ruins Retailing
▪ J. Crew began existence as “Popular Merchandise,” an affordable women’s retailer that
was founded in 1947 by Mitchell Cinader and Saul Charles.
▪ The “J. Crew” name derived from the sport, crew, and was popularized by its catalogue
launched in 1983 that combined affordable clothing with the premium branding and
American “preppy” styling popularized by the Ralph Lauren brand.
▪ Designs were overseen by Emily Woods, Cinader’s daughter.
▪ The J. Crew catalogues featured fresh-faced, windswept models in nautical stripes on a
sailboat off the coast of some New England town.
▪ The public was entranced by its aspirational style. 23

▪ Following explosive growth in its catalogue sales throughout the 1980s, J. Crew opened
its first store in 1989 in the SoHo section of Manhattan.
J Crew Case A – PE Ruins Retailing
▪ By 1997, it operated 41 stores in 24 states.
▪ The iconoclastic Jenna Lyons was overseeing its designs.
▪ J. Crew had established a strong brand identity that was associated with the leisurely
American lifestyle.
▪ Although the company enjoyed $600 million in annual sales in 1997, it was significantly
smaller than the leading catalogue retailers, such as L. L. Bean.
▪ To increase its sales, J. Crew’s founders sold a majority stake (88%) to Texas Pacific Group
(TPG), a private equity firm whose relationship with J. Crew was so tumultuous that the initial
deal to take J. Crew private almost didn’t go through. 24

▪ An initial purchase price of $560 million was renegotiated down to $500 million after TPG
noticed that J. Crew’s same-store sales had declined by 13.6% during the September 1997
strike by workers at United Parcel Service.
J Crew Case A – PE Ruins Retailing
▪ In the 1997 leveraged buyout of J. Crew, the deal was originally financed with $175 million in
senior subordinated notes with a 10% yield and $140 million in zero-coupon notes that were
offered at 54 cents on the dollar.
▪ In negotiating a lower purchase price, TPG agreed to contribute an extra $20 million in cash
and sell J. Crew’s accounts receivable to Chase for $39 million instead of $30 million.
▪ The size of the senior subordinated note issue was reduced to $150 million. As a result of the
lowered price, Moody’s Investors Service raised the rating of those notes, but the zero
debentures remained at Caa2, or junk.
▪ TPG recruited Millard “Mickey” Drexler, a famous retailing veteran who built Gap into a
powerhouse clothing brand to become CEO in 2003. 25

▪ With Drexler’s encouragement, Jenna Lyons, who became J. Crew’s executive creative director,
introduced the world to her luxurious fashion ideas—including combinations like sequins and
camouflage, pattern- and texture-clashing patterns, and brilliant color palettes like fuchsia
with red.
J Crew Case A – PE Ruins Retailing
▪ In 2006 TPG took J. Crew public at a stock price of $40 to sell $400 million in equity; it sold the
last of its 88% interest in J. Crew in 2009.
▪ Drexler and Lyons remained at J. Crew’s helm while it was a publicly traded firm.
▪ Golden era for J. Crew in retailing – In 2006, the company launched its hugely popular denim
brand, “Madewell,” to appeal to younger female customers.
▪ J. Crew’s sales increased year-over-year as celebrities appeared in public wearing J. Crew’s
distinctive apparel. For example, Michelle Obama campaigned in J. Crew’s sequined cardigans
and pencil-thin skirts during 2008.
▪ The Great Recession had taught retailing investors an important lesson concerning collateral.
26

The retailing industry was particularly dependent on access to credit to cover seasonal
fluctuations in its expenses. As consumers spent less, firms’ accounts receivables declined.
Smaller receivables meant less collateral that retailers could borrow against. When credit
markets were otherwise frozen and collateral was decreasing, many firms were unable to get
the loans that they needed to fund working capital. A spike in Chapter 11 filings by retailers
followed.
J Crew Case A – The Leveraged Buyout of 2011
▪ TPG and Warburg Pincus had taken Neiman Marcus private in 2005 for about $5.1 billion and
sold it in 2013 for $6 billion to an investor group including Ares Management.
▪ In 2003 Eddie Lampert of ESL Holdings bought K-Mart out of bankruptcy and leveraged its
assets to acquire Sears, Roebuck in 2004.
▪ Although such transactions were ostensibly to turn around underperforming assets, private
equity owners typically sold retailers’ real estate assets for cash (so that retailers subsequently
paid rent to use their stores).
▪ Leveraged buyouts saddled acquired retailers with immense debt burdens.
▪ Private equity firms extracted their value through dividends, fees, carried interest, and
27

