Description

This is an asymmetric trade that will have significant profit potential on the short side should the financial results of Tupperware China continue to decline.  We believe that the Wuhan virus could trigger that exact effect. We recommend shorting Tupperware 4.75% senior notes due 2021 at 99c, or 5.6% YTM.

Mostly_ugly has written TUP equity up long and short and he summarized the trends well in his short writeup last time.  I’ll try to add some color on what’s going on.

Tupperware is essentially a fallen angel.  It’s an outdated business model with overpriced commoditized goods that, combined with poor management decisions, exposure to volatile emerging markets, a bit of bad luck, and awful capital allocation, has a non-insignificant chance of facing bankruptcy within 12 months. 

As Mostly_ugly highlighted, MLMs are a momentum business within geographic regions.  More specifically, success encourages others to sign up more down-line direct sellers and creates a positive feedback loop.  The same is true going the other way.

Take a look at the historical growth rates by country (which the company stopped after 1Q19).  Once a country goes negative, it does not rebound. Indonesia was the star from 2012-2014, but beginning in 2015, momentum waned.  Our understanding is that leadership got disenchanted and sellers began running into each other and competing aggressively for the same sale.  As you can see, despite change in leadership, the region continues to decline precipitously. 

This is now happening in the Company’s two largest regions, Brazil and China.  As a result, growth in local currency will be -8% to -10%, down from -5% in 2018.  

Because of all this, the CEO was let go in November 2019, after only 18 months.  After already cutting the dividend in January 2019, the Company completely discontinued it in November as it had to reinvest in the business and deal with the leverage as EBITDA fell.  

The share price has gone from >$60 at the end of 2017 to $9 two weeks ago.  Subsequently, two things have happened. First, the China Wuhan coronavirus was disclosed to be much more contagious and potentially deadly, causing China to shut down Hubei and nearby cities and extending the Chinese New Year holiday.  Throughout, people are avoiding going outdoors. Stores like Starbucks and Apple are closing because of lack of traffic. This will have huge ramifications on Tupperware in its largest country because in China, the company’s sellers operate retail stores as MLMs are not allowed.  

Second, long-time former CEO and current chairman emeritus Rick Goings quietly announced his resignation in a Friday afternoon 8K on 1/24/20, effective 2/19/20.  Coincidentally, the company is not announcing 4Q earnings at the end of January for the first time and decided to announce 2/25/20, the week after Goings departs.  While this is not an issue operationally, allow us some conjecture here: we think it’s a huge red flag as Goings was CEO for 21 years from 1997 to 2018. This company was his baby.  To leave and not be involved in choosing the new CEO suggests to me that he would like to distance himself from the company and its future. Perhaps he saw the initial impact in China and decided to get out.  Regardless, he’s leaving the company in the hands of an interim CEO who has been on the board for a year as it faces its trickiest financial situation yet.

Capital Structure

There is a $650mm revolver secured by certain trademarks that is $324mm drawn as of 3Q19.  The $600mm senior note has a guarantee secured by the same trademarks, so technically it is pari passu to the revolver.  

The senior note is due June 2021, and is callable at par March 2021.

Downside Scenario

Given what is going on in China and the fact that no permanent CEO has been named, I doubt the company will be able to give guidance when they report in February.  The latest headlines are that Delta and American are suspending flights to China through late March. The Chinese economy will definitely suffer. If this were to extend into 2Q, the company would have a disastrous 1H20.  Given >10% of sales and even more EBITDA (as China has historically been higher margin) is at risk, we see significant downside to EBITDA. For most companies, this would be a temporary blip. But as we discussed, for MLMs the negative momentum is very hard to overcome.  As a result, we see huge downside to EBITDA for 2020. We currently estimate $200mm, which after restructuring costs would imply minimal FCF.

The revolver has a 3.75x maintenance covenant test, which at some point in the year the Company would breach as they burn cash through 3Q and only generate cash in 4Q.  To refinance the senior notes, Tupperware will at least have to show stability in EBITDA, which will be extremely hard to do by the time they report 4Q20 in February 2021.  At $200mm EBITDA, if they were to take a high interest rescue financing of 10%, it would add >$30mm of incremental interest, which would put them into negative FCF territory.  

The revolver lenders will hold the cards at this point.  Given the Company will have tripped the maintenance covenant, the revolver lenders could i) waive it and allow the Company to refinance the senior note and risk funding that negative FCF via additional drawdown, or ii) roll into a debtor-in-possession (DIP) and elevate themselves ahead of the senior notes in priority.  We think the latter would happen.

Recoveries in that scenario would depend on where EBITDA would stabilize.  Here, we assume i) incremental $100mm draw on the DIP (on top of the $250mm outstanding) given likely working capital impact and restructuring fees; ii) a range of $150-200mm of EBITDA and 4-5x EBITDA multiple.

So the notes could be fine in certain scenarios, but would have to go through Ch 11 and get equitized as a result.  Even in the best case, they would trade to 60-70c before recovering.  

What happens if the Company can refinance these bonds?  Well, shorting at 99c would mean you would have to pay out 100c, and whatever coupons.  So the downside risk is that you lose 1c of principal and 17months of coupon, or 6.7c.  

So what’s the likelihood it all plays out like this?  We think there’s a 30% chance the China virus could lead to Tupperware facing significant refinancing risk on this bond.  At 99c, it provides a very asymmetric risk/reward scenario we like.

Catalyst

• Wuhan virus leads to slowdown in TUP China
• Company trips covenant and runs into refinancing risk of bonds

• Credit markets let the company raise expensive debt despite tough EBITDA trends
• EBITDA holds up as Brazil rallies back or China isn't that bad