subsequent debt restructurings that often allowed them to recover their initial investments
during progressive refinancing activities.
▪ Executives who led their firms into such transactions with private equity often participated in
the carried interest and enjoyed the other rewards of leveraged buyouts.
J Crew Case A – The Leveraged Buyout of 2011
▪ 2010/2011 – Drexler orchestrated a second private equity buyout of the company.
▪ Drexler had been maneuvering to go private with two different investor groups but waited
seven weeks to tell J. Crew’s board of directors about his discussions.
▪ Critics complained that Drexler had put himself between shareholders and the private equity
firms by (a) refusing to consider a third private equity firm’s offer, and (b) lowering final bids
from both private equity firms (thus ignoring the board’s obligation to get shareholders the
highest feasible price).
▪ Drexler aligned himself with TPG. TPG took Leonard Green Partners as 25% co-sponsor in the
2011 leveraged buyout and their total bid was valued at approximately $2.86 billion
(assuming a price per share of $43.50—a 23% premium over J. Crew’s 20-day market price
28

average).
▪ Drexler was paid a $200 million completion bonus and reduced his ownership stake in J. Crew
from 11.8% to 8.8%.
▪ Drexler’s rationale for leading the leveraged buyout was that J. Crew needed to be a private
company in order for him to turn its operations around.
J Crew Case A – The Leveraged Buyout of 2011
▪ The retailing industry was suffering from a malaise that had infected most competitors—
including J. Crew—and private equity firms had become concerned that their golden geese
would no longer lay golden eggs.
▪ Clothing is a discretionary purchase that is dependent upon cycles within the economy,
consumer tastes, and the differentiated images of the brands themselves.
▪ Consumers and industry analysts began to comment that J. Crew’s clothes were too
expensive—particularly when compared with fast-fashion retailers like H&M and Zara.
▪ “J. Crew was out of touch,” critics ranted. “Over-styled, overpriced, elitist. Too geared toward
the moneyed cool of coastal creatives.”
29

▪ In August, 2010, Drexler issued “soft third-quarter guidance” that reflected caution concerning
J. Crew’s 2010 fiscal year outlook.
▪ J. Crew was failing to adapt to changing customer trends and simultaneous with the
announcement of its impending buyout, J. Crew announced that it would miss its third-
quarter sales forecast.
J Crew Struggles Under PE Ownership
▪ In the 2011 leveraged buyout, J. Crew Group, Inc. was acquired by Chinos Intermediate B, Inc.,
which was a subsidiary of Chinos Intermediate A, Inc., which was a subsidiary of Chinos
Holdings, Inc.
▪ The J. Crew Operating Group had many domestic and international stores that reported to it—
including its J. Crew, Inc. subsidiary, Madewell product line, and factory stores, among others.
▪ In its 3Q 10-Q, J. Crew disclosed that it settled shareholder claims adding $6 million to the $10
million shareholder settlement.
▪ During the three months ended July 30, 2011, the newly privatized J. Crew recorded a net loss
of $10.5 million, compared with net income of $34.9 million during the prior-year period
when it was a publicly traded firm.
30
▪ Stripping out costs and amortization related to the buyout as well as interest, taxes,
depreciation, and amortization, J. Crew’s adjusted EBITDA fell by 7.6% to $64.2 million, during
the three months ended July 30, 2011—as compared with adjusted EBITDA of $69.5 million
one year earlier.
▪ J. Crew’s revenues improved in the third quarter of 2011, but its net profit fell by 43% due to a
revaluing of its inventory following the buyout.
J Crew Struggles Under PE Ownership
▪ J. Crew had three credit facilities in 2011:
▪ (a) $250 million senior secured asset-based revolving facility (maturity five years from closing)
▪ (b) $1 billion senior secured term loan (maturity seven years from closing)
▪ (c) $600 million senior unsecured increasing rate bridge facility (maturity one year from closing)
▪ In early 2012, Standard & Poor’s Ratings Services reaffirmed J. Crew’s junk-level B
rating—“keeping it five notches below investment grade.”
▪ TPG and Leonard Green Partners contributed $1.2 billion in equity.
▪ J. Crew began issuing bonds to reduce its owners’ share of total equity (dividend
31

recapitalizations), service its debt, and pay $2 million per quarter in consulting and
management fees to the private equity firms that owned it.
▪ In December 2012, a dividend of $197.5 million was paid out of cash at hand. In
November 2013, J. Crew paid a dividend of $484 million (financed using payment-in-kind
[PIK] notes).
J Crew Struggles Under PE Ownership
▪ Although dividend recapitalization was beneficial to J. Crew’s private equity owners who
recovered their initial investments earlier, it was dangerous for J. Crew because—as the
company increased its leverage—there was a higher probability of default on its financial
obligations.
▪ Dividend recapitalization could potentially lead to financial distress and ultimately to
bankruptcy if J. Crew’s financial performance suffered.
▪ On November 4, 2013, J. Crew’s indirect parent holding company, Chinos Intermediate
Holdings, issued $500 million in PIK notes—7.75% cash/8.5% senior PIK (due May 1, 2019).
▪ The PIK notes were (i) senior unsecured obligations of the issuer, (ii) structurally subordinated
to all of the liabilities of the issuers’ subsidiaries, and (iii) not guaranteed by any of the issuers’
32

subsidiaries.
▪ Therefore, they were not recorded in J. Crew’s financial statements.
J Crew Struggles Under PE Ownership
▪ J. Crew declared dividends to the issuer in the first and third quarters of fiscal 2014 to fund the semi-
annual interest payments due May 1, 2014, and November 3, 2014, totaling $28 million.
▪ Additionally, J. Crew disclosed, while not required, that it intended to pay dividends to the issuer to
fund future interest payments, which would aggregate to $174 million through the remainder of the
note’s term if all interest on the PIK notes were paid in cash.
▪ In fiscal year 2015, J. Crew paid dividends of $38 million in the aggregate to the issuer to fund the
semi- annual interest payments due May 1, 2015, and November 1, 2015.
▪ On April 29, 2016, the issuer elected to pay in kind at the PIK interest rate of 8.50% instead of paying
in cash.
▪ The PIK election increased the outstanding principal balance of the PIK notes by $22.2 million to
33

$543.4 million.
▪ Therefore, J. Crew did not pay a dividend to the issuer in the third quarter of fiscal 2016 to fund its
semi-annual interest payment.
▪ Furthermore, pursuant to the terms of the indenture governing the PIK notes, the issuer intended to
evaluate the option of paying in kind prior to the beginning of each interest period based upon
relevant factors at that time.
J Crew Struggles Under PE Ownership
▪ On March 5, 2014, J. Crew refinanced its term loan facility, the proceeds of which were used
to (i) refinance amounts outstanding under the former senior secured term loan of $1,167
million, (ii) together with cash on hand, redeem in full the outstanding senior notes of $400
million, and (iii) pay fees, call premiums, and accrued interest.
▪ The maturity date of the new term loan facility was March 5, 2021. The refinancing was
expected to result in an annual savings of $16 million in interest expense.
▪ On December 10, 2014, J. Crew’s asset-backed loan (ABL) facility was amended to (i) increase
the revolving credit commitments from $250 million to $300 million, (ii) extend the maturity,
and (iii) reduce the pricing on loans and letters of credit.
▪ After refinancing, any amounts outstanding under the ABL facility were due and payable in full
34

on December 10, 2019.

▪ In the fourth quarter of fiscal 2015, J. Crew amended its ABL facility to increase the revolving
credit commitments from $300 million to $350 million. Average short-term borrowings under
the ABL facility were $17.5 million in fiscal 2015 and $1.7 million in fiscal 2014, respectively.
J Crew Struggles Under PE Ownership
▪ In addition to increasing J. Crew’s debt, the private-equity owners endured several non-cash
write downs of assets.
▪ 1H14, J. Crew Group, Inc. concluded that the carrying value of the Stores reporting unit
exceeded its fair value and recorded a non-cash goodwill impairment charge of $562 million,
of which $26 million was recorded in the fourth quarter of 2014.
▪ Additionally, J. Crew Group, Inc. recorded a non-cash impairment charge of $145 million to
write down the intangible asset related to the value of the “J. Crew” trade name.
▪ During fiscal 2015, J. Crew Group, Inc. experienced a reduction in the profitability of its J. Crew
reporting unit. As a result of current and expected future operating results, J. Crew Group, Inc.
concluded that the carrying value of the J. Crew reporting unit exceeded its fair value
35

▪ Therefore, it recorded non-cash impairment charges of (i) $1,017 million related to goodwill
and (ii) $360 million related to the intangible asset for the “J. Crew” trade name.
▪ The carrying value of the intangible asset for the “J. Crew” trade name was valued at $380.0
million on January 30, 2016.
J. Crew Restructures Its Debt
▪ In December 2016, J. Crew Group, Inc. prepared to exploit the low trading price of some of
its debt, which fell as low as 36 cents on the dollar on December 9, 2016.
▪ Debtwire reported that J. Crew, Inc. was transferring its intellectual property to a Cayman
subsidiary.
▪ This move would give J. Crew Group, Inc. a number of options to reduce its debt, including
raising new financing to buy back its loans and bonds at a discount, or offering creditors the
chance to swap into the new debt holdings.
▪ Exhibit 3 depicts J. Crew Group, Inc.’s capital structure before it completed its restructuring
process.
36

▪ Attorneys for J. Crew Group, Inc.’s private equity owners had carefully drafted the terms of
the 2011 loan agreement that governed how the firm might restructure its capital structure
J. Crew Restructures Its Debt
▪ Three covenants from the loan agreement were critical to the actions taken to implement J.
Crew’s refinancing in 2017:
1. Total Leverage Ratio: contract language permitted J. Crew Group, Inc. to create unrestricted (not
bound by loan covenants) subsidiaries as long as the company had not defaulted on interest payments
and had a six-to-one leverage ratio.
2. Negative Investment Covenant: permitted restricted subsidiaries (bound by loan covenants) to make
or hold investments only if the investment was from a loan party (the holding company, borrower, or a
guarantor) to a non-loan party.
3. Permitted Investment Covenant: permitted a non-loan party, restricted subsidiary to invest up $250
million if it had rec
▪ A critical part of the total leverage ratio clause was that leverage ratio was defined as
37
consolidated debt to consolidated EBITDA.
▪ Because EBITDA was a measure outside of generally accepted accounting principles, there
was significant room for firms to adjust EBITDA. The total leverage ratio clause specifically
permitted J. Crew to calculate EBITDA based upon projected future cost cutting, thereby
allowing the company to “achieve” the required ratio. The only requirement was that
EBITDA be projected “in good faith.”
J. Crew Restructures Its Debt
▪ In 2016 and 2017, J. Crew created several offshore and domestic subsidiaries.
▪ Within the corporate structure, Chinos Intermediate B, Inc. and J. Crew Group, Inc. were
loan parties.
▪ J. Crew Operating Group, J. Crew Inc., and J. Crew International, Inc. were also loan parties
and they were “restricted subsidiaries,” as defined in the 2011 loan agreement.
▪ J. Crew International Cayman was a non-loan party, but “restricted subsidiary.”
▪ J. Crew Brand Holdings, LLC (DE), J. Crew Brand Intermediate, LLC (DE), and J. Crew Brand,
LLC (DE) were non-loan parties and unrestricted subsidiaries.
▪ In 2016, J. Crew Group, Inc. hired a firm to value its most valuable asset, its trademark.
38

▪ The trademark was valued at approximately $350 million due to past non-cash impairment
charges. This meant that—based upon the permitted investment covenant—a non-loan
party, restricted subsidiary was permitted to move 72% of the trademark (just under the
$250 million limit) to a non-loan party, unrestricted subsidiary.
J. Crew Restructures Its Debt
▪ Because of the negative investment and permitted investment covenants, the flow of assets
had to be orchestrated in the following steps:
1. From the loan party to a loan party, restricted subsidiary;
2. From a loan party, restricted subsidiary, to a non-loan party, restricted subsidiary;
3. And finally, from a non-loan party, restricted subsidiary, on to a non-loan party, unrestricted subsidiary.
▪ In the “down streaming” step, J. Crew, Inc. transferred 72% of its trademark, valued at $250
million, through J. Crew International, Inc. to J. Crew International Cayman, and ultimately to
J. Crew Brand, LLC (DE) — ultimately leaving J. Crew, Inc.’s most valuable asset in the hands
of a non-loan, unrestricted subsidiary.
▪ J. Crew Brand, LLC (DE) then issued notes secured by trademarks, in exchange for the
39
Chinos Intermediate Holdings A notes, which were senior and secured by trademarks.
▪ J. Crew Brand, LLC received a license fee from J. Crew International for use of trademark
assets, and J. Crew International indirectly serviced the interest of the trademark notes. The
outcome of this debt swap was that structurally subordinated notes were exchanged with a
new maturity date. In effect, the newly issued notes became structurally senior to the
senior secured term lenders.
J. Crew Restructures Its Debt
▪ J. Crew brokered this deal with its debtholders to extend the maturity on its $566.5 million
junior PIK bonds from 2019 to 2021.
▪ Of the lenders, 88% voted in favor of the debt swap. However, term lenders Eaton Vance
Management and Highland Capital Management LP sued on June 22, 2017, claiming that (i)
the debt swap transferred “all or substantially all” of the lenders’ collateral, which would
have required unanimous consent from all lenders; and (2) J. Crew was delaying an
inevitable insolvency and moving junior creditors to the front of the repayment line to
preserve equity value.
▪ The holdout voters alleged that the initial transfer of trademark assets to non-loan party
unrestricted J. Crew subsidiary, was a so-called fraudulent transfer, made with the intent of
40

keeping the assets away from secured lenders, and could therefore be clawed back.
▪ Furthermore, they complained that the swap offer, which gave lenders four days to decide
whether to agree to it, put undue pressure upon creditors because, if they did not accept it,
they would not benefit from J. Crew’s repurchase of $150 million of debt at par, with interest,
at a time when it was trading at less than 70 cents on the dollar.
Corporate Structure Following Creation of Subsidiaries in 2016 and 2017

41
J. Crew Financials

42
J. Crew Capital Structure Prior to 2017 Restructuring
J. CREW CAPITAL STRUCTURE BEFORE 2017 RESTRUCTURING

Liabilities

Amount Type Notes Maturity

$350 million Asset Backed Undrawn Nov. 2021

Loan L+1.50/2.50%
$1.532 billion Term Loan L+300bps March 2021
$873 trading in the
market at $57, yield
of 21.6%
$543 million PIK 7.75% Cash/ 8.5% May 2019
43
PIK
Liquid Assets

$80 million Cash on hand

Net Debt = $1.432 billion

J. Crew’s Down Streaming of Assets

44
J. Crew Case A – Group Assignment
▪ Why was J. Crew’s purchase price decreased by $60 million during its first
leveraged buyout?
▪ How did this first round of private equity money help to build the brand?
▪ Why did TPG take J. Crew private again? What role did CEO Mickey Drexler
play?
▪ Should J. Crew creditors have objected to the terms of this deal? Who got J.
Screwed?
▪ How did J. Crew engage in a trapdoor maneuver? 45

▪ How did TPG attempt to induce creditors to accept the debt swap?
J. Crew Was Taken Private TWICE
▪ J. Crew lacked capital to compete with bigger catalog sales brands, e.g., L.L. Bean
▪ Founders nearing retirement at 1997 funded exit
▪ Drexler led second leveraged buy-out for gain
▪ Private equity firms appreciated the cash flow attributes of retailing—as long as
demand for services was increasing
▪ Stores have real estate assets that can be monetized
▪ Information available per store facilitated control

▪ TPG (and Leonard Green) must recover investment when they cash out of J. Crew.
Purchase Price Decreased By $60 Million
▪ Cinader may have been overly-eager to close
▪ TPG dominated buy-out transaction from start
▪ Although TPG wanted to control J. Crew, it acted apprehensive about work
stoppage (even though TPG owned Neiman Marcus)
▪ J. Crew was still largely a catalogue sales firm.
▪ TPG must assess methods by which it recovers value that are idiosyncratic to J. Crew’s part of
retailing industry.

▪ Most important asset to control is brand-equity and trademarks are legal means of conveying
control of intangible assets.
First Leveraged Buyout Was Financed By
▪ $150 million senior subordinated notes with 10 percent yield (reduced from $175
million).
▪ $140 million zero-coupon bonds offered at 54¢ per dollar unit.
▪ TPG contributed $20 million extra cash to working capital requirement and allowed an
extra $9 million in accounts receivable.
▪ TPG collected fees for eight years from operations.
▪ TPG sold $400 million in equity in 2006 to pay off debts and recover its investment
(when J. Crew went public).
Private Equity Money Built Up Brand Equity
▪ From 1997 through 2006, TPG financed investments to increase value of J. Crew’s
brand equity.
▪ Mickey Drexler (as CEO) promoted Jenna Lyons

▪ Stores were opened, promotions were backed

▪ Began cash-out via public offering in 2006—just before the Great Recession and
Credit Freeze era.
▪ TPG kept some its J. Crew equity through 2009.
▪ Although other retailers suffered when consumers stopped spending on luxuries,
J. Crew scraped by.
▪ Accounts receivable less satisfactory as collateral.
J. Crew Thrived During “Credit Freeze”
Second Leveraged Buyout Instigated By Drexler
▪ Drexler’s behavior in playing off private-equity offers against each other violated
fiduciary trust
▪ because Board of Directors not informed

▪ Minor fine resulted that J. Crew owners paid for

▪ Drexler achieved his partial exit by selling a portion of his shares which had been paid to
him as past compensation
▪ Typically top executives received equity or carried interest in target firm that they
managed
▪ Private equity firms used debt to fund dividend recapitalization payments and collected
fees
Almost Immediately, PE Owners Took Payouts
▪ After leveraged buyout, in addition to store leasebacks, J. Crew issued PIK bonds to
reduce their equity, service debt, and pay their fees
▪ Began reporting shortfalls, missed performance targets, and revalued inventory to
prepare for taking non-cash impairment charges
▪ Refinanced loan facility in 2014
▪ Refinance balance of senior secured loan ($1,167 million)

▪ Redeem senior notes ($400 million)

▪ Pay fees, call premiums, accrued interest

▪ Amended and Increased Asset-backed Facility (ABL)

Non-Cash Impairment Charges
▪ Write-down of assets reduces valuation of
▪ Stores reporting unit
▪ J. Crew reporting unit
▪ “J. Crew” brand name

▪ Lowering the accounting value of trademarks to $380 million was an incremental step
to the external valuation needed in order to transfer 72 percent of the trademark [$250
million] to a non- loan party, unrestricted subsidiary
▪ It was a step in the chain to refinancing debt.
Dividends Paid (To Private Equity Owners)
▪ December 2012: $197.5 million cash
▪ November 2013: $484.0 million (Chinos International Holdings issued $500
million PIK notes)
▪ Year end 2014: $28 million (to pay PIK notes)
▪ Year end 2015: $38 million (to pay PIK notes)
▪ Chinos Holdings prepares to restructure maturity of its debt to 2021
Estimated Capital Structure
Face Leverage Leverage
Instrument/Capital Layer Coupon Price Market Amount Yield Maturity
Amount at face at Market
USD 350m ABL Facility L+1.50/2.50% $0 $0 $0 - 17-Nov-19 0.0x 0.0x
Term Loan Facility L+300bps $1,532 $57 $873 21.60% 5-Mar-19 8.8x 5.0x

Total Direct Debt Outstanding $1,532 $873

Consolidated Debt (Excluding

$1,532 $873
Parent Debt)
Estimated Cash $80 $80
Net Debt $1,432 $793 8.3x 4.6x
Chinos Intermediate Holdings A 7.75% Cash/
$543 $45 $245 53.60% 1-May-19
(PIK Toggle) 8.5% PIK

Net Debt Including Chinos Note $1,995 $1,038 11.5x 6.0x

FY 16 Est. Adj. EBITDA $174

J. Crew’s Corporate Structure in Early 2017
2011 Loan Agreement Provided
▪ Unrestricted subsidiaries could be formed, provided that Company had not
defaulted on interest payments and had a six-to-one leverage ratio
▪ Calculated leverage using EBITDA (“good faith” estimate)

▪ Restricted subsidiaries could make or hold investments—provided

investment was from a Loan Party to a Non-Loan Party.
▪ Non-Loan Party, restricted subsidiary may invest up to $250 million if it had
received said investment from a restricted subsidiary.
▪ Valuation of 72% of trademark was $250 million and it was invested into
Non-Loan Party, Unrestricted Subsidiary.
Trap Door Maneuver For Transferring Assets
▪ J. Crew International [Loan Party and Restricted Subsidiary of J. Crew Inc.]
transferred a 72% interest in certain U.S. trademarks to J. Crew International
Cayman Limited [which was not a Loan Party but was a Restricted Subsidiary].
▪ The Restricted Subsidiary [Cayman] invested the interest in U.S. Trademarks in J.
Crew Domestic Brand, LLC [was not a Loan Party and was an unrestricted
subsidiary].
▪ Restricted subsidiaries of Borrower are subject to covenants, restrictions of Credit
Agreement.
▪ “Cayman” and “Domestic Brand” did not exist then.
J. Crew Brand LLC then issues Notes secured by trademarks,
in exchange for the Chinos Intermediate Holdings A Notes
Inducement For Creditors To Accept Debt Swap
▪ J. Crew offered to redeem $150 million of its debt at par when it was trading
at substantial discount.
▪ J. Crew wanted to extend the maturity of its junior PIK debt from 2019 to
2021 [$566.5 million].
▪ Brokered deal with current debtholders rather than attempt to refinance the
debt in high-yield and leveraged-loan markets.
▪ 99.85 percent of creditors accepted the exchange of debt for equity.
▪ Only 88 percent accepted the debt-for-debt offer which created a new $127
million debt instrument.
Exchange Offer – Both Equity And Debt Offered
▪ Each $1,000 of Notes will receive $414.308013 of 13% Senior Secured Notes
due 2021 ($249,596,000).
▪ Shares of 7% Preferred Stock Series A of Chinos Holdings Inc., liquidation
preference of $335.394 (189,688 Shares)
▪ 30.695204 shares of common stock (17,362,719 (15% of Parent stock) in the
aggregate).
▪ New Term Loan (88 percent of Principal consented)
▪ Dropping lawsuits against J. Crew was requirement to receive the new debt
▪ Par repurchase of undervalued notes (plus accrued interest) was only for
consenting creditors.
Details of New Term Loan/Notes – $127 million
▪ $30MM of New Term Loans (at a 2% discount).
▪ New Sponsor Notes in the principal amount of $97MM (3% discount).
▪ Collateral of 27.96% of trademarks transferred to J. Crew Brand.
▪ Creditors accepting equity would receive dividends whenever they may be
paid.
▪ In July 2019, J. Crew appeared on Fitch’s U.S. Leveraged Loan Default Insight
report for the first time.
Details of New Term Loan/Notes – $127 million
▪ $30MM of New Term Loans (at a 2% discount).
▪ New Sponsor Notes in the principal amount of $97MM (3% discount).
▪ Collateral of 27.96% of trademarks transferred to J. Crew Brand.
▪ Creditors accepting equity would receive dividends whenever they may be
paid.
▪ In July 2019, J. Crew appeared on Fitch’s U.S. Leveraged Loan Default Insight
report for the first time.
The Demise of J Crew
Corporate Profile
– J.Crew Group, Inc. (J.Crew) is a retailer of women's, men's and children's apparel, shoes and
accessories. For the fiscal year ended February 1, 2020, the company generated $2.5 billion of sales
through its stores, websites, catalogs and retail partners. The company is owned by TPG Capital, L.P.,
Leonard Green & Partners, L.P., former HoldCo noteholders, and others. The company was purchased by
TPG in 1997 in a leveraged buyout from the founding Cinader family and was taken public in 2003 —
only to be reacquired for approximately $3 billion by TPG and Leonard Green & Partners nearly
a decade ago.
Key Credit Challenges
– High business risk as a premium apparel retailer operating in a challenging environment.
– While J. Crew’s struggles pre-dated the coronavirus outbreak (changing consumer taste,
ecommerce penetration etc.), it’s the first major US retailer to go bankrupt during the ensuing economic
shutdown, which has pushed dozens of chains to the brink of failure.
– Elevated default risk magnified as a result of high leverage (Crew was carrying a debt burden of $1.7
billion based on a leveraged buyout in 2011 by two private equity firms — TPG Capital and Leonard
Green & Partners )and approaching maturities.
Key Indicators – J Crew Group

Moody’s 12-18
US Millions Jan-16 Jan-17 Feb-18 Feb-19 LTM Aug-19 months
forward view

Revenue 2,505.8 2,425.5 2,373.7 2,484.0 2,523.3 2,546.1

EBIT / Interest 0.8x 0.7x 1.0x 0.4x 0.4x 0.7x

Expense

RCF / Net Debt 6.7% 8.0% 5.8% 3.0% 1.9% 5.3%

Debt / EBITDA 8.0x 8.3x 6.7x 9.3x 9.1x 7.2x

[1] All figures and ratios are calculated using Moody’s estimates and standard adjustments. Moody’s Forecasts (f) or Projections (proj.) are
Moody’s opinion and do not represent the view of the issuer. Periods are Financial Year-End unless indicated.
In the Run up to the COVID Crisis…
– The segment is mostly discretionary, highly seasonal and extremely fashion sensitive,
particularly at the premium price point segment, in which both of the company's brands
operate. The acceleration of the fashion cycle over the past several years makes it even
more challenging for traditional retailers to adapt to changing consumer tastes.
– J.Crew's credit profile (Caa2 Corporate Family Rating) was constrained by the company’s
upcoming 2021 maturities and high leverage, with credit agreement debt/EBITDA near 10
x (based on management adjusted EBITDA and additional add-backs for 4Q 2018 charges,
equivalent to 7.1 times Moody's-adjusted).
– The credit profile also incorporated J.Crew's relatively small scale, high fashion risk, and
exposure to changes in consumer spending, as well as its revenue declines and negative
free cash flow and a weak liquidity profile (SGL-4 Speculative Grade Liquidity rating :
Limited balance sheet cash position of $27m, Negative FCF of $10-40 m in 2019 and
breakeven to positive $30 million in 2020, including $35-40 million of net CapEx +
$1.9billion of debt matures in 2021).
– COVID-19-related temporary store closures, intense promotional activity and weak
consumer spending were the final blow!
What Happened Next?
– J.Crew and its subsidiaries commenced voluntary Chapter 11 proceedings in the U.S.
Bankruptcy Courts. The company has received commitments of $400 million in debtor-
in-possession financing facility and committed exit financing provided by existing lenders
Anchorage Capital Group, L.L.C., GSO Capital Partners and Davidson Kempner Capital
Management LP, among others. Subsequently Moody's will withdraw all of its ratings for
J. Crew given the company's bankruptcy filing.
– J.Crew has also signed a transaction support agreement specifying that J.Crew's
approximately $2 billion pre-petition debt will be converted into 82% of post-petition
common equity.
New Capital Structure :
Anchorage Capital Group, Blackstone Group Inc.’s GSO Capital Partners and Davidson
Kempner Capital Management will be among.
J. Crew’s new owners and will shape the board of directors once it exits bankruptcy. Those
firms are leading a $400 million bankruptcy loan to keep J. Crew operating.
What Happened Next?(continued)
Debt Swap
– About $2 billion of debt will be converted into equity, wiping out existing stakes held by TPG and
Leonard Green & Partners. Suppliers may be hard-hit by the bankruptcy deal, which calls for a 50%
cap on their claims and a total pot of $50 million. Other low-ranking creditors will share a
disbursement as low as $1 million depending on how stakeholders vote. Revenue for 2020 is
expected to be down about 32%, according to a regulatory filing, with a measure of adjusted
earnings down 53%.
Asset Shuffle
– The company managed to sidestep default once before in 2017, with a financial overhaul that
included shuffling assets in a way that moved fast-growing Madewell out of reach of creditors. The
change did little to reverse the company’s fortunes, but it irked creditors and turned J. Crew’s
name into a synonym on Wall Street for lopsided debt deals that leave lenders with weaker claims
on company assets. J. Crew was relying on an initial public offering of Madewell to raise capital
and ease its heavy debt load, a legacy of the 2011 buyout. The turmoil in financial markets put an
end to that option. Madewell will remain part of J. Crew under the bankruptcy agreement reached
with its lenders.
– 71% of the company’s term loan lenders and 78% of its so-called IPCo notes agreed to the deal.
Private Equity Gags on Its Own Medicine
Indicators of Financial Distress
▪ Distressed investors use credit ratings, predictive models, and market prices to
identify firms in potential distress.
▪ Credit ratings from agencies like Moody’s or S&P are accessible but lag real-time
market movements.
▪ Altman’s Z-score uses accounting ratios to statistically predict bankruptcy within a
two-year horizon.
▪ Market trading prices of debt and equity can signal investor sentiment and are often
faster than ratings.
▪ While useful, these indicators cannot by themselves identify attractive investment
opportunities.
▪ Early identification gives investors time to research, prepare, or avoid mispriced
securities.
Debt Ratings and Their Limitations
▪ Debt ratings summarize default risk but do not reflect relative value or potential
recovery.
▪ Rating agencies may receive private information, improving assessment
accuracy compared to public markets.
▪ Ratings can be gamed—issuers often seek only favorable ratings and avoid
lower ones.
▪ The rating process does not guarantee prompt updates and often trails actual
deterioration.
▪ Investment-grade firms often rely on dual ratings; speculative-grade issuers
may seek only one.
▪ Ratings serve a function, but distressed investors must go deeper than agency
conclusions.
Predictive Models (Z-Scores)
▪ Altman’s Z-score uses five ratios to assess default probability, with high
predictive power under 1.81.
▪ Liquidity, cumulative earnings, profitability, equity cushion, and asset turnover
form the model’s basis.
▪ Z-scores over 3.0 typically indicate relative financial stability and low short-
term bankruptcy risk.
▪ The model was originally tailored for manufacturers and may be less relevant
for service firms.
▪ It omits leverage directly, surprising for a distress model, but emphasizes
operating efficiency.
▪ Despite limitations, the Z-score remains a helpful screening tool for distressed
debt investors.
Market Prices as Indicators
▪ Sharp debt price drops may precede equity declines, signaling heightened
credit risk.
▪ Bond markets often anticipate distress more accurately than equity markets in
early stages.
▪ Equity prices may remain inflated while debt reflects more realistic downside
scenarios.
▪ Market pricing provides real-time insight but can overreact, creating false
signals.
▪ Unusual pricing divergence between debt and equity can uncover potential
mispricings.
▪ Investors must analyze why the market is pricing securities at distressed levels
before acting.
Why Distressed Securities May Be Mispriced
▪ Market dislocation, forced selling, and panic can lead to price levels that
do not reflect fundamental value.
▪ Liquidity-driven selling by mutual funds, ETFs, or CLOs may push prices
below recovery value.
▪ Index-driven investors may exit based on rating downgrades, not credit
analysis, exacerbating inefficiencies.
▪ Sell-side analysts may stop coverage due to bankruptcy risk, reducing
market insight and transparency.
▪ Limited market participation reduces price discovery, especially in thinly
traded or complex capital structures.
▪ Investors willing to conduct diligence and tolerate volatility may find
opportunities in these inefficiencies.
Distressed Securities and Return Expectations
▪ Distressed investing often involves asymmetric returns: downside protection
with significant upside optionality.
▪ The potential return comes from price recovery, restructuring upside, or legal
claims realization.
▪ Losses may be limited if entry prices are below realistic recovery value and
recovery occurs quickly.
▪ Recovery timelines vary—some turnarounds are fast (6–12 months), others
span years depending on legal complexity.
▪ IRR expectations must reflect illiquidity, legal cost, and idiosyncratic risks
involved in distressed processes.
▪ Investors require higher returns to compensate for greater uncertainty, limited
liquidity, and diligence intensity.
Short-Term vs. Long-Term Distress
▪ Short-term distress may arise from liquidity issues or missed covenants
with otherwise sound fundamentals.
▪ These situations often resolve through refinancing or bridge capital,
limiting investment upside.
▪ Long-term distress stems from structural issues, like flawed business
models, declining industries, or poor management.
▪ Investments in long-term distress may offer higher returns but also higher
risk and require more patience.
▪ Short-term situations require agility and strong catalysts; long-term
distress needs deep diligence and restructuring experience.
▪ Understanding the nature and causes of distress is essential to align
strategy, timeline, and return goals.
Summary of Distress Indicators and Mispricing
▪ Distress indicators include credit ratings, predictive models like Z-scores, and
real-time market prices.
▪ Each indicator has benefits and limits—no single tool suffices to identify high-
quality distressed opportunities.
▪ Mispricings arise due to technical selling, lack of coverage, investor
psychology, and structural constraints.
▪ Understanding how and why securities become mispriced is a core skill in
distressed investing.
▪ Combining indicators with fundamental research helps identify when market
prices diverge from intrinsic value.
▪ Successful investors exploit these gaps while managing downside risks through
credit and legal analysis.